NHLA Blog

In its official announcement, Fannie Mae says the updates minimize long-term lending risks. If that's the case, this won't be the last guideline change Fannie Mae makes -- especially with loans defaulting at an above-normal clip.

The immediate changes are major. The first pertains to credit scores.

Effective December 13, 2009, the bulk of Fannie Mae's loans require a 620 credit score minimum. There are very few exceptions.

A second relates to loans with private mortgage insurance.

Homeowners whose loan-to-value exceeds 80 percent now have a choice:

1. Pay higher mortgage insurance premiums month-after-month
2. Pay a one-time fee paid at closing to compensate for higher risk

Both options result in higher consumer loan costs.

A third change concerns maximum debt-to-income ratio. Fannie Mae will no longer approve loans with debt ratios exceeding 45 percent except with very strong assets and very high credit scores.

In no case whatsoever may debt-to-income exceed 50 percent.

There are other changes, too, including the elimination of seldom-used mortgage products and additional risk-based fees for "expanded level" mortgage approvals. These updates affect just a small part of the population.

So, home prices are rebounding, mortgage rates are low, and -- for 5 more months at least -- there's a federal tax credit for qualified buyers. You don't have to buy a home now, but with mortgage guidelines sure to tighten in 2010, now may be a better time than later.

Considering bonds? Keep an eye on interest rates

By: Jim Larkin, CFP^®, CRPC^®

A low appetite for risk and lingering uncertainty about the health of the stock market has many consumers weighing the pros and cons of bonds and other fixed income investments. If you’re looking to invest in these steady return options, here are a few things you should keep in mind.

Bonds vs. Stocks

Under normal economic conditions, stocks tend to outperform bonds over long periods of time. This makes them an attractive option for risk-tolerant investors who can handle seeing their assets fluctuate with the ups and downs of the stock market. Contrarily, bonds are fixed; barring a default or other unusual event, bond investors receive their principal plus the assigned interest at the time of maturation.

Exceptions to the rule exist. In periods of severe economic volatility, bond interest rates can yield higher returns than stocks. Until the stock market began to rally in the second half of 2009, the decade prior generally proved more favorable to bonds than stocks. This fact, coupled with a sense of uncertainty about the market, has driven some investors to recalibrate their portfolios’ bonds to stocks ratio.

But, now that it appears we are on the road to economic recovery, will bonds continue to generate higher returns going forward? Nobody can say for certain, but the low interest rate environment may be an obstacle that stands in the way of superior bond market performance in the years to come.

Interest rates and prices – an inverse relationship

An important fact to keep in mind is that bond prices are affected by the direction of interest rates. When interest rates decline, bonds increase in price. When interest rates rise, bond prices fall. Returns for bondholders typically rise in an environment where interest rates are declining, a trend that has worked to the benefit of bond investors in the past decade.

Why do interest rates affect bond prices? Consider this simplified example: Suppose you invest in a bond from an issuer for $1,000 and it pays 4% interest. That amounts to $40 in annual income from the bond. If, one month later, the same issuer offers a $1,000 bond with a 5% interest rate, you could buy the same bond and receive an annual income of $50. In that case, the original bond you purchased that pays only $40 in income is no longer worth $1,000. To match the current market yield of 5%, a buyer would only offer $800 for your older bond to achieve a comparable yield based on the $40 annual income payout. That represents a 20% loss of investment principal.

Of course, if you hold the bond until it matures, the issuer is obligated to repay the entire face value of the bond, in this example, $1,000. Then again, if you wish to sell it in the secondary market prior to maturity, the bond has lost value (unless the interest rate environment has changed enough in your favor to compensate.)

Today’s low interest rate environment

Keeping in mind how interest rate movements affect bonds, consider the state of interest rates in today’s market. They are at relatively low levels on an historic basis.

For example, one of the benchmark measures of the bond market, the 10-year U.S. Treasury note, had a yield of 3.4% (as of October 30, 2009). At the end of 1999, the same maturity government issue yielded 6.3%.

The yield on the 10-year Treasury note has rarely dipped under 3%, and typically is much higher. In fact, in the fall of 1981, 10-year Treasury note yields soared above 15%. The note of caution for investors is that long-term interest rates may not have much room to decline from current levels, limiting the potential upside for bond values.

The greater risk in the current environment is that interest rates will rise, depressing values of existing bonds. If that occurs, it could have a detrimental impact on your bond portfolio. One way to measure interest rate risk in a bond mutual fund is to look at the fund’s duration. The longer the duration, the more it is affected by changes in interest rates. That can work to your advantage in a declining interest rate environment, but will have a negative impact on your returns if rates move higher.

Historically, interest rates have tended to move higher in periods of an economic recovery. This is important to bear in mind as you consider putting your money in bonds. If the economy continues to build steam, you may need to temper your expectations about future returns on your fixed-income portfolio.

Jim Larkin, CFP^®, CRPC^®

Financial Advisor

CERTIFIED FINANCIAL PLANNER™ practitioner

Ameriprise Financial Services, Inc.

1308 Village Creek Drive | Suite 2000 | Plano, TX 75093

Bus: 469.865.1050 | Fax: 469.865.1010

E-mail: James.k.larkin@ampf.com

Website: www.ameripriseadvisors.com/james.k.larkin

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This column is for informational purposes only. The information may not be suitable for every situation and should not be relied on without the advice of your tax, legal and/or financial advisors. Neither Ameriprise Financial nor its financial advisors provide tax or legal advice. Consult with qualified tax and legal advisors about your tax and legal situation. This column was prepared by Ameriprise Financial.

There are risks associated with fixed income investments, including credit risk, interest rate risk, and prepayment and extension risk. In general, bond prices rise when interest rates fall and vice versa. This effect is usually more pronounced for longer-term securities.

Investment products are not federally or FDIC-insured, are not deposits or obligations of, or guaranteed by any financial institution, and involve investment risks including possible loss of principal and fluctuation in value.

Brokerage, investment and financial advisory services are made available through Ameriprise Financial Services, Inc. Member FINRA and SIPC. Some products and services may not be available in all jurisdictions or to all clients.

©2009 Ameriprise Financial, Inc. All rights reserved.

File # 93139

(12/09)

This communication is published in the United States for residents of Texas, Louisiana, Arizona, Colorado, Florida only; and this advisor is licensed only in the states of Texas, Louisiana, Arizona, Colorado, Florida.