How much house can I afford?

My grandmother, age 77, has been advised to invest in Collateralized Mortgage Obligations. What are your thoughts and where does she go to get detailed information?
LaWana S., Atlanta, Ga.
First off, we don’t believe people should ever invest in something they don’t understand. So have your grandmother ask whoever came up with this idea to explain it to her. If they start talking about how these are complex instruments that are beyond the capacity of an individual investor's financial intellect, tell Grandma to smile sweetly and send the nice young salesperson on their way.

To get her started, Collateralized Mortgage Obligations are what are known as mortgage-backed securities, a form of derivatives. CMOs comes in various flavors, but essentially they are pools of home mortgages that are bundled together and then chopped up as securities and sold in relatively small amounts to individual investors. Wall Street loves these things because they get a fee for the bundling and another fee for the selling. In theory, CMOs are considered relatively safe because they’re backed by the stream of payments from homeowners paying off their loans.

While the basic concept of a CMO is fairly straightforward, the individual terms and conditions attached to each issue are not. Some are guaranteed, some aren’t. Some carry relatively high transaction costs (which means they’re hard to sell), and you can’t track them in your local newspaper the way you can a Treasury bond. At the end of all that, you may not get much more return than Treasuries.

There are other significant risks. And the devil is in the details: One round of CMA may be structured very differently than the next, and the exact structure creates specific levels of risk that are often difficult for an individual investor to decipher. And with any CMO, you face risks posed by changes in interest rates and defaults by homeowners. So these are not as safe as, say, a U.S. Treasuries.

Here’s what the U.S. Securities and Exchange Commission has to say about CMOs. And here’s more from MSN Money on mortgage-backed securities:

Rebate madness
I have two credit cards that pay a cash rebate of 1 to 5 percent depending on the card and the purchase. Last year this amounted to a surprisingly large dollar amount. Since I pay these cards off each month I pay no interest or fees, so it is clear that the rebates come from the vendors and other cardholders. At 5 percent the rebate amount is more than most vendors pays. My questions are: Why does this work for the card issuers? How long can they keep doing this?
Jarl M. -- Guilford, Conn.

Because for every guy like you who pays off his balance every month there are 100 others who sign up for cards to get the rebate and end up paying much more than that in interest and fees.

In other words, it’s worth it to the card company to lose a few bucks on you as a way of buying new customers who generate profits.

    

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