Loans and Mortgage Tips

Many investors go to full-commission brokers for stock research, investment advice, and financial planning. Today, online discount brokers also provide these services. Unfortunately, most brokerage information is designed to sell more product more often, not to improve your financial position.

Wall Street has always known that buyers are primarily interested in stocks that increase in value. Profiting from declines is un-American. The easiest sell is a stock or fund that has already gone up. You will naturally be more confident that a stock or fund that has gone up will continue to do so. A broker will show you a select list of stocks that have strong momentum. Your overconfidence will hurt you. Studies show that stocks that have good streaks soon revert to the mean. While your broker is sure to know this, he will not disclose it to an optimistic buyer. He also has other sales tools.

The misery of repeated, painful investment mistakes will be over and creativity and joy will grow in your life.
Michael and Susan are typical of investors who need to take an inventory. They know something is not working in their investment lives. As yet, they cannot pin down the nature of the problem or the solution. Though many of their friends and co-workers are aware of Michael and Susan’s specific character flaws, Michael and Susan themselves are unaware. A weekend working through the exercises in Chapter 8 will change their lives. Once they find their comfort zone, other aspects of their life will improve as well. Their children will be integrated into their investment life. Their investment life will improve their marriage rather than be a source of division.

Remember, this chapter is all about getting started. It’s your pep talk to get you over the hump. So while we’re breaking it all down, let’s look at your credit score (we’ll discuss it more in Chapter 20). It’s a great measure of how bad your debt situation is.

If your debt situation is worse than you care to admit, your credit score will help to bring you back to reality. It’ll also help you measure your progress in the eyes of lending professionals.

I’d suggest that you check your credit score once a quarter as you’re trying to clean up debt. It’s kind of like standing on the scale when you are trying to lose weight. It’s where the rubber meets the road. Either your overall situation is improving, or it isn’t. Getting your credit report isn’t the same thing as getting your credit score. Ideally, you would check both two to four times per year. You can receive your free credit report, which shows your account history and should be checked for errors once per year by visiting www.AnnualCreditReport.com. Your credit score, which is actually computed for lenders by private companies like the Fair Isaac Company (creators of the FICO score), is not required to be given to you for free. However, you can visit websites such as www.MyFico.com and pay a small fee to view this score that determines your rates on loans.

Here are the basic ranges and ratings for the FICO credit scores:

700–850. You’ve got “Very Good” to “Excellent” credit depending on where you fall in that range. Getting a loan is usually no problem for people with scores in this range, and borrowers with these scores usually get the best rates and terms.

680–699. You’ve got “Good” credit. With a score in this range, you can usually get a standard loan as long as your other factors, like income and down payments, are solid.

620–679. You’ve got “Okay” credit. You can usually get a loan for smaller purchases without a co-signer or a major down payment, but you’re going to pay for it. Borrowers in this range and below start getting charged higher interest rates and fees.

Below 620. It’s official, you’ve got “Bad” credit. You may or may not get approved for a loan based on how far below 620 your credit score is. If you do manage to get approved, the further your score falls, the higher the interest rate you’ll typically pay.

It’s important to stop and assess if your debt problem is getting worse by the day, or if you’ve managed to stop the bleeding. If your monthly debt service is steadily climbing each month, that’s the dead opposite of trying to get rid of debt. If more water is leaking into the rowboat than you’re bailing out, it’s only a matter of time before you sink. In other words, you’ve got to take decisive action.

To make sure you’re not taking two steps forward and three steps back, make a chart where you start tracking your short-term balance, long-term balance, monthly debt service, and credit score.

It doesn’t matter how you create this chart. If you know how to use a computer spreadsheet, you can do it there. If not, go steal some paper and crayons from the closest kid you can find. Whatever you do, make sure it’s got a graph that plots your progress or decline. I promise this will go a long way to keeping you motivated and on track.

Loan workouts are voluntary agreements to restructure a company’s finances. The principal aim of such transactions is to improve a company’s ability to service its debt.

At its core, this requires one or more of the following:

• A reduction in the nominal or present value of the company’s debts.
• An extension of the period over which its debts are serviced.
• The provision of new finance.
• The appropriate restructuring of the business of the enterprise.

A loan workout may be formally defined as: An out-of-court agreement between the stakeholders of a company on a mutually acceptable course of action, with the aim of rescuing an enterprise with a commercially viable future. Loan workouts are entered into voluntarily by all the participants affected by their terms, without being compelled to do so by a court. There is also a distinction between the company (or the legal entity) and its business undertakings. The focus of a loan workout is on the latter. In certain circumstances, a business may be viable, whereas the company which owns it, may not be. In such circumstances, a loan workout may focus on the commercially viable parts of an enterprise (provided they are a relatively significant element of the group), whereas other parts may be subject to statutory insolvency procedures.

A typical loan workout involves three stages:

• The calling of a moratorium to achieve stability.
• A restructuring of the company’s business and finances.
• A refinancing once the business has been turned around, or the implementation of other exit strategies by the company’s lenders.

Statutory frameworks can be broadly categorised into those that are ‘creditor-friendly’
or ‘debtor-friendly’. In a strict creditor-friendly insolvency regime, the control over all the assets and businesses of a company is taken away from its management and shareholders upon entering into formal procedures. Responsibility for managing and realising the assets passes to a trustee or administrator, who does so on behalf of all, or the secured, creditors. Also, the country’s priority rules are followed strictly when proceeds are distributed among creditors. Countries with English law tradition, such as England, Ireland, Malaysia and Australia, are considered as having strongly pro-creditor insolvency regimes.

Scandinavian countries and those with German law traditions also have creditor-friendly regimes, although less so than the first group. Insolvency under debtor-friendly regimes tends to encourage some form of debt
forgiveness or forbearance as part of the financial restructuring. Also, the company is generally allowed to continue operating, either in the hands of its existing management, or a trustee. The creditors have a relatively passive role in the restructuring process. Debtor-friendly insolvency procedures are found in the United States, France and, to a lesser extent, in parts of Central and South America. The lenders’ influence over the outcome of statutory insolvency proceedings is considerably weaker in debtor-friendly regimes.

Some countries without a corporate tradition, such as Islamic jurisdictions, tend to be neutral in this area.

Statutory insolvency frameworks provide the rules and mechanisms for the realisation and distribution among stakeholders of the assets of insolvent companies. If the value of a company as a going concern is greater than if it were to be liquidated, such frameworks also enable the preservation of the enterprise of the company so that, if appropriate, it can be rehabilitated. If necessary, this can be under a different ownership. Also, the procedures provide for changes in control once insolvency is established or expected. Statutory insolvency frameworks aimed at the recovery of assets from a non-viable business are prevalent in all countries around the world, although they vary considerably in their effectiveness. They generally provide for a trustee or other official appointed by a court (or other body empowered by legislation) to realise the assets of an enterprise and distribute them to the various stakeholders of the company in accordance with priority rules. In many jurisdictions, they also provide for the prevention of preferential treatment of a party or interest group in the period leading up to a financial crisis.

Insolvency procedures aimed at rehabilitation are also common, providing for the stabilisation and, usually, sale of the business to new owners, under the supervision of a specialist appointed under the provisions of a statute.

There is normally considerable uncertainty and instability surrounding a company experiencing financial difficulties. This makes an accurate assessment of its position and prospects difficult. Reaching agreement on a course of action becomes problematic.

Insolvency legislation is aimed at overcoming such problems. The key challenge for policy-makers in this area is to design a legal and regulatory framework that meets two key objectives:

• To identify and rescue those companies that can and should be rehabilitated.
• To liquidate efficiently those companies that do not have a viable future.

In reality, various shortcomings associated with statutory frameworks, highlighted later in this chapter, create difficulties in meeting these objectives. Rescuing commercially viable companies within a statutory framework can be particularly difficult. Failure of such companies causes unnecessary losses among their stakeholders and for the economy as a whole.

Many of the drawbacks of rescuing companies within a statutory framework can be avoided if a company’s stakeholders, and in particular its creditors (who are usually the interest group most affected) can assess a company’s commercial viability and agree a financial restructuring without recourse to the courts. Loan workouts, which are essentially financial restructurings agreed in an out-of-court process, can therefore be
an effective tool for corporate rescues.

While there are a few differences, the structures for conventional small business loan transactions are similar to those of the unguaranteed portions of SBA 7(a) loans. One distinction is the excess spread available. Note, for 7(a) transactions, excess spread from the entire loan is available with only the unguaranteed portion being securitized, where for conventional business loans the entire loan is in the transaction.

Conventional small business loans are also made to “qualifying borrowers,” whereas the eligibility requirement of SBA loans is for borrowers that cannot obtain this financing. Therefore, the quality of conventional small business loans is generally better than SBA loans.

The average loan balance for conventional business loans for the most part will be higher than the SBA due to a lack of SBA limits on loan size. Also recall that SBA loans are typically floaters indexed to the prime rate. Conventional loans tend to be indexed to three-month LIBOR because the investment community prefers LIBOR floating rate bonds. Indexing the underlying collateral to the same index mitigates basis risk. SBA transactions have basis risk; however, the rating agencies take this into consideration when specifying levels of credit enhancement for deals.

Large portions of conventional loans are secured by first liens on real commercial property. Transactions will often consist of pools of loans backed almost completely by real estate collateral. When the loan is not backed by real estate, losses on defaulted loans will typically be higher due to the lack of real estate collateral, which is generally an appreciating asset, versus collateral such as equipment, which is a depreciating asset.

Prepayment penalties for conventional loans tend to be more severe than the SBA. Penalties are set by the lender and will likely start at 5% and step down one percentage point per year for the first five years following disbursements.

SBA transactions are generally more geographically diverse than conventional transactions. Forty-eight states could be represented in an SBA transaction where conventional transactions may contain only eight with around 70% of loan concentration in one state. Small business performance is negatively affected by downturns in economic cycles; the geographic diversity of SBA transactions lessens some of this risk.

Grace

Following graduation or withdrawal from school, Stafford, and Perkins borrowers are granted a period before the repayment of their loan begins. During the grace period, the government continues to pay the interest for subsidized and Perkins loans. For unsubsidized Stafford loans, the interest is still the responsibility of the student, who may request a shorter grace period to avoid additional accrual of interest. Grace periods for Stafford and Perkins loans are typically six and nine months, respectively.

Deferral

A deferral is a postponement of the loan repayment and acts similarly to the grace period. Interest accrues and the government pays it for subsidized and Perkins loans. However, for unsubsidized loans, the borrower is required to pay the interest or have it capitalized. Following are some circumstances in which students may receive deferment:

• Enrollment in postsecondary school at least half time.
• Economic hardship.
• Inability to find full-time employment.