Beginning on April 1, Fannie Mae follow in Freddie Mac’s footsteps and formally raise the fees that they charge lenders, which will almost certainly pass these fees on to borrowers. The bottom line is that for virtually all borrowers, obtaining a mortgage is set to become significantly more expensive.
As mentioned earlier, Fannie/Freddie are currently hemorrhaging money at the combined rate of $1-2 Billion per month. While the government hasn’t yet determined how these two organizations – which currently underwrite 95% of all new mortgages and without whom, the mortgage financing system would collapse – in the mean time, it will certainly seek to limit their losses. Thus, the expansion of “loan-level price adjustments” should not have come as too much of a surprise.
Basically, Fannie/Freddie charge lenders fixed fees for all mortgages that they agree to purchase, and in return, the lender is alleviated of most of the risk. In the past, these fees were relatively modest, and certainly inadequate to offset the risk borne by Fannie/Freddie. Meanwhile, a few years have already passed since the collapse of the housing bubble touched off a wave of defaults, and since then, the mortgage behemoths claim to have learned a few lessons about the actual creditworthiness of borrowers.
Under the proposed changes, all borrowers will be charged an “adverse-market” fee of .25%, which can be paid upfront or rolled into the mortgage. Supplementary “risk-pricing” fees will be set in terms of the borrower’s credit rating, downpayment size, mortgage type, property type, and a handful of other factors. Only those borrowers (encompassing about 12% of the total) with FICO credit scores above 740, that make downpayments >25% for stand-alone residential properties will be exempt from this additional layer of fees. Everyone else will be required to pay up to 3% in fees, depending on their risk profile.
It’s worth pointing out that FHA loans are naturally exempt from these additional fees. In addition, “not all lenders sell all mortgages to the secondary market, so not all loans are subjected to the fees.” In addition, given that the profitability of issuing mortgages has surged in the last year (due to shrinking competition), it’s possible that some of the additional fees will be absorbed by lenders.
A few tips for borrowers, then. All else being equal, try to close on your mortgage before April 1. If you haven’t yet looked into the possibility of obtaining an FHA loan (which permit lower down-payments and lower credit scores), you should probably consider doing so. (However, FHA loans are also becoming more expensive and carrying higher restrictions). Next, make sure that your credit score is as high as possible, and that your credit report is free of errors. A difference of 5-10 points in your score could make a big difference in the fees that your lender charges you.
Finally, remember to shop around for a mortgage, and that all fees are ultimately negotiable. As I said, the dynamics of mortgage lending have changed dramatically since the collapse of the housing bubble, and it’s possible that your lender will agree to certain fee reductions in order to retain your business.
A few months have passed since I last offered an update on the state of the housing market. Since then, there have been a number of developments which suggest that 2011 could witness double-digit declines in housing prices, and that the long-awaited double-dip will finally materialize.
In an analysis of the housing market, it’s difficult to know where to begin. So much has been written on this topic over the last month and a trove of new data [Gary Shilling has dutifully compiled all of this data in a must-read research report] has been released, to the point that I experienced an acute case of information overload when researching this article. Here’s where we stand: the bellwether Case Shiller Housing Index “has risen 4.4 percent from its April 2009 bottom. But it remains 29.6 percent below its July 2006 peak.” According to some measures, this is already a larger decline than that which transpired during the Great Depression. While the national housing market stagnated in 2010, there was tremendous regional disparity. While prices fell ~20% in Dayton and Columbus, Ohio, they actually rose in 70% of major markets, including Washington DC (5%) and Honolulu (7.5%).
Meanwhile, the number of foreclosures also exploded: “Banks seized more than 1 million homes in 2010, according to RealtyTrac. That was up 14% from 2009 and the most since the company began reports in 2005….About 3 million homes have been repossessed since the housing boom ended in 2006…That number could balloon to about 6 million by 2013.” While the number of foreclosures fell in December because of legal uncertainty over the rights of lenders to repossess, delinquencies and defaults are still rising, and foreclosures will almost certain follow. 10% of all residential mortgages are now past due, and 4.5% are in foreclosure. (5 States: California, Arizona, Florida, Illinois and Michigan have accounted for more than half of the foreclosures). In addition, distressed properties accounted for about 30% of all home sales in 2010.
The clear consensus is that the only reason that the housing market didn’t completely collapse in 2010 is because the government intervened, in the form of a homebuyers tax credit. In hindsight, the tax credit merely pulled demand forward, instead of creating new demand. According to economist Nouriel Roubini, “If you look at the data, Case Shiller has been falling every month since the tax credit expired in May. Everyone who wanted to buy a home did so by April. That tax credit stole demand from the future…”
Going forward, there is more reason than not to believe that further declines are in store. There remains a massive shadow inventory of unsold foreclosed properties, which will expand further before it contracts. Mortgage rates have ticked higher in recent months from record lows, and besides, tighter underwriting standards are making it more difficult to obtain a mortgage. (Fannie Mae and Freddie Mac now underwrite almost 100% of residential mortgages). Meanwhile, the economy has only just escaped from recession, consumer confidence is low, and unemployment remains at a 30-year high of ~9.7%.
Even if you ignore the fundamental picture, econometric analysis suggests that housing prices have yet to “revert to the mean” of their long-term trend. Based on almost every measure, housing prices are still above historical levels, rent ratios remain high, and affordability indexes reflect inflated prices. From a purely financial perspective, then, housing prices would have to fall 20% in order to offset the appreciation of the bubble years. Moreover, it’s possible that the correction will “overshoot,” in which cases prices could drop by 25-30% before resuming their long-term average rise of 3.5% per year.
Yet, there are some economists who are cautiously optimistic. According to in Frank Nothaft, chief economist of Freddie Mac, “I do think we’ll see these housing prices bottom out, maybe by the spring.” Due to a drop-off in new housing developments, supply (not including the shadow inventory) is low. There is also hope that the economy will recover, and lift employment and consumer spending with it. As one columnist summarized, “The minute Americans see a real reason for hope…housing will come roaring back.” Even the most dire housing forecasts concede that some regional markets will probably rise in 2011.
From where I’m sitting, however, there really isn’t cause for much optimism. Unless you live in Hawaii or Texas, the next year (or two or three) will probably witness further declines.
A recent spate of lawsuits has accused mortgage lenders of impropriety or outright fraud at virtually every level of the mortgage process. Moreover, as lenders increasingly find themselves on the losing end, these lawsuits will have important implications for the future of mortgage lending.
Bank of America is currently in the process of resolving all of the disputes surrounding Countrywide Financial, which it acquired during the height of the housing boom. In 2009, it was sued by the state of Massachusetts for originating risky loans without verifying borrowers’ ability to repay the loans. BofA ultimately settled the case in May 2010, and agreed to “$18 million in loan modifications for Massachusetts homeowners, $3 billion in loan modifications for homeowners across the country, and a $4.1 million payment to the Commonwealth.”
However, the Attorneys General from the states of Nevada and Arizona have already filed suit alleging that BofA has failed to live up this agreement, as it “told consumers they would not be foreclosed on while requests for loan modifications were under way, not acting on the modifications within a specific time, making false promises to consumers and potentially selling their homes while they were waiting for decisions.”
Last week, Bank of America finally settled its case with Freddie Mac and Fannie Mae, in which it agreed to repurchase a substantial portion of Countryide mortgage securities, and subsequently write down $2-5 Billion of it. Meanwhile, All State Insurance, which also lost money on investments in mortgage securities, and MBIA, which lost money insuring such securities, have also filed lawsuits. Both allege that BofA deviated from its underwriting standards when it originated such loans. Such claims are supported by an internal Countrywide audit, which found that “approximately 40% of the Bank’s reduced documentation loans . . . could potentially have income overstated by more than 10% and a significant percent of those loans would have income overstated by 50% or more.”
Meanwhile, the State Supreme Court of Massachusetts “affirmed a lower court judge’s ruling invalidating two mortgage foreclosure sales because U.S. Bancorp and Wells Fargo did not prove that they owned the mortgages at the time of foreclosure.” While there was no doubt – as in thousands of other cases – that the borrowers were in default, the lenders failed to convincingly establish proof of ownership at the time of foreclosure. These cases were closely watched by foreclosure defense attorneys around the country, and it is likely that additional cases will now be brought forward.
The upshot is that lenders are finally being held accountable for lax origination/documentation practices that were begun during the housing boom. As if it wasn’t already clear, their operations will continue to be the subject of rigorous scrutiny, and it’s possible that more lawsuits will be brought forward.
What a mundane and seemingly obvious piece of advice! And yet, according to the results of a recent survey by LendingTree.com, 40 percent of mortgage shoppers obtained just a single quote before settling on a mortgage. Given that the same poll established that 96% of consumers will comparison shop for most items, this is nothing short of astounding.
There are a few probable causes for this phenomenon. First of all, there is a small contingent of borrowers that either doesn’t understand that mortgage rates vary among lenders and/or mistakenly believe that rates are determined by the Federal Reserve Bank and that such variations are therefore trivial. Second, there is a factor of laziness. How else can you explain the 10% of borrowers that “admitted they had spent the same amount of time searching as it takes to brush their teeth.” There is also an aura of complexity surrounding mortgages, which spurs fatigued borrowers to simply choose any lender at arm’s reach. Finally, there is a misconception that lending standards have become so stringent that borrowers should immediately pounce on the first approval that they receive.
While mortgages have become a commodity product over the last decade, there is still a tremendous amount of variability between mortgage lenders, in terms of rates, points, fees, service, and lending standards. At the very least, it’s worth speaking to a few different lenders to make sure that you receive a good deal, fair terms, and good service.
The first step is to use the newspaper, internet, friend’s referrals, etc, to develop a preliminary list of 3-5 potential lenders. (You may also want to consider including a mortgage broker on the list. While this will add an extra layer of fees, a good broker will do your mortgage shopping for you and might even be able to help you save money overall). The next step is to contact each lender and ask them basic information about the types of mortgages that they offer and are potentially suitable for you. While you should focus on the financial (i.e. rates, points, fees) parameters, you should also inquire about other points of distinction. (The FTC has created an excellent table that you can use to comparison shop).
In order to give you an accurate quote, each lender will probably ask you for personal financial information. Bear in mind, however, that in order for them to offer you a precise estimate, they will need to separately pull your credit history, which could adversely affect your credit score. For that reason, it’s probably only worth obtaining a Good Faith Estimate only once you have settled on a property, and/or you know approximately how much you will need to borrow. If you elect to obtain pre-approval prior to shopping for a home, remember that you are not bound to that lender. You can always continue mortgage shopping or start afresh, after identifying the home that you wish to purchase.
Remember that different lenders have different lending standards. Don’t be discouraged if you are rejected by the first lender(s) that you contact. Conversely, don’t automatically accept the first offer that you receive. Even if you have a mediocre credit score, you might still be able to find a handful of lenders that are willing to give you a mortgage at an attractive rate.
Finally, there is something to be said for dealing with a broker/lender that you trust. As the LendingTree survey confirmed, shopping for a mortgage is a daunting process. It might ultimately be worth paying .05% more if you feel more comfortable with one lender than another.
As if obtaining a mortgage loan wasn’t difficult enough, it turns out there was one more obstacle which has to be overcome: the appraisal. Thanks to new federal regulations, appraisals have now become a nail-biting experience. The best advice for both buyers and sellers is to avoid obtaining one altogether.
Unfortunately, all lenders will stipulate that an appraisal must be performed in order for the mortgage to be originated. During the inflation of the housing bubble, this was hardly an onerous requirement. Given that appraisal is inherently more art than science, it was easy enough for appraisers to adjust their comparison tables and deliver a value that was in line with what the buyer and seller had agreed upon. In fact, many appraisers reported receiving pressure from lenders to deliver a value (so that the sale would close), thereby minimizing the importance of their role in the process.
In some ways, this changed as a result of the Dodd-Frank financial reform bill and the related Home Valuation Code of Conduct (HVCC). Among other things, the independence of appraisers (such that they would be immune from third party pressure) was stipulated. This led to the creation of Appraisal Management Companies (AMCs), which has unfortunately led to a decrease in quality: “They mostly care about getting the appraisal done quickly and cheaply, not necessarily well. And they take a good chunk of the appraiser’s fee—often more than half—with the result that appraisers say they can no longer make a living; competent people are fleeing the profession.”
Moreover, appraisers still report being pressured from lenders – this time to deliver lower appraisals – “from lenders who want to make sure they have enough equity to cover them even if home prices fall further. As if this were not enough, a preponderance of short sales and foreclosures in some areas is making it difficult for appraisers to find comparable properties, and is putting downward pressure on both home values and appraisals. The news has been filled with horror stories of second and third appraisals that came in 10% (or more lower) than the first appraisal, making it difficult to complete the sale. According to the National Association of Realtors, “One in 10 member agents said they’d had a contract canceled as a result of a low appraisal, 13 percent said they’d had a contract delayed, and 16 percent said they’d had a contract negotiated to a lower sales price as a result of a low appraisal.”
In short, it’s probably best to avoid having an appraisal performed if you can help it. If the buyer and seller can agree on a price, it’s pointless to request the opinion of an appraisers unless it is ordered by the lender as a precondition to mortgage financing. If, on the other hand, you are stuck with an unpalatable appraisal, you should challenge the valuation and/or request a home inspection. If the appraiser isn’t willing to bend, you might be forced to find another appraiser.
The majority of home-buyers conduct their house-shopping before obtaining financing. After all, how can you obtain a loan for a property that you have not yet purchased?! What if I told you, however, that you could achieve a loan guarantee from a prospective lender at the beginning of the process, such that you could close on the purchase of a home immediately after selecting it?
Known as pre-approval, this guarantee represents a commitment by a specific lender to underwrite a mortgage for the potential purchase of a home. Based essentially on your credit score and a handful of other selected financial characteristics (pertaining to your assets and income), the lender will determine the maximum monthly payment you can afford to make. Prevailing interest rates are then applied to this figure in order to determine the maximum overall mortgage amount.
The advantages of pre-approval are two-fold. First of all, you can shop for a home with the confidence that you can obtain financing for it as long as it falls within the financial specifications laid out by the lender. Second, the pre-approval letter can be used as a bargaining chip in negotiations with the seller. For example, if two potential buyers make similar offers for the same property, the seller might be more willing to accept the offer from the pre-approved buyer, because it is more likely that the sale will close quickly. The advantage to the lender is that the borrower is more likely to return to it when he begins the actual process of obtaining a mortgage.
Unfortunately, it seems that lenders are now reluctant to grant pre-approvals, as part of a general trend towards stricter lending standards: “The rules from the Department of Housing and Urban Development require lenders to issue a binding good-faith estimate of total closing costs within three days of submission of a formal loan application.” In other words, it is not so much the pre-approval itself that frightens lenders, but rather locking in the closing costs.
Instead, lenders are turning to pre-qualification, which is “a less rigorous assessment of how much they can afford to borrow based on unverified financial data.” In such cases, a pre-approval might only be granted after the borrower’s loan application has been formally reviewed. While a pre-qualification is useful in that it gives the borrower a reasonable idea of the maximum loan they can hope to obtain, it is ultimately non-binding and thus, unreliable. Even if it is based on the same underwriting standards, the fact that it is only a pre-qualification means that a lender is not legally bound to it in the same way it would be to a pre-approval.
Borrowers should ultimately be aware of this distinction and push for a pre-approval. Most lenders should theoretically still be willing to issue them; it might just be a matter of persistence and understanding the process for applying for them.
If the statistics are to be believed: “strategic default” – the act of voluntarily walking away from one’s mortgage – is now becoming quite fashionable. According to the latest estimates, more than 30% of foreclosures are strategic defaults, compared to 20% in 2009. However, the calculus of “strategic default” is changing, such that you need to think twice before jettisoning your mortgage.
The debate surrounding strategic default was ignited by Brent White, a Law Professor at the University of Arizona, who suggested that breaking one’s mortgage contract was a choice like any other, and that some borrowers were acting against their best interests by continuing to pay their mortgages. White urged such borrowers to mail their keys back to their respective lender, and continue living – rent-free – in their homes until they were forcefully evicted through foreclosure.
According to White and other proponents of walking away, the only down-side of such a decision is a negative hit to your credit score. To be sure, you can expect that foreclosure will cause your FICO score to decline by 100 – 400 points, which will make securing any kind of loan in the immediate future quite difficult, to say the least. Thanks to a 2007 law enacted by Congress, you are not responsible for paying tax on a canceled mortgage, which otherwise would be treated as forgiven debt and taxed accordingly.
However, this is not the whole story. There are 11 states that have so-called non-recourse laws, which prevent lenders from laying claim to borrower assets if the proceeds from foreclosure are insufficient to repay the mortgage: Alaska, Arizona, California, Iowa, Minnesota, Montana, North Carolina, North Dakota, Oregon, Washington, and Wisconsin. That means that there are 39 states which the lender can effectively go after you for the difference, by garnishing your wages, freezing your liquid assets, or obtaining a lien on other hard assets. In addition, the lender has up to 7 years to seek such restitution, which means that you can only really escape the lender through bankruptcy.
Finally, there is the matter of securing a new place to live. Even ignoring your beaten-down credit score, the stain of credit default will prevent you from obtaining a mortgage for 5-7 years, thanks to a recent rule imposed by Fannie Mae and Freddie Mac. Buying and Bailing – in which you attempt to secure a new mortgage on a new home, before dumping your existing one – is now quite difficult, again thanks to increase vigilance by Fannie and Freddie, as well as a more stringent guidelines for mortgage lending. The only realistic alternative, then, is to rent….that is if you can find a landlord who is amenable to your financial situation.
In short, I would like to clarify my position regarding strategic default: you should only do so if you live in one of the 11 states listed above and if you are sure about your ability to secure a new place to live following foreclosure. You are also advised to speak to an attorney in order to fully understand your liability. Of course, if all things considered, it’s in your best interest to strategically default, then by all means, go right ahead.
Last week, I reported that mortgage rates have declined to another record low. Unfortunately for the housing market, the resulting uptick in mortgage activity was dominated by refinancings, and there is little evidence that low rates are spurring new borrowers. This is confirmed by the updated S&P Case Shiller Index, which shows that while prices are still rising on average, they are rising at a slower rate than before and appreciation could soon turn negative.
Morgan Stanley may speak for everybody; “It expects 2011 home prices to fall 5% to 10% from this year with four years of flat prices after that, although ‘the risk of slight additional downside in prices, and extension of the trough to 2012, has increased.’ ” Most of the government home-buying incentives have expired and lending standards have tightened. If the government doesn’t continue to support the mortgage industry, declines could be even more significant.
The biggest variable is the ongoing foreclosure scandal, in which lenders have conceded to fraudulently processing foreclosures for tens of thousands of borrowers. As a result, foreclosure listings have been pulled until the investigation is resolved. Most analysts have argued that this will be roundly negative for the housing market, especially in depressed areas were foreclosure sales represented the brunt of buying and selling: “These delays ‘are just going to cause more chaos and confusion. At this point, this is probably the nail in the coffin for housing. I think worse times are still ahead of us.’ ” As a result, the shadow inventory of foreclosures will be unable to clear, and prices continue to fall.
While I think this is a reasonable argument, I think the opposite interpretation is also justifiable. Think about it- if the foreclosure probe causes the housing supply to shrink, should that shift the balance back in favor of sellers. Of course you could argue that the shadow housing inventory will continue to exist, or that buyers who would have foreclosed properties now won’t buy anything, or that lenders will be stuck with these properties on their books and will cut down on new lending to compensate. Still, the shrinking of supply should have at least a temporary stabilizing effect on the market. Incidentally, Shaun Donovan, head of the Department of Housing and Urban Development (HUD) has sided with the majority in this debate: “A national, blanket moratorium on all foreclosure sales would do far more harm than good — hurting homeowners and homebuyers alike.”
If you’re in the market for a home, you should probably stay away from foreclosed properties for the time being, due to uncertainties over title. Otherwise, remember that there is not one national housing market but hundreds of regional markets. Each of these markets has its own nuances, and may be governed by different trends and demographics. Some markets remain depressed, while other markets have barely suffered. [For value shoppers, Coldwell Banker compiled rankings of the most/least affordable markets]. Finally, consider that it’s still a buyers’ market and that there is certainly no rush to buy. If historic trends are any indication, prices will decline slightly as we move towards winter, a period when the market usually slows down.
Why do I feel a sense of Deja Vu every time I write a post on this topic? Maybe because mortgage rates have been in a state of free-fall for the last year, and every week seems to offer the same story of new record lows. This week was no exception, as Freddie Mac reported that the average 30-year fixed rate is now at 4.19% and the average 15-year fixed rate was 3.62%. Both rates have declined nearly 20 basis points over the last month.
Interestingly, points (which are paid upfront and used to buy down the mortgage rate) have been rising, from .6 earlier this year to .8 today. That implies that the actual decline in interest rates is less than Freddie Mac would have you believe. It’s interesting that while lenders are willing to pass along low rates to borrowers, they are taking a larger cut for themselves in the form of points. In practice, this means that your APR will be higher than the mortgage rate quoted to you be your lender.
Furthermore, the lowest rates are only available to the most creditworthy borrowers. Those with FICO credit scores of 720 or above can expect to pay around 4.3%, according to a Zillow survey of mortgage data. That’s great for the 47% of borrowers that fall into this category, but what about everyone else? As you would expect, (prime) borrowers with even slightly lower credit scores are offered interest rates that are more than .5% higher than their 720+ counterparts. Unfortunately, those with scores below 620 probably won’t even receive an offer. Regardless of how you slice the data, however, rates are extremely low across the board.
One columnist recently wondered aloud whether they could fall even lower, perhaps all the way to 0%. It seems impossible, but then again no one thought that rates would be this low only a couple years after the housing bubble burst. She speculated that, “Rates at or near 0% could bring more first-time home buyers out of hiding to seek out extremely favorable financing for a house.” Even ignoring the fact that no sane lender would ever offer 0% mortgage financing, it seems unlikely that a significant number of potential borrowers are still biding their time in anticipation of still-lower rates, given that government home-buying incentives have expired and lending standards are being tightened. Already, 80% of mortgages are actually refinancings of existing mortgages. If rates decline further, it seems like it will only a trigger a new round of refinancing (as those who refinanced at 5% repeat the process).
At this point, I don’t really think it’s a meaningful exercise to ponder whether rates will fall farther. If you asked me for my honest opinion, I would say that an expansion of the Federal Reserve Bank’s Quantitative Easing program (in the form of additional purchases of Mortgage-Backed Securities) could drive rates even lower. Still, you have to wonder how much it would matter if rates fell to 3.5%, for example. For the purchase of a $200,000 home, this would lower one’s monthly mortgage payment by about $100. Don’t get me wrong- one would certainly be grateful for the savings, but for the majority of people, it wouldn’t be enough to make an otherwise unaffordable mortgage affordable.
As for how lower rates are affecting the housing market and housing prices, that’s the topic of my next post.
Interview with Dr. Housing Bubble: “You shouldn’t take on a mortgage that is 3 times your annual household income.”
Today we bring you an interview with Dr. Housing Bubble, whose blog promises to take a critical look at the policies that have created one of the largest asset bubbles ever known to mankind and whose mission is to provide a candid account of what is going on in today’s housing market. Below, Dr. Housing Bubble expounds upon the housing bust and the potential for recovery.