Consider this scenario.

Two years ago you, a self-employed California home owner with good credit, were talked into taking a neg-am adjustable rate mortgage for “the payment flexibility” by a slick-talking loan officer.  In order to get a “no points, no fee” loan you took a 3-year hard prepayment penalty with the loan.  That prepayment penalty isn’t up until some time late next year.

Your home is “worth” $550,000 right now, down from $600,000 a few short months ago, but there are homes on the market that have been sitting and you feel future price devaluations are imminent.  You bought before the peak of the market and have 25% equity currently at $550,000.

You have no problem making the fully-amortized payment; but your Option ARM loan (scheduled to recast in 3 years) has an interest rate of nearly 8%; and with a 30-year fixed in the mid-5% range right now - it could save you some serious cash.  The prepayment penalty is 2% of the loan amount - $11,000.

The Question: Do you eat your prepayment penalty?

Consider what happens if we wait it out.  Home prices continue to decline - perhaps to the point of wiping out the remaining 25% of equity that currently exists in the home.  Loan guidelines tighten up to the point where self-employed borrowers have a much harder time of qualifying for loans with underwriting guidelines that become more restricted as we move through this mortgage meltdown.

It is conceivable that by the time the prepayment penalty is up this borrower will have little to no options for refinancing.

In this case I think it makes sense to  eat the $11,000.  Particularly if the borrower is planning on staying in the home for a period of time that surpases the recast date of the Option ARM.  Why?  Because there is a very good likelihood of the following occurring:

• Foreclosure, short sale or further price cuts in the neighborhood wipe that $11,000 out quickly - no matter what the borrower does.
• Potential market declines could wipe out nearly the entire 25% of the borrower’s equity in 14-16 months.
• Banks eliminate or overly restrict program guidelines that make it difficult for self-employed borrowers to get financing when compared to today’s qualification guidelines.
• Interest rates begin to rise in the face of inflation making his Option ARM more expensive.

In this case I say the risks outweigh the rewards of sitting on the sidelines.  You’re sitting on a mortgage that is expensive and fluctuating.  Even though you can afford the payments at the near-8% rate you are risking losing your options once you come out of your prepayment penalty and may be stuck in that expensive loan for much longer than you initially planned on when you took it as a “short-term” flexibility option.

I’ve never been a fan of the ‘eat the prepayment penalty’ argument.  I thought it was just a shameless way for LO’s to promote equity withdrawal and refi churn during the run-up.  But now watching programs, values and lenders getting swept away by this mess gambling on what the future lending environment will look like in 16-24 months seems like a poor bet for someone who may find themselves on the outside of much tighter guidelines in the future.

What do you think?  And are there other reasons why someone should pay the prepayment penalty now to get out of a loan?

Share This

Share This

Filed under: Law, Marketing and advertising, Scandals

On December 1, I wrote about Amway’s defense of its conduct in the United Kingdom. John Hutton, Britain’s Secretary of State for Business, Enterprise, and Regulatory Reform is attempting to shut down the company’s operations there, charging that Amway is essentially an endless chain scheme.

The government has demonstrated that only 10% of Amway’s multi-level marketing Independent Business Owners turn a profit, while only 6% ever actually sell a product to someone outside of the organization.

This is compelling evidence that Amway is a pyramid scheme. People buy products to qualify for commissions, and the business operates as a closed system: Money is made by recruiting new distributors, not selling products. This is not different from a chain letter in any meaningful way.

According to the Times, David Chivers, an attorney for Amway, said that Amway’s own rules say that promotional material should state that income can only be achieved by the sale of products to end clients and that the company does not pay simply for recruiting further agents.

And yet the data would seem to suggest that the company is doing just that. Meanwhile, Amway continues to recruit “distributors” in the United States, unimpeded by government officials who have essentially been bribed.

To learn more about Amway, check out this Dateline special available on YouTube, or read Amway: The Cult of Free Enterprise.

Permalink | Email this | Comments

Share This

Filed under: Google (GOOG), Apple Inc (AAPL), Wal-Mart (WMT), Home Depot (HD), Exxon Mobil (XOM), McDonald’s (MCD), Bank of America (BAC), JetBlue Airways (JBLU)

We recently took a look at the Best & Worst of 2007 in sixteen categories and asked you to vote for your favorites, as well as sharing the reasons for your picks and any other contenders we may have overlooked. And voting is off to a strong start, with more than 100,000 votes in each category so far.

Some categories have shaped up to be close races. Chuck Prince, Bill Ford, and Bob Nardelli each have a little less than a third of the vote for Best CEO Departure of the Year. Britney Spears and Michael Vick are neck and neck as the Celebrity Most Likely to Lose It All, while Lindsey Lohan’s relatively low profile recently has garnered her just 6 percent of that vote. In the Most Shameless Attempt at Cashing in on ‘15 Minutes’, Sanjaya Malakar has a slim lead over Howard K. Stern/Larry Birkhead, but poor Chris “Leave Britney Alone!” Crocker has gotten no respect with a mere 6 percent of the vote. McDonald’s has a small lead as the Hottest Chain Restaurant, thought Chipotle isn’t far behind with more than a quarter of the vote. And while the iPhone has the lead now as the Hottest Gadget of the Year, it and the Nintendo Wii have been trading places as the front runner.

Continue reading Best & Worst of 2007: Early voting results

Permalink | Email this | Comments

Share This

Filed under: Scandals, Countrywide Financial (CFC), Washington Mutual (WM)

Some nasty things have been said about Gradient Analytics, even resulting an SEC investigation of the firm that was dropped in short order.

But as Herb Greenberg points out in his latest column (subscription required), the research firm has about as stellar a track record as you will find, having been among the first to raise questions about accounting at Krispy Kreme Doughuts (NASDAQ: KKD), Children’s Place (NASDAQ: PLCE), and Biovail (NYSE: BVF).

Now, in a report available free on the firm’s website (a must-read if you are even thinking about buying financials), Gradient wonders about the accounting at Washington Mutual (NYSE: WM), Citigroup (NYSE: C), Wachovia (NYSE: WB), Wells Fargo (NYSE: WFC) and, my personal (least) favorite, Countrywide Financial (NYSE: CFC).

According to Gradient’s report, the financial statements of these firms raise serious questions with respect losses being hidden on assets that are being held to maturity (essentially failing to take appropriate writedowns), shifting loans into “assets held for maturity” to avoid taking writedowns, the use of “not necessarily fair market values,” off-balance sheet arrangements, and the concealing of the “after-effects of aggressive gain-on-sale accounting.”

Continue reading Gradient Analytics raises questions about banks’ accounting

Permalink | Email this | Comments

Share This

Filed under: Google (GOOG), Yahoo! (YHOO), salesforce.com inc (CRM), Small business

Every month or so, it seems that I get a new phone book. But I throw them away. When I need to get information on a local business, I go to Google (NASDAQ: GOOG) Local.

According to a research report from the Kelsey Group, about 54% of consumers have substituted internet search in place of phone books. “Users are searching local information from the desktop as well as mobile devices,” said Kirk Crenshaw, who is the CEO of RevCatalyst. “Apple (NASDAQ: AAPL)’s iPhone should also accelerate these trends.”

So how can your business capitalize on local online advertising?

Continue reading Entrepreneur’s Journal: Ditch the phone book and advertise online?

Permalink | Email this | Comments

Share This

Filed under: Law, Blogs, Scandals

Sheila Bair, chairman of the Federal Deposit Insurance Corp., is suggesting that some critics of President Bush’s subprime bailout plan may not exactly have the most altruistic motives.

Ms. Bair, who was appointed by President Bush in 2006, told the Wall Street Journal (subscription required) that “I do worry that some of the investors have taken short positions on the ABX,” an index based on subprime-mortgage-backed securities.

Well isn’t that enlightened. A lot of people have spoken out with intelligent reason in opposition the President’s bailout plan. And now the chairman of the FDIC is saying, utterly without evidence, that some of these people have nefarious ulterior motives.

Here’s the problem with Bair’s “worrying”: This issue should be decided on the merits, regardless of the motives of the individuals behind the arguments. Short-sellers will always be criticized for “bashing.” But they’re usually right. And if the critics of the bailout are making reasonable arguments, who cares if they’re short?

It’s a really sad commentary on how low the debate has fallen when the chairman of the FDIC is resorting to what is essentially name calling, rather than defending a position on its merits. Happily, some of our bloggers have made cases on the merits — without resorting to name calling, and they mostly oppose the bailout.

Homeowner bailout sets lousy precedent
Bust mortgage rescue plan: Winners and losers
Our government’s mortgage bailout madness
Proposed subprime bailout gives the shaft to responsible consumers

Permalink | Email this | Comments

Share This

Filed under: Management, Citigroup Inc. (C)

Several sources, lead by the Wall Street Journal (subscription required), are reporting that Vikram Pandit, the head of Citigroup’s (NYSE: C) investment bank, is likely to be made the new head of the firm early next week. There have been rumors that several outsiders have turned their backs on the job. That would not be surprising. No one is certain whether there is another shoe to drop if and when Citi takes more write-offs to its huge portfolio of mortgage-backed financial instruments.

But, if not Mr. Pandit, then who? He has been at the bank and knows its structure. It might take an outsider several months to learn about all of the pieces of the big bank. Citi does not have the luxury of schooling a new chief.

Citi’s board will certainly keep in daily touch with the bank’s progress. There may be only one CEO, but he will have a number of coaches. The board cannot afford to be seen as the group that let the company fall apart on its watch.

The other reason for appointing Pandit is that the truth about a company the size of Citi is that the CEO does not run it. He may set policy, but there is no practical way for him to make all of the critical decisions. Charles Prince learned that lesson the hard way when some of his key aides made bad calls on risk management.

Mr. Pandit? Yes. The sooner, the better.

Douglas A. McIntyre is an editor at 247wallst.com.

Permalink | Email this | Comments

Share This

Filed under: Wal-Mart (WMT), Columns

Welcome to the 39th installment of The Wal-Mart Weekly, a column dedicated to bringing you insight, wit, facts, results, opinions and just a bit of everything else when it comes down to a very hot topic these days: Wal-Mart.

Last week, I looked at a recap of Wal-Mart Stores, Inc. (NYSE: WMT) Black Friday and Cyber Monday sales and related marketing efforts. This week, I’ll be talking about a “Black Sheep” when it comes to Wal-Mart’s employee pay policy — the “Living Wage,” as it’s been called.

This is the wage that would significantly up the amount of pay many Wal-Mart employees would see in their pockets while not affecting pricing very much from the consumer standpoint. Sounds like an oxymoron, doesn’t it? Any slight upward movement in pricing would be seen by Wal-Mart’s price-savvy customers, yet the retailer is constantly bombarded by accusations of low pay. How can it mesh the two for a solution?

Continue reading The Wal-Mart Weekly: The living wage ordinance rears its head

Permalink | Email this | Comments

Share This

Filed under: Wal-Mart (WMT)

The Boston Globe reports that shoppers are buying toys for their children at small stores and avoiding Wal-Mart Stores Inc. (NYSE: WMT) whose Chinese toys they fear.

One Cambridge, MA store, Stellabella Toys, has shifted its merchandise suppliers from Chinese to European and U.S. toy makers. Stellabella bought as many LEGO toys (made in Denmark) and Playmobil products (made in Germany) as possible. And it added new lines, including German stacking toys and wooden trains from Maple Landmark Woodcraft of Vermont.

More than 65% of consumers will refuse to buy toys from China this season. This hurts Wal-Mart which offers cheaper prices by importing Chinese merchandise. That’s because 80% of all US toys are manufactured in China, where they are cheaper to produce. It is more likely that the Chinese toys will end up in mass merchants like Wal-Mart, which often carry large volumes of toys.

I don’t know if Wal-Mart will start buying safe toys — its purchasing volume could drive down the prices and thus bring back some of those shoppers. But in the meantime, you can check out the toys sold by small stores like Stellabella. At least it’s supplying what American shoppers want — safe toys for their families.

Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter. He has no financial interest in Wal-Mart.

Permalink | Email this | Comments

Share This

Filed under: Bad news, Getting started, Comfort Zone Investing, Housing

Ted Allrich is the founder of The Online Investor and author of Comfort Zone Investing: Build Wealth And Sleep Well At Night. In this weekly column, he offers advice to investors who are just getting started.

Financial institutions continue to struggle with subprime mortgages, but the homebuilders have their own battle: tight credit and wary buyers. While builders target different markets from entry level to luxury in order to define their niche, when no one’s buying, it doesn’t matter. Sales aren’t happening across the housing spectrum.

According to a recent survey done by Bank of America, real estate agents are all saying the same thing, no matter what part of the country they’re showing houses: traffic is lower than expected, and buyers are waiting, thinking the bottom isn’t here. There is anecdotal evidence that things are even worse than that.

Continue reading Comfort Zone Investing: Homebuilder blues — stay cautious

Permalink | Email this | Comments

Share This