Bad News for Condo Buyers

Good thing first time buyers are getting that $8000 tax credit, because if you're a first time buyer looking at condos there is some bad news headed your way on April 1. Fannie Mae & Freddie Mac, the government sponsored entities that help keep mortgage rates low for borrowers with loans less than $417,000 (now about to rise to $729K in our area thanks to the stimulus bill), has announced higher fees and tougher credit score requirements. These extra fees are supposed to counter the higher risks and losses associated with certain loans.

Condo borrowers, in particular, have been singled out: unless you have a whopping 25% downpayment, you'll be hit with a three-quarter point add-on penalty regardless of your credit score. Buyers with a FICO score between 700 and 720 will pay an extra three-quarters of a point, too, whether on condos or not (a point = 1% of the loan amount). Below 700? Expect 1.5% in fees. Ouch.

All the more reason to look at FHA, which is less harsh about credit scores and requires just 3.5% down payment. But condo borrowers may still have a tough time: FHA does not mesh well with many condo buildings.

Stimulus Bill To Be Law: First Time Buyers Get $8000 Credit, Conforming Loan Limits Increase

The stimulus bill, having had its original House and Senate versions reconciled in Committee, is now on its way to President Obama's desk in time for his President's Day goal. I'm still wading through the Committee report text, but here is what I can see:

• Credit is $8000 (up from the House version of $7500 but down from the Senate's $15,000)
• Does not have to be repaid as long as you own the house for 36 months from the date of purchase and you purchased in 2009. If you sell before 3 years then you have to repay the entire thing.
  
• Applies to purchases from January 1 through December 1, 2009. (Note: I've seen some other reports saying 12/31, and others saying July or August, but from what I read in the Conference report posted online, it says 12/1) If you bought in 2009 you can elect to treat it as purchased on 12/31/2008 so you can claim it on your 2008 return.
  
• Is a refundable credit - so even if you don't owe $8000 in income taxes then you get the difference back (NB: This is an update from previous post)
• DC buyers cannot claim both this credit and the $5000 DC homebuyer credit.
• Unlike the previous $7500 credit, you can claim the credit even if your mortgage was financed by a mortgage revenue bond (like with VHDA loans) - check with your tax advisor!
• Limitations are similar to the previous $7,500 "credit" (interest free loan) in 2008: income restrictions start at $75,000 (single) and phase out completely at $95,000 or $150,000 (married filing joint) and phase out at $170,000, and have not owned a home in previous 3 years.
  

See page 19 of the Conference Report pdf file here for more.

Here's a handy chart of the old law versus the new law.


Move-up (non first time) buyers -- don't worry, there's something in the Bill for you, too...

There is another important change that hasn't been getting nearly as much press: the temporary reinstatement of the increased conforming loan limits for high cost areas. You may recall that our local Washington, DC, area's conforming loan limits rose from $417,000 to $729,750 last year, giving purchasers of higher end homes an important break on interest rates for loan limits up to that amount. At the end of 2008, the temporary limit expired and it dropped to $625,500. That means any loan above that amount fell into the "jumbo" category--making it very difficult and very expensive for borrowers in that bracket. This stimulus bill reinstates that $729,750, which should make it easier for folks to get these loans which now qualify for Fannie, Freddie (and possibly FHA...unclear at this time) guidelines, which translates to lower rates and greater availability.

Read more about conforming loan limits and how they work here.

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What Does the Fannie & Freddie Bailout Mean To Home Buyers?

Big news over the weekend and today is that the Federal government is 'bailing out' Fannie Mae and Freddie Mac, who lacked enough access to capital to keep the secondary mortgage market going. While buyers and sellers might initially think that this is bad news, it's actually good, as evidenced by the 300 point market rally at the opening bell today. The markets are glad that what was an 'implied' guarantee is now an explicit one and the markets like transparency.

This is critical to the mortgage industry: Freddie and Fannie buy mortgages that are originated by banks, then package those loans up, slaps a guarantee on them, and sell them to investors. This helps transform what would normally be a very illiquid and long-term investment (30 year mortgages) into a very liquid asset: mortgage-backed securities. This keeps access to capital for borrows high, and interest rates low. Both Fannie and Freddie were chartered by Congress for specifically this purpose.

Before you start slamming this as another taxpayer funded bailout, remember that Congress has control of both their charters and heavily regulates what they can buy and sell. Both companies, though publicly traded, have many restrictions on how they operate their businesses. (The government, for example, sets the conforming loan limit of $417,000, now $729,750 in our area, but due to drop back down to $625,000 at year end). If the governments wants the right to legislate how a publicly traded company--presumably accountable to shareholders--is going to operate, then it's only fair that when things get mucked up the government needs to help out.

In terms of rates, we should expect to see conforming/jumbo-conforming rates drop in the coming weeks by as much as a percentage point.

If you're on the fence about buying, this means the (possibly temporary) return of rates in the 5.5% range! For those of you who recently purchased, keep a close eye on rates -- if rates drop to a full percentage point below what you have, it may actually be worth it for you to refinance. Discuss this with your lender.

Housing Bill: Buyer Credits, Loan Limit Increases, FHA Changes

Breaking news on the latest version of the Housing Bill, now on a fast-track to a vote and onto the President’s Desk, where he has signaled he will sign it. The newest developments:

• Permanently increase the conforming loan and FHA loan limits (previously $417,000, and increased to $729,750 in the Washington, DC, area in 2008) to 115% of the median home value - $625,000 in our area, effective 1/1/09
• Increase the FHA down payment from 3% to 3.5%
• Provide a first time home buyer “credit” (really, more like an interest-free loan, to be repaid over 15 years by the buyer) of up to 10% of a home’s price, to a maximum of $7500. The refund is gradually reduced for single filers with AGI above $75K ($150 for joint). It applies to home buyers who purchased between April 9, 2008 and July 1, 2009.
• Bar down payment assistance programs like Nehemiah
• Allows the Treasury to offer Fannie and Freddie an unlimited line of credit over the next 18 months to serve as a ‘backstop’ and provide liquidity. The bill also creates a regulator for the two companies.
• Gives $4 billion in grants to states to buy and rehabilitate foreclosed homes
• Create an FHA program which will help strapped homeowners who are upside-down. The program will require lenders to write down loans to 90% of the appraised values and pay an FHA fee in exchange for an FHA guarantee. Lenders and FHA would then share in any future price appreciation.

Update 8/10/08: Here are some FAQs, including one important for our answer -- can a DC homebuyer claim both the DC credit as well as the non-interesting bearing loan ("credit")? Unfortunately, no.

What is the State of The Housing Market? (Multiple Choice)

What is the State of the Housing Market? Please choose the best answer.

A. Looks like the start of a recovery. NAR Q3 2007 Report indicates roughly half of US markets show an increase in median home prices.

B. About flat, plus or minus 1%...OFHEO reports Home Prices down 0.4% in Q3 2007

C. We have years of decline ahead of us…start keeping cash--strike that, better make it Euros--in your mattress, folks! Case Shiller reports “The Sky is Falling, The Sky is Falling!” (Ok, that wasn’t really a headline attributed to them, but that’s basically the message in all of their press releases…pick which ever press release you want.)

Ok, pencils down. You all get a gold star. No matter which one you choose, you're correct. Why? It comes down to the methodology.

The National Association of REALTORS® statistics captures the median value of home transactions that come from all of the Multiple Listing Services nationwide. They cover all home sales at all price points, and release data in a relatively timely manner.

OFHEO, the government agency that works with Fannie Mae and Freddie Mac, also releases its quarterly analyses. They cover 287 markets, but because they are primarily concerned with the conforming loan market, the track only resales that meet that criteria (until recently, loans under $417,000. See my post on Conforming Loan Limits.) It also includes refinancings, which arguably have more generous appraisals. FYI, OFHEO does typically include an attempt at reconciling their numbers to Case Shiller. Because CS is a privately owned index, the exact methodology is impossible to duplicate.)

Case-Shiller, which is probably the most widely quoted analysis, covers only 20 US markets BUT includes ALL price points and loan types—exotics, sub-prime, and limited documentation. Of course the 20 metro areas covered are very large ones, which typically have more expensive homes (anyone ever compare a 4BR colonial on an acre in North Arlington to a 4BR colonial on an acre in Cleveland?) It excludes 13 states completely and has limited information on 29 others—so incomplete or missing data from 42 states! It also weights transactions—a $700,000 home gets weighted twice as heavily in their index as a $350,000 home. But isn’t a 10% decline a 10% decline, regardless of the baseline? Apparently not.

Dramatic headlines sell papers--remember all the 2004-2005 headlines screaming Buy! Buy, Before You're Priced Out Forever! Doesn't sound like a great idea in hindsight, does it?) While I’m definitely not saying that those in the industry can’t spin stats better than a Maytag, I did find this little tidbit from the NAR pretty interesting:

“Another factor that rarely gets attention is that Dr. Shiller, a Yale professor, has a side business in Chicago. His index is used at the Chicago Mercantile Exchange for hedging housing futures values. The more hedging of bets that occur, the more profits go into Dr. Shiller’s bank account. And more hedging of the bets will take place if people believe there will be a crash in housing values. So naturally he has a financial incentive to “scare” the market.”

So what’s a buyer to do? Whom to believe? First, understand the methodology and if one matches up with your situation, pay closer attention to that one. Are you in one CS’s 20 markets and looking to use a no doc loan for a $600K home? CS may be the better measure for you. Are you looking to buy below $417,000? OFHEO may be a better report for you. Want the broadest measure possible? Use NAR. I find that with statistics, perception is reality, and no one calls a market bottom until it’s months behind us, and in the meantime, life goes on. If you’re buying a home, as opposed to an investment property, then do what's best for you, pick a time that works with your life, plan to stay there at least 3-5 years, and buy only what you can afford.

Read more: See my post from last year on Yes, the Market is Down 7% AND up 1%

Read more: from one of my favorite mortgage blogs on spin in the mortgage industry headlines: How Ignoring Adjectives Can Improve Your Understanding of Mortgages

Read more in the Carnival of Real Estate, which included this post. They make the extremely important observation that all real estate is local, so national trends don't mean very much in the first place! Read my posts making similar points here and here. This one is also interesting to look at the very different foreclosure stats, even from county to county, in our area.

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Conforming Loan Limit Increase

In conjunction with the stimulus package on its way to the President's Desk, a new conforming loan limit is on its way in our area. The final legislation effectively limits the increase to certain high cost areas including California, Boston, NY, and metro DC. In our area, the limit will be $562,500, up from $417,000, for the remainder of 2008 only.

The impact of this generally will mean lower rates, and perhaps easier refinancing, for loans between the old limit and the new one. However, the actual rate differential between this new "tier" and "original" conforming loans (still below $417K) remains to be seen; the rates likely won't be equal because of some market constraints. Namely, the temporary nature and limited geography means lower volume and lower trading liquidity, which equals lower demand for these types of securities. So will it help? Yes. Dramatically? We'll see.

Read more: Why Didn't the Fed Cut Impact Mortgage Rates More?

What's Going On With Increasing the Conforming Loan Limit?

Update 2/12/08: See my post with more recent information here.

Original Post:
The mortgage market is in a state of flux, with multiple proposals floating around Congress regarding a potential increase in the conforming loan limit. That limit, currently $417,000, is the congressionally mandated maximum loan size that Fannie Mae and Freddie Mac--the largest players in the secondary mortgage market--can purchase. That helps keep rates lower for buyers in that bracket because there's an active place for banks to sell those loans. However, as many of you know, in this area that amount doesn't always buy much. An increase in the limit would make higher priced properties more affordable because a new and liquid secondary market would exist. (Jumbo rates, i.e., loans for more than $417K, run about 1% higher than conforming, though all rates change all day, every day, according to market conditions.

So what's all this about raising the limit, and what are they raising it to?

Nancy Pelosi first published that the limit would increase to $625,000 as part of the stimulus package. Then immediately she clarified to say that the new limit would be $729,750, an a similar (but permanent) increase for FHA limits. The difference is that the higher limit would be restricted only to certain high cost areas. Rep. Barney Frank then later added that the limit would be the lesser of $729,500 or 125% of the median home price, and only until the end of 2008, but for FHA any changes would be permanent. (FYI, the median home price for Washington's MSA according to OFHEO is $438,000, meaning our new limit would be $547,500 under that proposal) Other variations of the bill are floating around, disputes are ensuing, and some in Congress are saying any change needs to be part of a GSE reform bill.

The bottom line is that nothing is final yet, just as with the entire stimulus bill.

In related news, there have been several Fed rate cuts this month; first a 75bp emergency cut, followed by another 50bp cut this week. For those playing rate roulette, this last cut actually caused rates to increase, though they are still lower than a year ago. Read about why Fed cuts don't directly impact mortgage rates in my blog post here.

Fed Rate Cut - Why Didn't Mortgage Rates Fall Much?

The Fed's emergency three-quarters of a point rate cut didn't have much impact on mortgage rates...or did it? Well, it did and it didn't (don't you love answers like that)? The bottom line is that the Fed Funds rate certainly impacts mortgage rates, but sometimes indirectly, and surprisingly, sometimes they can move in opposite directions! This is a very high level and over-simplified discussion of the whys and hows -- it's tough to fit this in to one post though, and I'm not a mortgage banker, so bear with me, and feel free to contact me directly if you want to discuss more. Here we go:

The Fed Funds Rate is the overnight borrowing rate between banks. Banks are required to have certain reserve funds at the Fed each night to cover their deposits (remember reading about the Depression and runs on banks?) Sometimes banks don't have the funds so they borrow from other banks who have excess funds. The rate is an important policy tool of the Fed--it helps keep the balance of economic growth vs inflation in check. That's the key trade-off that the rate helps control--if rates are too low, we'll get inflation. If rates are too high, it prohibits growth.

The FFR is a very short term rate (overnight), whereas mortgage rates are more aligned with longer term instruments like bonds. After all, a buyer is theoretically borrowing money for 30 years (the length of a mortgage, though the lenders all know that most borrowers sell or refinance long before that time.) Bond yields, which impact 30 year mortgages, are tied to long term investor market expectations.

So which loans does the FFR impact?

30 year fixed -- Not directly impacted, though they often move in tandem because of shared expectations about long term growth of the economy. But if the FFR drops too low and investors get too worried that it will result in inflation, then mortgage rates can actually move in the opposite direction.

ARM loans -- These are generally tied to short term (1 year) treasuries, and so likely are impacted by rate cuts, but only if it varies from what was "expected" (see more below).

HELOCS -- These are generally tied to the prime rate, which moves in step with the Federal Reserve.

Subprimes -- Depends what index it's tied to, but they are often tied to LIBOR. LIBOR rates have been falling this month.

How markets move after FFR changes depends on expectations; the Fed meets on a regular schedule and many pundits predict their every move, so there are expectations "built in" to interest rates. If the Fed acts "as expected", then there are minimal changes following an announcement. Yesterday's announcement was a surprise mostly in the timing--many pundits had already predicted a half point cut later in January. So the impact was not overly dramatic.

NB: Not covered in this post is the differences in impacts between "Jumbo" and "Conforming" loans -- the magic number there is $417,000 because that's the mandated upper limit of loans that Fannie and Freddie can purchase from banks and re-sell--with a guarantee--to investors, creating a very liquid secondary market. Liquidity and guarantees lowers risk for banks, which helps keep rates lower for buyers in that bracket.

Update: In conjunction with the just released stimulus package comes news that Congress is evaluating whether or not to raise that $417K limit to $625K. If implemented, this will do a ton to create more affordable mortgage options in the DC area...more to come.


Read more: How do Fed rate cuts affect adjustable mortgages?

Read more: A slightly dated article that still does a nice job explaining impacts on different mortgage types.

Interest Rate Jumps; Unfortunate, but not Catastrophic

I'll be writing on this quite a bit, and I'll start off by saying that, as regular readers know, I do NOT think recent interest rate jumps are the end of the world. I'll get to why in a bit, but first, a recap.

Last week, large mortgage lender American Home Mortgage shut its doors. That made the markets very panicky and led to an increase in rates for two specific loan types: "Jumbo" and 2nd trusts.

"Jumbo" loans are loans above $417,000--the limit for "conventional" loans set by Fannie and Freddie, who buy mortgage loans from originators. Fannie and Freddie exist to create a “secondary market” for mortgages—that is, they buy loans for cash, and then originators use that cash to make more loans to homebuyers. If they didn’t exist, then banks would only be able to loan as much cash as they had on hand, and would have to hold the mortgages until each homebuyer sold or paid it off. (That’s a bit of an over-simplification, but for our purposes it should suffice.) Fannie and Freddie are government “sponsored” (though not technically government-insured), and so the loans they can buy have certain restrictions, i.e., are under $417K. Because there’s an easily available secondary market for this size loans, they typically have a lower interest rate than the larger, or “jumbo” loans.

Now, $417K doesn’t buy you much in this area, so lots of people end up with “jumbo” loans. And since even the smallest place is usually in the $300s, many people in this area don’t put 20% (or about $60K+) down. That hasn’t been an issue until now. You can put 5% down, take out two “trusts” (or loans)—one for 80% and one for 15%, and be on with your home purchase. Those second trusts are becoming an issue, though. Read on:

The second impact of this panic is a big jump on the 2nd trust rates. 2nd trusts have always been riskier for lenders—they’re junior liens, after all, and so carried a higher interest rate. But that rate is the other important change in the past week. It jumped significantly.

Two impacts on this market are clear, but in my opinion, neither is catastrophic. At least not yet.

1) For most buyers, they can afford less. So if you were shopping at the top of your affordability range, chances are you can no longer afford that payment, regardless of how much you were putting as a down-payment. How much less? We’ll have to see where the rates stop. According to the Post, rates are up almost a full percentage point since May. So for every $10,000 borrowed, that’s $100/year.

Let’s use an example. Let’s say a buyer was looking at in the $600,000 range starting in May. Rates jumped up a point since then. That means that if there is NO room in their monthly budget (and why would any responsible person be looking at that price if there was absolutely no room in their budget?!) then now they can only afford $500,000. Another way to say it is that having the same $600,000 mortgage now costs them an extra $6000/year (which, making some assumptions about income bracket, is about $4000/year out of pocket after taxes.)

My guess—and I certainly could be wrong—is that people shopping for $600,000 homes have just a little bit of wiggle room in their budgets, maybe even up to $4,000/year. I think most people in that income and affordability bracket will make the trade-off, see their home as an important investment, and forgo a few discretionary items to get the house that they still want. I believe that the majority of the people are NOT going to change the range in which they’re looking, at least not by much. Again, maybe I'm naive, or maybe I'm just lucky that my clients tend to be responsible purchasers (or, not to pat myself on the back too much, but maybe I do a good job counseling them up front and introducing them to reputable lenders who counsel them too).

In my experience, the people who tend to stretch their budgets to the breaking point are the people who are buying their first place, which is often under $417K, and therefore not impacted by the jumbo rate jump. They are, however impacted in another way. They usually have less of a down-payment (because they’re not rolling over equity from a previous home), and are borrowing more than 80% of the purchase price.

2) For all borrowers planning to finance more than 80% of the purchase, you can afford less. This one worries me less—one, because only 15% of the loan is going to have a significant jump in rate, and that’s a whole lot better than having it hit the 80%. Second, there exists an option to borrow 95% as one trust and pay PMI. PMI, which historically was a dirty word for borrowers, is more acceptable now because in 2007 it’s tax deductible, same as interest. Boy, did they pick a good year to change that rule! So the 95% trust, as long as it’s not jumbo (see impact #1) should keep the payment roughly what a borrower was planning two weeks ago.

I’m sure this will continue to be a front-page crises for a few weeks. I’ll write more as the situation evolves. But I still stand firm in my conviction that if you are:

- Financially able to buy: good credit, a reasonable budget, about 8% of the purchase price in savings, and
- Your life situation calls for buying instead of renting: will be in this area for 3 or more years, you have reasonable expectations of what you get for the money, and you recognize that even a flat return on an investment is better than rapidly increasing rents (see Rent vs Buy calculator post),

Then this is still a good time to seriously consider buying.

Sub Prime Meltdown: The Middle of the End?

Several weeks ago I posted about Fannie Mae and Freddie Mac programs to help borrowers who are in risk of defaulting, or have already defaulted, on their sub-prime loans. By now, everyone has read of the "melt down" fueled by 2/28 and 3/27 adjustable rate loans that offered very low teaser rates back i n 2004-2005, and are due to begin resetting this year. The issue is that lenders approved borrowers based on those low initial payments and now that the payment will be going up--often very dramatically--borrowers who either didn't understand the resets, or just aren't good at budgeting, are in serious trouble.

Now Congress may be stepping in as well, in the form of a "stealth bailout" via the FHA. The Federal Housing Authority has many loan programs aimed at helping first time buyers, but the loans came with some serious drawbacks: heightened inspection requirements, mortgage insurance, and most importantly in this area, a relatively low maximum borrowing cap. With prices so high in this area, FHA loans just weren't a good deal for most borrowers. Congress is currently considering an FHA overhaul package that would, among other things, raise the cap, and lower the down payment requirement, all while providing 30 year fixed rates that are about 3% below the going sub-prime rate. Obviously FHA is expecting to see a surge in applications. Of course there will be snags as this bill makes it through the convoluted process, but if it comes through relatively intact, this could be the "middle" of the end of the "meltdown."

Sub Prime Meltdown: The Beginning of the End?

Freddie Mac announced it will buy $20B in fixed-rate and hybrid adjustable rate mortgage products to provide alternatives for sub-prime borrowers. Both Freddie and Fannie Mae are also working on developing new loan types to help distressed borrowers keep their home.

I think these announcements will limit the fall out of the subprime "meltdown"...much to the dismay of the buyers circling and waiting for the big spike in foreclosures in the DC metro area. The fact is that banks don't WANT homes...they want viable loans. They're not in the home foreclosure business, and they take big losses too, so the incentive is there for them to do everything they can to keep a buyer in their house, even if it's a less profitable loan than it was several years ago.

Congress is too wary of being saddled with a "bailout" label to make any broad-scale changes, but Fannie and Freddie are already stepping in to manage the situation. I think buyers who are waiting for short sales and foreclosures in DC or close-in suburbs may be waiting much longer than they anticipated.