The Subprime Jitters and You:
November 2007The recent subprime mortgage scare sent many investors and potential homebuyers running for the hills. But financial expert Eric Tyson says the housing market isn’t as bleak as some would have you believe.
The dust seems to be settling after the panic-inducing stock market drops caused by the subprime mortgage crisis of just a few months ago. The good news is the market is starting to stabilize. The bad news? Plenty of people are still jittery—particularly investors and potential homebuyers. If you’re one of these parties, relax. Financial counselor and best-selling author Eric Tyson wants to end (or at least lessen) your hand wringing and clear up all the misinformation that is floating around. In short, don’t pull your money out of the market or toss your investment home buying dreams to the side just yet. And, if you’re a home builder, the information in this article is something you may want to share with potential clients.
"The problem is not as widespread or as devastating as some people believe,” Tyson says. "When the stock market plunged, some investors got spooked and sold their stocks. Given the realities of human nature, it was bound to happen. But now the market is rebounding—as it always does, and we’re seeing once again that making financial decisions rationally rather than emotionally is always best.”
Here is Tyson’s expert advice on how investors and homebuyers can manage today’s market.
Insights for Investors Stock market gyrations are always great media fodder. When the market plunged a few months ago, the attention it received probably made many investors feel like we were facing another Crash. Of course, investors should be concerned about how their stocks are doing, but they should also know that market fluctuations are never the end of the world.
Here is Tyson’s "reality check” for investors:
Don’t panic. Even if you are the not-so-proud owner of some of those plunging stocks, remember the words of Little Orphan Annie: "The sun’ll come out tomorrow!” In other words, don’t panic over short-term events.
"The reason so many people sold off their stocks after the plunge is because of fear,” Tyson says. "They lost their cool and forgot they originally invested for long-term results, not one day’s or one month’s winnings or losses. Don’t shun stocks as an investment simply because of the down periods. If you want wealth-building investments that provide superior long-term returns, you must be willing to accept risk and volatility. In this and any down period, sit tight and don’t be swayed by the mob mentality of other panicked investors. Use market corrections as buying opportunities.”
Tune out negative, hyped media. When the stock market is crumbling, subjecting yourself to a daily diet of bad news and conflicting opinions about what to do next makes most investors do the wrong things—for instance, panicking and selling off their stocks. Just like a steady diet of junk food is bad for your physical health, a continuous stream of negative, hyped news is bad for your financial health.
"Conflict is always occurring somewhere in the world,” Tyson says. "The business world will always have unethical and corrupt company executives. Holding stocks always carries risk. That’s why those who see the glass as half full, and who see the positive and not just the negative, build wealth by holding stocks, real estate and small businesses over the long-term.”
Ignore large point declines—consider the percentages. Any time a major stock market index, such as the Dow Jones Industrial Average, drops a large number of points, it is big news. But smart investors should pay more attention to the percentage of an index’s decline, not the point decline.
"Although 200 points sounds like a horrendous drop, now with the Dow well above 10,000, that drop amounted to a move of less than 2 percent,” Tyson says. "No one likes losing that portion of their wealth invested in stocks in one day, but the percentage of change sounds less horrifying than the point change. Remember that when you’re considering the recent drops in the housing and stock markets, the losses are a relative issue. Those markets enjoyed large rates of appreciation in recent years, so percentage-wise the drops that have occurred are small.”
Keep your portfolio’s perspective in mind. Smart investors have portfolios that consist of diversified stock holdings, including some international stocks, preferably through mutual funds, along with some bonds.
"Here’s a great example of why you should always take into consideration how your portfolio as a whole is doing rather than one particular stock,” Tyson says. "One of my counseling clients called me when the stock market was dropping precipitously during the summer of 2002. He said, ‘I just saw that the S&P 500 is now down 28 percent so far this year and the NASDAQ is down 34 percent. Should I sell?’ He was quite surprised when I crunched some numbers and determined that his portfolio of stocks and bonds was down just 8 percent for the year. Now, mind you, I wasn’t trying to minimize or trivialize the fact that he had lost money so far that year. However, he overlooked the fact that the bonds in his portfolio had actually increased in value, as had some of his stock funds that were invested in value-oriented stocks.”
Don’t put all of your eggs in one basket. When something like this occurs, use it as an opportunity to expose any problems that might be lurking in your portfolio.
"A situation such as the recent stock plunge might reveal that you have too many stocks in your portfolio from one sector of the market,” Tyson says. "Much like investors with huge amounts of technology stocks realized they were overexposed in the tech market when those stocks tumbled in 2000 and 2001, those with too many mortgage stocks suffered in July. In addition to a poorly diversified portfolio, a declining stock market can also expose the high fees you may be paying on your investments. Fewer investors care about getting whacked with fees amounting to, say, 2 percent annually when they’re making 20 percent year after year. But after a few years of low or negative returns, such high fees become quite painful and more obvious.”
Straight Talk for Homebuyers
It’s true that the housing market isn’t performing as well as it had been, but don’t think of it as a downturn, advises Tyson. Think of it as a market correction. The fact is, real estate, like stocks, is a good long-term investment—emphasis on long-term. While home values may go through periods of ups and downs, if you’re a homeowner during most of your adult life, your home should enjoy a healthy appreciation of value, no matter what’s going on in today’s market. Here’s what you need to know about buying a home in the wake of the post-subprime mortgage collapse:
Understand what’s going on with credit. After the recent subprime collapse, credit restrictions are tightening and many homebuyers are worried that their chances of getting a loan have decreased. It’s a valid concern. In fact, partly because of the credit issue, the number of mortgage applications has dropped since the subprime fallout.
"Lenders are scaling back on making the riskiest loans, which we’ve long advised against in our real estate books,” Tyson says.
Know how your mortgage works. The riskier loans that we saw collapse in recent months can work for people who understand how they work. Problem is, these loans were overused. They were sold to people who couldn’t afford them and who probably didn’t fully understand what would happen when the loan rates changed.
"If you’re going to buy a house and you take out a loan where the payment is artificially low in earlier years and then balloons, don’t sign on the dotted line until you are certain you will be able to afford that ballooning rate,” Tyson says. "If you aren’t absolutely certain, find another way to finance your house or wait until you are more fiscally sound to purchase property. If you do take on an adjustable rate mortgage, ask your lender how you can figure out what your interest rate will change to over the life of the loan. This way you will never be surprised when you open your mortgage bill.”
The housing market isn’t weak nationally. The media, along with certain experts, have been making some sweeping generalizations about how weak the housing market is nationwide. As a result many people looking at buying a home or trading up have been spooked out of doing so.
"The truth is housing prices are actually appreciating in many places,” Tyson says. "Remember, housing is a local market situation. If you’re looking to buy, you need to know the area you are buying in. Do the research and you’ll find that it’s a good time to buy in certain areas. As a general rule, the best time to buy is usually at the bottom of a real estate cycle when no one else thinks it’s a good time. Just compare the monthly costs of renting a home to buying to see whether buying offers a good value for you.”
Avoid balloon loans. With balloon loans the interest rate is fixed at the beginning of the loan, for example, for five, seven or 10 years. However, at the end of this time period, the full loan balance becomes due. In other words, you must pay off the entire loan. Balloon loans can be appealing because they start at a lower interest rate than do fixed-rate mortgages, and they look very appealing during high-interest-rate periods or for buyers who can’t qualify for or afford the payments of a traditional mortgage.
"These loans can quickly blow up in your face,” Tyson says. "A lot of things can happen that could make refinancing your loan difficult when it’s ‘payoff time.’ You could lose your job, your income could drop, your property’s value could decline and the appraisal could come in too low for you to qualify for a new loan, or interest rates could rise and you could be unable to get a new loan at the higher rate. Take a balloon loan, if and only if 1) it is your only financing option and you’ve really done your homework to exhaust other alternatives, and 2) you’re certain that you can refinance when the balloon comes due.”
Find the best lenders. There are plenty of lessons to be learned from what recently happened in mortgage lending. Whether you do so on your own or hire someone to help you, you can easily save thousands of dollars in interest charges and other fees if you shop around for the right mortgage deal. Typically, good lenders can explain their various loan programs without using double-talk or jargon. They approve locally. They’re market savvy and as a result will understand the type of property you want to buy. They’re competitive. And they meet contract deadlines and approve and fund loans on time.
"Many of the subprime mortgage lenders that we saw fall to pieces were bad lenders,” Tyson says. "They convinced people to take out risky loans that they really couldn’t afford.”
"Yes, the stock market took a tumble in August but let the bad news end there,” Tyson advises. "No one month’s stock market results should stop an investor of any kind in his tracks. Whether you’re invested in the market or in real estate, keep in mind that you’re in it for the long-term and don’t be sidetracked by everyone else’s panic and misinformation. Successful investing is about making decisions and sticking with them. Ultimately, if you can tune out the gloom and doom, you’ll be happier and more financially successful.”
About the Author
Eric Tyson, MBA, is one of the nation’s best-selling personal finance book authors and has penned five national bestsellers (he is also the only author to have four of his books simultaneously on BusinessWeek’s business book bestseller list). His Personal Finance For Dummies (Wiley) won the Benjamin Franklin Award for the Best Business Book of the Year. He is also the author of Investing For Dummies and coauthor of Home Buying For Dummies and Real Estate Investing For Dummies, among other titles.