As almost everyone who takes out a mortgage is certainly aware, mortgage interest payments are tax deductible, which means the actual interest rate paid by the borrower is often significantly lower than the rate quoted by the bank. [The precise discount depends on one's tax bracket]. However, the understanding of most borrowers doesn’t extend much beyond this, which is problematic because it turns out mortgage-related tax matters are actually quite complicated.

For example, the tax benefit can only be claimed on mortgages under $1 million, and cannot generally be increased as a result of a refinancing, unless the proceeds are used to improve one’s home. Points, which are used to buy down the interest rate when the mortgage is first issued, are deductible in the year they are paid, as are loan origination fees. Lender fees, private mortgage insurance, and other settlement costs cannot be deducted.

As for home equity loans, the limit is $100,000. Paradoxically, the proceeds from a home equity loan cannot be used in relation to the home in order to be eligible for the deduction, but can be used for almost anything else, from credit card payments to school tuition, etc. If the borrower is subject to the Alternative Minimum Tax (AMT), however, the opposite applies, and the proceeds MUST be used towards the improvement of the home in order for the interest to be tax deductible. Confused yet? If so, the chart below represents the best summary of the IRS rules I have ever come across and should be a great reference when it comes time to file your taxes!

The IRS doesn’t make things easier. According to the GAO assessment, taxpayers have to go through as many as 13 steps to determine first whether mortgage interest is tax deductible, second whether points are deductible, and third the size of any deduction. Included in the official tax forms is a handy flow chart, which borrowers can theoretically use to complete these steps. However, the increasing majority of taxpayers that use tax preparation software to file probably doesn’t ever see this chart. To make matters worse, the GAO report found that such software uses inconsistent methods to determine tax detectability, sometimes even asking the borrower to make the determination/calculation himself.

The main purpose of the report was to assess the ability of the IRS to properly determine and manage mistakes in mortgage tax issues, and in this aspect, the report was scathing. Due both to inadequate resources and insufficient information about taxpayers’ mortgages, mistakes were often allowed to slide. Although, the GAO found that the claimed deduction was understated as often as it was overstated, so the net result is probably a wash for the government.

In any event, it seems clear that something has to change. Either the IRS has to streamline paperwork associated with the mortgage tax deduction, or the government needs to revamp the rules. When you consider that the deduction costs the government $80 Billion in foregone tax revenues per year – especially in the context of the current budget problems – this could conceivably become a major political issue.

Timeshares surged in popularity over the last decade as consumers flush with disposable income made purchases for their own use and/or to rent out to others. In the wake of the credit crisis, many of these consumers have found themselves unable to make the payments associated with the timeshare and have taken to reselling them at a fraction of the cost that they paid for them. “This is the best time to buy and the absolutely worst time to sell. A few years ago you got 50 cents on the dollar. Now you’re lucky if you get 10 cents on the dollar,” writes one insider.

The problem has been exacerbated by a drought in financing. Banks have always been reluctant to underwrite a mortgage on a property that isn’t fully owned, as as the case with a timeshare. Accordingly, the burden to provide financing typically fell on the timeshare companies that owned the properties, which “now demand that buyers have higher down payments and good credit scores to qualify for a loan. At Marriott International, 80 percent of buyers used to receive financing, but now only half do.”

Compare this to the comeback in cooperative housing, which, “holding over 1.5 million households, comprises less than one percent of the nation’s housing. Largely concentrated in high-density urban areas, cooperatives range from luxury homes in posh urban areas…to suburban town houses and senior high-rises.” As a result both of the economic downturn and mortgage quagmire, buyers are turning to co-ops like never before, due to their low purchase prices and even lower monthly payments.

Just like with timeshares, however, it can be difficult to secure a mortgage on a co-op property because the buyer doesn’t own (even a portion of) property, but rather an equity stake in a corporation. In one recent case, a buyer forfeited a $25,000 down payment for a co-op after the lender discovered it was built on rented land and consequently reneged on the mortgage. [As an aside, it's important that you protect yourself from such an outcome by structuring an agreement to buy a co-op accordingly].

Perhaps a new type of service will help to alleviate this problem. I recently stumbled upon a “points-based way to fund the housing, wherein the owner pays points to a mortgage company and redeems them to live in a particular place during his work assignment or visit with the grandkids.” In other words, a borrower can move between participating properties as long as there is availability.  Whereas a co-op represents a hybrid between renting and owning, this points system seems to represent neither, and both could appeal to the emerging class of people dissatisfied with the current system which forces them to choose between two equally unappealing choices.

The explicit goals of are to raise standards for future mortgages, as well as to make it easier for homeowners already to trouble to have their loans modified. “If the protections in this bill had been in place, we would not have had the foreclosure crisis, we would not have had the financial crisis,” offered one Representative.

Towards this end, “The measure would require mortgage lenders to ensure a borrower has a ‘reasonable ability to repay‘ the loan products offered to them. For refinancings, the lender has to believe the transaction provides a ‘net tangible benefit’ to the borrower.” In addition, loans repackaged as CDOs and sold to investors will face new restrictions, in order to give originators more of a stake in ensuring loan quality. Accordingly, originators will be required to maintain at least a 5% equity stake in all securitized mortgages.

There is also a subtext in the bill designed to steer all participants back towards plain-vanilla lending practices, since esoteric and complex mortgage products are near the heart of the crisis. For example, lenders will be encouraged to promote traditional 30-year fixed-rate mortgages- generally viewed as the safest and most transparent type of mortgage- by way of a “safe-harbor” clause “to protect mortgage-holders from investor lawsuits if they modify the terms of a home loan.” Regulators have been authorized to expand the scope of the safe-harbor program to other types of qualifying mortgages as well.

As one columnist pointed out, this program does contain an inherent conflict of interest, since many of the financial institutions with the power to modify loans are also those with a financial stake in doing so. He argues that there is a “huge incentive for self-dealing by servicers to rewrite the investor-owned first mortgages in ways that increase the value of their affiliated bank-owned second mortgages.” Regardless of whether it’s fair for banks and investors, all homeowners need to know is that it makes it more likely that the terms of their loans will be modified.

As the Mortgage Calculator reported last week, the cram-down clause was officially rejected by the Senate, despite having been approved by the house. This would have authorized judges to to lower mortgage payments for homeowners involved in bankruptcy proceedings. “Judges handling bankruptcy cases can already reduce the principal — and thus the size of the payments — on a vacation home, car or boat, but not on a mortgage for a primary residence.”

Less visible components of the legislation include a “measure that would allow renters of foreclosed properties to stay through their lease, or be given 90 days to vacate” as well as “capital to be allocated to provide borrowers with independent counseling on their mortgages.” In this way, renters won’t be punished for their landlords’ misjudgment, and homeowners will have access to more resources so that they can make more informed decisions. Finally, “The legislation would also ban yield-spread premiums, payments to mortgage brokers or loan officers for steering borrowers to high-cost loans.”

These last few rule changes, while small, encapsulate the overarching purpose of the legislation, which is to place the burden of mortgage origination firmly on the shoulders of lenders as well as to improve the transparency of the entire mortgage process. In short, borrowers will be protected against “predatory” lenders that seek to exploit their ignorance, as well as from themselves, by making it more difficult for them to take on mortgages that they cannot reasonably afford.

The Case-Shiller report underscored important regional differences in the impact of the housing crisis: “While all cities posted monthly declines, 16 of the 20 declined at a slower pace than they did in January. The Cleveland, Charlotte, N.C., New York and Washington markets showed larger monthly declines in February than they did in the prior month.” In addition, “Seven of the 20 metro areas included in the index posted home-price declines of more than 40% since they peaked.” As the Mortgage Calculator reported last week, markets in Florida and the Sun Belt, have been hit especially hard, due to a preponderance of both speculation and sub-prime lending in those areas.

Housing analyst John Burns predicts that “Washington, D.C. and Sacramento, Calif…will recover first….Other markets at the top of Mr. Burns’ list include Denver and Raleigh, N.C., which were not that overheated during the boom, and San Antonio, which has a solid economic base and extremely inexpensive housing.”

“Fundamentals” in the housing industry are finally returning to sustainable levels. According to Warren Buffet’s analysis, “Roughly 1.3 million households are created each year in the U.S., while about two million homes were being built a year during the recent boom….Now housing starts are running at roughly 500,000 units a year, which means the excess inventory is being absorbed at a rate of about 700,000 to 800,000 units a year.” Finally, builders have caught on and are reducing supply proportionately.

Unfortunately, the economy may not return to long-term equilibrium as quickly, which could ultimately represent a bigger impediment to the stabilization of housing prices than oversupply. This is especially true in areas that have been devastated by the economic downturn, as unemployment and declining wages/disposable income is driving a decrease a demand. If people can’t even afford to buy houses, you can forget about the supply side of the equation.

As a result, one especially pessimistic economist predicts that, “It will take until 2020-21 for home prices to reach the levels seen in 2006, before the real estate bubble deflated.” Another offers that, “It is unlikely that we are anywhere near a bottom in nationwide home prices…After all, in the seven years leading up to the peak in July 2006, the national 20 city home price index jumped by 155% (126 index points). So far, this index has dropped by 31% (63 index points) in the 30 months since the peak.” The problem of course is that homebuyers who accept this forecast will put off buying under the expectation that the market has not yet stabilized, making further declines in prices self-fulfilling.

First came the victory, in the form of an expansion of mortgage aid. Specifically, borrowers with second mortgages will now find it significantly easier to refinance their first mortgages. Previously, “borrowers who [were] trying to get their primary mortgage modified at a lower monthly payment need[ed] the permission of the company holding the second mortgage.” This might not seem like much, unless you consider that these types of loans are “attached to about half of all troubled mortgages.”

“The administration initiative, funded out of $50 billion in financial rescue money, relies on a series of payments to mortgage companies as an incentive to modify second loans at lower interest rates.” Lenders will also receive government money in exchange for canceling second mortgages altogether. Borrowers, meanwhile, are eligible for cash that can be used to pay down the principal balance of their mortgages.

It’s unclear whether this plan will succeed where the earlier plan failed. The problem of course lies with the lenders themselves, as well as with the investors that own collateralized pools of mortgages. A component of the original plan, for example “was supposed to allow 400,000 troubled homeowners to swap risky loans for traditional 30-year fixed-rate mortgages with lower rates.” Unfortunately, lending standards have tightened to such an extent that it’s nearly impossible for borrowers to get bank approval for such a swap. “Meanwhile, lenders have said they are unable to change some mortgages because they fear being sued for breaking their contracts with investors who own pools of mortgages.”

All of this is outweighed by the defeat of the Helping Families Save Their Homes Act, which was voted down in the Senate despite its passage in the House. “The legislation, widely opposed by the financial services industry, would have allowed homeowners to petition bankruptcy court judges to write down the principal and interest payments for their primary home mortgages.” This practice was nicknamed “cramdown” and was first introduced in a bill nearly two years ago. Since then, the banking industry (with the exception of Citigroup) has universally opposed its implementation.

Mortgage debt and student loans are the main types of debt that are not forgiven as part of filing for personal bankruptcy. Excuse my cynicism, but the rejection of this legislation indirectly demonstrates the power of both lobbies in government. Even with limitations on time and caps on the size of mortgage, opponents were unwilling to budge. “Arizona Senator Jon Kyl said the measure would force mortgage companies to offset losses in court. ‘The result will be higher interest rates for home loans and fewer Americans will be able to afford to buy a house…The answer is not to incentivize bankruptcy by making it the means to save one’s home.’ ”

It’s back to the drawing board for now, as several Congressman have announced plans to introduce similar bills, with or without watered-down versions of the mortgage debt forgiveness clauses.

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.

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.

This parody Bird & Fortune Financial Adviser video really captures the essense of the modern banking system.

The subprime mortgage crisis was also covered in this funny but curt slideshow titled The Subprime Primer.

According to a BBC interview with Citigroup’s CEO Sir Win Bischoff, house prices in the UK and the US are likely to fall for another two years…but then again, they are part of the same banking system that never saw the initial collapse coming.

The US based growth in demand for mortgage calculator searches was largely on the demand created by the sharp lowering of the Federal Reserve funds rate from 5.25% to 2.00% during the September 18, 2007 to April 30, 2008 time period.

As a website that publishes in the space we had a pulse on the search volume changes and reasoning behind them

• the lowered Fed funds rate lifted search volume
• eroding conumer confidence, a glut of housing inventory, and falling real estate prices have made people far more comfortable sitting out buying a new home until the pricing trend reverses

The Bank of England has lowered rates much slower than the United States, lowering from 5.75% to 5% over the course of 5 months from December 6, 2007 through April 10, 2008. In spite of their rate cuts, UK mortgage rates have reached 8 year highs amid higher inflation.

For fifty years we simply believed that home prices would always increase, and then one day it was no longer true. Many people are looking, but few people are buying right now.

We simply attempt to be fearful when others are greedy, and to be greedy only when others are fearful. – Warren Buffett

Surely amongst the chaos and fear in the markets there is lots of opportunity. Are you a contrarian investor? Or is it best to wait until you see market stability before investing?