Harvard University’s Joint Center for Housing Studies just released a new report entitled, “The State of the Nation’s Housing 2009.” [By the way, the report is incredibly informative, and I would strongly encourage everyone to give it at least a quick skim]. The conclusion of the study’s authors can be understood as follows: “Despite unprecedented federal efforts to jumpstart the economy and help homeowners keep up with their mortgage payments, home prices continued to fall and foreclosures continued to mount in most areas through the first quarter of 2009.”

The report further points out that “By all measures but homebuyer affordability, housing market conditions deteriorated further in 2008. Housing starts were down by more than 30 percent for the year and more than 50 percent from the 2005 level…Reported new home sales also showed a record-breaking plunge of more than 60 percent from the 2005 level…The seasonally adjusted supply hit a record 12.4 months in January 2009.”

The prognosis for the future is uncertain: “With prices down by double digits, interest rates moderating, and reasons to believe that pent-up demand is building, the prospects for a recovery have improved…Still, clear signs of a recovery have yet to emerge, and job losses and the steady stream of foreclosures are keeping many markets under pressure.”

Last week also witnessed the monthly release of the oft-cited Case Shiller index, which registered a decline of “only” 18.1%, compared to a year earlier. Because of delusion and/or blind optimism, analysts interpreted this as a positive development. To be fair, the decline was better than both economists’ forecasts and last month’s reading. Robert Shiller, whose name is attached to the index, suggested that “Home prices are going to level off — they’re not going to keep falling.” He added that it’s “hard to predict” and “I am not optimistic that we’re going to see any sharp rebound.”

Some analysts are taking a more objective/cautious approach to predicting housing prices, and are inclined to see slight month-to-month changes are mere noise. I personally fall into this camp, as I don’t consider a decline of 18.1% a material improvement from an 18.6% decline. In addition, there are inconsistencies in the way that data is collected which have a confounding effect on median numbers. For example, “A house that sold for $600,000 during the boom and $400,000 in foreclosure will be recorded by the NAR as a $400,000 sale, lifting the national median but suggesting no real improvement in housing.” Not to mention the vast regional disparities that are masked by national numbers.

In short, it’s probably wise to avoid to reading too much into both the forecasts as well as the underlying data upon which the forecasts are built. It’s cliche to point out that the housing market is inherently unpredictable, but in the current environment, this cliche is especially worth repeating.

One of the cornerstones of the Obama administration’s plan to overhaul the US mortgage system is an emphasis on so-called “plain-vanilla” financing. Specifically, “The government would give its seal of approval to a handful of mortgage types — a standard 30-year fixed-rate mortgage and perhaps a few varieties of adjustable-rate loans. For a loan to get the ‘vanilla’ label, the lender would have to verify borrowers’ income and have them set aside money for property tax and insurance.” A 20% down-payment would be required, prepayment penalties would be eliminated, and all fees/costs would have to be clearly stated. [See chart below, courtesy of WSJ].

The primary purpose of the plain-vanilla system would be to protect borrowers, many of whom were burned by complicated mortgages during the height of the housing boom. Types of mortgages have exploded both in number and complexity, such that there are now hundreds of different variations, requiring various levels of risk disclosure and creditworthiness. Ostensibly, this innovation was designed to help consumers by giving them more choices. Human nature being what it is, many borrowers opted for the riskiest mortgages. Meanwhile, banking profits soared. Given how opposed the banks are to the return to plain-vanilla lending practices, it’s pretty obvious as to who is benefiting most from the current system.

There is a strong political bend to this regulation, given the assumptions about human nature that it makes. Still, there is something to be said for simplicity. A fixed-rate mortgage is predictable and easy to understand. Income verification confirms the borrower’s ability to afford the mortgage, and a large down-payment lowers the possibility of default. Sure there are borrowers who liked the freedom to use their mortgage to make a bet on the direction of interest rates, and/or who successfully exploited liar’s loans to purchase a house they otherwise wouldn’t have received lending approval for. But for everyone who came out ahead with a zero down payment ARM, anecdotal evidence suggests that there are 9 who came out behind and are now in default.

Under the new system, those who want to play roulette with their home/finances can still do so, but will be strongly discouraged in the form of un-preferential treatment/pricing. “According to the administration’s ‘white paper’ on the proposal, the agency ‘could impose a strong warning label on all alternative products; require providers to have applicants fill out financial experience questionnaires; or require providers to obtain the applicant’s written ‘opt-in’ to such products.’ ” In this way, banks will also be protected, since consumers can no longer pretend that they weren’t aware of the risks when they signed up for the mortgage.

In the wake of the housing crisis, risk aversion has increased, and it looks like banks/consumers are actually one step ahead of the government. “With the housing bubble burst and mortgage rates near historic lows, fixed-rate loans — 30-year, 15-year and other types — now account for about 95 percent of the market,” compared to only 50% during the height of the boom in 2004. But people have short memories. If this regulation passes, it will make it more difficult for people to overextend themselves when the economy begins to recover.

In the mortgage game, many potential borrowers simply shop around for the best deal, and simply compare the rate quotes that lenders offer them. This approach, however, is somewhat passive, as it ignores one very important step: researching and improving your credit score. In light of the housing and credit crises, banks are relying increasingly on the credit score as a risk metric, so it’s crucial that you understand how the process works.

While every lender utilizes credit scores slightly differently, there is still a consistent relationship between the strength of the score and the “competitiveness” of the mortgage. In other words, one lenders might have 5 interest rate tiers which correspond to five credit score levels. Other lenders might have 3 tiers, or 10 tiers. Still other lenders might have minimum credit score requirements for certain types of mortgage. But the fact remains, the higher one’s credit score, the better/cheaper the mortgage is.

The credit score formula evaluates payment and credit history, utilization, new loans, types of credit in use, and the age of accounts. Generally speaking, your credit score will be highest if you pay your bills in time, have a small amount of debt (but not zero debt) relative to your credit limits, and have older and fewer sources of credit.” While dozens of different credit scoring formulas have been developed, the Fair Isaac Corporation’s FICO score has long been the industry standard. The exact formula is a closely guarded secret.

As part of the Fair Credit Reporting Act, you are entitled to view your credit score free once a year. Unfortunately, this rule might be doing more harm than good, since the free score that you can expect to receive probably isn’t your FICO score, but a score calculated using the specific reporting agency’s proprietary formula. Sometimes, there are wide disparities between different companies’ scores, such that the number you receive may not be entirely useful. Still, it’s important to review your credit report itself for errors, and to file a complaint if you discover any.

If your credit score is lower than you want/need, there are a couple steps you can take to improve it, most of which are self-evident. Namely, pay off any outstanding balances and cancel any credit cards that you aren’t currently using. In addition, have yourself removed as an authorized user on any cards that you don’t use since delinquent payments on such cards (by other authorized users) could negatively affect your credit. At the same time, don’t worry about consolidating debts under fewer cards, since this won’t meaningfully affect your credit score. Also, be advised that (sometimes arbitrary) cuts in credit limits can negatively impact your score because they increase your utilization rate.

While it may take years for such these measures and other responsible borrowing practices to result in an improved score, you could see a slight bump in only a few months. If there’s one particular blip on your credit score, it doesn’t hurt to submit a letter of explanation to the mortgage lender, in which you make it clear that extenuating circumstances (i.e. job loss, illness, personal issues) caused a temporary interruption in an otherwise seamless history of good behavior.

Last week, The Mortgage Calculator explained the government’s loan modification program. What I neglected to cover in this post, however, is how this program has been commandeered by scammers and private interests. Whereas the government has arranged for both the provision of “free” counsel and “free” loan modifications (free in the sense that the program is funded through taxes, and not by charging mortgagers directly), middlemen and for-profit counselors have nonetheless come out of the woodwork to take advantage of this potential windfall.

Some of these “counselors” are outright scam artists, while others extort a fee for services that should be free. The most blatant scams involve phony correspondence, ostensibly from the government or one’s lender, offering a loan modification in exchange for a fee. Often, they will guarantee a loan modification and use this as justification for charging money up-front. Naturally, this fee is not refunded when the counselor fails to procure a loan modification on behalf of the mortgager. According to the Federal Trade Commission, “These companies touted so-called guarantees and high success rates to mislead consumers about their services; charge upfront fees that legitimate nonprofit organizations do not charge; and use copycat names or look-alike Web sites to appear to be a nonprofit or government entity.”

According to another source, “There are numerous scams involving deed transfer or questionable loan paperwork. The strategy varies, but the goal is always the same; separate you from your money and, possibly, your property.” These scammers deliberately aim to overwhelm borrowers with paperwork, such that unfavorable terms can be easily concealed. In some cases, mortgagers will unwittingly sign over the deed to the counselor; in other cases, deed transfer is stated as necessary in order to secure a loan modification. In yet another scam, a “counselor” will pretend to assume the loan for you, so that you erroneously make payments not to the actual lender but to a fake intermediary that will probably disappear after a couple months.

There are also legitimate “foreclosure rescue” companies that “prey upon the financially unsophisticated.” While such companies are technically above-board, their exorbitant fees place them in the same company as the actual scammers. These companies may insist “only an attorney or licensed debt adjuster can legally represent a borrower for a mortgage modification.” While someone with a working knowledge of the legal side of mortgages may have an easier time negotiating the loan modification process, there is no rule that stipulates that a lawyer must be involved. Then again, one consumer rights advocate says that “Unless your agent is a licensed attorney, it is illegal in most states for an agent to negotiate a loan modification with your lender.” This is a testament to how much confusion there is surrounding this system.

In the end, there are a few common-sense rules that you should follow if you want to avoid becoming a victim of a loan modification scam. First, loan modification counseling is available free of charge, which means you should never have to pay money/engage the services of a for-profit counselor. Most states remain databased of HUD-recommended counselors. At the same time, while such a counselor may be more capable of securing a loan modification, there is nothing that prevents you from trying to negotiate with the lender directly. Lastly and most importantly, if it seems to good to be true, it almost certainly is.

While the government has done a reasonable job of facilitating the housing market and keeping mortgage rates low, the same can’t be said about the underwriters, namely Fannie Mae and Freddie Mac. Both organizations are tightening standards, not in spite of but because of the housing crisis. Few can blame them; after all, it was their laxness that only facilitated the crisis, but also necessitated large-scale government bailouts.

Specifically, both Fannie and Freddie have tweaked their rules regarding the treatment of so-called trailing spouses, a term which refers to “one who joins his or her spouse or partner in a job-related move but who has yet to obtain employment in the new location.” Previously, at least part of this income could be used to satisfy the ratios that lenders calculate when writing mortgages.

Under the new rules, Fannie won’t allow any of this income to be applied. Freddie, meanwhile. will continue to allow trailing spouses to apply their income, under the conditions that they have been continuously employed for the last two years at the same job, that the money wasn’t earned from self-employment. Also, income from a trailing spouse cannot exceed 33% of qualifying income.

In addition, stocks and bonds will now be discounted by 30% in the calculation of certain ratios and when used to meet net asset tests. “For retirement accounts, it [Fannie Mae] will count only 60 percent of the value toward reserves.” Previously, no discount was applied. Given both the economic downturn and the accompanying collapse in securities prices, these rule changes are understandable. With steady employment more difficult to come by, and with stocks and bonds worth a fraction of their bubble values, more conservative rules were probably inevitable.

While these rules cannot be circumvented, they can still be skirted. For those of you who otherwise would have sought to use the income from a trailing spouse, you can still claim their income, but won’t be able to officially verify it. The same goes for assets. If you are confident that a certain mortgage is ultimately affordable regardless of what the lender (via the underwriter) is telling you, it’s still possible to take out such a mortgage. Since your assets and/or income can’t ultimately be verified, however, you may have to suffer a higher interest rate. At the same time, these standards not only exist to protect the underwriter, they also exist to protect you from overextending yourself. In short, think long and hard before going ahead when the lender tells you no.

The phrase “buyers’ market” continues to crop up in housing market commentary. The idea is that since home prices are still sliding, buyers naturally have the upper hand. But bargaining power is slippery, and shrewd sellers can actually exploit this perception to their own advantage. Still, there are sellers offering legitimate incentives, and if you understand how the game works, you can come out ahead.

Seller incentives come in various forms. They can be material in nature, such as a free furnishings/electronics or an “upgrade” on a house bought directly from the builder. Other times, sellers will agree to cover closing costs and other fees. Still other sellers will try to compete by offering unique financing, such as a lease-to-own or wraparound mortgage. Some sellers will even offer a discount on the purchase price.

The latter is certainly the best incentive, with rebates for closing costs not far behind. Both represent cash in your pocket, as opposed to a nice television, which can be difficult to quantify, in which case you might just ask for the cost of the TV to be handed to you, in which case you have the freedom to spend the money on whatever you’d like. Still, a free TV is a nice incentive, as long as it’s truly free (i.e. not factored into the purchase price) and is something you would have probably purchased anyway. If the purchase price has been adjusted for the cost of the incentive, then you essentially lose twice. Not only were you conned via a false incentive, but also the higher purchase price equates to a bigger mortgage, and more interest.

Seller financing can also be a great incentive. A lease-to-own mortgage gives you an extra year to raise cash for a down payment and also a chance to live in the property before you commit to buying it. Usually, a portion of the rent you pay to the seller during that year is applied towards the down-payment. A wraparound mortgage, in which the seller keeps the original mortgage and you make payments directly to him- works great when interest rates are rising. Even in the current low-rate environment, wraparounds can be useful for buyers with less-than-stellar credit. A wraparound mortgage is ultimately more risky for the seller, who also assumes the role of lender. Still, it’s important to first seek the actual lender’s approval.

Builders are especially ripe for seeking incentives. They are often unwilling to lower the sale price, in order to maintain the appearance that the homes are more valuable than perhaps they actually are. Accordingly, a builder may thrown in a free sunroom in order to close a sale, since he can still show that the house sold for a certain value. If instead he had discounted the sale by the value of the sunroom, then he would have lowered his bargaining power with future buyers.

When bargaining with buyers, it’s important to be aware that some “incentives” are actually scams. The most common scam is a “recommendation” to use a specific selling agent (if you must first sell an existing home) or lender. “A builder will often try to steer you to an affiliated mortgage lender, with a promise to give you a discount. But you can’t count on the mortgage company to give you the best deal on rates and closing costs in the first place.” Anecdotal evidence suggests that such “referrals” rarely result in better deals, and in fact some practices may soon become illegal, as they violate anti-trust provisions.

As I started to explain in yesterday’s post, government is keen to help borrowers and homeowners in need. More than $75 Billion has already been allocated towards helping homeowners avoiding foreclosure. An additional $1.5 Trillion has been deployed by the Federal Reserve Bank; as part of its quantitative easing plan, it has purchased mortgage securities in bulk, which has helped to keep mortgage rates relatively low.

Both of these programs have targeted those who already own homes, by allowing them to lower their monthly payments through loan modification and refinancing. What about those who aspire to own homes but don’t currently have a stake in the system? This is where the tax credit comes in; both the Federal government and select state governments are now offering qualifying homebuyers a break on their taxes if they purchase a home before a certain date.

“As of May 29, 2009, the $8,000 federal tax credit can be used as ‘an additional down payment or closing costs’ for buyers who apply for mortgages insured by the Federal Housing Administration before Dec. 1, 2009″ and must have been purchased after January 1, 2008. There are two key stipulations: first, the credit is limited to first-time home buyers, defined as not having owned a residence in the last three years. Second, there are income limitations: “A phase-out of the credit begins when the taxpayer’s modified adjusted gross income exceeds $75,000 or $150,000 if married filing jointly. The credit is eliminated completely when the taxpayer’s income reaches $95,000 or $170,000 if married filing jointly.”

In an effort to maximize the benefit of the tax credit, the government has the designed to program to be extremely flexible. First of all, qualifying homebuyers have the option of claiming the tax credit in either 2008 or 2009. In addition, the tax is not only deductible but actually refundable; in other words, “This means that even if you don’t owe the government money in taxes, you can still take part in this incentive program,” as the government will simply write you a check for the difference. Finally, the tax credit can be applied immediately in conjunction with the purchase of a home; through the use of a bridge loan, homebuyers can use the credit prior to actually filing their taxes. Consult the First-Time Home Buyer Tax Credit website for more information.

While the federal credit is available to anyone who qualifies during the given time period, some state programs are available on a first-come, first-served basis. California, for example, recently set aside $100 million to be meted out in the form of $10,000 credits. In only four months, most of this money has already been distributed; “Some $94.7 million has been claimed via 9,848 applications, according to the most recent data from the state’s Franchise Tax Board.” Better Hurry!

For those of you neither own a home, nor aspire to own one in the short-term, the government is also watching your back. “The Consumer Financial Protection Agency, if approved by Congress, will have broad authority to protect consumers of credit, savings, payment and other consumer financial products and services…It could write rules, reform mortgage laws, examine financial institutions’ practices, enforce compliance through penalties, ban unfair practices and require that companies be “clear and conspicuous” in informing consumers of costs, penalties and risks.” In addition, lenders would be required to offer a “plain vanilla” mortgage (i.e. 30-year fixed rate). Prepayment penalties and yield-spread premiums would be banned, and lenders would “not be able to issue mortgages…that they knew consumers would not be able to pay back.”

Barack Obama and the rest of the federal government continues to roll out new initiatives designed proximally to help mortgagers in need, and ultimately to stimulate the ailing economy. At this point, pretty much everyone is eligible for help, regardless of what stage of the process they are at.
 
For those that already have a mortgage and are facing foreclosure, the government has pledged money to incentivize banks to grant loan modifications for qualifying mortgagers. “To be eligible, a homeowner must have a monthly mortgage payment larger than 31 percent of their gross income. The monthly payments of those who qualify are lowered to the 31 percent limit. Lenders can do this by reducing interest rates to as low as 2 percent, by extending the term of the loan to 40 years or by deferring principal.” Borrowers are then placed in a temporary program whereby they must make their reduced payments successfully for three months, after which points they see their loans permanently modified.
 
On the one hand, the Treasury Department is trying to make it easy for eligible borrowers to receive modifications: “About 100,000 homeowners across the country so far have been extended loan modification offers. ‘We are encouraging servicers to staff up, establishing a hotline for homeowners, looking for new tools to expedite this process, working with communities to get the word out about resources available to homeowners,’ ” declared the department’s spokesperson.
 
At the same time, those who have applied tell stories of long waits, lots of uncertainty, and probable rejection. There are two related reasons for this discrepancy. First, there is a lack of lender impetus to facilitate loan modifications: “Housing counselors say that while 15 lenders — including major ones like Bank of America, CitiMortgage, Chase and Wells Fargo & Co. are participating, many have yet to fully train people to process the applications. As a result, housing counselors say they often receive mixed signals, with different lenders offering different interpretations of the guidelines.”
 
Second, the mortgageholders (i.e. investors) have the ultimate say in whether a mortgage can be modified. In situations where the value of the mortgage exceeds the value of the home, investors are more willing to agree to modification, because a foreclosure would result in lower remuneration. In relatively healthy markets, however, investors are more reluctant, especially since all of the incentives are directed towards the banks.

Ultimately, “One thing is clear: Homeowners who have a HUD-approved housing counselor championing their cause are more likely to get a modification than those who try it on their own. Housing counselors say they often understand the program’s guidelines better than the people answering phones for lenders, so they know how to pursue a case aggressively.”
 
Stay tuned for tomorrow’s post, where I will outline the homebuyer tax credits and the implications of the proposed Consumer Financial Protection Agency…