Ergodicity: The Coolest Idea You’ve Never Heard Of – The Best Interest

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Surely that’s a typo…ergodicity!? No, it’s right! Ergodicity is a powerful concept in economic theory, investing, and personal finance.

Even if the name seems wild to you, the idea is simple—stick with me while I explain it. And then we’ll apply ergodicity to retirement planning and investing ideas.

By the end of this article, you’re going to be seeing ergodic systems and non-ergodic systems all over your life!

Ergodic, Non-Ergodic, and Russian Roulette

Ergodicity compares the time average of a system against the expected value of that system. Let’s explain those two terms: time average and expected value.

The time average asks, “If we did something a million, billion, trillion times…what would we expect the results to look like?” It needs to be a sufficiently long random sample.

The expected value asks, “By simply averaging probabilities, where would we expect the result to be?”

At first blush, you might think, “Those two are the same thing…right?” Right! Or, at least you’d be right if the system in question is ergodic.

I flip a coin a billion times, and I end up with a time average of 50/50 heads and tails. Alternatively, I could just use their known probabilities and surmise the expected value of 50/50.

In this case, the time average and the expected value are the same. Therefore, the system—coin flipping—is ergodic.

But let’s contrast coin flips against Russian Roulette. The expected value of Russian Roulette is optimistic. ~83% success and ~17% failure. But what happens if one “plays” a million times? Ahh! I think you’d agree that the time average of Russian Roulette is 100% failure.

When one fails in Russian Roulette, it is a devastating failure. To only look at the expected value of the system is too simple. The expected value is far different than the time average. Thus, Russian Roulette is non-ergodic.

Ergodicity –> Over and Over, Big & Small

Ergodicity rears its head in two circumstances. First, ergodicity matters when we do things over and over and over. And second, ergodicity matters when certain outcomes are meaningful while other outcomes are insignificant.

To further explain ergodicity, imagine this bet:

I have a 100-sided die.

I’ll roll the die and you pick a number. If it lands on any other number than your number, then you win $1000.

But if it lands on your number, then Mike Tyson punches you in the face and takes your money.

What a deal! You call 99 of your friends and you all come to take this bet. Sure enough, one of your friends loses. But the rest of you win a combined $99,000 and agree to pay for his medical bills (which may or may not be covered by the $99K…which is another crazy blog post waiting to happen).

The “ensemble average” is that you won! One individual loss doesn’t change that.

But would that result be the same if you had played 100 times by yourself? No! In that scenario, there’s a 63% chance that you’d eventually lose the roll, lose your money, and get punched in the face.

The expected value (you and all your friends) is different than the time average (you doing it 100x). This is not an ergodic process.

Revisiting Ergodicity & Coin Flips

We concluded earlier that coin flips are ergodic. The expected value of a single coin flip equals the time average results of many coin flips.

But let’s change the rules a bit. Imagine I promised you a 40% positive return on heads but a 30% loss on tails. You start with $100,000. Would you take this bet?

Again, let’s call up 100 of your friends. You each take the bet.

We can predict that half of you will end up with $140K (40% return) and half end up with $70K (a 30% loss). On average, you each have $105K. As a group, you’ll end up 5% higher than you started.

Sure enough, we can run this simulation a million times and that’s exactly what we see. Both the mean and median results of these simulation show a 5% profit. Taking the bet was smart.

But what if you took the bet 100 times? Same result?

Same for You?

To start, let’s look at two common snippets in the sequence of returns: one win followed by one loss, and one loss followed by one win.

Win then loss

Loss then win

(You mathematicians will see the commutative property at play. The order of this multiplication didn’t matter.)

This result completely shifts our mindset.

When two people share a win/loss, then end up with $140K+$70K = $210K, or $105K each. They gain $5K. But when one person sequentially suffers a win/loss, she ends up with $98K, or a $2K loss.

What happens if you take this bet 100 times in a row? On average, you are going to lose money. Let’s look at a 50/50 heads/tails split.

Group 50/50:

That’s a 5% profit.

You 50/50:

That’s a 64% loss

But you might “spike” a certain run where you get more heads than tails. What happens if the group gets 60 heads and 40 tails? What happens if you get 60 heads and 40 tails?

Group 60/40:

You 60/40:

That’s…a big profit. $37.3 million.

I simulated the “you get 100 flips” case 100,000 times. As expected, the median result is a 64% loss. But the best result of the 100K simulations turns your $100K bet into $950 million dollars (68 heads, 32 tails).

This bet is non-ergodic. The expected value (100 friends scenario) is completely different than the time average (you 100x bets scenario).

But it’s also interesting that the distribution in the expected value case is tight (low risk, low reward) while the distribution in the time average case is extremely wide (high risk, potentially high reward).

EV is a profit, while time average is a loss. EV is low variance, while time average is high variance.

In case you can’t tell, ergodicity economics and subsequent economic theory is a serious field. There are big conversations taking place and serious money to be made (or lost).

But let’s focus a little closer to home: ergodicity and retirement.

Ergodicity and Retirement

In retirement planning, probability of success is often used as a figure of merit. I’ve used it here on the blog.

For example, the famous Trinity Study and 4% Rule cite a “95% chance of success,” where success is equivalent to “not running out of money before you die.”

Die with money? Success! Die without money? Failure! This is an expected value metric—for 95% of all people, the 4% rule would have worked.

But a few problems in this thinking immediately arise and ergodicity is to blame.

Problem 1: Equal and Opposite?

The 5% of retirement fail cases are painful. Very painful. I would argue that the pain of failure in retirement is greater than the joy of success.

This is reminiscent of loss aversion, or the “tendency to prefer avoiding losses to acquiring equivalent gains.” The keyword in loss aversion is “equivalent.” People would rather avoid a $100 parking ticket than win a $100 lotto ticket. Those are equivalent. And yes, loss aversion is irrational.

But is failing in retirement equivalent-and-opposite to succeeding in retirement? I’d argue no. Failing in retirement is akin to a Russian Roulette loss. Devastating! And succeeding in retirement is a Russian Roulette win. It’s “expected.”

Problem 2: Expected Value & Risk Sharing

Let’s assume we all follow the 4% rule. And true to historical form, let’s assume that 95% of us have successful retirements, but 5% of us “fail” and run out of money.

In the previous examples—100 friends and Mike Tyson, or 100 friends and the 40% win/30% loss coin flip—we assumed that the group would share the risk and share the reward.

This guaranteed that we’d see profits, but eliminated our chance to win $950 million. This guaranteed that even if we did get face-punched by Mike Tyson, our winning friends would still help us out.

But in retirement planning, people do not share risk. The 95% winners have no obligation to bail out the 5% losers. This changes the game. This isn’t traditional ergodicity.

Instead, we’re all in the game by ourselves (like the time average participant), but only have one shot to get it right (lest our retirement plan fail). From the ergodicity point of view, it’s a conundrum. It’s like playing Russian Roulette with a 20-chamber gun (5% failure = 1 chance in 20).

How do potential retirees react to this change in the rules?

For starters, many real retirement plans are couched with so much conservatism that the retiree ends up with more money when they die than when they retired. Put another way—their investment gains outpace their ability to spend.

And we know that money is time. Therefore, we can conclude that many people work for years more than they need to. They’re cursing at spreadsheets when they could be sipping mojitos. Pardon my 2020 vernacular, but this is an abundance of caution.

Is there an ergodic solution to this over-cautious planning?

Does Ergodicity Have a Solution?

What did we learn from Mike Tyson ergodicity example? What did we learn from our coin flipping?

If we share risk, we reduce our potential upside but also eliminate downside.

Imagine that 100 retirees pool a portion of their money together. They all know that 95% of them won’t need to dip into that pool. They also know that their money in the pool is probably going to have worse returns than it would outside of that pool.

However! These 100 retirees also realize that the pool will save 5 of them from failure. And thus, the pool guarantees that their retirement will be successful. Instead of 100% of them worrying about a 5% downside, now none of them need to be concerned.

The purpose of investing is not to simply optimise returns and make yourself rich. The purpose is not to die poor.

William Bernstein

Some of you will know that this “pool” concept already exists. It’s called an annuity.

Annuities?! Jesse, You Son of a B…

Wait, wait, don’t shoot me! Besides, you only have one bullet in those 20 chambers (thank ergodicity)

Real quick: an annuity is a financial product where a customer pays a lump sum upfront in return for a series of payments over the rest of their life. Insurance companies often sell annuities.

Annuities—on average—are losing propositions. Just like my pool above, the average annuitant will suffer via opportunity costs. Their money—on average—is better invested elsewhere.

Insurance protects wealth. It doesn’t build wealth.

Ben Carlson

Never let someone convince you that an insurance product is going to build your wealth. Why? There are only two parties involved—you and the insurance company. If you’re building wealth, then the insurance company is…losing money? No way.

Insurance products are equivalent to average mutual funs with high fees. The high fees drain you like a vampire bat. They make money, and you lose via opportunity costs.

But one thing that annuities get right is that they hedge against downside risk in your retirement planning. The insurance company—i.e. my pool in the example above—collects a loss from most customers in order to provide a vital win to few customers.

This is just like real insurance. Most people pay more in insurance premiums—for their house, their car, their medical life—then they ever see in payouts. But for a vital few, insurance saves them from complete disaster.

Of course, detractors will rightly point out that annuities aren’t always guaranteed. If the insurance company goes belly-up, your state guarantor might only cover a portion of what you’re owed. Yes—that means your risk mitigation technique has risk itself. Riskception.

Annuities aren’t perfect. I don’t plan on buying one. But if the ergodicity of retirement planning has you fretting small chances of failure, annuities are one way to hedge that downside.

Is Robin Hood Ergodic?

Jesse is a boring index fund investor. It’s true.

But not Robin. She day-trades on Robin Hood, often experimenting with exotic trades with high leverage.

We can examine Jesse and Robin using ergodicity.

Jesse is playing the long game. In this simple hypothetical, his yearly returns are +30%, +10%, then -15%. The same three-year cycle keeps repeating. One might look at those three values and think, “Ah. About 8.3% per year, on average.”

Robin thinks daily. She wants money now. In this hypothetical, her daily returns are +60%, +15%, and -50%. The same three-day cycle keeps repeating. Again, one might look at those three values and think, “Ah. About 8.3% per day, on average.”

You might see a problem. We’ve used the arithmetic mean here. The arithmetic mean is useful in finding the expected value, in ergodicity terms. If Person A gains 60%, Person B gains 15%, and Person C loses 50%, their average change is an 8% gain.

But sequencing investment returns—e.g. the ergodicity time average—requires that we use a logarithmic average. So let’s do that below:

[note: exp = the exponential function, ln = the natural log]

Uh oh. Robin’s log average return is negative. And sure enough, if Robin executed this particular day-trading strategy, she would turn her $10,000 into $500 in less than four months. Meanwhile, Jesse is fine with his 6.7% annual return (trust me…he is).

The simple lesson is one that new investors love to scream from the rooftops (and that’s a good thing). Namely, a given portfolio loss requires a larger equivalent gain to return back to even. The arithmetic mean does not capture this fact, while the log mean does.

The larger the loss, the more significant the returning gain needs to be. That’s another ergodicity concept.

E.g. a 1% loss is offset by a 1.01% gain—they’re essentially the same. But a 50% loss—like the one Robin suffers every third day—requires a 100% gain to offset it

Just like we said earlier in the post—big risks matter most, and those large downsides are when we’re likely to see non-ergodic systems.

Everyday Ergodicity

I would argue that a smooth, ergodic personal life is also optimal. Imagine ranking your days on a scale of 1-10. Would you rather have half 10’s and half 4s? Or all dependable 7’s? Or two-thirds 10’s and one-third 1’s?

To each their own. I’d prefer the 7’s. I don’t want half my days to be “bad,” even if the flip side of that coin is that half my days are “perfect.”

Don’t make ‘perfect’ the enemy of good enough.

-Someone at Jesse’ work

Maybe it’s boring. Maybe it’s the same muscle that pushes me towards indexing and away from Gamestop. To each their own. But I’ll take the 7’s.

Ergodicity in Grad School

In grad school, I studied fluid dynamics. See—this is me! Specifically, I worked on reaction-diffusion-advection problems in the University of Rochester Mixing Lab.

Fluid mixing is a terrific example of ergodicity. Take a few seconds to watch the video below. It’s a pretty way to view equilibrium statistic physics. Ergodicity applies to many different dynamical systems, stochastic processes, thermodynamic equilibrium problems, etc. It’s a mechanical engineer’s dream.

Ergodic mixing

If we mix sufficiently, we see that small sub-sections of the fluid are representative of the fluid as a whole. The time average of many mixes is equal to our expected value of a uniform mix. This is ergodicity. This system is ergodic.

If this was butter and sugar—soon to be cookies—we could take any teaspoon of the mixture and draw reasonable assumptions about the mixture as a whole. Mmmmm!

But imagine if we accidentally introduce a dog hair into the mix (not that that’s ever happened in my kitchen). Suddenly, the mix is no longer ergodic.

Why? The expected value of any given cookie is that it will not contain the dog hair. But of course, eat enough of the cookies and you’ll eventually find the hair.

Or put another way, a single teaspoon of the mixture—which will contain either the entire dog hair or no dog hair at all—is no longer representative of the total mixture.

Good Article. Ergo…

Ergo it’s time for the summary.

Ergodicity is a fun concept. Or at least fun for nerds like me. It’s a terrific way to consider risk. It helps us in behavioral economics, personal finance, and real retirement planning.

What do you think? Any cool ergodic or non-ergodic systems in your life?

If you enjoyed this article and want to read more, I’d suggest checking out my Archive or Subscribing to get future articles emailed to your inbox.

This article—just like every other—is supported by readers like you.

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Tagged ergodicity, retirement, risk, statistics

Source: bestinterest.blog

Ergodicity: The Coolest Idea You’ve Never Heard Of

Table of Contents show

Share This Post:

Surely that’s a typo…ergodicity!? No, it’s right! Ergodicity is a powerful concept in economic theory, investing, and personal finance.

Even if the name seems wild to you, the idea is simple—stick with me while I explain it. And then we’ll apply ergodicity to retirement planning and investing ideas.

By the end of this article, you’re going to be seeing ergodic systems and non-ergodic systems all over your life!

Ergodic, Non-Ergodic, and Russian Roulette

Ergodicity compares the time average of a system against the expected value of that system. Let’s explain those two terms: time average and expected value.

The time average asks, “If we did something a million, billion, trillion times…what would we expect the results to look like?” It needs to be a sufficiently long random sample.

The expected value asks, “By simply averaging probabilities, where would we expect the result to be?”

At first blush, you might think, “Those two are the same thing…right?” Right! Or, at least you’d be right if the system in question is ergodic.

I flip a coin a billion times, and I end up with a time average of 50/50 heads and tails. Alternatively, I could just use their known probabilities and surmise the expected value of 50/50.

In this case, the time average and the expected value are the same. Therefore, the system—coin flipping—is ergodic.

But let’s contrast coin flips against Russian Roulette. The expected value of Russian Roulette is optimistic. ~83% success and ~17% failure. But what happens if one “plays” a million times? Ahh! I think you’d agree that the time average of Russian Roulette is 100% failure.

When one fails in Russian Roulette, it is a devastating failure. To only look at the expected value of the system is too simple. The expected value is far different than the time average. Thus, Russian Roulette is non-ergodic.

Ergodicity –> Over and Over, Big & Small

Ergodicity rears its head in two circumstances. First, ergodicity matters when we do things over and over and over. And second, ergodicity matters when certain outcomes are meaningful while other outcomes are insignificant.

To further explain ergodicity, imagine this bet:

I have a 100-sided die.

I’ll roll the die and you pick a number. If it lands on any other number than your number, then you win $1000.

But if it lands on your number, then Mike Tyson punches you in the face and takes your money.

What a deal! You call 99 of your friends and you all come to take this bet. Sure enough, one of your friends loses. But the rest of you win a combined $99,000 and agree to pay for his medical bills (which may or may not be covered by the $99K…which is another crazy blog post waiting to happen).

The “ensemble average” is that you won! One individual loss doesn’t change that.

But would that result be the same if you had played 100 times by yourself? No! In that scenario, there’s a 63% chance that you’d eventually lose the roll, lose your money, and get punched in the face.

The expected value (you and all your friends) is different than the time average (you doing it 100x). This is not an ergodic process.

Revisiting Ergodicity & Coin Flips

We concluded earlier that coin flips are ergodic. The expected value of a single coin flip equals the time average results of many coin flips.

But let’s change the rules a bit. Imagine I promised you a 40% positive return on heads but a 30% loss on tails. You start with $100,000. Would you take this bet?

Again, let’s call up 100 of your friends. You each take the bet.

We can predict that half of you will end up with $140K (40% return) and half end up with $70K (a 30% loss). On average, you each have $105K. As a group, you’ll end up 5% higher than you started.

Sure enough, we can run this simulation a million times and that’s exactly what we see. Both the mean and median results of these simulation show a 5% profit. Taking the bet was smart.

But what if you took the bet 100 times? Same result?

Same for You?

To start, let’s look at two common snippets in the sequence of returns: one win followed by one loss, and one loss followed by one win.

Win then loss

Loss then win

(You mathematicians will see the commutative property at play. The order of this multiplication didn’t matter.)

This result completely shifts our mindset.

When two people share a win/loss, then end up with $140K+$70K = $210K, or $105K each. They gain $5K. But when one person sequentially suffers a win/loss, she ends up with $98K, or a $2K loss.

What happens if you take this bet 100 times in a row? On average, you are going to lose money. Let’s look at a 50/50 heads/tails split.

Group 50/50:

That’s a 5% profit.

You 50/50:

That’s a 64% loss

But you might “spike” a certain run where you get more heads than tails. What happens if the group gets 60 heads and 40 tails? What happens if you get 60 heads and 40 tails?

Group 60/40:

You 60/40:

That’s…a big profit. $37.3 million.

I simulated the “you get 100 flips” case 100,000 times. As expected, the median result is a 64% loss. But the best result of the 100K simulations turns your $100K bet into $950 million dollars (68 heads, 32 tails).

This bet is non-ergodic. The expected value (100 friends scenario) is completely different than the time average (you 100x bets scenario).

But it’s also interesting that the distribution in the expected value case is tight (low risk, low reward) while the distribution in the time average case is extremely wide (high risk, potentially high reward).

EV is a profit, while time average is a loss. EV is low variance, while time average is high variance.

In case you can’t tell, ergodicity economics and subsequent economic theory is a serious field. There are big conversations taking place and serious money to be made (or lost).

But let’s focus a little closer to home: ergodicity and retirement.

Ergodicity and Retirement

In retirement planning, probability of success is often used as a figure of merit. I’ve used it here on the blog.

For example, the famous Trinity Study and 4% Rule cite a “95% chance of success,” where success is equivalent to “not running out of money before you die.”

Die with money? Success! Die without money? Failure! This is an expected value metric—for 95% of all people, the 4% rule would have worked.

But a few problems in this thinking immediately arise and ergodicity is to blame.

Problem 1: Equal and Opposite?

The 5% of retirement fail cases are painful. Very painful. I would argue that the pain of failure in retirement is greater than the joy of success.

This is reminiscent of loss aversion, or the “tendency to prefer avoiding losses to acquiring equivalent gains.” The keyword in loss aversion is “equivalent.” People would rather avoid a $100 parking ticket than win a $100 lotto ticket. Those are equivalent. And yes, loss aversion is irrational.

But is failing in retirement equivalent-and-opposite to succeeding in retirement? I’d argue no. Failing in retirement is akin to a Russian Roulette loss. Devastating! And succeeding in retirement is a Russian Roulette win. It’s “expected.”

Problem 2: Expected Value & Risk Sharing

Let’s assume we all follow the 4% rule. And true to historical form, let’s assume that 95% of us have successful retirements, but 5% of us “fail” and run out of money.

In the previous examples—100 friends and Mike Tyson, or 100 friends and the 40% win/30% loss coin flip—we assumed that the group would share the risk and share the reward.

This guaranteed that we’d see profits, but eliminated our chance to win $950 million. This guaranteed that even if we did get face-punched by Mike Tyson, our winning friends would still help us out.

But in retirement planning, people do not share risk. The 95% winners have no obligation to bail out the 5% losers. This changes the game. This isn’t traditional ergodicity.

Instead, we’re all in the game by ourselves (like the time average participant), but only have one shot to get it right (lest our retirement plan fail). From the ergodicity point of view, it’s a conundrum. It’s like playing Russian Roulette with a 20-chamber gun (5% failure = 1 chance in 20).

How do potential retirees react to this change in the rules?

For starters, many real retirement plans are couched with so much conservatism that the retiree ends up with more money when they die than when they retired. Put another way—their investment gains outpace their ability to spend.

And we know that money is time. Therefore, we can conclude that many people work for years more than they need to. They’re cursing at spreadsheets when they could be sipping mojitos. Pardon my 2020 vernacular, but this is an abundance of caution.

Is there an ergodic solution to this over-cautious planning?

Does Ergodicity Have a Solution?

What did we learn from Mike Tyson ergodicity example? What did we learn from our coin flipping?

If we share risk, we reduce our potential upside but also eliminate downside.

Imagine that 100 retirees pool a portion of their money together. They all know that 95% of them won’t need to dip into that pool. They also know that their money in the pool is probably going to have worse returns than it would outside of that pool.

However! These 100 retirees also realize that the pool will save 5 of them from failure. And thus, the pool guarantees that their retirement will be successful. Instead of 100% of them worrying about a 5% downside, now none of them need to be concerned.

The purpose of investing is not to simply optimise returns and make yourself rich. The purpose is not to die poor.

William Bernstein

Some of you will know that this “pool” concept already exists. It’s called an annuity.

Annuities?! Jesse, You Son of a B…

Wait, wait, don’t shoot me! Besides, you only have one bullet in those 20 chambers (thank ergodicity)

Real quick: an annuity is a financial product where a customer pays a lump sum upfront in return for a series of payments over the rest of their life. Insurance companies often sell annuities.

Annuities—on average—are losing propositions. Just like my pool above, the average annuitant will suffer via opportunity costs. Their money—on average—is better invested elsewhere.

Insurance protects wealth. It doesn’t build wealth.

Ben Carlson

Never let someone convince you that an insurance product is going to build your wealth. Why? There are only two parties involved—you and the insurance company. If you’re building wealth, then the insurance company is…losing money? No way.

Insurance products are equivalent to average mutual funs with high fees. The high fees drain you like a vampire bat. They make money, and you lose via opportunity costs.

But one thing that annuities get right is that they hedge against downside risk in your retirement planning. The insurance company—i.e. my pool in the example above—collects a loss from most customers in order to provide a vital win to few customers.

This is just like real insurance. Most people pay more in insurance premiums—for their house, their car, their medical life—then they ever see in payouts. But for a vital few, insurance saves them from complete disaster.

Of course, detractors will rightly point out that annuities aren’t always guaranteed. If the insurance company goes belly-up, your state guarantor might only cover a portion of what you’re owed. Yes—that means your risk mitigation technique has risk itself. Riskception.

Annuities aren’t perfect. I don’t plan on buying one. But if the ergodicity of retirement planning has you fretting small chances of failure, annuities are one way to hedge that downside.

Is Robin Hood Ergodic?

Jesse is a boring index fund investor. It’s true.

But not Robin. She day-trades on Robin Hood, often experimenting with exotic trades with high leverage.

We can examine Jesse and Robin using ergodicity.

Jesse is playing the long game. In this simple hypothetical, his yearly returns are +30%, +10%, then -15%. The same three-year cycle keeps repeating. One might look at those three values and think, “Ah. About 8.3% per year, on average.”

Robin thinks daily. She wants money now. In this hypothetical, her daily returns are +60%, +15%, and -50%. The same three-day cycle keeps repeating. Again, one might look at those three values and think, “Ah. About 8.3% per day, on average.”

You might see a problem. We’ve used the arithmetic mean here. The arithmetic mean is useful in finding the expected value, in ergodicity terms. If Person A gains 60%, Person B gains 15%, and Person C loses 50%, their average change is an 8% gain.

But sequencing investment returns—e.g. the ergodicity time average—requires that we use a logarithmic average. So let’s do that below:

[note: exp = the exponential function, ln = the natural log]

Uh oh. Robin’s log average return is negative. And sure enough, if Robin executed this particular day-trading strategy, she would turn her $10,000 into $500 in less than four months. Meanwhile, Jesse is fine with his 6.7% annual return (trust me…he is).

The simple lesson is one that new investors love to scream from the rooftops (and that’s a good thing). Namely, a given portfolio loss requires a larger equivalent gain to return back to even. The arithmetic mean does not capture this fact, while the log mean does.

The larger the loss, the more significant the returning gain needs to be. That’s another ergodicity concept.

E.g. a 1% loss is offset by a 1.01% gain—they’re essentially the same. But a 50% loss—like the one Robin suffers every third day—requires a 100% gain to offset it

Just like we said earlier in the post—big risks matter most, and those large downsides are when we’re likely to see non-ergodic systems.

Everyday Ergodicity

I would argue that a smooth, ergodic personal life is also optimal. Imagine ranking your days on a scale of 1-10. Would you rather have half 10’s and half 4s? Or all dependable 7’s? Or two-thirds 10’s and one-third 1’s?

To each their own. I’d prefer the 7’s. I don’t want half my days to be “bad,” even if the flip side of that coin is that half my days are “perfect.”

Don’t make ‘perfect’ the enemy of good enough.

-Someone at Jesse’ work

Maybe it’s boring. Maybe it’s the same muscle that pushes me towards indexing and away from Gamestop. To each their own. But I’ll take the 7’s.

Ergodicity in Grad School

In grad school, I studied fluid dynamics. See—this is me! Specifically, I worked on reaction-diffusion-advection problems in the University of Rochester Mixing Lab.

Fluid mixing is a terrific example of ergodicity. Take a few seconds to watch the video below. It’s a pretty way to view equilibrium statistic physics. Ergodicity applies to many different dynamical systems, stochastic processes, thermodynamic equilibrium problems, etc. It’s a mechanical engineer’s dream.

Ergodic mixing

If we mix sufficiently, we see that small sub-sections of the fluid are representative of the fluid as a whole. The time average of many mixes is equal to our expected value of a uniform mix. This is ergodicity. This system is ergodic.

If this was butter and sugar—soon to be cookies—we could take any teaspoon of the mixture and draw reasonable assumptions about the mixture as a whole. Mmmmm!

But imagine if we accidentally introduce a dog hair into the mix (not that that’s ever happened in my kitchen). Suddenly, the mix is no longer ergodic.

Why? The expected value of any given cookie is that it will not contain the dog hair. But of course, eat enough of the cookies and you’ll eventually find the hair.

Or put another way, a single teaspoon of the mixture—which will contain either the entire dog hair or no dog hair at all—is no longer representative of the total mixture.

Good Article. Ergo…

Ergo it’s time for the summary.

Ergodicity is a fun concept. Or at least fun for nerds like me. It’s a terrific way to consider risk. It helps us in behavioral economics, personal finance, and real retirement planning.

What do you think? Any cool ergodic or non-ergodic systems in your life?

If you enjoyed this article and want to read more, I’d suggest checking out my Archive or Subscribing to get future articles emailed to your inbox.

This article—just like every other—is supported by readers like you.

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Tagged ergodicity, retirement, risk, statistics

Source: bestinterest.blog

Do Personal Guarantees Affect Credit Scores?

December 15, 2020 &• min read by Garrett Sutton Comments 0 Comments

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Disclaimer

Whether you’re a solopreneur launching a start-up or a small-business owner seeking to grow your company, you might need extra funding. And if you’re looking for business loan, you might need a personal guarantee. Does a personal guarantee impact your credit and your own financial situation? Find out below.

What Does a Personal Guarantee Mean?

A personal guarantee means you personally promise that a debt will be paid back. If you sign a personal guarantee on a business loan, you are responsible for paying back the money if the business is unable to do so. The lender can try to collect the money from you, including by suing you.

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Why Would a Lender Require a Personal Guarantee?

Personal guarantees are all about reducing risk for the lender. If you sign one, it has two potential entities to chase to collect the loan. First, the lender will attempt to collect from the business itself. If the business doesn’t make payments as agreed or defaults on the loan, the lender will try to collect from you personally.

The benefits to the lender are pretty big. They’re much more likely to eventually recoup their investment, even if your business fails. That means many, though not all, small-business loan options do come with a personal guarantee requirement.

Some factors that can increase the chance that a lender might ask for a personal guarantee include:

  • You’re a solopreneur or very small business. In this case, the business’s reputation and credit is likely very tied to your own.
  • Your business is new and doesn’t yet have a solid credit history of its own. The lender can’t decide if the business is a good risk, but it can decide if you’re a good risk.
  • Your business doesn’t have enough income or collateral. If you’re trying to borrow money to grow your business, it might not make enough money for the lender to seriously consider shelling out funds. But if you’re confident in the growth plan and know money will come in once you implement it, you might put up your own collateral to secure the loan.

How Does a Personal Guarantee Affect Your Credit Score?

Whether or not a personal guarantee affects your credit score depends on the situation. First, business loans may or may not be reported on your credit history.

If you sign as a personal guarantor for a traditional business loan, the loan itself will be reported on your business’s credit report. Timely payments on that loan will help build your business’s credit history. Missing a payment could cause the business credit score to take a hit.

In these cases, your personal credit isn’t likely to be impacted. However, if the business defaults on the loan and the lender comes to you for payment, your credit history could start to take a hit. If you immediately make a payment to catch up the loan, you may not see any impact to your personal credit. If, however, you don’t pay and the account goes to collections, that’s likely to show up on both your personal and business credit histories.

Other types of business funding, including some small-business lines of credit and credit cards, do get reported on your personal credit. This can be a good thing if payments are made timely and as agreed, as you could get a bump on that for your own credit score. In the meantime, however, it does potentially impact your credit utilization ratio and your debt-to-income ratio.

Should You Sign a Personal Guarantee for a Business Loan?

This is a personal decision that depends on a variety of factors, including your confidence in the business. But here are a few questions to ask yourself before you take this action, which can have long-lasting consequences on your own personal finances.

  • Do you really need to guarantee the loan? Your business doesn’t need perfect credit to get a loan, and there are many financing options available. Make sure you explore all your resources and understand what they’ll cost you and your business before you decide on one.
  • Are you confident the business will be able to handle the debt? If the business is stable and you know it will be able to cover the debt, you have less risk in signing a personal guarantee.
  • Are you in control of how the business handles finances? If it’s your business and you’re the one who signs the checks, you can make sure the bills are paid on time. If someone else is handling the accounting, you may want to be wary about signing a personal guarantee.
  • Can you afford to take the hit if the business fails? There’s no such thing as a sure deal, and you can’t assume the business will 100% make it. That means you need to be able to make good on the debt yourself in a worst-case scenario without giving up your personal financial stability.

The Bottom Line

Ready to get that business loan? If you’ve thought it out—and analyzed your personal financial situation—start shopping for options today. If you’re wondering where to start, check out the business loans at Credit.com. You can compare rates and requirements, so you can find the right business loan for your needs. 


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Source: credit.com

Getting a mortgage without your spouse: What are the benefits and drawbacks?

Do you have to apply for a mortgage with your spouse?

Married couples buying a house — or refinancing their current home —
do not have to include both spouses on the mortgage.

In fact, sometimes having both spouses on a home loan application causes mortgage problems. For example, one spouse’s low credit score could make it harder to qualify or raise your interest rate. 

In those cases, it’s better to leave one spouse off the home loan.

Luckily, there are a wide range of mortgage programs including low- and no-down payment loans that make it easier for single applicants to buy a home. And today’s low rates make buying more affordable.

Verify your mortgage eligibility (Jan 23rd, 2021)


In this article (Skip to…)


Benefits of having one spouse on the mortgage

There a several reasons a
married couple might want to purchase a home in one spouse’s name only:
to protect the buyer’s interests, to plan their estate, to save money, or to
qualify for a mortgage.

Avoid credit issues on
your mortgage application

Serious mortgage problems can arise when one person
on a joint application has poor or damaged credit.

That’s because mortgage lenders pull a “merged” credit report with history and scores for each applicant, and they use the lowest of two scores or the middle of three scores to evaluate applications. The score they use is called the “representative” credit score.

Unfortunately with two applicants, lenders don’t
average out the representative scores. They discard the better applicant’s FICO
score completely and make an offer based on the lower one.

This could easily result is a
higher interest rate. Or, if your spouse’s credit score is low enough, you might
have trouble qualifying for a loan at all.

Credit scores below 580 will get
denied by most lenders. If one spouse has a score that low, the other should
think about going it alone.

Save money on mortgage
interest

If one spouse has passable credit
but the other has exceptional credit, the higher-credit spouse might consider
applying on their own to secure a lower mortgage rate.

This could save you thousands on
your home loan in the long term.

A few years ago,
the Federal Reserve studied mortgage costs and found something
startling. Of over 600,000 loans studied, ten percent could have
paid at least 0.125% less by having the more qualified buyer apply alone.

In addition, another 25
percent of borrowers could have “significantly reduced” their loan costs
this way.

It may pay to check with your
loan officer. For instance, if one borrower has a 699 FICO and the other has a
700 FICO, they’d save $500 in loan fees for every $100,000 borrowed due to
Fannie Mae fees for sub-700 scores.

The main drawback to this
strategy is that the sole borrower must now qualify without the help of their
spouse’s income. So for this to work, the spouse on the mortgage will likely
need a higher credit score and the larger income.

Verify your new rate (Jan 23rd, 2021)

Preserve assets if one spouse
is debt-challenged

Your home is an asset which
can be liened or confiscated in some cases. For instance, if your spouse has
defaulted student loans, unpaid taxes or child support, or unpaid judgments, he
or she might be vulnerable to asset confiscation.

By buying a house in your
name only, you protect it from creditors. Note that if your spouse incurred the
debt after marrying you, this protection may not apply.

This also applies if you’re
buying the place with money you had before marrying. If you purchase the house
with your own sole-and-separate funds, you probably want to keep it a
sole-and-separate house.

Simplify estate planning

Having the home in your name
simplifies estate planning, especially if this is your second marriage. For
instance, if you want to leave your house to your children from a previous
union, it’s easier to do when you don’t have to untangle the rights of your
current spouse to do it.

Head off divorce battles

Of course, you don’t plan on divorcing when you
marry. But if the state of your union is a little shaky, and you’re the
one doing the heavy lifting on the purchase, you might want to maintain control
by buying in your name only.

Verify your loan eligibility as a single borrower (Jan 23rd, 2021)

One
spouse on the mortgage: Drawbacks

If both spouses have comparable credit and shared estate planning,
it often makes sense to use a joint mortgage application.

That’s because leaving a creditworthy spouse off the mortgage can
sharply decrease your borrowing power.

Less income means less
buying power

The biggest drawback of leaving a spouse off your mortgage is that
their income typically can’t be counted on the application. This could have a
big impact on the amount you’re able to borrow.

In simple terms, more income means you can afford a larger monthly
mortgage payment. This increases your maximum loan amount.

As a result, couples applying for a mortgage jointly can often
afford larger and more expensive homes than single applicants.

Potentially higher
debt-to-income ratio

Leaving a spouse off the mortgage can also affect your debt-to-income ratio (DTI).

DTI is a key number lenders use to determine how much house you can
afford. By comparing your gross monthly income to your monthly debts —
including student loans, auto loans, and credit card payments — lenders can
determine how much money is ‘left over’ in your budget for a mortgage payment.

The higher your income, and the lower your debts, the more house you
can afford.

If one spouse is going it alone on the mortgage application and they have high debts, they could have a harder time meeting a lender’s DTI requirements. Or they may qualify, but for a smaller loan amount than expected. 

Then again, if one spouse has a lot of debt and does not earn the bulk of the income, it might make more sense to leave them off the application as it could ease up on the other spouse’s debt-to-income ratio.

What
if one spouse has high income but bad credit?

What if one spouse had great credit but can’t afford the home one
their income alone — and the other spouse has good income but poor credit?

In this case, a good solution could be the HomeReady loan from Fannie Mae.

This mortgage program allows you to count extra household income
toward your mortgage, without adding the other person as a full co-borrower on
the application.

That means the spouse with good credit could apply for the home loan
on their own and supplement their income with a portion of their partner’s
income to boost their borrowing power. Since the low-credit spouse is not on
the application, their poor credit score would not affect the loan eligibility
or interest rate. 

The HomeReady loan requires a minimum FICO score of 620 and a 3%
down payment.

In addition, the couple must prove they’ve been living together for
at least 12 months prior to the application in order for the non-applicant’s
income to be counted toward the mortgage.

Check your HomeReady loan eligibility (Jan 23rd, 2021)

Can
one spouse refinance a mortgage without the other?

If only one spouse is on the existing mortgage — for instance, if
they bought the home before getting married — that person is free to refinance
the mortgage in their name only. 

If both spouses are on the current mortgage, your options depend on
your refinance goals.

In situations where both spouses want to remain on a joint mortgage,
they must both apply for the new home loan, go through underwriting, and sign
the mortgage papers. It is not possible to refinance with only one borrower on
the application and still keep both your names on the mortgage.

Other times, a couple or divorced couple might want to refinance to remove one person’s name from the mortgage. This is possible, but the borrower being removed needs to agree to the arrangement.

It is not possible for one spouse to refinance a joint mortgage
without the other borrower’s knowledge or consent — that would be mortgage
fraud.

In addition, the spouse remaining on the mortgage needs to be able
to qualify for the loan on their own. That includes meeting credit score,
employment, income, and DTI requirements. And the person on the loan will have
to pay closing costs, as well.

Verify your refinance eligibility (Jan 23rd, 2021)

Can
one spouse be on the mortgage but both on the title?

If the main reason for
purchasing a house in your own name is to have a cheaper mortgage, or to
qualify for a mortgage, you can always add your significant other to the home’s
title after the loan is finalized. This would officially make you
“co-owners” of the home.

Just note, the person on the
mortgage loan is solely responsible for repayment.

The co-owner’s name listed on the title does not give them any legal responsibility to help with mortgage payments. And in the event of a foreclosure, only the spouse whose name is on the loan will have their credit damaged.

Can
both spouses on the mortgage but only one on the title?

There aren’t
too many times when you’d want to do this, because you’re on the hook for the
loan without the protection of any ownership interest. But there are instances
in which it would be appropriate.

For instance, if you needed
the property in just your name for estate-planning purposes, but could not
qualify for a mortgage on your own, your spouse might co-sign on the mortgage
for you. Or you could both be co-borrowers, because legally, only one mortgage
borrower has to be on title to the property.

However, many lenders prefer
that all borrowers also take title. That’s because technically, a borrower not
on title is not a borrower — just a guarantor.

Guarantors are not legally responsible for making monthly payments. They are liable only for loan balances if the primary borrower defaults. Lenders have to take an extra step and sue the guarantor if the borrower defaults, and they don’t like this.

Taking title as your “sole
and separate property” means that you both still get to live in the house — however,
only you have an ownership interest. Only your name is on the deed.

But this arrangement is not
always 100 percent straightforward.

You will probably have
to “quitclaim”

In community property states,
just taking title as sole and separate is not enough. That’s
because it shows you intend
the home to be yours and only yours, but it
does not indicate your spouse’s
wishes.

In community property
states, it’s assumed that anything acquired by either spouse during the
marriage is the property of both. That includes real estate.

A quitclaim deed, which your
spouse signs and you record with your county, identifies the grantor (the spouse
relinquishing rights to the property) and the grantee, who remains on title.

Community property states are
as follows:

  • Arizona
  • California
  • Idaho
  • Louisiana
  • Nevada
  • New Mexico
  • Texas
  • Washington
  • Wisconsin

In other states, you may also
have to quitclaim, so you can’t secretly buy real estate without your
spouse’s knowledge. And many lenders also require it for the same reason.

Government-backed
loans in community property states

One advantage of having the
mortgage and ownership in your name only doesn’t apply in community property
states. If you get a government-backed loan like FHA, VA or USDA financing,
your spouse’s separate debts still count in your debt-to-income ratios.

For these mortgages, the lender
may pull the non-borrower’s credit report to verify their debts. However, that
person’s credit score doesn’t count toward the application.

HUD guidelines state:

“The Lender must not consider
the credit history of a non-borrowing spouse. The non-borrowing spouse’s credit
history is not considered a reason to deny a mortgage application.

The lender must

  • Verify and document the debt of the non-borrowing spouse
  • Make a note in the file referencing the specific state law that justifies the exclusion of any debt from consideration
  • Obtain a credit report for the non-borrowing spouse in order to determine the debts that must be included in the liabilities”

Fortunately, other loan
programs don’t necessarily carry this requirement.

What are today’s mortgage rates?

Today’s mortgage rates are
excellent for both home purchases and refinancing. And you may
be able to reduce what you pay by only putting the most qualified applicant on
the mortgage. Check all your options to see what makes the most sense for your new
home loan.

Verify your new rate (Jan 23rd, 2021)

Source: themortgagereports.com

Podcast #13: Commercial Lending and Real Estate

podcast 13 commercial lending and real estate

For this podcast about commercial lending I sat down with Angie Hoffman at U.S. Bank.  During the podcast we discussed investing in real estate, commercial lending, and how commerceial mortgages can help investors.  If you want to learn more about commercial loans this is a great pdocast for you.

I hope you enjoy the podcast and find it informative.  Please consider sharing with those who also may benefit.

Listen via YouTube:

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You can connect with Angie on LinkedIn.  You can reach out to Angie for more information on their lending products by emailing her at angela.hoffman@usbank.com.

You can connect with me on Facebook, Pinterest, Twitter, LinkedIn, YouTube and Instagram.

About the author: The above article “Podcast #12:  Hard Money Lending” was provided by Luxury Real Estate Specialist Paul Sian. Paul can be reached at paul@CinciNKYRealEstate.com or by phone at 513-560-8002. If you’re thinking of selling or buying your investment or commercial business property I would love to share my marketing knowledge and expertise to help you.  Contact me today!

I work in the following Greater Cincinnati, OH and Northern KY areas: Alexandria, Amberly, Amelia, Anderson Township, Cincinnati, Batavia, Blue Ash, Covington, Edgewood, Florence, Fort Mitchell, Fort Thomas, Hebron, Hyde Park, Indian Hill, Kenwood, Madeira, Mariemont, Milford, Montgomery, Mt. Washington, Newport, Newtown, Norwood, Taylor Mill, Terrace Park, Union Township, and Villa Hills.

TRANSCRIPT

Commercial Lending Podcast

Paul Sian: Hello everybody. This is Paul Sian, Realtor with United Real Estate Home Connections, licensed in the State of Ohio and Kentucky. With me today is Angie Hoffman with US Bank. Angie how are you today?

Angie Hoffman: I’m doing great Paul. How are you?

Paul Sian:  Great. Thank you for being on my podcast. We’re gonna start off. Today’s topic is ‘Commercial Lending’. Angie is a commercial lender with US Bank, as I mentioned. Angie, why don’t you tell us a little bit by your background. What you do with the US bank, and how did you get started in that field?

Angie Hoffman: Sure. So, I am a Cincinnati resident, have been my entire life. Was previously with a company called the ‘Conner group’, which is located out of Dayton, Ohio. They’re a private investment real estate firm. I was with him for about five plus years, just learned a ton of information, really loved the financing portion of their group. So, that turned me to the banking portion, which I ended up going with US Bank just because of the knowledge and the breadth of what they can do as well. Just the culture within US Bank has been phenomenal. I’ve actually been with us Bank now for five years; in the last three years I’ve been within the commercial real estate side as well as the business banking side.

Paul Sian: Okay. Your primary focus is commercial loans.

Angie Hoffman: Correct. Yes, both investment real estate as well as owner-occupied and small to medium businesses. 

Paul Sian:  Okay. The investment side, I represent a lot of buyers of multifamily. I know with the form below we do, the conventional space generally, and then when you’re in the five units and above. You go into the commercial space, which is your space. I have also heard it being covered with mixed-use buildings, industrial properties, is there something else that commercial loans would cover?

Angie Hoffman: Correct. I mean it can really be quite an array of properties, office is one that we see pretty often, and can tend to be either hot in certain areas, whether it’s office Class B or Office Class A. Retail strip centers, we’ll look at Triple Net properties, and absolute not properties. We are very popular, if you’re looking at diversifying a multi-family portfolio and adding in some triple net properties. We also do, obviously owner-occupied properties too. When you have that small business or medium business owner who wants to own their own real estate. We do that as well, and that’s again part of what my position entails, and then we will also look at portfolios will do single-family homes. 

I’m actually working with somebody now who has a portfolio of several single-family homes, that were looking to kind of restructure and refinance for him. We can even utilize current equity and properties to purchase additional properties to help you grow your portfolio. We do try to have a full understanding of your portfolio or a full understanding of what your strategy is. How partner with you, as you continue to grow that portfolio short- and long-term goals.

Paul Sian: For our listeners, who don’t know. What Triple Net means, do you mind explaining that.

Angie Hoffman:  Sure. So, Triple Net is gonna tend to be your properties that have the tenant itself is paying the taxes, the insurance, you may have some pretty minimal depending upon the property, responsibilities that are usually restricted to the exterior of the building. It may be like a roof or a parking lot. Type of maintenance but generally speaking the great thing about the triple net is that for some clients, it’s a property that you can basically own, and you have to do pretty much nothing with. So, you’re gaining that income without having to do a very minimal type of responsibility or maintenance. 

The downfall of that is that typically they’re gonna be somebody, who is gonna be a longer-term lease, which is great. However, you still have the issue that it’s a bigger square footage generally. So, five, ten, twenty thousand plus square feet. If you lose a tenant obviously, that can be very impactful. It just depends upon your, again your focus of your portfolio, and if you want to add in that. But it can be great opportunity, but tends to again be a little bit less of a return. Because of the minimal responsibilities.

Paul Sian: Going back to single family. That is similar, I am using the same term your bank use but to ‘wrap mortgage’. Is that what you use for single families?

Angie Hoffman:  We do have the ability, from the perspective of what you say wrap mortgage.  We’re typically calling that like an umbrella, if you’re grouping all, let’s call it, if there’s ten single family homes. You’re grouping this all into one, it lies together. We have the ability to do that depending again on the structure that the client is looking for. 

We also have the ability to separate out those facilities, and do a simultaneous closing for each one of them to have them separated out from each other. Obviously, there’s some contingencies but that the properties itself have to be able to cash flow by themselves, things along those lines that we would underwrite to. But we do have ability to look at it from both perspectives.

Paul Sian: Okay. The biggest advantage of that if someone has reached the maximum ten convention mortgage loanlimit. They can step into your space there and you could cover them, and they can either restart that or. With something like that, let’s say somebody does get ten properties, and are they able to finance in additional properties into that same loan or is that has to re-finance each time?

Angie Hoffman: No. We would be able to add in. I mean, if you’re asking like if they want to refinance these properties, and they’re also looking to maybe either use some of the equity in them or they’re also buying at the same time. We can do all of that together, so that’s not an issue at all.

Paul Sian: Let’s say to somebody new coming to investment. What is the typical down payment on commercial loans? That are looking to buy in the mixed-use space or multifamily space?

Angie Hoffman: So, generally speaking. We’ll go up to 80% loan-to-value. The biggest factor within that is gonna be how much the capability of the property to hold that debt. We’re gonna have, we have a pretty. I don’t want to say complex but we do have  multiple factors that go within our cash flow, and net operating, income calculation, that we’re gonna want to see. It balanced to a certain point for it to be able to hold the debt at an 80% loan to value. Again, we tend to partner with our clients. I have several clients who will send me properties on a daily basis, that they’re interested in. We will let them know what the debt capacity would be on that property.

Paul Sian: Okay. Income from the rents per sale, let’s say, something’s got a ten-unit building. Then you’re looking at the rents that are coming in. You’re also considering the buyers income level, income to debt ratio, all that as well.

Angie Hoffman: Yes. When I talk about the capacity, the debt for the property is being the one of the first things we look at is. In order to get to that 80% LTV, if you’re looking at the actual depth, they’re wanting the property to take on. Compared to other rent they’re taking in and the expenses, as well as some vacancy factors, things like that. That’s what we’re looking at to have a certain ratio, then on top of that. When we get to the next step would be look at the client globally, and their personal debt to income, and that factor too.

Paul Sian: Looking at that commercial mortgages, can buyer use the mortgage to upgrade property, to build in some equity in the property. Does the building of the equity get taken into account, and do you have a loan that allows them to do that?

Angie Hoffman: That question is kind of twofold. If you have a property, let’s say, it’s multiple unit, and you’re continuing to kind of do some improvements and renovations. If the property has the equity, we can look at small lines of credit to help with that renovation cost. Then once everything’s complete to be able to wrap that together. If you’re looking at a property that’s completely distressed, and doesn’t have any type of income. Then that’s gonna be something that generally we’re gonna have a harder time with. Because it’s a speculative type of scenario, and we want to typically see the actual income.

Paul Sian: How about converting something, I am interested in buying warehouse, either in retail space or multifamily. Do you offer products for that, or is that a similar situation when you’re looking at the risk as being a little high?

Angie Hoffman: Yes. So, that is gonna be a similar situation. Once the actual project would be completed again from a speculative standpoint, it just it becomes a little bit more difficult from a risk perspective. However, we’ve been in scenarios where we’ve worked with clients and partnered clients, people we know who work in that space more than we do. We can look to, guide them to what we would look at if we wanted to refinance that once it was completed, and there were leases in place.

Paul Sian: Okay. So, that is one of the benefits working with a big bank like US bank, is you can reach across departments there, and tap other resources within your organization.

Angie Hoffman:  Even if it’s within the organization, we have other resources whether it’s our private wealth or wealth group, have some capabilities that are different than what we have as well as from a CUI or network basis. It may be somebody just within my network that I know works within that space to introduce that way and hopefully can get that client taken care of.

Paul Sian: Are you able to comment on the underwriting process of commercial loans compared to residential. Is there a big difference in that process? 

Angie Hoffman: So, yes and no. I know we touch on it already a little bit. One of the biggest differences is obviously we’re gonna look at the actual collateral in a very different way, especially on the investment real estate side. When you’re looking at investment real estate, the factors that the net operating income as well as the cash flow of the property become factors. Whereas, when you’re buying a home, obviously it’s a lot more about the loan to value of the property. However on the other side of that, if we are looking at a property that’s gonna be owner occupied by a small to medium business. It becomes a lot more about the loan-to-value as well. So, it can depend upon the situation.

Paul Sian: Okay. How important is the person’s experience when they come to loan, get a loan for you. If it’s a new first-time investor looking at multi families versus somebody who’s already got five to ten units and then either self-managing or running it for a couple years.

Angie Hoffman: I mean, generally speaking, if you have somebody brand new, one of the biggest things is if you’re not familiar in the scope. You don’t have experience, you gonna be partnering  potentially with a property management company or somebody else who is maybe a partnership within the LLC or the property that you’re buying that has the experience. Just being able to show you may not have previous experience in this but you are partnering with a property management company that has historical success in these properties. You’re partnering with somebody, for instance, who has historical success in the properties.

Paul Sian: So, yeah boils down to your team then. What you’re bringing to the team. What kind of document requirements are there to start a commercial loan process with US bank?

Angie Hoffman: Generally speaking, in every situation is different, every request is different, client is different. But it’s typically going to be two to three years of taxes, personal and business, personal financial statements pretty standard as well. If it’s a purchase, we’re gonna want to see a purchase agreement or understand the purchase agreement as well. As you’re gonna want to have financials whether it’s profit loss or the rent rolls preferably a Schedule E or 8852 from the client. Showing what the historical trends of that property of have been. That’s where we really try and partner with our clients of understanding their portfolios, understanding what purchase they’re trying to make. So, that, does it fit, and is there anything we see because we see them on a very regular basis that. Maybe we need to discuss or let the client know that we are suggesting maybe prying a little bit more information.

Paul Sian: How important is ones credit score when they come to apply for loan with you?

Angie Hoffman: It is a factor, I mean. In any type of just like the traditional mortgage, it is gonna be a factor. But there are so many different factors that, it’s only one of many.

Paul Sian: One of the important things when it comes to purchasing real estate is I always tell the buyers that have a pre-approval letter ready. Is there something similar in the commercial loans place? A pre-approval letter, pre-qualification letter. Just something that says, somebody sat down with you, they started the initial process. They’ve got access to certain amount that they can borrow to purchase this property. Do you have something like that?

Angie Hoffman: We do. So, on the commercial side it’s gonna be called a letter of interest, and it basically lays out that we are working with a client. We have a price range or up to a price range that we’re looking for with the client, and depending upon the collateral. We are looking to work with him on the financing, again depending upon what the collateral is, and then we also have once we’ve actually maybe gone through a more official process of underwriting and submitted an actual financial package. We do have, depending again on what the financing contingency is for that client. 

We do have a letter of commitment, which lays out that there is an approval but it goes through all of the conditions as well like your appraisal certain things like that, that we’re gonna have to clear.

Paul Sian: Okay. How long does that process take? If you are writing an offer today for a client, and then usually you have to write in how many days we’re gonna close in. 30 days, 40 to 45 days. I know conventional, it’s usually a little quicker, a little easier. So, we can do it in 30 days or so. I mean, what would you recommend for a commercial loan?

Angie Hoffman: I think 45 days is very practical. One of the biggest things that I always talk about with my clients is that 45 days really is incumbent of me having a full financial package, meaning those two years of tax returns. The financials, I spoke about from the client that you’re purchasing, and or if you’re refinancing. To me, having that full financial package is really the key and then, again from there it’s gonna be some of the factors of the appraisal as well as the title work that would go along with it. But generally speaking, 45 days to close is pretty.

Paul Sian: Reasonable.

Angie Hoffman: Yes.

Paul Sian: You mentioned the documents that was my blog article documents for the conventional mortgage process. You mentioned W2s, 1040, tax returns, that is pretty similar the document requirements for commercial loans that it is for residential space?

Angie Hoffman: Yes. It’s very similar. With the PFS is gonna be one of the biggest as well as the two years of tax returns. Potentially three years depending upon, again the request size. Like you said, I mean, if they’re a W2 income type of employee, then we may need additional pay stubs. like I said, for any client, it could be very different depending again on what their history is. If they’re a business owner, then we may mean some more details but generally speaking, again it would be two to three years of personal business has returns, personal financial statement, and potentially obviously purchase agreement or additional documentation from that side.

Paul Sian: Okay. When it comes to partnership, people coming together, those documents from everybody. Correct?

Angie Hoffman: Correct. So, depending on what the ownership structure is. Generally, if somebody’s over 20% ownership within the property, then we’re going to need that financial information from them as well.

Paul Sian: Okay. I know with the conventional space. Lending into an LLC is generally impossible. Most lenders will not allow conventional borrowers to use an LLC. How does that work on the commercial side?

Angie Hoffman: The vast majority of the lending that I do is going to be through an LLC in a holding company. The clients are still a personal guarantor but the lending itself in the title is all within the LLC.

Paul Sian: Is it a requirement in LLC or is it an option for the buyer?

Angie Hoffman: It’s an option. I mean, one that again depending from an attorney’s perspective, if you’re talking about liability. It may be a best-case scenario to have an LLC with that property. But we always reference stuff talk to your attorney about what makes sense for you.

Paul Sian: How much, do you have any minimum loan requirements and your maximum loan requirement?  

Angie Hoffman: Up to ten million on the investment real estate side, and then once it’s beyond that, we do have a commercial group that we would work with a real estate group as well as our middle marker group that would potentially be involved. As far as minimum typically, again if it’s under 2,50,000. It’s still something that we would do. It just, we pull in a different partner to work with us on that too, because it kind of goes into a little bit different of a space.

Paul Sian: Is there, under 250,000$ or is there a lower minimum. I know some conventional lenders won’t touch anything fifty thousand and under.

Angie Hoffman: It’s pretty common. Yes, under fifty thousand is gonna be a little bit more difficult. 

Paul Sian: 50,000 to 2,50,000, and above that.

Angie Hoffman: But keep in mind too. I mean, if you have properties itself. It may be again, you see this more with the single-family home portfolios. You may have multiple properties that are under fifty thousand. But we’re looking at the entirety of the portfolio, makes a little bit different of a scenario. I would caution that anything that somebody is looking at from the perspective of either total lending amount or even individual property. We’re happy to take a look at it, have an understanding of what you’re looking to do, and if for some reason it’s not something that is in our world necessarily. Again, from an internal and external standpoint. We typically have somebody who I can contact.

Paul Sian: Discussing interest rates from general perspective, everybody’s situation is different and unique. But in terms of paying more, having a lower LTV, 60% LTV rather than 80%. People get themselves a better interest rate or is it generally, can we same and more just depending on credit and history.

Angie Hoffman: So, from an interest rate standpoint, the commercial side is a little bit different. Then maybe the mortgage or lines of credit side, then you then you generally see. Ours is based off of what banks cost the funds are, and then there is a spread that is on top of that. That’s where you get the percent from. Right now, cost of funds are pretty minimal. So, interest rates are extremely competitive. But from that perspective, it doesn’t necessarily factor in the actual loan it saw or the guarantor itself or the property itself.

Paul Sian: So, there’s some risk-based consideration towards interest rates. I guess a little higher risk project is that something you would price a little higher in the interest rate or generally that it’s not considered as much?

Angie Hoffman: No. That’s not considered as much, generally.

Paul Sian: Okay. Great. That’s all the questions I have for you today Angie. Did you have any final thoughts to share with the group?

Angie Hoffman: Sure. One thing I would say is if anybody has any questions about property specific, cash flow, if this property may fit into their portfolio or something that we would look to land up to 80%.I’m happy to partner with anybody on that side as well, and be resource for them. On top of that, I did want to mention that obviously US Bank is across the country. That gives us the ability even, if I’m your contact in Cincinnati to lend out-of-state borrowers.

I’ve worked with quite a few clients obviously from California that are buying in Cincinnati as well Chicago. So, those are people that I’ve worked with quite frequently as well.

Paul Sian: That is perfect. I’ve got a number of out of state clients to. That is one of the biggest challenges that I’ve faced with some local lenders is that they don’t lend to out of state. That’s a great ability to have.

Angie Hoffman: So, the key with in that too is just as I want to mention too. I mean, anytime that scenario comes up. We are happy to discuss it. One of the biggest factors with out-of-state lenders is that we do look for them to be within US bank footprint. So, we are very much on the west coast and Portland, all of those areas. If they’re somewhere you’re not familiar, if we’re within that area, please reach out. Let me know, and I’m happy to take a look.

Paul Sian: Great. Thank you again. I will leave your contact information on my blog post once it gets published live. Thanks again for being on the podcast.

Angie Hoffman: Thanks for having me. 

Source: cincinkyrealestate.com

Why I’m Grown-Up and Employed, but Still Need Mom to Co-Sign on My Home

When I got my first apartment after college, I needed my mom to co-sign my lease.

The landlord required proof that I made three times the rent, but since I wasn’t making nearly enough, I called Mom to sign on that second dotted line.

Then, in my mid-20s, when I bought my first condo, I needed a co-signer again. Once again, my mom was there for me.

Now I’m almost 30, married, and expecting our first child. Both my husband and I are gainfully employed and have good credit histories, so you’d think we wouldn’t need any parent co-signing for us to rent a home! But alas, we’d recently moved to New York City, where rents were so high, snagging a half-way decent apartment would require Mom to co-sign once again.

What’s going on? Would I need my mother to co-sign forever?

Of course, I feel lucky to have a parent who’s so supportive. But I can’t help but think that there’s something wrong with me, where I was choosing to live, or perhaps the housing system in general.

So, I started looking into why co-signing is so often required, even in cases where it seems unnecessary. Here’s what I learned, and some words of wisdom from experts that could help you get through the inconvenient (and embarrassing) cycle.

Why co-signers are required

What bothered me most about needing a co-signer was that I felt like I wasn’t being taken seriously as a tenant. I had a good job and a college degree, why couldn’t I be trusted to pay my rent?

As it turns out, many people face this problem.

While landlords may have differing requirements, the industry standard is that your take-home income must be three times what you pay in rent. So if you make $3,000 a month, your monthly rent should not exceed $1,000.

But is this realistic with today’s runaway rent prices?

For instance, in 2013, as a fresh college graduate, I paid $1,600 a month for a one-bedroom, third-floor walk-up in Los Angeles. So based on the three-times rule, I should have been earning $4,800 a month, or $57,600 a year.

A salary that size was an unattainable dream for me right out of college. Even though I had a great sales job and a minimum-wage side hustle, I was making only about twice the annual rent, or $40,000.

And I was one of the lucky ones. The minimum wage in California is $12 an hour, but in 2013 it was $8. To afford a monthly rent of $1,600 in 2013, a minimum-wage worker would have needed to put in 150 hours a week.

Is the three-times rent rule realistic?

Because I needed a co-signer, I couldn’t help but wonder about the three-times rent rule, and the reason for it. Did this mean I’d overextended myself?

As it turns out, I had no reason for worry. With a monthly rent of $1,600, I had another $1,600 left for other expenses, and it was more than enough.

So I started wondering: If twice my income worked just fine for my bills, why do landlords want proof that renters make three times their rent?

“The exact origins of the three-times rule is unknown,” says Michael Dinich of Your Money Geek. Nonetheless, this rule has remained the industry standard—for renters and home buyers alike.

“Mortgage lenders have often used the guideline that housing costs should be no more than 30% of income,” Dinich says. “The three-times rule is likely a handy approximation based on those old guidelines.”

This guideline may even contribute to younger generations’ low rates of homeownership.

“The income of many people, particularly younger adults, has not kept up with home prices in many areas,” says Andrew Latham, managing editor of SuperMoney. “This is why millennials have lower homeownership rates than previous generations.”

Plus, experts say that most landlords (even the nice ones) don’t necessarily care if people aren’t making as much money as they used to. They care more about finding a renter who will be able to pay their rent on time. And if that means sticking to the tried-and-true method of renting to those who can prove they have plenty of income to spare, or can at least get a co-signer, they’ll do it.

How I pay my rent without a co-signer today

While it’s tough for young renters and home buyers almost everywhere to cover their housing costs, it’s even worse in New York City.

Sure, my mom agreed to co-sign the lease, as always. Yet with a baby on the way, my husband and I decided that, rather than taking my mom up on her kind offer, I’d try to find an apartment with a rent that fell comfortably within the three-times rule.

We started crossing things off our wish list. We moved our search from Manhattan to Brooklyn. We stopped looking at homes near subway stations and cute cafes and started touring apartments that were a bit farther out. In the end, we found a studio we liked, and the low rent didn’t require a co-signer.

For more smart financial news and advice, head over to MarketWatch.

Source: realtor.com