Housing is one of the issues that is center stage in the presidential race. Senator John McCain and leading Democratic contenders Hillary Clinton and Barrack Obama are pitching their respective solutions to the housing crisis. Each is trying to convince voters that he or she has the best plan for fixing the housing mess. So which plan is better ?

The major difference is over the role of government. The Democratic contenders argue that if the Federal Reserve could intervene in the rescue of Bear Stearns by plunking down $ 29 billion, it can play a more active role in bailing out the homeowners with a high risk of foreclosure. Obama argues for a $ 10 billion foreclosure prevention fund to help homeowners. Clinton wants federal government to provide $ 30 billion to finance an emergency fund to help local governments with the purchase and resell of foreclosed homes.

McCain on the other hand noted in a speech recently that ‘Government assistance to the banking system should be based solely on preventing systemic risk that would endanger the entire financial system and the economy.’ In short, he argued that the Fed’s move prevented a further collapse in the mortgage market. He is also asking lenders to do the same for borrowers that they in turn are asking the government to do for them.

In summary, the Democrats are advocating a larger role for the government with the two contenders offering different degree of detail on how that can be achieved.

The Federal Reserve’s rescue of Bear Stearns has unleashed a huge debate on Main Street. Should the Federal Reserve and Congress step in to save homeowners troubled by sinking home prices and disappearing home equity ?

The rescue of Bear Stearns was important because the meltdown of a major financial house can not only have a ripple effect through other financial institutions but it can also further tighten credit or money supply which is the main stay of the mortgage market. Individual homeowners are difficult to target, and raising the jumbo loan limits, as well as providing relief to owners in certain income brackets and certain types of mortgages is justified.

Like Wall Street, it’s very important that people get back to the basics: treat credit with respect. Credit is not a free ride! It should be used only as is needed, and it should never be used beyond the capacity to service it. Greed is central in this housing crisis - the homeowners got greedy, the lenders got greedy and the financial institutions that provided the money for these loans as well as sold these loans got greedy. We think that the government should target first the those homeowners who are most susceptible to a foreclosure, second they should target homeowners who are victims of mortgage fraud, and lastly they should enforce reform and regulation that not only reins in predatory lending but also oversees dissemination of credit in the future. However, it’s also important that homeowners take responsibility for their actions - they should completely understand the underlying risks of choosing certain kinds of risky mortgage, they should not take on too much leverage that they cannot service if the economy goes south or if they suffer a job loss. A CNN poll conducted almost 6 months ago suggested that 48% of homebuyers don’t know which mortgage they have. Clearly, this cannot continue. Today, it will pay to completely understand one’s mortgage !

Behavorial finance is an interesting field. It presents insight into why markets and individuals behave in a certain way in response to certain market moves. One doesn’t have to look too far to see how our ‘herd mentality’ is affecting the housing market.

When housing markets across the country were growing at a fast clip between 2002-2006, people piled on risky mortgages. It was important to get into the housing game, regardless of the risk i.e. type of mortgage or the cost i.e. the interest rate on the mortgage. The general belief was that the market would continue to appreciate at double digits, and any cost incurred or risk borne by acquisition of exotic mortgages would be offset by the gains in equity by increases in house prices. The result - homebuyers, lenders, underwriters, players in the complex mortgage backed security market such as investment banks, sovereign funds, hedge funds etc. all got into the game. They all leveraged to the hilt in the belief that the house prices would continue to increase perpetually.

Now, with house prices, as per the Case Shiller Index, retreating by more than 10% in the major metros year over year in the first quarter of 2008, everybody is proclaiming that the real estate market is unlikely to return until 2009. Home buyers are panicking and offloading their houses at throw-away prices, lenders are tightening lending standards to the extent that even borrowers with excellent credit are facing an uphill task to get loans.

This behavior is not uncommon and is always observed during large stock market rallies or declines. Sane investors will do well to understand the risks and rewards of buying a home with a mortgage. Time is always a critical part of any financial investment. It should be considered very carefully. Debt or leverage as well as the cost or rate of borrowing are the two common critical factors against a majority of the players involved or associated with the mortgage business. Performing a sanity check by carefully evaluating the above factors with little heed to the ‘herd mentality’ will stand most in good stead !!

Conventional wisdom may suggest that the foreclosures are rising because homeowners cannot meet their mortgage obligations. That’s true, but there’s another twist in this tale !

As home prices decline thereby deflating the equities in homes, lenders are becoming more cautious to the extent that homeowners who may have a chance of refinancing their loans are not able to do so. Stuck with higher interest loans, they are unable to make their monthly mortgage payments. This problem can impact even homeowners with good credit. If houses continue to decline in value, lenders will further shy away from refinancing. The reduction in interest rate will help but how far it will dampen the foreclosure giant’s advance is anybody’s guess !

Should I wait or should I buy today ? This is the most common question confronting potential home buyers today. The answer is ‘It depends!’. Here are some guidelines to help you make a decision:

1. Understand the state of housing in your area: Today, plenty of builders may be offering great incentives on home purchases in your area. If there are large mark-downs on prices, it may be a great time to buy especially if the rent vs. buy compare becomes more favorable. However, it’s also important to understand what the projection on home prices is for the foreseeable future, as a steep decline in prices may quickly eat up any advantage a ‘bargain’ may have earned you. You can get a good forecast on the home prices by referring to the CNN Money website that regularly publishes 12 month forecasts from reputable sources such as Fiserv.

2. Time horizon: If you are planning to buy the property in hopes of living there for atleast 5 years, then, this may be a good time to buy. Most markets will continue to show declines, or move side-ways for a better part of 2008. The markets will start stabilizing if the mortgage rates drop another 0.5-1% in addition to a reduction in inventory. If you have a time horizon of 5 years, this is an excellent time to drive a hard bargain and get a 30 year fixed rate mortgage.

Lastly, all things equal i.e. the rent vs. buy differential is minimal, you can comfortably afford the mortgage payments (Read the ratio of monthly mortgage payments to gross monthly income is 28% or less than 30%), the single most important factor that should drive your purchase decision should be home prices. Check out this blog for announcement on an exciting new tool we are launching to help you in this area !!!

These are interesting times for homebuyers. The reduction in the Federal Funds rate by 50 basis points or 0.5% bodes well for the mortgage rates and may drive them down providing much needed relief to homebuyers and homeowners. This added to the fact that lenders and homebuyers won’t again (atleast in the short term) go crazy with bad lending and over building respectively, may prevent the bottom from falling off! So, is this a good time to step in ? The answer is ‘It depends’!

If you are planning to buy a house for atleast 3-5 years, then, it may be a good time to get in. Again, it’s crucial not to buy a house beyond one’s means. For e.g. if prices have fallen in your area, don’t try and buy the largest house a mortgage can get you into. That will spell trouble ! This is a great time to buy a ‘house on sale’ - a house you would have rationally saved for and planned for, rather than a Mac Mansion. Don’t get into an ARM even if the rates dip a bit, because, rates are still historically low, and getting an ARM to buy the most house you can afford will land many in trouble.

When housing starts and sales are poor, rents go up, and the advantage of buying vs. renting  grows, as homebuyers,typically, by paying a little more than rent can buy a home with its obvious advantages - build equity, potential tax savings. So, if that’s the case in your case, just consider buying a home with a simple fixed rate mortgage, and stay put for 5 years. Although, the worst may not be over in the housing area, the builders won’t be contributing to the problem in the short term, and the lenders will be cautious about overexposing themselves to too much sub-prime credit, thus, alleviating atleast part of the problems we saw in 2007.

Last week, the Federal Reserve chairman Mr. Ben Bernanke announced a cut of 50 basis points or 0.5% in the Federal Funds rate. The market welcomed the news and all major stock indices responded positively. This rate cut may come as a welcome relief for aspiring homebuyers as well as beleaguered home-owners who may find it more affordable to get a mortgage or refinance an existing home. However, they should be very cautious before they tread again into the world of risky mortgages. The slowing US economy may have contributed to the rate cut, and if the fears about a recession are realized, borrowing risky money due to lower interest rates may once again come to haunt homebuyers. The housing market is not out of the woods yet, and a slowing or an economy in recession may take a bite out of any relief the rate cut may offer, so, stick to the basics - assess the home based on its economics (price), downpayment (20%), your ability to pay the housing payments such that they do not exceed 30% of your monthly gross income and the duration of stay.Stay safe !

On August 31st, President Bush announced that his government was ready to step up and help the subprime borrowers wade through the mortgage crisis and protect their homes. The stock market reacted well to the announcement and most stock guages ended the day higher. This is a welcome move, however, the duration of such an action will have to be pronounced or atleast spread over 1-3 years to cover the large number of sub-prime and risky loans that have proliferated over the last 1-3 years. In addition, the Federal Reserve will have to cut the federal funds rate by several basis points to provide relief to homebuyers on the interest they pay for the mortgage. Regulation aimed at catching predatory lending practices, mandatory disclosure on the risks associated with any kind of adjustable mortgages will also help.

The mortgage crisis is not over ! The effect of the subprime mess will be felt until the end of 2009. All involved - lenders, borrowers and legislators have 1 1/2 years to clean up their acts !

Don’t buy a home even if a lender offers you a mortgage without verifying your income or your documents. No matter how tempting the mortgage offer is, don’t buy the mortgage without taking a hard look at your finances. Are the mortgage payments more than 50% of your monthly gross income ? If so, stay away from the mortgage. If the mortgage offers you a low teaser rate, ask the lender how the interest rates may reset in the future. Calculate the mortgage payments at the reset interest rate. Can you afford them ? If you can’t, don’t buy the mortgage. Remember, if you can’t make the mortgage payments and foreclose on the house, it will wreck your finances and upset your life ! The lender will sell your loan to another buyer, and frankly, you will be ‘left holding the bag’. No docs or no income verification loan offers may help you bypass the hard evaluation every homebuyer should make before he or she buys a home, but make no mistake, it doesn’t change the reality once you own the home and the mortgage payments kick in !

The stock market is in disarray. The volatility is scaring even the most well entrenched of financial institutions. The rumor in the market today was that Countrywide Financial was having a tough time raising money. How does all this impact the homebuyer ?

If the economy faces a ‘credit crunch’ i.e. if borrowers face difficulty in raising capital, typically, they have to pay more to raise the same amount of capital. Thus, the increase in the borrowing cost by the lenders ultimately trickles down to the home-buyer in the form of higher interest rates. This increases the mortgage payments. However, there’s a silver lining to this mortgage mess if you are not a sub-prime borrower.

Slipping home prices have opened the doors to home ownership. The increase in interest rates is being partially offset by the decrease in home prices i.e. although buyers may buy mortgages at higher interest rates, for the same amount of downpayment, the amount they will have to borrow will be lower.

Aspiring homebuyers can track the following signs to ‘time’ the market:

1. Track the sale prices of comparable homes for a period of 3-6 months before they plan to buy - have the prices been steadily slipping or are they holding up ? A call to a local broker or online search on sites such as zillow.com can provide  more clues on this topic. If the prices have stabilized, if the inventory of homes on the market has declined, if homes are getting sold faster than they were 3-6 months ago, these may be signs that the prices may be stabilizing.

2.  ‘Houses on sale’ ? - The markets that have seen the highest growth in home prices over the last 1-2 years, say, markets like Las Vegas etc. are most vulnerable to steep declines because buyers overpaid for their houses, however, in markets such as the SF Bay Area, which have seen strong if not spectacular price increases, chances are that markdowns on prices may actually offer a bargain. Check out resources such as the OHFEO HPI (Home Price Index ) (google it !) or the National Association of Realtors (nar.org website) or cnnfn.com/realestate for information on recent house price trends.

You may hedge your bet by ensuring that you get a good deal from the buyer - low ball the selling price by 5-10%, get the fellow to chip in for closing costs, ask him to ’sweeten the pot’ by paying for minor repairs around the house.

3. Save up that 20% downpayment - Don’t buy risky mortgages unless you are confident that you can meet your mortgage payments if interest rates go up. Best bet is to save up that 20% downpayment before you enter the market. A higher downpayment lowers the amount you need to borrow, and ultimately, reduces your interest costs, thus, lowering your exposure to interest rate increases, besides, a 20% downpayment will almost guarantee you a fixed rate mortgage which is the safest bet today.