The Ugly Reminder

Mortgage rates soared again Monday, tacking on a half-percent in a day for the second time in under a week.

For reference, each half-percent adds $62 to a $200,000 home loan’s monthly payment, or $744 per year. No, it’s not the end of the world, but it’s real money.

I Can Relate

For home buyers recently under contract, it’s a tough time to be shopping for a home loan.  Morning mortgage rates have been typically gone by early-afternoon and — in some cases — lenders have changed rates five times in one-day span. Yea, no kidding.

Why’s It Happening?

The reasons for surge in rates are varied, but each is related to the idea that the economic recession may be nearing its end.

• Consumer optimism is the highest as it’s been all year.
• Consumer spending is falling at a slower pace than in past few months.
• China’s factories reported an expansion in business.

Each of these points is good news for the economy and pushes Wall Street investors towards more risky investments.  As a result, “safe” investments get sold — including mortgage-backed bonds, the basis for conforming mortgage rates.

In short, the bad news, is less bad.  Therefore, investors are hopeful.  The rates show that.

For as long as the future of the economy remains in question, expect mortgage rates to remain volatile.  We won’t get half-point rate swings or five pricings in a day every day, but both are becoming more common.

Be careful when shopping for a mortgage — the rate you’re quoted may not last long.

The Future

It should also be said that this spike is likely not permanant.  Rates move on a daily basis, so if you are still in the process of shopping for a home or if you’re over 30 days from a closing date, don’t lose sleep over this.  I’m sure rates will come back slightly, it’s just a matter of how much.

If you’re in the market to refinance and were holding off for low 4% range, I think it’s time to reconsider your objectives and get realistic.  The next sweep down may be your last chance, and I don’t think mortgage rates are going to 4%.

Rates Drop!

Last Thursday morning, homeowners in different parts of the country woke up to find the following headlines in their newspapers:

• Rates on 30 year mortgages sink to 4.78%, a new low (LA Times)
• Mortgage rates at record low for a 2nd week (Miami Herald)
• Mortgages hit another record low (San Francisco)

The driver of this story was that Freddie Mac’s weekly Primary Mortgage Market Survey showed the lowest, average 30-year fixed rate mortgage in its 38-year, rate-tracking history.  Yes, this is good news.

That’s Old News

However, once again, the headlines came too late for homeowners.

Prior to Thursday’s market open, mortgage markets had already worsened from their record-setting levels.  The worsening started slowly at first, and then sped up.  The shift pressured rates higher so that when lenders issued their Thursday morning rate sheets, most showed an 1/8 increase from Wednesday’s close.

Even worse, the negative momentum carried into the afternoon, forcing a second increase of an 1/8 percent.  A 3 rate sheet day, but that shouldn’t surprise you.

The Freddie Mac survey may have been accurate when the sun came up on Thursday. However, by the time the sun went down, it wasn’t even close.  It is another example of why you can’t do your rate shopping by watching newspaper headlines.  Mortgage markets are volatile and rates often change without notice.

Thursday, they did it twice.

Is The “Credit Freeze” Over?

If the unfreezing of credit is extremely important to an economic rebound, the first signs of a thaw might actually be here.

Last Monday, the Federal Reserve released its quarterly survey of 84 member banks.  In it, the Fed says that fewer than half of its responding banks tightened “prime” mortgage guidelines over the last 3 months.

This is good news for active home buyers and others looking for a new mortgage.

So, What’s A Prime Mortgage?

“Prime” is a loose term with respect to home loans, but it usually refers to mortgage applicants who have:

• Equity or downpayment in a home
• Credit scores over 740
• Excessive income versus debt

Dissecting The News

By looking at the Fed’s survey, we can conclude that because less than 50% of banks made credit less available, more than 50% did not.  Borrowing money may not be easier for prime borrowers, but it’s not harder, either.  Put one on the board for the housing market, this is good news.

Even with this said, guidelines remain restrictive.

Looking Back

In the 12-month period beginning late-2007, banks continuously tightened down on low credit scores, low downpayments, and high debt-to-income levels.  While all this was happening, Fannie Mae added new fees based specific loan characteristics and second mortgages practically vanished from the marketplace.

The cumulative outcome of these actions keeps many Americans from participating in the current Refi Boom.  The good news is that if the trend reported by the Fed continues, lending may get easier a bit later this year.  This would definitely provide a boost to housing and to the economy.

Experts believe that the tightening of credit helped create this recession. The loosening of credit, therefore, may be the way out.

How You Can Prepare

Things are definitely changing and some borrowers being told no right now, may qualify in the next few months.  The only way to take advantage of future offers is to have a mortgage professional that can keep you informed.  If you don’t have someone to help you do that, I’d love to be your guy.

It’s Not Always What It Seems

With respect to mortgage rates, you can’t always believe what you read in the papers.  Or what you see.  The folks who write the articles are only as well informed as the sources that gave them the information.

A great example is the chart here on the right.

Published by Freddie Mac, it shows the 30-year fixed mortgage’s “going rate” as reported by the nation’s mortgage lenders. On December 30, 2008, that rate was 5.1 percent.

But 5.1 percent is only half of the relevant information.  There’s a mandated fee schedule that accompanies the Freddie Mac-reported rate survey.  Notice this chart doesn’t detail the fee schedule.

Sort of misleading, right?

The Fees Aren’t Always Mentioned In These Articles

Currently, the published fee (per: Freddie Mac) required to get a 5.1 percent mortgage rates is 0.7% of the borrowed amount, or $700 per $100,000 borrowed.  This fee is more commonly known as “points” and versus last year, it’s nearly doubled from 0.4 points.  Interesting, right?

So, yes, conforming mortgage rates are low and they have fallen near all-time lows but there’s more to the story than just the interest rate — there are the fees that go with them, too.

Make Informed Decisions

Mortgage rates and loan fees often move in opposite directions so to get lower rates, consider paying additional points.  Conversely, to face fewer fees, accept a higher rate.  It’s a trade-off and your loan officer can help you best understand the choices.  You can read my extremely popular blog post on deciding if paying points is right for you can be found here.

(Photo Kudos: The Wall Street Journal)

Calling The Shots

The New Year is not yet one week old but that’s not stopping market “experts” from predicting what’s in store for 2009.

The calls on housing and mortgage rates run the gamut:

• Home prices have farther to fall
• Home prices have touched bottom
• Mortgage rates will dip
• Mortgage rates will rise

Their Guess Is As Good As Ours

Put it all together and it’s pretty clear that the experts have no better idea about the future than you or I.  Their guesses are educated ones, but they’re guesses nonetheless.

A terrific (or extremely sad) example of how poorly experts can predict the future comes from a Wall Street Journal performance analysis of 1,700 mutual funds.

In 2008, only one earned a positive return.  That one fund represents zero-point-zero-six percent of all tracked mutual funds.  Surely, the fund managers of the other 99.94% didn’t expect to post negative returns on the year.

Fair Warning

So, before you use predictions about the demise (or recovery) of the broader economy to make “personal economy” decisions, consider that the oft-quoted experts have a hugely better track record in analyzing the past than the future.

All we know for sure right now is that home prices are, in general, lower than at the time point last year, and mortgage rates are, too.  By 2010, both could be lower still.

Don’t try to time the market.  Make finanical decisions based on your personal timing.

Understanding the Mortgage Market

Mortgage markets are like any other market, in order for goods to change hands, a buyer and a seller must first agree to “trade” at a specific price point.

In general, the more buyers and sellers there are for a particular item, the easier it is to find that “fair value” and make the deal.

A Normal Market

An abundant number of buyers and sellers often creates a liquid market in which assets (in this case mortgage bonds) can be sold rapidly with minimal loss.

A Vacation Market

This week, there are some people on vacation.  The “liquid market” has gone illiquid.  The treasury market posted just 41 percent of its normal, daily volume Monday (yes, seriously), leading to wild pricing in the mortgage bond market which, in turn, caused mortgage rates to follow.

For example, mortgage rates started the day lower yesterday before moving back higher over a 30-minute, early-afternoon span.  Markets weren’t provoked by economic data, geopolitical developments, or technical factors.  It just, kind of, “happened” and the move left mortgage rate shoppers in the dust.

Learning From Mistakes

This scenario could continue to happen a lot this week.  So, if you’re in the market for a mortgage, be ready to lock quickly.  With low liquidity, rates rarely sit still for long.

Photo Kudos: Purdue BCM

It Might Be On Your Radar

As mortgage rates have fallen (and risen) in the past couple of weeks, there are a lot of Iowans considering refinancing their home.  I want to go on the record and say, don’t just lock it in and close it.  It’s all about timing.  If you lock out of emotion (which most loan officers force you to do), you’ll end up paying more than you should.

If you have patience and work with someone that will watch rates for you, you can lock in when rates swing lower.  This normally lasts for a couple of hours, but if your lender is watching things closely, they can lock you in.

Basic Questions

With that said, I’ve had many potential clients reach out to me through my blog and ask about what ‘refinancing’ means.  It’s not a silly question, it’s not like you learn this stuff in school!  So, here’s my ‘Refinancing 101′ blog post.  Of course, if you have questions — feel free to contact me.

In general, a mortgage is a contract between a bank and borrower, defining the terms by which a home loan must be repaid.

The paperwork, signed by both parties, includes agreements for things such as:

• The interest rate
• The length of the loan
• The amount of money to be borrowed

But, like all loans, a mortgage loan can be paid off at any time.  So, when market interest rates fall, homeowners will often exercise their right to an “early payoff” by securing a new loan that pays off the old one. Often times without any pre-payment penalties (I can help you determine if you have one).

This process is most commonly known as a refinance.

What Is It?

A refinance is the changing of the loan terms against a property, often for a better interest rate or a lower monthly payment.  When the refinance process is complete, the original lender’s loan is paid in full using the money from the new lender’s loan and the former’s relationship is officially terminated.

There’s no rule against how many times a person can refinance, nor is there an easy way to determine whether or not a refinance makes sense.  In general, if you can reduce your monthly payment while limiting your closing costs, to refinance is a smart decision.

However, there are other reasons to consider refinancing too, including:

1. To convert from an ARM (or Adjustable Rate Mortgage) into a fixed rate mortgage (or vice versa)
2. To extract equity for paying off third-party debts or for cash
3. To extend a loan from 15 years to 30 year for payment relief

Because there are fewer third-parties involved with a refinance, it’s often easier and less expensive than a comparable purchase transaction.  The paperwork stack is often smaller, too.

Like I said, right now there are a lot of homeowners considering to refinance.  It’s OK.  It’s perfectly natural

Don’t Rush It.  Work With Someone That Has YOUR Best Interests In Mind.

Just make sure you’re waiting until the ‘bottom’ for mortgage rates.  Often times loan officers will rush the process.  After all, that is how we get paid.  Unfortunately, we don’t get paid when clients ‘wait and see’.  However, ultimately it is in your best interest hold off until mortgage rates hit a threshold that you’re comfortable with.

Trust me, it will not be a large window of time, work with someone that knows what they’re doing.  There are some extremely talented mortgage professionals in town.

Taking Action

When it comes to mortgage rates, sometimes it’s better to “act now”.  For clarification, it is no longer the time to “act now”.

On Tuesday, mortgage rates fell to their lowest levels in 4 years. It happened because the Fed said it would “employ all available tools” to resuscitate the economy.  Not because they cut the fed funds rate, as you know from previous conversation the two are not connected at all.

Quick Reversals

On Wednesday, however, the mortgage markets had second thoughts.

After considering the long-term implications of a near-zero percent Fed Funds Rate and the cumulative cost of government intervention to-date, suddenly, traders grew fearful that U.S. government action would devalue the dollar and lead to inflation — the enemy of low mortgage rates.

As a result, mortgage markets unwound. Quickly.

At first, the exit was a slow and orderly. Then, without warning, investors began a full-on sprint for the exits. By the end of the day, mortgage rates were higher by as much as a half-percent. Nearly all of Tuesday’s big gains were erased.

Learning From This Experience

In hindsight, the reversal Wednesday wasn’t all that surprising — it’s the same trading pattern we’ve seen twice already this year. The first time was after the Fed’s “surprise” rate cut in January, and the second time was after the federal takeover of Fannie Mae and Freddie Mac in September.

If history tells us anything, sharp rate drops tend to be followed by immediate bounce-backs.

But, unfortunately, not every would-be refinancing homeowner saw the increase coming. While those that locked at the first opportunity to save money are sitting pretty today, the rest that “waited for rates to go lower” are likely kicking themselves about it.

Going forward, mortgage rates may fall, or they may not. We can’t possibly know. But we’ve now seen the pattern 3 times now — when mortgage rates plunge like they did Tuesday, they rarely stay that low for long. When you find a rate you like, get in and get locked as soon as possible.

Sleeping on it for even one night may end up costing you dearly.  I’m sure this speaks volumes to many mortgage rate shoppers!

Be Prepared for the Next Drop

As you may have heard in prior posts, we’re unique at Four Legacies Mortgage.  We offer free mortgage management services.  This means that when rates drop like they did, we go on a locking spree.  History shows that mortgage rate drops like this only last a few hours at most.  Waiting isn’t smart.  Locking in and moving quickly is.

Check out more about our auto-lock program here.  I think you’ll really like it.  Feel free to drop me an e-mail if you have any questions about our program.

Also, don’t jump and refinance after you miss the lows.  That’s just silly.   Often times when we’re looking to refinance, we just want to save money on the interest rate.  However, what if you initiate the process and lock at say 5.375% and then rates fall to 4.5% again.  Would you be bummed?  I thought so.

Rates will eventually come back down with the volatility we see in the market.  The key is working with a loan officer that understands the mortgage market.

In the meantime, keep your seat belts on.  This will be a bumpy ride.

(Image courtesy: The New York Times)

Let me save you some time and money.

The Fed does not control mortgage rates.  Not at all.  The Fed can do many things to influence the economy, but one of those things they control is NOT mortgage rates.  Influence, yes.  Control, no.

Let me explain.

What Does The Fed Control?

Now that I’ve established the Fed doesn’t control mortgage rates, it’s important to realize what the Fed does control.

1. Fed Funds Rate – This is the rate that banks are charged directly from the Fed for overnight funds. (More at Wikipeida).
2. Discount Rate – This is similar to the Fed Funds Rate (FFR), but often used to simply increase liquidity. (More at Wikipedia)

Since I’m not focusing on these two items, I’ll leave the extra reading to you.

What Does A Fed Movement Mean to Mortgage Rates?

Okay.  Now what you came for.  There are three moves the Fed can make in regards to the Fed Funds Rate each meeting.

1. Keep the FFR unchanged.
2. Decrease the FFR.
3. Increase the FFR.

Obvious, yes.

Now, let’s put our ‘Trader’ hat on and think about what these movements mean to the economy and markets in general.  I promise this will all come together at the end…. PROMISE.

1. Unchanged means more of the same.  If the Fed doesn’t see a need to step in and take action, you can expect the economy to do more of what it is currently doing.
2. Cutting rates means cheaper money.  This also (often) implies that consumer spending will increase. When Americans spend more money, they also drive inflation higher.  Remember that.
3. Hiking rates means more expensive money.  Common sense would tell you this leads to decreased consumer spending.  As the Fed makes money more expensive, the rules of supply and demand kick in and fears of inflation go away.

What’s Inflation Got To Do With It?

A valid question.

Now that we’ve established that mortgage rates are not based on the Fed Funds Rate, It’s important you know what they are connected to.  The answer is mortgage backed securities.  These are special bonds.  If the value of a mortgage backed security increases one day, mortgage rates go down.  If the value of a mortgage backed security decreases, mortgage rates go up.  Make sense?

Remember, a bond is an investment that promises a certain return on your money each month.  So, an investor puts their money in mortgage backed securities for that purpose.  A certain return on their investment.

Now, the question Americans should be asking is “What does a Fed Cut mean to mortgage backed securities?”  Well, I’m glad you asked!

If an investor knows that inflation will be a concern in the future, they’ll want more return on their money.  Because after all, they want to continue getting the equivalent return on their investment.  So, they actually push down the value of a mortgage backed security (by trading them in the market) and that results in higher mortgage rates.

Don’t Believe Me?  Here’s a History!

I tell this to every client when we’re looking at locking an interest rate around a Fed meeting.  It’s always the same conversation.  “Yes Tyler, this makes sense, but I still don’t believe it.”

Well, here’s what I show them next.  If this doesn’t prove my point, I’m not sure what will.

So, as the value of mortgage backed securities (MBS) go down, mortgage rates go up.

Roughly, every 25bps is equivalent to .125% in rate.  Roughly.

So, you can see there have been some pretty big swings in mortgage rates shortly after the Fed’s actions.

Now You Know

No surprises any more.  Fed cuts lead to inflation.  Inflation leads to higher mortgage rates.  If history has a way of predicting the future (which it normally does), you can expect a Fed cut to lead to higher mortgage rates.

Bond History Chart Courtesy of MortgageMarketGuide.com

Trying To Time The Real Estate Market?

Don’t.  You may think that you’re going to get a home while it’s at the ‘bottom’.  Here’s the thing though, are you considering what your overall cost of ownership would be?  More importantly, do you know what is going on in the mortgage market today that will impact you 60 days, 120 days or 12 months from now?  If you don’t, step back and listen.  You may think you get the real estate market, but I’d be willing to bet you don’t know what’s happening in the mortgage market.

So What’s Up?

It’s a great question.  The mortgage market has seen a lot of changes in the past year.  Now that we’re pretty much down to conventional loans (Fannie Mae and Freddie Mac) and FHA loans, they’re calling the shots.   As you may have heard, the conventional lenders aren’t being extremely profitable right now (understatement of the YEAR).  Since they’re seeing rougher times, they’re naturally passing that cost onto consumers.  The good news is you still have time to beat the clock!  Remember, home ownership is not all about the price of the home.  It’s your overall cost of ownership and your home financing should be taken into consideration!

How High Will Rates Go?

I want to be extremely clear – mortgage rates are NOT moving higher because of inflation fears right now.  They are moving higher because Fannie Mae and Freddie Mac are re-assessing risk.  They’ve seen way too many deals go south and they’ve lost their shorts (and so have their stock holders).   Fannie Mae recently announced (last Monday) that they will be increasing their ‘adverse market fee’ from .25% to .50%.   For consumers, that roughly means about .125%-.25% higher interest rate.  That is about $16 per $100,000 your borrowing.  Over 30 years, that’s over $5,700!  Do I have your attention yet?

It Gets Better

Yes, Fannie Mae and Freddie Mac often follow each other.  So, count on Freddie Mac instituting the same increased fees in the next couple of months.  Furthermore, Fannie and Freddie have been implementing credt score (FICO) based increases to interest rates.  You could literally have a 1% higher rate than some consumers just because of your credit score.  This credit score based system is likely to stay and likely to get even worse.  That’s right, it will get worse before it gets better.

Still Don’t Believe Waiting is a Suckers Choice?

I’m going to put together a comparison.  This is simply for demonstration purposes only, but it should drive my point home that your overall cost of ownership should be what you’re focusing on.

Assumptions:
Let’s assume that homes could drop another 5% and that would be the skeptics “bottom”.  Let’s also assume in this scenario, there will be 20% down (only to make this the best case scenario for skeptics).  Let’s also assume that in the future the new ‘adverse market fee’ from Fannie Mae has kicked in with a small credit score adjustment (this really is more than fair).

Today:
You decide you want to buy a home for $200,000.
You are financing $160,000 (80% of purchase price).
You can obtain financing at 6.25% for 30 Years, Fixed.

Your monthly payment (principal and interest) would be: $985

Billionaire Investor, Waiting For Bottom:
You have waited for the home to be bought for $190,000.
You’re financing $152,000 (80% of purchase price).
You can now obtain financing at 6.75% for 30 Year, Fixed.

Your monthly payment (principal and interest) would be: $985

They cost EXACTLY the same!

The Big(ger) Picture

The one thing that isn’t being addressed here is the availability of these programs.  If you’re putting 20% down, you’ll always be able to get a loan (assuming you have a job, and some money in the bank).   However, What If:

• You’re short on cash?
• You’re a first time home buyer?
• You’ve got less than perfect credit?
• Don’t have a credit score at all?
• Need to use a roomate’s rent for income?
• Want that home that’s currently on the market?
• Your landlord kicks you out?
• A dog had a square….?

My point is these things begin to matter.  If you want to bulletproof your approval, you need to get started today.  While there is still a loan you can get.  I’ve had multiple potential homeowners come to me (in the past few months) and I’ve had to turn them down (when they were well qualified) and they could have qualified without a problem just 6 short months ago.   That hurts.

There Is No One Size Fits All Answer, But There is a Way to Find Out!

If the answer was the same for everyone, there would be no need for professionals in this business (oh wait, that recently changed huh?)… Truth is, things have changed.  Some Iowans are sitting on the sidelines waiting for the ‘bottom’ of the market, but have no idea how their financing impacts their plan.

If you or someone you know is looking to purchase…. or sitting on the bench, tell them to check this out.  I think the comparison is about as ‘best case scenario’ you could use.  Trust me, things could get much more different.

As always, if you’ve got questions and need answers, I’m here to help.

Photo Kudos!