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Interview with The Mortgage Professor: “I would not buy for speculative purposes”

Published on 16/06/10 5:06 AM
Today, we are honored to bring you an interview with Jack Guttentag, the self-styled Mortgage Professor. Dr. Guttentag is a Professor of Finance Emeritus at the Wharton School of the University of Pennsylvania, and founder of GHR Systems, Inc., a mortgage technology company. He is also one of the most prolific and respected mortgage columnists, and his advice can be found on his personal website and in the Washington Post. Below, Dr. Guttentag shares his thoughts on locking in an interest rate, the mortgage interest tax deduction, and a handful of other topics.
Mortgage Calculator: Mortgage interest rates are currently at record lows, and it would seem that they couldn’t possibly fall any lower. Would you recommend, then, that borrowers obtain a “rate lock” as soon as they begin the process of shopping for a mortgage?

Coincidentally, I recently received a letter from a “Reader B” whose experience appeared to be directly relevant to this question:

“While comparing two lenders, the first lender sent me the GFE and TIL and locked us immediately upon receiving the memorandum of terms of the house purchase. The second lender gave us a rate quote via e-mail that was 1/8% less than that of the first lender for the same lender fees, so we cancelled our lock with the first lender. But then the second lender told me he needed the signed purchase contract before he could lock, which took one day. Then he told me he needed additional verification of my income, which took two more days. Next he told me that he needed an appraisal, which took two more days. By the time he was prepared to lock, the market had changed and both the rate and fees were higher than those offered by the first lender. We had no choice except to close with the second lender”

Reader B thus followed your suggestion by locking  immediately, but then B walked away from the lock because he thought he could do better, only to learn (at considerable cost) the difference between a price quote and a price lock. Does his experience confirm your observation that the best policy is to lock ASAP?

I think it does, but for a different reason. You suggest you lock ASAP because of a concern that market rates have nowhere to go but up. Reader B’s experience suggests that lenders who will lock quickly, say within 24 hours, are more reliable than those who stretch out the process.

The lender who won’t lock until he has all the data is positioned to cheat. He can “low-ball” when he first quotes a price to which he cannot be held, where the intent is to snare the borrower. He can then raise the price when the borrower is committed and it is too late to back out. In all probability, reader B was ripped off in that way.

This view that reliable lenders will lock quickly was confirmed by my locking guru, Jack Pritchard. In most cases, he says, the borrower’s credit and a computerized estimate of property value can be obtained within a few minutes, while the borrower’s income can be verified or at least checked for reasonableness within the day. These are the critical factors involved in a lock.

Because locking imposes a cost on the lender, however, no lender wants to lock a loan that is unlikely to close. If something does not check out, therefore, even a reliable lender won’t lock. Further, occasionally a lock is nullified when new information received by the lender invalidates the information on which the lock is based. The most common such occurrence is an appraisal that comes in so low that the borrower can only keep the lock alive by reducing the loan amount.

Borrowers working with mortgage brokers who want to lock should make sure they receive a lock confirmation notice from the lender. Some mortgage brokers offer their own locks, usually oral, but these are worth very little. Even if the broker honestly intends to bear the risk of a rate increase himself, he will do it only for a small rate increase that can be covered by a reduction in the broker’s fee. If the market rate takes a significant jump, which is the hazard the borrower needs to protect himself against, the broker will disappear, figuratively if not literally.

Bottom line, “lock ASAP” is a good rule in today’s market, and always make sure you have a written lock statement from the lender.

Mortgage Calculator: I read an interesting report that essentially blamed the housing bubble (and subsequent collapse) on cash-out home equity loans, because such borrowers were infinitely more likely to default. What’s your take?

If it made any sense to blame the crisis on an instrument that performed badly, you would have to include stated income loans NINA loans, option ARMs, 80/20 loans, all sub-prime loans, and on and on. The real issue is why these loans were made.
Mortgage Calculator: According to your analysis, it is rarely advantageous for borrowers to obtain an FHA loan when a conventional mortgage is available. Can you elaborate? In light of this, how do you explain the explosion in FHA lending activity?
When there is a choice, the  conventional is usually cheaper because the MI premium is higher. FHA volume has expanded because the underwriting requirements on conventional loans have tightened to the point where large numbers of borrowers no longer qualify for conventionals, only for FHAs.
Mortgage Calculator: You have advised ARM borrowers to consider switching to fixed rate mortgages because they are vulnerable to a sudden increase in interest rates. Given that adjustable rates have continued to fall and that a Fed rate hike is nowhere in sight, do you stand by this recommendation?
I’m not sure how sweeping a recommendation I have given, when its one on one, I tell borrowers that retaining an ARM is a bet, and some bets are OK to make if you can affords to lose. Delaying the refi to milk the ARM for as long as rates remain low is a bet that should be made only by those who can afford to lose. When rates increase, it may well happen very fast, so it will be too late  to switch at that point.
Mortgage Calculator: It has been argued that the mortgage interest tax deduction is expensive, inequitable, and inefficient and that there are better ways to promote homeownership. Do you agree? Under current parameters, do you think it should be a factor in the decision to purchase a home?
I am opposed to  the interest rate deduction because it is a regressive subsidy —  the larger the loan, the larger the subsidy. Subsidies should be scaled by ability to pay. But so long as the subsidy exists, borrowers should take advantage of them.
Mortgage Calculator: You wrote recently that you don’t think reverse mortgages are expensive because there is nothing to which they can be compared. However, given the upfront fees, insurance premium(s), and compound interest, doesn’t it seem like they are better (and less expensive) alternatives?
The reverse mortgage is the only way to draw on the equity in your home to supplement income, and still retain the right to live in your house until you die. There is no other way to do that.
Mortgage Calculator: Strategic default is an issue that is receiving a great deal of attention in the media these days. Do you have an opinion on this choice, and how would you advise borrowers that are considering it?
I don’t advise on this issue, it is between  the borrower and his own values and conscience.
Mortgage Calculator: In light of what you have written here, how would you reconcile government and seller incentives and low interest rates with the possibility that home prices could fall further, when advising someone thinking about buying their first home? Would you advise them to buy, wait for a while, or wait forever?
I would buy now if they need a house, but I would not buy for speculative purposes. Prices may be soft for awhile longer, but further substantial declines are very unlikely. If they occur, we are all in trouble.

Coincidentally, the day after receiving that letter from reader A I received one from reader B whose experience appeared to be directly relevant to A’s question.

“While comparing two lenders, the first lender sent me the GFE and TIL and locked us immediately upon receiving the memorandum of terms of the house purchase. The second lender gave us a rate quote via e-mail that was 1/8% less than that of the first lender for the same lender fees, so we cancelled our lock with the first lender.

But then the second lender told me he needed the signed purchase contract before he could lock, which took one day.

Then he told me he needed additional verification of my income, which took two more days. Next he told me that he needed an appraisal, which took two more days. By the time he was prepared to lock, the market had changed and both the rate and fees were higher than those offered by the first lender. We had no choice except to close with the second lender”

Reader B thus followed the suggestion of reader A by locking  immediately, but then B walked away from the lock because he thought he could do better, only to learn (at considerable cost) the difference between a price quote and a price lock. Does his experience confirm reader A’s observation that the best policy is to lock ASAP?

I think it does, but for a different reason. Reader A suggests you lock ASAP because of a concern that market rates have nowhere to go but up. Reader B’s experience suggests that lenders who will lock quickly, say within 24 hours, are more reliable than those who stretch out the process.

The lender who won’t lock until he has all the data is positioned to cheat. He can “low-ball” when he first quotes a price to which he cannot be held, where the intent is to snare the borrower. He can then raise the price when the borrower is committed and it is too late to back out. In all probability, reader B was ripped off in that way.

This view that reliable lenders will lock quickly was confirmed by my locking guru, Jack Pritchard. In most cases, he says, the borrower’s credit and a computerized estimate of property value can be obtained within a few minutes, while the borrower’s income can be verified or at least checked for reasonableness within the day. These are the critical factors involved in a lock.

Because locking imposes a cost on the lender, however, no lender wants to lock a loan that is unlikely to close. If something does not check out, therefore, even a reliable lender won’t lock. Further, occasionally a lock is nullified when new information received by the lender invalidates the information on which the lock is based. The most common such occurrence is an appraisal that comes in so low that the borrower can only keep the lock alive by reducing the loan amount.

Borrowers working with mortgage brokers who want to lock should make sure they receive a lock confirmation notice from the lender. Some mortgage brokers offer their own locks, usually oral, but these are worth very little. Even if the broker honestly intends to bear the risk of a rate increase himself, he will do it only for a small rate increase that can be covered by a reduction in the broker’s fee. If the market rate takes a significant jump, which is the hazard the borrower needs to protect himself against, the broker will disappear, figuratively if not literally.

Bottom line, “lock ASAP” is a good rule in today’s market, and always make sure you have a written lock statement from the lender.

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