By now, most of us have some sort of idea of what caused the current financial crisis. Some notable attempts at a simplified explanation include these Powerpoint slides with stick figures, this British comedy routine, and the “Giant Pool of Money” NPR audio broadcast. Even the New York Times had a go.

Well, here’s one more by Jonathan Jarvis, which also happens to be excellent. If anything, it surely has the best animation and graphics of them all. Also available in high-definition (but it’s big). Via Bogleheads.

Since my post on the $7,500 tax credit for first-time home buyers has over 225 comments and growing, I thought I should point out that both the current House and Senate versions of the Obama Stimulus bill remove the requirement to pay back the credit over 15 years.

If it becomes law, this will be essentially $7,500 of free money for most first-time home buyers. You’ll have to wait until you file your taxes in 2010 to claim the credit, but you might be able to adjust your tax withholding to improve cashflow until then.

According to this CNN Money article, it will also expand the eligible dates retroactively to January 1st, 2009 until the end of June or August.

To be eligible, buyers cannot have owned a home for the past three years, and the new home has to be used as a primary residence. The credit phases out as income rises above $75,000 for singles and $150,000 for couples, and disappears entirely at $95,000 and $170,000, respectively.

Will this really make a long-term difference?

When I bought our house, I considered setting up a home equity line of credit (HELOC) for primarily for emergencies. For a while there were a bunch of deals that offered no application fees, no closings costs, and no annual fee. Why not have a cheap safety net around? Some people even expected their HELOC as their primary emergency fund.

However, these days with loan-to-value ratios skyrocketing and lenders trying to limit their risk exposure, many HELOCs are getting frozen or reduced with little notice. Some lenders like National City Bank (now PNC Bank) and E-Trade have even been paying people to close their HELOCs early to avoid angering customers. Turns out they aren’t a very reliable safety net.

So what can you do about it? Yesterday, a reader left an interesting comment on a previous post I wrote about reasons why all homeowners should have a HELOC:

After hearing of people getting their HELOCS frozen, I tapped my HELOC which is prime minus 25 basis points. I took the proceeds and opened a one-year CD at Wachovia paying 4% APR for a 12 month CD (this was back in Dec 08). I’m actually making money on it and I have the emergency cash available. I don’t see interest rates rsing in the next year, given the economic depression.

The numbers do look a lot better than last time I looked. HELOCs are often indexed to the WSJ Prime Rate, for example being set at Prime minus 0.5%. The prime rate varies, but is currently only 3.25%. This means it’s possible to borrow the money and place in a safe FDIC-insured savings account or CD earning approximately the same amount of interest. (Interest paid on HELOCs is generally tax-deductible if you itemize deductions and your interest is under $100,000.)

In fact, you could easily be making money this way. If the interest rate spread does go up significantly, you can just pay back the loan.

Now, maxing out your HELOC may lower your credit score, so you might not want to take all of it out. I guess it all depends on how badly you want the safety net. On the other hand, if you have a really good rate you could arbitrage out a decent amount of profit for a while…

With the rate drop yesterday, mortgage rates are at amazing lows. People in the office are bragging about locking in 4.50% mortgage rates with no points, or 4.25% with 1 point. While I haven’t done a lot of in-depth research on this topic, I would agree that right now is a good time to explore your options. (Especially if you have a good credit score and a loan-to-value ratio below 90%.) My favorite source for helpful mortgage info remains the Mortgage Professor.

Breakeven Calculators
The main cost of a mortgage refinance are the points and settlement costs (appraisal, etc.). The primary benefit (when you aren’t trying to pull cash out) is a lower monthly payment. This way, you can find a break-even point after which you save money with the refinance, say 20 months. Obviously, you’ll want to be confident that you’ll be holding the loan longer than that. Here are two breakeven calculators: one and two.

If you want instant savings or are just short on cash, you can attempt to find a “no cost” refinance, where you get a rate with negative points that actually cover your upfront costs. Even better, to avoid funny business later, find a lender that actually guarantees that they will cover all settlement costs. However, your rate might not be the best.

After reading up on some articles on the Professor’s website, here seems to be a possible action plan:

1. Check with competitors first to get an idea of what combination of rates and closing costs you can get. Try an Upfront mortgage broker or lender.
2. Armed with this information, call your loan servicing company and ask about your remaining loan balance. Casually ask what could be done with the current low rates. If needed, use your rates collected previously to let them know you’re shopping around and make them go one better. Your existing lender may have more flexibility in waiving and/or reducing fees.
3. Ask for a loan modification if your lender has not sold the loan, and are servicing it themselves (see below).

My Refinance Attempt

I am in the least common situation, where I got my loan through a community bank who did not sell the loan. They are both the lender and servicing agent. Thus, they are very interested in keeping my loan and not losing it to a refinance. After talking to them, the refinance route was not looking too good, and so they offered me a rate reduction instead. I got to keep my same loan with the same remaining term length, but the rate would be reduced from 5.625% down to 5.125% for a $500 fee. Neither of us has to pay for an appraisal, title insurance, document fees, recording fees, or another mortgage broker commission.

After running the numbers, I would be saving $150 per month, which would give me a break-even period of only 4 months! The catch: I had to lock today to get it guaranteed, and I could not lock again for 30 days. I decided to not to be greedy and locked it in (at no cost). I should get the paperwork tomorrow. If I have a $150 lower monthly payment for the next 29 years, that’s a potential savings of $50,000! ($150 x 12 x 29, but less if you calculate back to present value…)

It’s almost too good to be true, considering I don’t have to try and go through the hassle of a refi. In fact, since I paid points to lower my mortgage rate initially, I thought my chances for a profitable refinance were slim to none. Now, I still have to look at the fine print, so this is not a done deal.

Again, I am not an expert on this stuff. But given the weird situation we have right now, if you have a mortgage professional that you trust, you might want to give them a call. This one phone call today saved me tens of thousands of dollars. I just read a newspaper article that they have gotten more loan requests in the last two weeks than they have had in the last 11 months! So while they are busy again, they are less likely to take your business for granted.

Good luck, and share your success stories below! Oh, and if you missed it before, you can read about our (long) first-time home-buying experience here.

In an earlier post on motivating myself to work harder, I had thrown out a piece of “common” financial advice:

Spend less than 30% of income on housing.

It was really just an afterthought, but I got a bunch of e-mails about it. Where did you get this? Why 30%? Is that gross income or after taxes?

The source of this “rule of thumb”, which is about as useful (or useless!) as most such rules, is the traditional underwriting requirements of mortgage lenders. You know, before many of them went nuts.

Lender Ratios
Also called the debt-to-income (DTI) ratio, this is the maximum debt load that the lender will accept and still lend you money. You have two types of debt. Housing debt, which usually means PITI, or principal + interest + taxes + insurance, so it’s a bit more than just the straight payment from a mortgage calculator. The “other debt” is the sum of your other recurring monthly liabilities – car loans, credit card balances, student loan payments.

There are usually two lender ratios, a front and a back (Example: 28%/36%). The front ratio meant housing debt divided by gross income. The back ratio was housing + other debt divided by gross income. Usually you have to satisfy both of these ratios.

Some superficial online searching reveals that Fannie Mae and Freddie Mac allow a maximum of 28% for the front ratio and 36% for the back ratio. FHA loans have ratios of 29% and 41%. So that’s where my 30% number came from. Of course, even earlier this year you could find people allowing front ratios of 50-60%.

So if your gross income was $4,000 a month, to get a conforming Fannie Mae loan your housing payment should be no more than $1,120 per month. At the same time, your housing + other debt obligations altogether should be below $1,440 per month.