“Today’s Mortgage Market Place”
This is most definitely a time of extreme change in our industry. It seems that every day another mortgage company closes its doors. Gone are the days when everyone seemed entitled to owning a home. Instead, now are the days when you have to earn the right to have your own home. Guidelines for obtaining a mortgage in the here and now are more strict than ever. Mortgage lenders everywhere are having to change the way that they have do business in order to try and qualify as many borrowers as possible with less program options.
As sad as it is to say, we seem to have done this to ourselves on many fronts. For many years the mortgage industry seems to have given the opportunity to own a home to many people that weren’t ready. Many lenders that were also only out to make as much money as possible, as quickly as possible, put consumers in the wrong loan programs. Most of these loan programs have now become pretty close to non-existent. All of the above is nothing too new to anyone. The media has had a field day with this, and in many cases, has made things seem worse than they are. That is where we really want to start and clarify several things that many consumers aren’t aware of.
While guidelines for obtaining a mortgage have tightened up, there are still many options for potential buyers that are thinking about purchasing a new home! Not only that, there are many options for 100% financing that are still available and will most likely remain available. Now is a great time to buy a home because with the surplus of current homes on the market, sellers are more willing to negotiate the terms of the sale. Whether it be reducing the purchase price, paying closing costs or contributing to down payment assistance programs, more and more sellers are doing what it takes to close the deal. What people don’t realize is that a lot of these sellers are looking to buy another home and need to sell their existing residence in order to do that. Now is also a good time to buy because interest rates have continued to improve over the last few months, and we are presently sitting at the lowest level of the year for rates.
The most important thing that we can stress at this point in time is to work with someone you trust and that is knowledgeable in our industry. We know that things have changed and will continue to do so for awhile longer while the industry and the housing market correct themselves. That is why it is so important for us to make sure that our past, present and future clients stay well informed of what is going on in our market today. As things continue to change, we will constantly give you updates and answer questions that will serve the purposes of educating you on current events and keeping your best interests at heart! Feel free to contact us anytime and ask us questions that you may have. With your permission we may even post your questions on the site!
I've heard that the Federal Reserve is planning more rate cuts. Does that mean I should wait for rates to get better before I refinance?
No. As with most things on Wall Street it isn’t that simple. The Federal Reserve is clearly in an aggressive mode to lower short term interest rates. The Fed Funds Rate is currently at 3.00% and most economist and bond watchers believe that the Fed plans to drop rates another 1.00% before they take a meaningful pause to reflect. The Fed is aggressively dropping short term rates in order to stimulate a slumping economy…an economy that most believe has already entered a recession. The lowering of short term rates by the Federal Reserve pressures banks into lowering Prime rate on a one to one basis. This means that if the Fed drops the Fed Funds rate by 1.00% then Prime rate drops by 1.00% as well. When Prime rate gets better certain financial instruments like home equity lines, credit cards and car loans improve. These lower interest rates encourage people to borrow money and most importantly spend money. When consumers spend the economy gets the grease it needs to grow. Sounds good right? Well, here’s the rub.
We’ve discussed how the lowering of short term interest rates affects the economy. Money gets spent, goods are purchased and manufacturers hire more labor to replace diminished inventories. All this buying, hiring and industrial production causes raw materials, labor and goods to become scarcer. And when more is demanded than can be supplied goods and services get relatively more expensive…or put another way their value becomes inflated. And there hidden in “inflated” is the Federal Reserve’s (and the Bond Markets) worst enemy…Inflation. Mortgage loan interest rates are not set by the Federal Reserve. Rather, mortgage loan interest rates are determined by the demand for mortgage backed securities (mortgage bonds) which are volatile securities that are traded every day just like stocks. If there are more buyers of mortgage bonds than there are sellers of mortgage bonds then the sellers can offer a lower rate and still sell their bond inventory. Conversely, if there are more sellers of mortgage bonds than there are buyers of mortgage bonds then the sellers have to raise the interest rates offered on their bonds to attract buyers and liquidate their inventory. This is very important to understand because inflation erodes the value of all mortgage bonds regardless of the rate being offered. This is true because mortgage bonds are fixed return investments. For example, if a mortgage bond is paying 6.00% and inflation is averaging 3.00% then a mortgage bond holder’s real return is the difference between these. Therefore, if overall inflation creeps up to 4.5% then mortgage bonds have to yield 7.5% to maintain their same inflation adjusted purchasing power. We are just beginning to see this paradox take place in the mortgage bond markets. Mortgage bond traders are very aware that the Federal Reserve is planning more of these economy stimulating/inflationary rate cuts and they are starting to demand more adjusted purchasing power…or higher rates. For many years the Fed has enjoyed an economic playing field where inflation was very tame. This time around, however, the markets aren’t so optimistic.
And if history is any indicator of the future then home buyers and those seeking to refinance to fixed rate loans should be locking in now. Simply put, history tells us that mortgage interest rates go up when the Federal Reserve lowers the Fed Funds rate. Now you understand why history is likely to repeat itself! So, if it’s a 30 year fixed rate you want better get it now.
How will the lowering of rates by the Federal Reserve affect Adjustable Rate Mortgages?
Adjustable Rate Mortgages (ARM Loans) will likely get better. The lowering of short term interest rates has more of a direct impact on these types of mortgages. This is true because the index used to determine the rates offered on these mortgages is generally one of two indexes. One index is the 1 Year Treasury Index and the other is called the 1 Year LIBOR index. Both of these indexes are short term in nature and are very sensitive to Federal Reserve action. We expect that ARM interest rates will go lower. How low some ARM loans go will be determined primarily by how low the Fed takes rates. We have already noticed a big drop in all Treasury indexed and LIBOR indexed adjustable rate loans. This drop has been mostly ignored by the media and consumers because these loans have been out of favor for a few years. The media and many misinformed consumers have wrongly associated these mortgage vehicles with the well published Sub-Prime Mortgage Crisis. This is unfortunate. Adjustable Rate Mortgages, when used appropriately, can offer consumers with a great opportunity to match loan term with likely home holding time frames. The likely result of this Federal Reserve lowering of short term rates will be what industry professionals refer to as a “steeper yield curve”. Steeper yield curves mean that short term rates will go down and long term rates will go up. Steeper yield curves are generally a precursor to an improved economy.
How do the recent changes in the mortgage industry affect my ability to get a loan?
That is really easy. Now more than ever it is so important to have good credit! The better your credit is, the more loan programs you will qualify for and the better your interest rate will be. It is very important to check your credit at least once a year and make sure that no one is using your credit profile fraudulently. The easiest way to do that is go to freecreditreport.com. You can see what things that you need to do in order to improve your credit score and see the progress that you have made so far!
What 100% loan program options are still available?
For a long time many lenders were doing 80/20’s (which means an 80% first mortgage and a 20% second mortgage). Basically your 20% second mortgage acts as a 20% down payment and eliminates the need to pay monthly mortgage insurance. Recently the 80/20 option has become less available to many buyers with credit scores below 700. Not only that but the second mortgage rates have gone up so much that it makes the 80/20 a less reasonable option. A better option today for 100% financing is to do one loan with what we call “lender paid mortgage insurance” or “LPMI”. The lender actually pays the MI for you up front so that you avoid the monthly MI. We think that this is a great option because it can actually increase your tax deduction at the end of the year. Monthly mortgage insurance is currently tax deductable for the first time in 2007, but we are not sure how long this will continue. Mortgage interest will more than likely always be tax deductable. Some people argue that the borrower paying monthly mortgage insurance is better because the rate is a little lower and you can eventually drop the monthly MI when you pay the loan down enough to reach the 20% equity point. The problem with that is that it will probably take 8-10 years to do this making your minimum monthly payment. Since the average life of a mortgage loan is about 5 years or less before people sell or refinance, why not maximize your tax deduction and have a lower payment in the meantime. You’re probably not going to pay your house down to reach that 20% equity point unless you plan on being there for a long time! Now we reference back to question #1 where we will reiterate how important credit scores are. If your score is less than 680, it probably doesn’t make sense to do LPMI and paying monthly mortgage insurance makes more sense at this point. There are several loan programs that offer borrower paid MI at great interest rates and some of these programs don’t have minimum credit requirements! Again, the better your credit score is, the more programs that you will qualify for.