Although it doesn’t feel like it, the calendar shows that it’s late February, and that means that most of us will be filing our tax returns in the next several weeks. We’ve mailed out all the documentation our clients need from us for taxes, and if clients haven’t received 1099s from TD Ameritrade yet, they should in very short order. If you’ve got any questions about what documents you need for taxes, the article in last February’s newsletter (here) should be helpful.

For this newsletter, I thought it would be useful to check in with what’s going on in the economy and the markets. The short answer is that things are looking better, but there are still real risks – primarily international – to the recovery. On the plus side, additional mortgage refinancings should begin to provide a tailwind in the coming months. As outlined in the financial planning tip below, changes to the government HARP program and the mortgage settlement will allow a wider group of homeowners to refinance. Finally, in the client question of the month, I provide a framework to allow you to determine if refinancing makes sense.

Feel free to forward this newsletter on to friends and family, particularly if you think they might be in the group now eligible to refinance. As always, if you have any questions or suggestions for topics, don’t hesitate to contact us.

Best regards,
Micah Porter, CFA, CFP®

A Look at the Economy and Markets
Micah Porter, CFA, CFP®

Over the last few weeks, there has been a steady stream of news indicating  continued modest improvement in the U.S. economy. A drop in unemployment has been the most promising indicator, but manufacturing data has been positive as well. And even in housing, a laggard since the downturn began, there are signs that the decline in the housing market is slowing with prices bottoming in some markets. Overall, the picture is one of cautious optimism tempered by ongoing developments overseas.

Foremost among these is the ongoing European debt crisis. The big news from the continent over the weekend was the approval of a second tranche of Greek aid. The approval was given in exchange for Greece’s passage of additional austerity measures. These cuts will be made in an economy which has been in recession for over 5 years and where 1 in 6 is unemployed. The overwhelming preponderance of the evidence is that these cuts will just exacerbate this situation, so it’s difficult to see how the second bailout does more than buy time. That may be sufficient to allow the global economy to continue to muddle along, but it’s far from an optimum solution that would drive growth in the near term while addressing structural deficits over the longer term.

Another area of global concern is the Middle East, where Iran is engaging in brinksmanship with the West and its neighbors, most notably Israel. Increased tensions are driving oil prices higher, and this acts as an inevitable drag on economic growth. The political question is whether war can be avoided, and the economic question is how high the price of oil will go and to what extent that will impact the U.S. economy. The good news is that there is some evidence that changing driving patterns will lead to less of an impact, but regardless, higher oil prices will lead to some economic drag.

Against this economic backdrop, equity markets have generally moved higher, with international and mid/small cap posting particularly strong performances. Fixed income benchmarks indices have been flat, but our funds have handily outperformed benchmarks given their exposure to corporate and international bonds. Overall the story is much the same – continued slow growth, with defensiveness warranted given the risks to the recovery that still exist.

Financial Planning Tip – Eligibility to Refinance
Micah Porter, CFA, CFP®

Although silver linings have been tough to find in the most recent downturn, an easily identifiable one has been lower interest rates. As rates have headed downward, I’ve discussed the idea of refinancing with clients who hold mortgages and I’ve written columns when rates hit new lows. As a result, I know several clients with higher interest mortgages have refinanced and lowered their payment or moved to a shorter-term loan to build equity more quickly. Still, not everyone is in as favorable a financial position as our clients and thus they may not have had the equity needed to refinance. Two recent changes, however, have made refinancing possible for those with solid payment records but too little equity in their home.

The first of these changes was a reconfiguration of the government’s HARP program. HARP, or the Home Affordable Refinance Program, was rolled out several years ago. It was designed to allow those homeowners with solid credit and good payment records to take advantage of lower rates through refinancing. However, one of the provisions that kept many from refinancing was that the loan to value ratio could not be greater than 125%. Thus, a homeowner that owed $150,000 on a house worth $100,000 would not be eligible, even if that homeowner’s credit rating was sterling and their payment record unblemished. The new version of HARP does away with the loan to value provision, allowing a much wider group of homeowners to benefit from the program. Another key change is that the program now includes rental property and isn’t limited solely to owner-occupied property. As a result of the two changes, the new program is available to a much wider group of homeowners. For more details on HARP, check here.

Another recent development that will be beneficial to some homeowners is the settlement between the Department of Justice, states attorneys-general and the five largest mortgage servicers. The settlement includes a number of provisions, one of which is the agreement to allow certain borrowers to refinance. While details on this settlement are less clear than those for the new HARP program, more information is available at this website, or on the website of the individual’s state-attorney general.

While these programs likely won’t have a direct impact on our clients, there are likely to be several indirect benefits. Aside from the fact that there are undoubtedly friends and family who can take advantage of these revamped programs, the programs themselves serve as an indirect stimulus as millions will see their mortgage rates decrease. Additionally, the mortgage settlement in particular will reduce the number of distressed sales, thereby reducing the downward pressure on housing prices.

Client Question of the Month – When Should I Refinance?
Micah Porter, CFA, CFP®

The simplest rule of thumb when it comes to refinancing is to do so when you can save a percent or more on the new interest rate. As with most rules of thumb this oversimplifies things a bit and might not apply to your specific situation. For example, what if you are moving from a 30 year to a 15 year loan, or are planning to move in the next 3 years? Does refinancing still make sense? If you really want to determine whether or not refinancing is for you, focus on three things: the cost of refinancing, how much you’ll save on interest and how long you plan on living in your home.

When determining how much you’ll save on interest, bear in mind that most loans – aside from interest only loans – include both principal and interest payments. As time goes on and the loan balance is paid down, an increasing amount of the payment is applied to principal. Thus, the best way to determine how much interest you’re saving over a specific time frame is to use an amortization table for the loans being compared. As an example, if you can refinance a 4.85% loan on a $300,000 balance to 3.5%, you’ll save over $8100 in interest over 2 years.

Once you understand the potential savings, the next step is to determine (a) how much the loan will cost, and (b) how long you plan on living in the home. In determining how much the loan will cost, it’s key to omit pre-paid expenses like interest and escrow, as they are expenses you would have incurred even if you hadn’t refinanced. However, all costs being incurred solely because you refinanced – like stamp fees, lender fees, mortgage broker fees, appraisal costs and the like – should be factored into the analysis. Additionally, if you’re paying points, factor that in as well to the total cost of the loan. Ultimately, if you’re able to recoup these costs well before you plan on moving via the savings on interest – what’s typically referred to as payback – then refinancing probably makes sense. If payback won’t occur until after you plan on moving or if it looks to be a close call, then think twice about refinancing.

One advantage to the approach outlined is that you can use it to compare loans of varying terms. Whether a loan has a 15 year term, a 30 year term or something else, what’s critical is the amount of interest saved and when you’ll ultimately achieve payback on savings. In fact, one of the best ways to save for many people is to move to a shorter term loan. As long as the borrower can easily make the payments, the end result is a lower interest rate and a much quicker accumulation of equity in the home.