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Personal Finance Blog By MoneyRates - August 2012

Escaping the underwater world

August 31, 2012

| MoneyRates.com Senior Financial Analyst, CFA

Underwater mortgages -- loans on which the amount owed exceeds the property's value -- have posed a serious hardship for many homeowners in recent years. Fortunately, conditions are right for more and more of these loans to emerge from their underwater state.

In many cases, being underwater shouldn't be a big problem for a homeowner. Real estate should be viewed as a very long-term investment, and what matters in the short term is how affordable your mortgage is. However, an underwater mortgage can cause problems under the following circumstances:

  • When home owners need to sell the property.
  • When home owners can't afford their mortgage payments, either because of a financial setback or because they over-reached on their original loan.
  • When home owners were looking to "flip" a house for a quick investment gain.

But luckily for people in these circumstances, signs have appeared lately that more underwater borrowers may soon get a break.

Underwater mortgages finally get some relief

A report from CoreLogic indicated last month that the number of underwater mortgages recently declined to its lowest level in three years. What is even better news is that conditions look right for more mortgages to emerge from underwater status soon.

Here are three things that may throw a lifeline to underwater mortgages:

  1. Rising home prices. The S&P/Case-Shiller Home Price Index has now risen for five straight months. The gains are modest -- nothing that would be confused with the real estate boom of the previous decade -- but even slow progress will steadily help bring the value of homes above the remaining mortgage debt.
  2. Time and amortization. As noted above, rising home prices are helping mortgages emerge from underwater, but even if home prices just broke even, time and amortization would help the problem. After all, most mortgages are designed to reduce debt month after month, with the amount of debt reduction accelerating as the mortgage ages. So, as long as home prices don't start falling again, in this case time really does heal.
  3. Low interest rates. It's a fundamental bit of mortgage math -- a lower interest rate on a mortgage pays down principal more quickly in the earlier years of the loan. With current mortgage rates below 4 percent, today's mortgages build equity more quickly than they have historically. While the rub is that many home owners haven't been able to take advantage of current mortgage rates because their loans are underwater, now there are more government programs that allow some borrowers to do just that. Lowering their interest rates should help these borrowers get their loans out from underwater more quickly.

Although you wouldn't know it from some of the national media coverage, a wide majority of mortgages are above water, and of those that aren't, there were nearly 2 million that were only 5 percent underwater at the end of the first quarter of 2012, according to the CoreLogic report. Current conditions suggest many of those mortgages should be emerging from underwater soon, even without a major rally in real estate prices.

Posted in: Mortgage

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The jobs paradox

August 28, 2012

| MoneyRates.com Senior Financial Analyst, CFA

Employment remains the key to the economy's turnaround. But a new report on state-by-state employment shows just how difficult it is to get job markets in 50 different states moving forward at the same time.

On August 17 the Bureau of Labor Statistics released its Regional and State Employment and Unemployment report for the month of July. Here's an example of how paradoxical conditions seem these days: While the report showed that the number of jobs was up in most states, it also showed that the unemployment rate was up in most states.

When the big picture conclusions are that contradictory, it takes a little sifting to get to the meaning of an economic report. Employment conditions matter to more than just job seekers. Putting more people back to work means conditions for businesses should improve as consumers have more money to spend, and savers should profit as interest rates on CDs, savings accounts and other deposits can start to rise again.

With so much riding on employment, here are some highlights from the recent report:

  1. Improvement is inconsistent from state to state. So much economic reporting refers to conditions on the national level, but the fact is that each state has its own distinct economy, often with very differing sets of conditions. For example, total employment increased in 31 states in July, with California, Michigan, and Virginia leading the way by adding over 20,000 new jobs apiece. At the same time, 19 states saw a net loss in jobs, with New Jersey getting the worst of it by losing 12,000 jobs.
  2. The West is not the best. Similar differences are apparent if you look at the country regionally. The unemployment rate is worst in the West, at 9.4 percent. It is significantly better -- though still unacceptably high -- in the Midwest, at 7.5 percent.
  3. Some troubled areas are making progress. Again, some areas have it much worse than others, but at least there are signs of improvement in some trouble spots. For example, California and Nevada continue to suffer two of the highest unemployment rates in the nation, but each has also been among the leaders in reducing unemployment over the past year.
  4. More people are looking for work again. Now back to that paradox: 31 states added jobs in July, yet the unemployment rate increased in 44 states. The number of jobs and unemployment rate can only rise at the same time if more people are joining the labor force. In part, this may be due to more people becoming encouraged enough to start looking for work again, which could be a sign of grass-roots optimism for the economy.

Because it showed net job creation, the overall message of the July state-by-state employment report was positive, but only mildly so. It will take less of a mixed message to help a meaningful number of unemployed people, let alone business conditions and deposit interest rates.

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Has inflation taken a summer vacation?

August 20, 2012

| MoneyRates.com Senior Financial Analyst, CFA

Last week's announcement of the Consumer Price Index (CPI) figures for July contained some pleasant surprises -- and brought at least a little relief to beleaguered savings accounts.

The CPI was unchanged in July, meaning that there was no overall inflation during the month. The pleasant surprise is that this lack of inflation runs contrary to recent warning signs that prices may be ready to start perking up again. With rates on savings accounts, money market accounts and other deposits near zero, the absence of inflation gives them an opportunity to do something they've rarely been able to do in recent years -- add real value.

Inflation's summer holiday

So far, inflation has taken the summer off, with no change in either June or July. In fact, when you factor in a 0.3 percent decline in May and no change in April, the CPI has actually declined since the end of March. Inflation over the past year has now moderated to 1.4 percent.

This mild inflation environment comes in contrast to the start of the year, when an increase of 0.9 percent in the first quarter signaled that inflation might accelerate in 2012. More recently, the absence of inflation runs counter to a couple of inflationary concerns that have been emerging:

  1. Rising fuel prices. Not surprisingly, the gasoline component of CPI was up in July, rising by 0.3 percent for the month. However, this was offset by falling prices in other areas, most notably by a 1.3 percent drop in the cost of electricity.
  2. The drought effect. It has become obvious that a prolonged drought will have a devastating effect on crops in many areas of the country. A poor crop yield can lead to rising food prices. While the impact of this year's harvest has yet to hit the food supply, commodity prices are often anticipatory, meaning that the expectation of an upcoming shortage can lead to an immediate jump in prices. However, this hasn't really happened with food prices yet, as this component of CPI was up by a mere 0.1 percent in July.

Dismissing cynicism about savings accounts

A cynical view of all this is that inflation has eased because the economy is dead in the water. In the end, that's not good news for savings accounts, because they need a stronger economic environment in order for interest rates to start rising again.

Still, the fact remains that rates on savings accounts and other deposits are already down near zero. While they ultimately do need a stronger economy so they can return to more normal levels, what they need most immediately is a break from inflation, so they can start earning a real return once again.

The retreat of inflation over the past four months has given savings accounts the opportunity to earn a positive return over inflation. Given how scarce such opportunities have been in recent years, the owners of those accounts might well put their cynicism on hold for the time being.

Posted in: Savings Accounts

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What to make of the latest GDP disappointment

August 2, 2012

| MoneyRates.com Senior Financial Analyst, CFA

Last week the Bureau of Economic Analysis (BEA) released an advance estimate of second-quarter 2012 Gross Domestic Product (GDP), and it didn't signal much hope for the U.S. economy.

The estimate indicated that the U.S. economy had slowed from the first quarter's already anemic pace. With no clear solution for breaking the economy out of its rut on the horizon, the era of low interest rates appears likely to continue for a while longer.

A lackluster economic report card

According to the BEA, the U.S. economy grew at an inflation-adjusted 1.5 percent in the second quarter, down from 2.0 percent in the first quarter. The slowdown tracked a falling-off in personal consumption, which declined from 2.4 percent after inflation to 1.5 percent. Most pronounced was a drop-off in durable goods spending, from a real increase of 11.5 percent to a decrease of 1 percent.

Advance estimates of GDP are often off by a fair amount from the final number, but whatever that final number turns out to be, it isn't likely to be pretty.

All eyes on the Fed

With a Federal Reserve meeting scheduled for the week following the GDP announcement, the stock market actually rallied in anticipation of what the Fed might do, but the Fed's lack of action quickly put the brakes on this.

The thinking that bad news is bullish because it will prompt action from the Fed has always been a little perverse, but it is especially so now. It's akin to thinking that it is good that a patient is still sick because now he will get to take more medicine, as opposed to the patient actually getting better.

But even if the Fed had taken more action, it has nothing left but extremely watered-down medicine. It has already taken low interest rate policies to the extreme; it can do little more now than announce that it intends to prolong those policies.

It's unlikely that prolonging policies that haven't worked so far will provide much help for the economy. Indeed, there are at least two reasons to suspect that extremely low interest rates may be counterproductive:

  1. Savers are being robbed of income. Savings and other deposit accounts are paying virtually no interest. With borrowers trying to work their way out of debt, low interest rates haven't prompted a new wave of borrowing, but they have taken income away from savers who might have applied it toward new spending.
  2. Lenders have little incentive to make loans. Consider current mortgage rates, at around 3.5 percent. This is roughly the historical rate of inflation. Why would anyone want to take the risk of lending money for 30 years with no real rate of return in exchange?

It's tempting to think that the Federal Reserve can get the economic engine running smoothly with just a little monetary policy tinkering. In this case, though, it is becoming increasingly clear that the Fed does not have the right tools to fix what is wrong with this engine.

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