Solve The Home Loan Puzzle

Earn My Business

2009-09-22T17:59:00.001-05:00

At this point, your eyes have rolled back in your head, or you are ready to negotiate with your lender. I’ll be an optimist and assume the latter. If not, read back though the last five or six postings. Email me if you are still lost.

Here are a couple of simple facts. It should cost about $3,500 to originate a mortgage. That includes the cost of everyone who may be in the food chain – the mortgage broker, the mortgage lender, the loan officer, etc. Most lenders would like to net about $2,000 after expenses.

You know how to calculate the gross profit the lender is quoting on your loan – by starting at the securities rate and working your way up. Subtract $3,500 from that. If the remainder is $2K or less, you’ve made a good deal. If it’s more, negotiate.

You can negotiate by asking for lower lender fees or a lower rate. Then recalculate the profit.

You are now empowered to negotiate for low mortgage rates and fees. Let the loan officer beware!

Circle the Wagons

2009-09-21T11:33:00.003-05:00

Image by Matthew Stewart | Photographer via Flickr

Let’s add all of this up. How much is your lender making from the origination of your mortgage? In previous postings, we identified the following sources of revenue that the lender is earning, as follows:

The Trading profit or loss from sale of the security and/or mortgage
The value created from the interest rate mark up – the MSR gain
The lender fees collected at closing

Here is an example. Lender A makes you a $200K FHA mortgage at a rate of 5%. The lender places your mortgage in a 4.5% GNMA mortgage backed security. Investinginbonds.com says that a 4.5% GNMA security is presently selling at 100.24 (100 24/32 or 100.75%). The lender charges a 1% origination fee, an underwriting fee of $350 and a processing fee of $250. The lender’s profit, before expenses, is

$1,500 trading profit (.75% times $200K) plus
$5,500 MSR gain (2.75% times $200K)
$2,000 origination fee (1% of $200K)
$600 underwriting and processing fees
The lender’s gross revenue is $9,600.

Before we go to the final tally, I must add one more ingredient. You may have noticed that the rate on your mortgage is not always exactly .5% above the security rate for an FHA/VA loan or .45% above the rate for conventional loans. In order to fit a loan into a security, the lender may have to discount the amount of the mark up above the security rate. That reduces their profit. As a rule of thumb, reduce the amount of the MSR gain .625% for each 1/8% that your mortgage rate is below the sum of the security pass through rate and the standard service fee mark up.

For instance, a 4.875% mortgage best fits into a 5% security. But the mark up spread is only .375%, not the normal .5%. Reduce the MSR gain of 2.75% by .625% in this example. If the mortgage rate is 4.75% in the same example, reduce the MSR gain by 1.25%.

You should now be able to calculate the gross revenue that a lender is making from the origination of your loan, before their expenses. Look back through the last six postings and play around with some real life examples. Email me if you get lost.

In the next posting, I will talk about how much a lender should be making on your transaction.

Lender Fees

2009-09-19T19:06:00.001-05:00

Most lenders charge fees. There are lender fees and there are third party fees.

Examples of third party fees are credit report fees, appraisal fees and loan documentation preparation fees. The lender is not allowed to mark up and make money on these fees.

Examples of lender fees are:

Underwriting fees
Processing fees
Admin fees
Origination fees
Discount fees (see the last posting regarding trading losses precipitated by an unusually low mortgage rate)

These fees are paid direct to the lender and represent part of their profitability model. You will find them in the 800 section of your Good Faith Estimate or HUD1 Settlement statement. Identification of these fees is perhaps the easiest part of this process.

Let the Fees Begin

2009-09-18T15:55:00.002-05:00

We have already determined that the yield investor buys a mortgage backed security with a guaranteed pass through interest rate. In the last posting, I told you where to find that pricing. Here is the next step.

If your mortgage is pooled with and backs one of these mortgage backed securities, you will have to pay more than the security pass through rate that the investor receives. That is because of two reasons:

Someone has to service your mortgage and handle all of the accounting related to the servicing of the security pass throughs to the investor
The lender who makes your mortgage wants to recoup the cost of that servicing, and make a profit

As a rule of thumb, the rate that you will pay on your mortgage will be higher than the corresponding security pass through rate by

.50% on an FHA or VA loan – a GNMA security
.45% on a conventional mortgage – a FNMA security

If the investinginbonds.com daily price sheet shows that a 4.5% security pass through rate is paying 100.875%, that means the mortgages that back that security – maybe yours - will average about:

5% for FHA and VA mortgages
4.95% for conventional mortgage

Also, as a rule of thumb, the value of that markup above the security pass through rate is equal to about 2.75% for an FHA or VA mortgage and 1.5% for a conventional mortgage. Those are simply the net present value of the anticipated collection of those mark ups collected over the life of the mortgage.

Let’s recap how your lender is doing so far. I will use an FHA loan for this example.

Your lender makes you a loan at 5%
Your lender puts your loan in a GNMA mortgage backed security with a 4.5% pass through rate
The 4.5% GNMA security with a 4.5% pass through is selling for 100.875% according to investinginbonds.com
Your lender sells the security at 100.875% and makes a profit of .875%. We will call this trading profit

Your lender realizes a 2.75% gain from the markup above the security pass through rate – the difference between your 5% mortgage and the 4.5% security pass through rate. I will call this the MSR profit – the mortgage servicing rights profit.

So far, your lender has made 3.625% (of your mortgage balance) through the origination of your mortgage. The math on that is .875% plus 2.75%. If it had been a conventional loan, the profit would be 2.375% - .875% plus 1.5% for the rate markup. On a $200K mortgage, that’s $7,300 for the FHA loan and $4,750 for the conventional loan.

Before I close this posting, it is important to note that a lender could originate a mortgage that is placed in a security that is trading at less than 100. Look back at the previous posting. The GNMA 3.5% security pass through is trading at 94 2/8/32 or 98.875. If the lender makes you a 4% FHA mortgage - .5% above the security coupon – and creates a 3.% security, they will realize a trading loss of 1.125% (100% - 98.875%) and rather than being at a profit of 3.625%, they will be at a profit of 1.625% ( minus 1.125% plus 2.75%). They make up the difference by charging discount fees, which I will discuss in the next posting.

We’re not done yet. So keep your eye out for my next post – there’s more!

The Yield Investor

2009-09-15T18:29:00.019-05:00

If you had $100,000 to invest, would you loan it to your nephew on a 30 year fixed rate mortgage? Probably not. You would not want to lock your money up for thirty years at a fixed rate of return, hassle with the possibility that he might not pay, collect the monthly payments, etc.

In previous postings, I talked about mortgage backed securities. Most investors who want to invest in a 30 year fixed rate mortgage prefer to simply buy a 30 year mortgage backed security. The security is guaranteed by one of the quasi-governmental agencies (Fannie Mae and Freddie Mac) and collateralized by 30 year fixed rate mortgages. This allows the investor to buy an interest in a pool of mortgages rather than an individual mortgage. By doing so, they gain the following advantages:

The security is easily saleable for cash – with a phone call.
There is an active market for these securities, the pricing is very efficient and the pricing is publicly available – just like a stock price.
The investor does not have to worry about payments being made – they are guaranteed by Fannie Mae or Freddie Mac and the investor is paid even if the borrower does not make payments

Agency guaranteed mortgage backed security prices are available on the Internet.

Today, here’s what the pricing shows. “Cpn” is abbreviated for Coupon. Coupon is the pass through interest rate that is paid to the investor who buys the mortgage backed security. The 15 and 30 years column is the price – the percentage of par – at which the investor can buy a security that pays the corresponding pass through Coupon. 15 ear is for a 15 year mortgage and 30 year is for a 30 year mortgage. GNMA securities are for FHA and VA loans. FNMA securities are for conventional loans with a balance less than $417K. For example, an investor can buy a mortgage backed security backed by 30 year fixed rate FHA and VA mortgages, paying them a rate of 4.5% for a price between 101.02 and 101.04, or between 103.08 and 103.10 if the loans are backed by 15 year mortgages. The corresponding FNMA price, for the same security pass through rate, is 100.28 and 103.00 respectively. The prices are quoted in 32nds. 101.02 actually means 100 2/32 or 100.0625. To buy a $100,000 security that is selling at 100 2/32 (or 100.02 from the chart), the investor will have to pay $100,062.50.

GNMA (as of 14:34 SEP 11, 2009)
Cpn	15 Years	30 Years
3.5	98.18/20	94.28/30
4.0	101.27/29	98.22/24
4.5	103.08/10	101.02/04
5.0	104.18/20	103.00/02
5.5	105.17/19	104.17/19

FNMA (as of 14:34 SEP 11, 2009)
Cpn	15 Years	30 Years
3.5	98.09/11	95.04/06
4.0	101.07/09	98.24/26
4.5	103.00/02	100.28/30
5.0	104.11/13	102.26/28
5.5	105.10/12	104.07/09

In the next posting, I will dig deeper into this.

The Pot of Gold

2009-09-14T17:17:00.007-05:00

Image by beluga 7 via Flickr

There are two reasons why a bank or mortgage company might make a residential mortgage loan:

To earn the interest that is paid over the life of the mortgage
To earn fee income from the origination and sale of the mortgage

At current interest rate levels, most mortgage borrowers want a 30 year fixed rate mortgage. Most banks do not want to lend their money at fixed rates for 30 years. That is because the money that the banks have to invest in that mortgage is from their depositors who, on average, have deposited the money for only about 3 years. The bank makes money on the spread – the difference between the rate on the 30 year mortgage and the rate that they pay the depositors. If the bank lends the money out for thirty years, and the depositor wants their money back after three years, the bank has a problem. In order to give the depositor their money back, the bank either has to sell the mortgage or take in new deposits at whatever deposit rates then exist.

If deposit rates have gone up, the rate on the 30 year mortgage stays fixed and the difference – the bank’s profit spread – goes down. If the bank tries to sell the mortgage, the value of the mortgage has gone down because current interest rates are higher than the rate at which the mortgage was made.

For that reason, most banks are willing to make 30 year mortgages, but they immediately sell those mortgages. They are willing to make the mortgages because they can earn fee income from the origination of the mortgage.

Who buys the mortgages? I will cover that in the next posting.

Who's Getting Rich?

2009-09-12T16:19:00.000-05:00

Over the weekend, my wife bought a new car. I helped her negotiate the purchase. The dealer had that sales process where you start out with the salesman and tell him what you are willing to pay. He takes the ridiculous offer to his sales manager. Then the sales manager comes out and works on you. She got the car for what we wanted to pay. The salesmen shook my hand, thanked us and congratulated us on the purchase. The sales manager did not.

It’s pretty easy to find out how much a car dealer is making and how much room they have to negotiate. There are websites that publish the dealer invoice and factory incentives to the dealer and to the buyer.

It is not quite so easy to find out how much your mortgage lender is making. Like the car business, there are many nuances that allow your mortgage lender to make more or less money. For the next few postings, I will lift the veil on the profit food chain. Perhaps that will make you a more informed borrower, or a better negotiator.

Back to School

2009-08-30T01:13:00.002-05:00

Retailers are closely watching back to school sales activity. The return of the consumer usually marks the end of a recession. Have back to school sales rebounded? Early signs indicate that they have not. The consumer is still worried about high unemployment numbers and a stock market rally that has stalled.

Foreclosure activity is predicted to be about 30% higher than last year. 30 year mortgage rates are about 5.38% - up about .21% from the previous week. But rates are still over 1% lower than last year’s level of about 6.57%. Why then have sales not increased? The conditions required to get a new mortgage have become somewhat oppressive for many. As much as anything, that has slowed activity of new mortgage loan applications. Fear of unemployment and income stability is a close second.

The new tax credit for first time homebuyers is creating significant activity in many markets – particularly those with reasonably stable unemployment numbers and lower foreclosed housing inventories.

Bargains still abound. It is a perfect time for cautious opportunism.

No Wonder

2009-08-28T21:26:00.001-05:00

The country has a huge fiscal deficit. FDIC is running out of money. The current administration is struggling with the actual amount of the annual budget deficit and how much their proposals may impact the federal deficit.

About 30% of Congressional representatives are attorneys. Less than 1% of the Congressional representatives are CPAs (Certified Public Accountants). Our President is a Harvard educated attorney.

Hmmm?

Why Take Out a 15 Year Mortgage?

2009-08-27T10:37:00.000-05:00

Many people sign up for a 15 year mortgage rather than a 30 year mortgage. Historically, the rate on a 15 year mortgage has been about ½% lower than a 30 year mortgage. In the recent financial crisis, the difference between 15 year mortgage rates and 30 year mortgage rates narrowed to almost nothing. Today, it has widened back out to about 5/8%.

In other words, you can now borrow mortgage money for 30 years at about 5 ½% and for 15 years at about 4 7/8%. On a $200K mortgage, the difference between the payments is only $433 per month and your mortgage is paid off 15 years sooner. You also save about $125K in interest.
That makes a lot of sense.

Un-American Activity - Paying Off Your Mortgage

2009-08-25T00:50:00.003-05:00

Do you know anyone who has paid off their mortgage? Do they still have their own teeth? Sure, there are plenty of people who diligently double up payments each month and pay their mortgages off at an early age.

It’s a great savings plan. A house is a shelter. For most people, it is also the largest investment that they will ever make. It may also be the most lucrative.

Prepaying your mortgage is a great way to invest money. Your return is equal to the rate on your mortgage – the amount of interest that you do not have to pay on the prepaid amount. Perhaps you think you can do better than that rate of return by investing that same money in the stock market, bond funds hog bellies or “show bull” sperm.

Today’s mortgage rates are about 5 ½%. If you prepay a little each month, you are earning about 5 ½% on that investment – assuming your house does not lose value.

Can you do better than 5 ½% over ten years? Unless you are a pretty darn good investor, I am going to bet not. Two years ago, your reply would have been that the stock market has averaged 10% over the last ten years. That argument now has leaks. If you prepay your mortgage, there is not really a way that you can do worse than the rate on your mortgage. For a lot of folks, 5 ½% is looking pretty good these days.

Mama He's Crazy

2009-08-21T15:20:00.002-05:00

I wonder this. If one had money to invest, why would they loan it to me for thirty years at a fixed rate of 5 ½%? That’s what banks, mutual finds, and investors are now doing.

I don’t get it. If and when interest rates go up, the liquid value of their investment will drop about 5% for each 1% that interest rates go up. So let’s say mortgage rates go to 7 ½% in 5 years. I think most people think that’s a reasonable possibility, and 7 ½% is not all that high. That wouldn’t cripple the economy.

If I bought an interest in a mortgage bond mutual fund that had bought alot of 5 ½% mortgages, the value of my investment would drop about 10% in five years – if rates went up 2%. I would of course earn 5 ½% per year for each of those five years – a total of 27 ½% for the five years (a simplistic way to look at this). If you take 10% off that – the drop in the investment's liquid value – my return drops to 17 ½% for the five years. That’s an average of only 3 ½% for a five year investment.

As an investor with money, would you commit your money for 30 years at a return rate of only 5 ½%? I wouldn’t. I’m not sure I would even do it for five years.

Would I borrow money for 30 years fixed at 5 1/2%? Hmmm...

Top 8 Reasons Not to Buy a Condominium

2009-08-18T12:57:00.001-05:00

The price usually includes an amount for an aggressive marketing and sales plan
If the project does not sell out, you are stuck with a unit that will be very hard to sell
If the homeowner’s association is not well run, your dues can get very high and the quality of maintenance can suffer
The homeowner’s association is a political body. Political bodies do not always manage things well
Mortgage financing for you, and for potential buyers, can be difficult to find and may have a higher rate
During the initial phases of project sell out, homeowner’s associations can be financially fragile. That exposes you to the possibility of special assessments or higher dues
For mature projects, it is very common to have special assessments for capital improvements or maintenance that were not adequately reserved in the annual budget
It’s an up close and personal living experience. Neighbors are very close. If you don’t like that, well...

The primary attraction to this type of ownership is the ability to obtain affordable housing in a highly desirable area that typically is beyond economic reach. Additionally, such properties benefit from having restrictions that maintain and enhance value, providing control over blight that plagues some neighborhoods - Wikipedia

Top 8 Reasons to Buy a Condo

2009-08-17T18:37:00.003-05:00

Lock and leave at your leisure
They are usually close to the action – entertainment, work, transportation, outdoor activities, resort amenities
Access to amenities that you could probably not afford in a neighborhood home – pool, tennis courts, gym
Low maintenance
Lower utilities...maybe
Safety and security from community security services
Usually found in a more exclusive location at which you could not afford a single family home
Community involvement and activities

Stop in tomorrow for the Top 8 Reasons Not to Buy a Condo.
In 1960, the first condominium in the Continental United States was built in Salt Lake City, Utah.

Housing Affordability Index

2009-08-16T15:09:00.001-05:00

In June, the housing affordability index was 159.2. That is very high. In June of last year, it was 122.6. In 2007, it was 115.8. In 2006, it was 107.6. Earlier this year, it reached 176.9. When mortgage rates are low and housing prices fall, this condition usually occurs. In theory, the high affordability index should attract more buyers and cause a gradual change towards a point of equilibrium – an index of 100. When the index is high, it is a good confirmation of an opportune time to buy a home.

The NATIONAL ASSOCIATION OF REALTORS® affordability index measures whether or not a typical family could qualify for a mortgage loan on a typical home. A typical home is defined as the national median-priced, existing single-family home as calculated by NAR. The typical family is defined as one earning the median family income as reported by the U.S. Bureau of the Census. The prevailing mortgage interest rate is the effective rate on loans closed on existing homes from the Federal Housing Finance Board and HSH Associates, Butler, N.J. These components are used to determine if the median income family can qualify for a mortgage on a typical home.

To interpret the indices, a value of 100 means that a family with the median income has exactly enough income to qualify for a mortgage on a median-priced home. An index above 100 signifies that family earning the median income has more than enough income to qualify for a mortgage loan on a median-priced home, assuming a 20 percent down payment. For example, a composite HAI of 120.0 means a family earning the median family income has 120% of the income necessary to qualify for a conventional loan covering 80 percent of a median-priced existing single-family home. An increase in the HAI, then, shows that this family is more able to afford the median priced home.

The calculation assumes a down payment of 20 percent of the home price and it assumes a qualifying ratio of 25 percent. That means the monthly P&I payment cannot exceed 25 percent of the median family monthly income.

Source : National Association of Realtors

How to Refinance if you Owe More than Your House Is Worth

2009-08-15T20:01:00.005-05:00

Image via Wikipedia

Both Fannie Mae and Freddie Mac have announced programs to provide refinancing to homeowners who owe more than their home is worth.

The newest program allows you to refinance up to 125% of the current value of your home. For example, if your home is worth $200,000 and you owe $250,000 (125% of $200,000), you could possibly refinance your current balance at a lower rate.

Your loan has to be owned by Fannie or Freddie. You can call your existing lender and ask them if your loan is owned by one of those two agencies. Your credit report should also indicate who owns your loan. If you owe less than $417,000 on your home, there is a good chance your loan is owned by Fannie Mae or Freddie Mac.

If you are paying more than 6% on your loan, this could be a good opportunity to lower your rate and payment. Most mortgage lenders who are Fannie Mae or Freddie Mac approved can handle the refinance. You do not have to go through your existing lender.

Housing Inventory Over-hang

2009-08-11T12:20:00.005-05:00

I am sure you have heard this term. Many homes (both vacant and occupied) are in the foreclosure process, the foreclosure redemption period or lender inventory.

In most states, the process of completing foreclosure is time consuming – from 90 days to as much as 18 months. During that time, the homeowner often moves out and the house just sits there.

In some states, the homeowner has the right to redeem the foreclosure (reverse the foreclosure by paying off the debt or bringing it current) within a defined period after the actual foreclosure occurs. During that redemption period, the lender cannot sell the house. As with foreclosed homes, many homeowners move out and the house just sits there.

Most lenders were not prepared for the recent glut of foreclosures. They are also reluctant to add permanent staff to handle what they hope will be a temporary phenomenon. Many lenders have outsourced this function to foreclosure management firms, or staffed the departments with contract employees. The staffing buildup to handle the activity is gradually catching up with the inventory, and more of the inventory is reaching market. It is possible that some lenders are still holding back inventory – to keep from further depressing the market. It is more likely that it has been a resource issue that is gradually correcting itself.

The Time Traveler

2009-08-09T21:54:00.019-05:00

Image via Wikipedia

Housing sales are up. Mortgage rates are low. Jobless claims are falling. The stock market is over 9,000. The economy is moving and we may actually show positive GDP growth. The President has cautiously acclaimed economic progress and recovery.

Unsold housing inventory is still high. Commercial real estate is in a slump. The top two car companies are still in bankruptcy. The federal deficit and total federal debt is huge and growing. Unemployment is still above 9%. Foreclosure rates are still high.

"It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness, it was the spring of hope, it was the winter of despair, we had everything before us, we had nothing before us, we were all going direct to heaven, we were all going direct the other way - in short, the period was so far like the present period, that some of its noisiest authorities insisted on its being received, for good or for evil, in the superlative degree of comparison only." Charles Dickens – A Tale of Two Cities (1812-1870)

Like Elvis, he’s been dead awhile……..probably. But it sure reads like an editorial in the weekly newspaper. Nice to know this has happened before…….and good times returned.

FDIC Closing Five to Ten Banks each Week

2009-08-05T17:12:00.006-05:00

Image by Tony the Misfit via Flickr

1933 was one of the darkest years in U.S. history. 25% of Americans were unemployed and unable to find a job. Public confidence in the U.S. banking system was at an all time low.

On June 16, 1933, President Roosevelt signed the Banking Act of 1933. As a result of the Banking Act of 1933, the Federal Deposit Insurance Corporation was created to restore public confidence in the U.S. banking system.

Over the last month, FDIC has been closing 5 to 10 banks each week. Look for that to continue for the foreseeable future. There are still a few multi-billion dollar banks that are in trouble. They will have to be closed or sold. The FDIC insurance fund is at very low levels. FDIC has increased insurance premiums to refill the coffers. That has been painful for most banks.

What happened to the Jumbo Loan Market?

2009-08-03T19:02:00.011-05:00

Image by Getty Images via Daylife

The secondary market for jumbo loans remains slim. The ability to create and sell jumbo mortgage backed securities remains problematic. There is no market for the securities and no confidence in the rating agencies' or issuers ability to price the risk. Some large banks and community banks have developed portfolio jumbo loan products. But they offer them only in their primary markets. There are only a couple of large banks who are offering jumbo loans in the national secondary market. By all accounts, they are keeping those on their balance sheet.

It is a good time for homebuyers to obtain a mortgage that falls under the conforming loan limit because Fannie Mae and Freddie Mac guarantee these loans.

Federal Deficit Financing

2009-08-01T19:50:00.013-05:00

Image via Wikipedia

The federal funds rate is the interest rate at which depository institutions (mostly banks) lend balances at the Federal Reserve to other depository institutions (mostly banks) overnight.
Financing of federal deficit has had an amazingly low impact on long term interest rates. The feds have been throwing huge sums of money at the economy.
Once the volatility of money increases, look for inflation and interest rates to increase. Job gains and consumer spending are examples of things that will accelerate the volatility of money.

Rates Are Up? Not Really....

2009-06-11T09:38:00.002-05:00

Image by Getty Images via Daylife

Over the last four weeks, there has been a major move in mortgage rates – up almost 1%. After a move like this, the market generally finds and settles into a trading range. That trading range is usually within a 1/4% range. I do not think the market has yet found that range, but I think it is close. For planning purposes, it is important to know and accept – regardless of our view on the matter - that bond traders presently have a bias towards higher long term interest rates.

The Fed and the Treasury are in a pickle, and it’s a sour one. Housing sales are critical to economic recovery. Low mortgage rates stimulate housing sales. Their ability to maintain low rates has been materially impacted by their need to finance huge federal deficits, with no end in sight. The growing supply of treasury bonds is putting considerable pressure on the long end of the yield curve. Their plan to support the market with the purchase of mortgage backed securities has been trumped by a rapid rise in treasury bond rates – especially the 10 year and 30 year bonds. Yesterday, China announced it is moving some of its reserves to the IMF and out of US Treasuries. It seems that some of our international benefactors are starting to question the safety of U.S. Treasury bonds – due to the huge supply and our fiscal deficits. Look for a lot of talk and “jawboning” on both of these subjects. They are the topic du jour and pose great danger to the economic recovery.

Sound scary? A little I guess. I offer it only as information and to assist with planning. Certainly, refinance activity will subside – already has. But there is still plenty of purchase activity and rates are still low. 4 ½% a month ago sounds great. But housing prices were still falling. Buying a house at 4 ½% is not quite so attractive when combined with the prospects of a drop in the value of the house you buy. Today, it seems housing prices are stabilizing. I think 5 ½% with a stable or increasing house value is better than 4 ½% wt a falling value. One can still buy a home for less than replacement cost. If you are a first time home buyer, you can get an $8Ktax credit as a bonus. Pretty sweet!

Non-Sequiturs

2009-04-23T08:39:00.002-05:00

The spread between the 10 year constant maturity Treasury and average conventional mortgage rates has narrowed from about 2.6% at the end of January to about 1.95% last week. That compares with a spread in April, 2008 of about 2.2% and about 1.5% in April 2007. The Treasury's plan to buy mortgage backed securities has precipitated some narrowing of the spread – which helps lower consumer mortgage rates. But the spread has not yet returned to the levels that existed before the financial crisis began.

Today, 30 year fixed conventional mortgage financing is available at approximately 4.75% plus a 1% origination fee.

In the last sixty days, 30 year fixed financing for jumbo loans (greater than $417K) has begun to return. Some lenders are quoting 30 year fixed rate jumbo financing in the high 5's with a 1% origination fee. Jumbo adjustable rate financing with the rate fixed for the first five years is plentiful - with the first five year's rate in the high 4's and low 5's.

In the fall of 2008, Fannie Mae and Freddie Mac tightened their mortgage qualification guidelines for investment property purchases and refinances. Their guidelines were changed to limit the number of financed properties owned by the borrower to five. Effective May 1, they have raised that limit back to ten properties. The qualifying and down payment requirements have been tightened for those borrowers who own 5 to 10financed properties. Nonetheless, this affords investors the opportunity to refinance their existing properties and to acquire new properties. This should help absorb some of the foreclosure inventory.

The state and federal moratoriums on foreclosures have expired, or soon expire, in most states. The federal foreclosure assistance programs do not work for everyone. We will see a spike in foreclosures and inventory over the next 30 to 120 days.

On April 29th, the Treasury will announce it's 10 year and 30 year offerings for the May bond auctions. Bond investors are concerned about the possible needs of the Treasury, the size of the auctions and the market's ability to absorb huge supplies of new bonds. This auction could be a glimpse of things to come. The fiscal deficits are just beginning to put pressure on the bond markets. It is reasonable to believe that this could signal the bottom of this interest rate cycle. If the auctions go well, rates could drop. But it will probably be temporary. If the auctions go poorly, rates could spike.

Your Home - Shelter or Investment?

2009-04-16T09:55:00.002-05:00

In recent postings, I have opined that it's a good time to buy a house – if you need a home and can afford to buy. My rational is that existing homes are selling below replacement cost and mortgage interest rates are at historical lows.

But is a house a good investment? Or should it matter? My Dad told me to buy a house with the primary motivation as shelter for me and my family. If it works out to be a good investment, that's even better. He also told me that a good investment is usually measured by what you buy it for, and not what you sell it for. OK, that works. If I need and can afford a house, I can now buy one cheap with a very low mortgage rate.

The things that assure the investment value of a house are exactly the same things that attract me to a house – good schools, good location, close to jobs, access to public transportation, access to good shopping, access to entertainment and cultural things, a stable local government with affordable property taxes, a price range that is affordable for the area in which I am buying (don't buy the most expensive house in the neighborhood – even if it looks like a great deal). If I stray from those values, I endanger the long term investment value of my home.

I believe the economic situation in which our country finds itself has changed the rules about real estate investing – at least for the next decade. The tremendous federal deficits will keep pressure on interest rates for the foreseeable future. The deficits and resulting financing needs will gradually erode our government's ability to impact interest rates with fiscal and monetary policy. That could create huge spikes and valleys in interest rates. It will cause banks and institutional investors to be volatile enterprises that behave with increased unpredictability. I believe that today's low, fixed rate mortgage financing offers generational opportunity to those who can afford a home.

For the next decade, I do not necessarily think that homes will be a great investment. Here's why.

If you think the federal government has problems, think about our state and local governments. I know very few that are healthy. Many state and local governments are facing large property tax increases, large income tax increases and cuts in services. If you purchase a home in one of those communities – and there are many – the value and “affordability” of your home will be impacted.

There is a large segment of our population that is unemployed, under-employed or nervous about their job stability. Do you see anything on the horizon that might cause that to get a lot better? I don't. If I'm right, that will inhibit home purchases and will probably keep home prices low, albeit stable, for the next five to ten years.

Interest rates will go up. When they do, that is likely to inhibit home sales. Hopefully, the rise in interest rates will be accompanied by economic improvement and consumer confidence. But it is more likely that it will be primarily due to huge federal financing needs.

Many think that the federal deficit will lead to inflation. In times of inflation, those who own tangible, scarce commodities usually win. Although it has lost its appeal, gold is the most common example of a scarce commodity. Real estate is also recognized as a good hedge against inflation. The current inventory of unsold homes seems to conflict with the notion of scarcity. That is probably a short term condition. But I believe it is only short term in those communities where there is or will be scarcity of housing. A fabulous home on 50 acres that is 75 miles from downtown is scarce. But the demand for such a property is limited and inconsistent. The supply of small homes on an 80X100 lot in a great school district that is 2 miles from downtown is limited and demand is fairly consistent. Many of us cannot afford the home close to downtown. But there are many communities that exhibit, or will exhibit in the future, the same characteristics.

I don't mean to sound negative. Actually, I see incredible opportunity.

If you are buying homes for investment, be disciplined and be prepared for a 10 year investment horizon. It's going to take awhile to straighten out this mess and the government is in the driver's seat. The government is unpredictable and has both social and economic agendas. The “bank problem” is not over. In fact, it is probably still in the early innings. For the foreseeable future, free market capitalism rules have been “trumped.” If you accept that and plan accordingly, you will be the smartest guy in the room. You will likely do very well on your investment.

If you need a home for shelter and can afford to buy one, this is a very good time to do so. But be careful, do your homework and be smart. Buy your home as shelter for you and your family. Keep some cushion in your cash reserves. Do your homework and don't stray from the basics of real estate investing. What the heck - plan on staying in the house for 20 years.

Blooms on The Rose

2009-04-03T15:30:00.002-05:00

“I compare you to a kiss from a rose on the gray, the more I get of you, the stranger it feels, and now that your rose is in bloom, a light hits the gloom on the gray” – Seal

Mustard seeds, blooms on the rose, chutes of green, the end of the Depression, the bottom of the market, St. Patty’s Day bear rally, return of a bull market, historically low mortgage rates, record high foreclosure rates, foreclosure relief, $1.4 trillion dollar federal deficits, 8.5% unemployment rate, at least 650,000 jobs lost each of the last three months, a strong dollar, mark to market relaxed, bank bailouts, federal debt at 80% of GDP, $ 1 trillion of IMF support for under developed countries, Madonna denied adoption rights (just slipped that one in to see if you’re paying attention).

Omigosh – talk about information overload! I watch the financial news far too much. It reminds me of a herd of cows following a feed truck with a leak in the truck bed. The cows want the feed. The truck driver is wandering through the field looking for a dry spot to park. The cows and the truck wander aimlessly through field, and it’s pouring down rain.

The financial markets are behaving much the same way. They seem to wander. Everyone is tired of the “gloom on the gray” and wants to acclaim the bloom on the rose. We have two or three weeks when bad news produces good results, and two or three weeks when bad news produces bad results. We are all looking for some sign of recovery, or some positive results from all of the money that our government is throwing at this problem. And the bad news just keeps pouring down.

Are there any blooms, or any buds on the vine? There are a few.

Mortgage rates are at incredibly low levels – in the mid 4’s. Given the outrageous financing needs that our government faces, I just do not see how they sustain these low levels. If you have not yet refinanced, hurry. If you need and can afford to buy a house, now is the time.

There are some indications that houses are beginning to sell. Realtors and mortgage companies are reporting increased activity. Prices are still below replacement cost in most areas of the country. The housing affordability index is at an all time high. New construction has been at a slow pace for almost a year. Foreclosures are still pervasive, but are showing some sign of stabilizing. As supply and demand stabilizes, home prices will go up. I believe there is little doubt that mortgage rates will go up – within the next year. If you need or want to buy or refinance your house, the bloom is on the rose.

Say what you will about the plan. It’s not perfect. But we finally have a plan. Banks are actually starting to see some operating profits. The government’s toxic asset plan and relaxation of mark to market rules will diminish the huge loan losses. Banks will soon begin to report decent quarterly operating profits – perhaps even this quarter. Once the banks sustain that profitability for a few quarters, we will see private capital start to come back into the banks. That will further the process of improving credit availability. It’s not a bloom, but there’s a bud on the vine for the banks and the availability of credit.

The notion of a world economy is disconcerting. It’s also a reality. Our country’s deficit is too large for us to be arrogant and protectionist. Let’s face it. We’re in better shape than most of them. But we badly need the rest of the world’s money to finance our bad habits and expensive mistakes. We also need to sell them our goods and services. I read where Rosetta Stone Co. will soon complete a $100 mm IPO. It’s time to brush up on your Arabic and Chinese. The recent G20 meeting signaled a new era of international cooperation for the economic good of all countries. That is a change of recent world status for our country, and a bloom on the rose.

There remains a “gloom on the gray” that bothers us all – job loss and unemployment. I think everyone would like to believe that the monthly job loss numbers have stabilized at the lowest levels we will see. But no one seems ready to say they will return to normal numbers. That’s the most positive way that one can think of such gloomy numbers. Unemployment stands at 8.5%. It is hard to imagine that it will not reach 10%.

The last issue is “the gray” itself. That is inflation and federal deficits. We are entering a gray zone in which we have never before been. Everyone likes to compare this to the great depression of the 1930’s. I don’t see it. Government and its institutions, the demographics and education of world population, the nature of industry and the point from which we are coming are all too different. Only time will tell. Our vigilance against run away inflation is the easy part. What to do is the problem. The speed and immensity of the fiscal stimulus could produce equally fast and immense inflation. If the Fed raises short term rates to fight inflation (and the yield curve flattens), they will harm the already weakened bank and financial sector. If we have to increase intermediate and long term rates to attract money to finance our federal debt, this could slow economic growth. This is the gray zone. A lot of smart and well educated guys are trying to figure this out. My guess is that we will just have to watch and be fast and graceful on our feet – something at which our government has never been good. Is it just me, or is the new group in Washington better dancers?