I've posted here before that there were signs that the sub-prime mortgage mess, while unfortunate for many, was not the crisis that the press makes it out to be. The housing market is just too important to this economy, and while no one is screaming "bailout", there have been consistent signs that the country is not going to sit idly by and let millions of people lose their homes.
Today President Bush announced that new programs were being established to help 80,000 people who have fallen behind on their payments. I'd be willing to bet that if conditions worsen, even more programs will be announced. Sure, they'll blame it on the predatory lenders rather than home buyers that made bad decisions, but at the end of the day, no one wants people out on the street. It's in everyone's best interests--from the owners', to the lenders', to the government's, to keep people in their homes.
Showing posts with label sub-prime. Show all posts
Showing posts with label sub-prime. Show all posts
Saturday, September 1, 2007
Saturday, August 11, 2007
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.
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.
Wednesday, May 30, 2007
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."
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."
Thursday, April 19, 2007
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.
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.
Thursday, March 15, 2007
Impact of Sub-Prime: Part I
The Post has had a very interesting series of articles this week about the sub-prime mortgage market, which was the impetus for market drops across the world in the last few weeks. So how bad will it get? It's a question I often get.
What is a sub-prime loan? Basically it's a loan offered to a borrower who has been turned away bya traditional lender because of credit problems or other factors. Loans in this category often have a higher-than-normal interest rate. In the housing run up of the last 5-6 years, this type of loan was the only way many peopld could get into a house, and the fear is now those borrowers are defaulting and may be foreclosed upon.
The Post article notes that the problems so far have been concentrated in areas reeling from layoffs (remember the post about the job markets and it being a great leading indicator of the housing market?) such as Michigan, Indiana, Ohio, and the Gulf coast.
The Northeast, Southeast, and Midwest have a moderate 4-6% subprime loans in foreclosure as of Q4 2006. VA/DC/MD, Florida, and the West coast all have the lowest: 1-3% versus the US average of 4.5%. As the Post notes: "There is scant evidence-so far-that the mortgage problems are causing wider economic damage."
Of course that's not to say the problem can't be here next, but it's not here yet.
Wednesday, March 14, 2007
FAQ: Short Sales
With all of the recent press about the crash of the sub-prime lending market, we will be seeing more and more "short sales." What's a short sale?
A short sale occurs when a seller is in a negative equity position and either does not have the liquidity to sell (that is, they need to come to the settlement table with funds to cover their loss) or is facing foreclosure but wants to avoid it. This situation happens when the seller owes more on the property than it is currently worth. It's being "underwater" or "upside down" on the mortgage.
Lenders in this situation often cooperate with the seller because it will maximize their payoff to do that versus foreclosing and selling the property at auction. Upon settlement, the lender receives all of the net proceeds (less closing costs), which is called the "short payoff." The lender, despite being owed more money, releases the lien anyway and the buyer gets title. Lenders must agree to cooperate in this up-front, and contracts are contingent on lender approval.
A short sale occurs when a seller is in a negative equity position and either does not have the liquidity to sell (that is, they need to come to the settlement table with funds to cover their loss) or is facing foreclosure but wants to avoid it. This situation happens when the seller owes more on the property than it is currently worth. It's being "underwater" or "upside down" on the mortgage.
Lenders in this situation often cooperate with the seller because it will maximize their payoff to do that versus foreclosing and selling the property at auction. Upon settlement, the lender receives all of the net proceeds (less closing costs), which is called the "short payoff." The lender, despite being owed more money, releases the lien anyway and the buyer gets title. Lenders must agree to cooperate in this up-front, and contracts are contingent on lender approval.
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