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.

Over the last month, mortgage rates have moved up rather quickly. In the last week alone, the average rate for a 30 year fixed-rate mortgage jumped by a staggering .5%, to 5.39%. Initially, some analysts speculated that the sudden jump was a fluke, but given that rates have now risen for several consecutive weeks and are now at the highest level in six months, it could be the case that higher rates are here to stay.

One the one hand, those that failed to lock in low rates for the purpose of buying a home or refinancing are probably kicking themselves. A 50 basis point difference in interest rates translates into tens of thousands of Dollars in added interest payments over the life of the mortgage. As a result, “mortgage applications…fell 16 percent last week, the Mortgage Bankers Association reported. Refinancing applications, which account for more than 60 percent of the total, fell 24 percent.”

Experts caution, however, that everything is relative. Rather than focus on the fact that rates are higher than last month, why not focus instead on the fact that rates are still around 5%, and near a 50-year low. For those looking to refinance, it might still be worthwhile, as long as you plan to stay in your home for at least a few years and your current mortgage rate is above 6%. Homebuyers (i.e. those thinking about an original mortgage), meanwhile, still have an opportunity to get a good deal, especially if home prices fall further in order to “equalize” the higher mortgage rates.

What’s the short-term prognosis for mortgages rates? To answer this question, it’s important to first understand the mechanics of the mortgage system. For those of you who aren’t familiar, consider that while rates are technically determined by your respective lender on a case-by-case basis, such lenders are ultimately guided by macro forces, specifically by investor demand for bundled mortgage securities. Demand for such securities (known as CMOs in industry parlance) had been artificially inflated (to the tune of $500 Billion) by the Federal Reserve Bank. This alone was largely responsible for the spring mortgage rate nadir.

However, the Fed may suspend its CMO program for fear of overstimulating the economy and stoking the fires of inflation. In other words, “Only if the Fed announces their intentions of buying lots more mortgage-backed securities and Treasury bonds, and lots of them,” will rates return to previous levels. Still, there is “a slight chance that rates could return to the mid-4 percent range, and I certainly hope they do. But most experts feel that the party is over and that we may be facing inflation in the near future.” In short, it’s near impossible to predict; my only advice is to not get caught trying to time the market…

In a noble effort to stem the rising tide of foreclosures, “President Obama’s Making Home Affordable program is attempting to help as many as 9 million U.S. homeowners refinance or modify their home loans.” The program has already proved to be a huge hit among homeowners, which have rushed to banks to take advantage. The US Treasury Department, armed with $75 Billion, is also doing its part to make sure that lenders are properly incentivized.

In the month of April alone, 127,000 mortgages were modified. If you include repayment plans (categorized separately from loan modifications for statistical reasons), the number rises to 270,000. Bank of America alone - via its now-defunct Countryside Financial unit - has already logged 50,000 modifications, with another 350,000 remaining- if it fully honors the terms of a legal settlement, that is.

Loan modifications work as follows:

“To qualify, mortgage holders must be an owner-occupant of a one- to four-unit property. The loan must have been originated on or before Jan. 1 and has an unpaid principle balance of no more than $729,750 for one unit properties –higher limits apply to multiple units. The mortgage payment must exceed 31 percent of gross monthly income, and the payment is not affordable because of a change in income or expenses.”

Once the terms are met, “Borrowers must make three months of timely payments before they qualify for federal aid, which will keep their interest rate as low as 2 percent for five years.” Participants are naturally advised both to be on the lookout for scams and to be aware that loan modification is not a given, and that in most cases lenders will only reluctantly agree to do so.

The unfortunate contradiction in this program is that for most homeowners, a loan modification does not get to the heart of the problem; home values have fallen so much and economic conditions remain so abysmal that a slightly lower monthly payment isn’t ultimately enough to make a difference.

According to Fitch Ratings, a “conservative projection was that between 65% and 75% of modified subprime loans will fall 60-days or more delinquent within 12 months of the loan change.” Sure enough, the record number of loan modifications has also been accompanied by a record number of foreclosures, with “3.85% of all mortgages somewhere in the foreclosure process at the end of the first quarter, compared with 3.3% in the fourth quarter.”

Still, qualifying homeowners need not be discouraged. The flip-side of this grim statistic is that 25% of homeowners avoided foreclosure in the near-term after modifying their mortgages, right? I would encourage you to check out Making Home Affordable, HUD, and the Homeownership Preservation Foundation for more information and/or to see if you qualify.

A smattering of mortgage-related headlines from the previous week tell complete different stories: “Mortgage Rates Tick Up;” “Mortgage Rates Fall Again;” and “Mortgage Rates ‘All over the Map.’ ” With such a disparity, it’s hard to make heads or tails of the situation.

In the end, all of these stories are accurate. The discrepancy can be explained both in the source of the mortgage data and by the time period implied by the comparison. For example, two different mortgage surveys revealed an average 30-year fixed rate of 5.24% and 4.82%. That’s a pretty sizable difference, and would amount to thousands of dollars over the life of the mortgage. Meanwhile, comparing mortgage rates to where they were last week yields a different result than comparing to last month, let alone last year. I think the most meaningful headline, then, is the one that I chose for this posting: “Mortgage Rates Remain Near Historic Lows,” which is true regardless of which data source you quote.

Jumbo mortgages, meanwhile, are currently being priced at 6.37%, on average, which unbelievably, is less than what you would have paid for a conforming loan only one year ago. The 15-year fixed rate is hovering around 4.5%. The spread to the 30-year fixed rate appears to have shrunk recently, in proportion to a similar tightening of the yield curve for US Treasury securities, upon which mortgage rates are usually derived. Based on the chart below (courtesy of the WSJ),you can see that the 1-year ARM rate has remained close to the 30-year fixed rate, with the exception of a brief spike during the stock market collapse last September. It, too, has trended downward recently.

There are generally a few factors which have coalesced to bring down mortgage rates. First of all is slacked demand. “Moody’s chief economist John Lonski notes that they [rates] have not have fallen by enough to stabilize home sales,” and that “fears of home-price deflation and worries about future employment and income “still outweigh near record high levels of home affordability.” In other words, low rates or no low rates, mortgage demand remains weak because the housing market is weak. In fact, most of the current demand for mortgages is coming from re-financings as opposed to home-buying. This is no mystery, since rates have fallen so precipitously that it would probably already be economical to refinance even if you’ve only held your mortgage for one year or so.

Rates are also being held low by the activity of the Federal Reserve Bank, which as part of its quantitative easing program, is purchasing hundreds of billions of dollars worth of mortgage-backed securities. This has made investors comfortable again with the notion of buying such securities, because it knows that the Fed is propping up the market.

You’re probably wondering: ‘Will these trends continue?’ and, by extension, ‘Will mortgage rates continue to remain low?’ Unfortunately, no one can answer these questions with any meaningful degree of accuracy. I will say that while it’s possible that mortgage rates won’t rise much until the economic recession heals itself, it seems unlikely that rates will remain low for much longer. This is not to be construed as an exhortation to run out and buy a mortgage or to refinance your existing mortgage, but at the very least, it’s a slight nudge towards paying attention to context; the average 30-year fixed rate has remained below 5% for an unprecedented 10 weeks, hint hint.

I would also caution you against trying to time the market. It doesn’t work for stocks, and it certainly doesn’t work for mortgage rates. You could get lucky by waiting a few weeks, and lock in an even lower rate. Then again, you could end up paying a substantially higher rate, if the market changes next week. While everyone wants to avoid “mortgage remorse,” just remember that it will hurt more to pay thousands because you waited than to have missed out on the possibility to save just as much because you got lucky and rates declined.

In a simple world, mortgage points wouldn’t exist. They were invented by the mortgage industry ostensibly to give you more options when taking out a mortgage. In actuality, they function mainly to increase certainty (you are essentially increasing the size of your down payment), and hence the bank’s profits.

Simply stated, a mortgage point represents 1% of the mortgage amount, equivalent to prepaid interest. The idea is that by paying upfront discount points to the broker, you can achieve a rate below par -  that which a borrower of similar circumstances/creditworthiness could expect to pay. On the surface, this seems like a great deal, since you only have to pay the discount points once, and you get to realize savings in the form of lower monthly payments for the entire duration of your mortgage.

Of course, there’s no such thing as a free lunch. The points will have been calculated very precisely by your mortgage originator based on his required rate of return. In other words, he makes an assumption about the return he can achieve on your upfront payment, such that if invested properly it will offset the lower mortgage payments he will receive from you. Naturally, you want to attempt to back out this rate of return, in order to determine whether the savings are sufficient enough given the number of points you are being charged. In other words, if you simply took the additional upfront payment and deposited it in a savings account, would it return more than what you otherwise would have saved by paying points?

The simplest, and perhaps most useful points calculation is that of the “break-even point.” This is the number of years it will take you to recoup the outlay of points, in the form of savings on your monthly mortgage payment. For example, if you are paying 1 point on a 500,000 mortgage ($5,000), it will take you 10 years (120 months) to break even if you can save $40 a month. Whether or not you think this trade-off makes sense depends largely on how long you anticipate staying in your house. It also depends on whether you can afford the additional upfront costs. For most people, a couple points won’t break the bank, but those who are having difficulty scraping together enough cash for the down-payment probably won’t want to even thinking about paying points, regardless of whether it saves them money in the long-term.

One important consideration when paying points is tax deductiblity. Discount points are considered prepaid interest by the IRS, and are thus fully tax deductible (like normal mortgage payments), as long as certain conditions are met and you didn’t borrow money to pay the points. Origination points, on the other hand, represent normal closing/settlement costs (The IRS lists “appraisal fees, inspection fees, title fees, attorney fees, or property taxes” as examples) and are not tax-deductible.

Consider this post a continuation of yesterday’s post, both of which aim to educate you on your rights as a (potential) mortgage borrower. Much like you are entitled not to be discriminated against, you are also entitled to honesty. Towards this end, the Federal Reserve Bank recently revised the Truth in Lending Act in the form of the Mortgage Disclosure Improvement Act.

Under this rule, “creditors must give so-called ‘early disclosures,’ or good faith estimates of mortgage loan costs, within three business days of receiving an application and before collecting any fees from a consumer in accordance with the Truth in Lending Act (TLA)…The final rules also require creditors to wait seven business days after they provide early disclosure before closing the loan and to provide new disclosures with a revised annual percentage rate (APR) — and wait an additional three days before closing — if any change occurs that makes the original APR inaccurate.”

Formally taking effect on July 30, 2009, the rule takes power away from banks and mortgage brokers and returns it to mortgage borrowers, by making the mortgage process more timely and straightforward. Consumers are now legally entitled to good faith estimates within mere days of filing a mortgage application. This is a reasonable requirement, since mortgage applications are inherently time-consuming, and can damage one’s credit score when a credit report is pulled.

When applying for a mortgage, it is recommended that you seek estimates from at least three potential brokers/banks, even if such banks discourage you from doing so. Under the amended rule, you will now be able to review/compare the resulting estimates almost immediately, in order to make an informed decision about which mortgage is most competitive.

Furthermore, mortgage providers will be barred (via a 1-week moratorium) from trying to pressure you into closing right away. During this period, it goes without saying that you should review the terms/costs of each mortgage very carefully. Before agreeing, make absolutely sure that there are no junk fees and questionable terms; signing your name will essentially commit you to the loan, regardless of whether the mortgage is actually fair. In other words, this rule change won’t protect you from exorbitant fees if properly disclosed and consented to. Pay special attention to ‘processing’ and ‘administrative’ and ‘transfer’ fees, which are almost always bogus.

Bank of America is among the banks taking the lead in implementing the Fed’s new disclosure requirements. Its website includes a home loan guide, and its new disclosure forms aim to explain mortgage terms in plain English, minus the legal jargon and fine print. Fees and costs should be broken down explicitly, along with broker commissions.

Meanwhile, “If the borrower has applied for an adjustable rate mortgage — where the rate varies, typically after a set period of five or seven years — the summary discloses the maximum possible monthly payment.” Personally, this strikes me as very reasonable, considering that the subprime crisis was at least partially caused by overly optimistic assumptions about adjustable rate mortgages. Specifically, holders of such mortgages assumed (and/or were misled into believing) that interest rates (and hence their monthly payments) wouldn’t rise much from the initial low base. When rates rose, naturally, many such borrowers were caught off guard.

It’s impossible to predict the extent to which other banks will follow the lead of BofA. Given the extensive fallout from the real estate crisis (now measured in Trillions of Dollars), however, it is probably now in the interest of banks, themselves, to make sure that consumers understand the terms of their mortgages. While banks are no doubt profit-maximizing, it is still in their best interest to avoid foreclosures by making sure that borrowers can ultimately repay their loans.

Commentators on the sub-prime crisis frequently point their fingers both at banks for being too complacent about risk, as well as consumer for borrowing beyond their means. Government regulators meanwhile, have been largely spared from rebuke, despite their role not only in condoning, but even encouraging Fannie Mae and Freddie Mac to increase their indirect mortgage lending to sub-prime borrowers. While their intentions- to increase affordable housing- were benign enough, this policy unquestionably contributing to the burgeoning of lending to un-creditworthy borrowers.

Now, the Federal Housing Finance Agency is quietly reversing course, and moving to rein in sub-prime lending by raising the standards to 2004 levels. “For 2009, FHFA has proposed notching down the companies’ benchmark for buying or guaranteeing mortgages of low- to moderate- income buyers to 51% from 56% in 2009. Meanwhile, the agency has proposed lowering the goal for underserved areas to 37% from 39%.” The implication is that sub-prime loans will be significantly harder to come by. This would seem obvious, given that banks have voluntarily raised their lending standards since the inception of the credit crisis in order to preserve their capital. However, for as long as Fannie and Freddie are/were willing to buy and repackage subprime mortgages, the banks bore little risk in originating them. Now that the secondary market for such mortgages is shrinking, banks will automatically curtail originating them.

At the same time, Fannie and Freddie are leading the way in implementing the Obama administration’s loan modification program, designed to mitigate foreclosures. “Nearly 70,000, or 20%, of the loans voluntarily modified in the U.S. last year were owned by Fannie or Freddie according to HOPE NOW, an industry group. More than half of those modified during the first three quarters of last year were in re-default after just six months, according to the Office of the Comptroller of the currency.” This is great for homeowners eligible for this program, which are able to modify their mortgages at extremely favorable conditions. Of course, it’s burdensome for taxpayers, which now indirectly own both Fannie and Freddie and are responsible for funding their losses.

If their is any silver lining, it is that the government bailout is enabling both organizations to offer “competitively priced debt for the affordable housing industry.” Consistent with increased government regulation and a climate of risk aversion, standards are much higher than before. According to an industry journal, “Deals are being underwritten at 75 percent or 80 percent loan to value (LTV) and 1.25x debt-service coverage ratios (DSCRs) in pre-review markets, as opposed to the 90 percent LTV and 1.15x DSCR the program offered. But even for deals in strong markets, Fannie Mae will often only go to 85 percent LTV and 1.20x DSCR, as of late February.” To translate this jargon, sub-prime borrowers must now provide 20% of the equity, and must maintain a debt service coverage ratio of 125% (net income must exceed mortgage principal and interest payments by 25%), a significant jump from before.

In short, the good news is that both organizations are still facilitating mortgages, and capital from investors is still finding its way to home buyers. The bad news for home buyers is that standards are becoming stricter, though not unreasonably so. Even buyers with mediocre credit can still secure a mortgage, provided they meet the requirements.

The Mortgage Bankers Association just released its weekly data dump, showing a downtick in mortgage applications. “Raw mortgage application activity slid 18.1% in the week ending April 24…The four-week moving average fell 4.9% after remaining up 0.3% the previous week…The volume of applications for refinance plummeted 21.9% while the…refi share of total mortgage applications fell to 75.3% from 79.7% the previous week.” [Chart courtesy of WSJ].

On the surface, it conveys a precipitous drop, and the numbers wouldn’t look out of place in any article on the ongoing housing bust and economic recession. But actually, the weekly decline contradicts the upward trend in mortgage applications that began in late 2008. “The MAX’s [another industry association] virtually static results from the week, combined with the MBA’s dive in raw activity, suggests interest by number of households remains unchanged.”

As reported yesterday, mortgage rates remain near record lows, so application volume should remain strong: “The average interest rate for 30-year fixed-rate mortgages fell to 4.62 percent from 4.73 percent, with points increasing to 1.14 from 1.12.”

As the data suggests, a large portion of the mortgage activity corresponds to re-financings. CNN reports that “While the keenly watched spring sales season should entice more potential buyers to deeply discounted prices, refinancing is expected to continue to dominate mortgage demand.” This is hardly surprising, given that banks are still highly risk-averse as a result of the sub-prime fiasco, despite the government’s best efforts to stimulate mortgage lending; “The government has rolled out a series of programs in recent months to lower mortgage rates and boost the struggling housing market. The Federal Reserve in November announced plans to buy mortgage-backed securities, while the Obama administration has rolled out programs to encourage strapped homeowners to refinance.”

Furthermore, given the tightening of lending standards, it’s likely that a smaller portion of mortgage applications are ultimately approved.  Combined with the fact that the overwhelming majority of new mortgages pertain to re-financings, it’s not clear whether the increase in applications will trickle down and boost home prices.

As far as the economy is concerned, “Any boost to consumer spending is likely to be small. Even if about $1.5 trillion of mortgages are refinanced in the next year, with an average reset of about one percentage point, that would amount to just $15 billion a year, a tiny share of overall consumer spending.”

Depending on your specific circumstances, it might be a good time to refinance. Based on anecdotal evidence, it’s more difficult/time-consuming than during the last few years, when rates were also relatively low and the approval process required only a few days. In addition, a lower rate doesn’t inherently justify a refinancing. It’s important to weigh the fees, for example, against any direct savings from lower monthly payments.

Freddie Mac’s chief economist just announced that “Interest rates for one-year ARMs exceeded those for 30-year fixed-rate mortgages over the last two weeks; this is the first time this has happened since Freddie Mac began collecting data for ARMs in January 1984.”  This is a pretty monumental occurrence, but it seems to have been received with surprisingly little fanfare.

One would naturally expect long-term rates to be higher than short-term rates, since the inherent uncertainty of the future must be priced into loans. As a result, there is a trade-off between duration and the rate of interest that a borrower must come to terms with when taking out a mortgage. If you want a long-term mortgage, you should pay a higher rate of interest in order to compensate the lender for future uncertainty surrounding your personal financial situation as well as the macroeconomic situation. In other words, the lender (bank) will charge you a higher premium because it doesn’t know where interest rates will be 15 years from now and also doesn’t know whether your ability to make payments on your mortgage will change over time. The disappearance of this trade-off means that borrowers can effectively borrow for a relatively longer period of time without paying the associated higher rate of interest.

It’s not clear exactly what’s responsible for this development. The benchmark 15-year fixed mortgage rate has gradually declined since the inception of the credit crisis; at 4.48%, it is currently hovering around an all-time low. This is also surprising, given that one would have expected the jump in risk aversion to be accompanied by a surge in mortgage rates. After all, it was excessively low mortgage rates which caused the crisis. The credit for keeping rates low probably belongs to the Federal Reserve Bank, whose “current policy during the financial crisis is to keep mortgage rates low….The effort seems to be working. Bankrate’s benchmark 30-year, fixed rate has been under 5.5 percent since the beginning of February.”

As for short-term rates, they are also falling, just at a proportionately slower pace than long-term rates.

Since this is the first time that the mortgage yield curve has (partially) inverted, it’s not clear what the implications are. An inversion of the Treasury yield curve is often seen as a harbinger for economic recession. In this case, however, recession has already descended upon the economy. Maybe it means that the recession will continue to worsen. Maybe reflects the possibility of deflation. Or maybe it is simply a reflection of supply and demand for mortgages.

Regardless of what it means, it is certainly a welcome development for home-buyers.