Low, Low, Low Mortgage Rates

photo by Martin Abegglen

TheStreet.com quoted me in Top 5 Lowest 15-Year Mortgage Rates. It opens,

U.S. mortgage rates have continued to decline in the aftermath of the Brexit vote, low Treasury rates and the stagnant economy, giving potential homeowners an opportunity to save money because of the dip.

The current market conditions give homeowners in the U.S. an opportunity to take advantage of the continuation of low mortgage rates since the Federal Reserve has not increased interest rates.

But, how do you snag the absolute lowest rates?

How to Get a Low Rate

Low mortgage rates can play a large factor in homeowners’ ability to save tens of thousands of dollars in interest. Even a 1% difference in the mortgage rate can save a homeowner $40,000 over 30 years for a mortgage valued at $200,000. Having a top notch credit score plays a critical factor in determining what interest rate lenders will offer consumers, but other issues such as the amount of your down payment also impact it.

A high credit score is the key to ensuring that borrowers receive a low mortgage rate. Here’s a quick rundown of what the numbers mean – a score of anything below 620 ranks as poor, 620 to 699 is fair, 700 to 749 is good and anything over 750 is excellent. Think carefully before canceling a credit card with a long, positive history, but decrease your debt. One of the biggest factors which impact your credit score is your credit utilization rate.

Many potential homeowners focus only on the interest rate or the monthly payment. The APR or annual percentage rate gives you a better idea of the true cost of borrowing money, which includes all the fees and points for the loan.

The origination fee or points is charged by a lender to process a loan. This fee shows up on your good faith estimate (GFE) as one item called the origination charge. However, the origination fee can be made up of a few different fees such as: processing fees, underwriting fees and an origination charge.

Homeowners who are able to afford a 20% down payment do not have to pay private mortgage insurance (PMI), which costs another 0.5% to 1.0% and can tack on more money each month. Having at least 20% in equity shows lenders that there is a lower chance of the individual defaulting on the loan.

Choosing Between 15-year and 30-year Mortgages

Obtaining a 15-year fixed rate mortgage instead of a traditional 30-year mortgage means homeowners can save thousands of dollars in interest. One drawback of a 15-year mortgage is that consumers will be locked into higher monthly compared to a traditional 30-year mortgage or a 5-year or 7-year adjustable rate mortgage, “which could put the squeeze on homeowners when times are tight,” said Bruce McClary, spokesperson for the National Foundation for Credit Counseling, a Washington, D.C.-based non-profit organization.

Many households would not benefit from a 15-year mortgage because it “does more to limit their financial flexibility than to enhance it,” said Greg McBride, chief financial analyst of Bankrate, a North Palm Beach, Fla.-based financial content company.

“Locking into higher monthly payments makes the household budget tighter and for what?,” he said “So you can pay down a low, fixed rate loan? On an after tax, after-inflation basis you’re essentially borrowing for free.”

McBride suggests that this strategy does not bode well for homeowners, especially if they are not paying down their higher interest rate debts and maximizing their tax-advantaged retirement savings options such as IRAs and 401(k)s.

“Even then, you might be better off investing your money elsewhere than tying up more of your wealth in the most illiquid asset you have – your home,” he said. “Just 28% of American households have a sufficient emergency savings cushion, so why the hurry to pay off a low, fixed rate, tax deductible debt. Money in the bank will pay the bills, home equity will not.”

The current economic situation has pushed down rates with 15-year mortgages becoming “relatively more attractive” than even 5-year adjustable rate mortgages (ARMs) over the last year, said David Reiss, a law professor at the Brooklyn Law School in New York. Last week Freddie Mac announced the average 15-year mortgage rate was 2.74% and the average for the 5-year ARM was 2.75%.

“These rates are virtually the same,” he said. “A year ago, the 15-year was relatively more expensive than the 5-year by about 0.16%. If you can swing the higher principal payments for the 15-year mortgage you will be getting about as good an interest rate as you could hope for.”

Ensuring Sustainable Homeownership

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My short article, Ensuring That Homeownership Is Sustainable, was just published in the Westlaw Journal, Bank & Lender Liability. It opens,

The Federal Housing Administration has suffered as a result of many of the same unrealistic underwriting assumptions that led to problems for many lenders during the 2000s. It, too, was harmed by a housing market as bad as any since the Great Depression.

As a result, the federal government announced in 2013 that the FHA would require the first bailout in the agency’s history. While facing financial challenges, the FHA has also come under attack for the poor execution of policies designed to expand homeownership opportunities.

Leading commentators have called for the federal government to stop having the FHA do anything but provide liquidity to the low end of the mortgage market.

These critics rely on a few examples of agency programs that were clearly failures, but they do not address the FHA’s long history of undertaking comparable initiatives.

 In fact, the FHA has a history of successfully undertaking new homeownership programs. However, it also has operational flaws that should be addressed before it undertakes similar future homeownership initiatives.

INTRODUCTION TO THE FHA

Mortgage insurance is a product that is paid for by the homeowner but protects the lender if the homeowner defaults on the mortgage. The insurer pays the lender for losses it suffers from the homeowner’s default. Mortgage insurance is typically required for borrowers who have limited funds for down payments.

The FHA provides mortgage insurance for loans on single family and multifamily homes, and it is the world’s largest government mortgage insurer. Other significant providers are the Department of Veterans Affairs and private companies known as private mortgage insurers.

Mortgage insurance makes homeownership possible for many households that would otherwise not be able to meet lenders’ underwriting requirements.

Just like much of the federal housing infrastructure, the FHA has its roots in the Great Depression. The private mortgage insurance industry, like many others, was decimated in the early 1930s. Companies in the industry began to fail as almost half of all mortgages went into default. The government created the FHA to replace the PMI industry, which remained dormant for decades.

In the Great Depression, the housing markets faced problems that were similar to those faced by the same markets in the late 2000s. These problems included rapidly falling housing prices, widespread unemployment and underemployment, the rapid tightening of credit and — as a result of all of those trends — much higher default and foreclosure rates.

The FHA noted in its second annual report, issued in 1936, that the “shortcomings of the old system need no recital. It financed extensive overselling of houses at inflated values, to borrowers unable to pay for them.” Needless to say, the same could be said of our most recent housing bust.

Over its lifetime, the FHA has insured more than 40 million mortgages, helping to make homeownership available to a broad swath of American households. Indeed, the FHA mortgage has been essential to America’s transformation from a nation of renters to one of homeowners.

The early FHA created the modern American housing finance system, as well as the look and feel of post-war suburban communities through the construction standards the agency set for the new houses it insured.

The FHA has also had many other missions over the course of its existence — and a varied legacy to match.

Beginning in the 1950s, the FHA’s role changed from serving the entire mortgage market to focusing on certain segments. This changed mission had a major impact on everything the FHA did, including how it underwrote mortgage insurance and for whom it did so.

In recent years, the FHA has come under attack for poorly executing some of its attempts to expand homeownership opportunities, and leading commentators have called for the federal government to stop assigning such mandates to the agency. They argue that the FHA should focus only on providing liquidity for the portion of the mortgage market that serves low- and moderate-income households.

These critics rely on a couple of examples of failed programs, such as the Section 235 program enacted as part of the Housing and Urban Development Act of 1968 and the American Dream Downpayment Assistance Act of 2003.

Those programs required borrowers to make only tiny and sometimes even nominal down payments. The government enacted the Section 235 program in response to the riots that burned through American cities in the 1960s. It was intended to expand homeownership opportunities for low-income households, particularly black ones.

The American Dream program was also geared to increasing homeownership among lower-income and minority households. The crux of the critique of these programs is that they failed to ensure that borrowers had the capacity to repay their mortgages, leading to bad results for the FHA and borrowers alike.

Notwithstanding these failed initiatives, the FHA has a parallel history of successfully undertaking new homeownership programs. These successes include programs for veterans returning home from World War II, a mission that was later handed off to the VA.

At the same time, historically the FHA has clearly suffered from operational failures that should be addressed in the design of any future initiatives.

Unfortunately, the agency has not really grappled with its past failures as it moves beyond the financial crisis. To properly address operational failures, the FHA must first identify its goals. (6-7, footnote omitted)

Reiss on FHA Mortgages for First Timers

MainStreet quoted me in FHA Loans Can Be A Good Option for First-Time Homebuyers. It opens,

FHA loans can be an attractive option for consumers purchasing their first home, because they require much smaller down payments.

First-time homebuyers often consider these Federal Housing Administration loans, because they do not require a large down payment or high FICO scores unlike traditional 30-year fixed mortgages. Given that young households tend not to have the savings for a substantial down payment, they can be an attractive option, David Reiss, a law professor at Brooklyn Law School.

Because FHA loans are mortgages insured by the Federal Housing Administration, this guarantee reduces the risk of “loss of principal for lenders, which is advantageous for borrowers,” said Joseph Cahoon, director of the Folsom Institute for Real Estate at Southern Methodist University’s Cox School of Business School in Dallas.

This results in some consumers being able to put down as little as 3.5% for a down payment towards the purchase of a new home. For many first-time Millennial homebuyers, the prospect of saving 20% for a standard down payment has been challenging during the past several years because of a combination of low growth in wages and high student loan debt.

“For those borrowers with good credit, FHA insured loans offer a good pathway to home ownership, he said.

*     *     *

“Homebuyers should compare all of their options before going with an FHA mortgage,” Reiss said.

Frannie Conservatorships: What A Long, Strange Trip It’s Been

The Federal Housing Finance Agency Office of Inspector General has posted a White Paper, FHFA’s Conservatorships of Fannie Mae and Freddie Mac: A Long and Complicated Journey. This White Paper on conservatorships updates a first one that OIG published in 2012. This one notes that over the past six years,

FHFA has administered two conservatorships of unprecedented scope and simultaneously served as the regulator for these large, complex companies that dominate the secondary mortgage market and the mortgage securitization sector of the U.S. housing finance industry. Congress granted FHFA sweeping conservatorship authority over the Enterprises. For example, as conservator, FHFA can exercise decision-making authority over the Enterprises’ multi-trillion dollar books of business; it can direct the Enterprises to increase the fees they charge to guarantee mortgage-backed securities; it can mandate changes to the Enterprises’ credit underwriting and servicing standards for single-family and multifamily mortgage products; and it can set policy governing the disposition of the Enterprises’ inventory of approximately 121,000 real estate owned properties. (2)

I was particularly interested by the foreward looking statements contained in this White Paper:

Director Watt has repeatedly asserted that conservatorship “cannot and should not be a permanent state” for the Enterprises. Director Watt has indicated that under his stewardship FHFA will continue the conservatorships and build a bridge to a new housing finance system, whenever that system is put into place by Congress. In this phase of the conservatorships, FHFA seeks to place more decision-making in the hands of the Enterprises. (3)

Those who have been hoping that the FHFA will act decisively in the face of Congressional inaction should let that dream go. And given that just about nobody believes (I still hope though) that there will be Congressional reform of Fannie and Freddie during the remainder of the Obama Administration, we must face the reality that we are stuck with the conservatorships and all of the risks that they foster for the foreseeable future. Today’s risks include historically high rates of mortgage delinquencies and exposure to defaults by counterparties like private mortgage insurers. As I have said before, the risks that Fannie and Freddie are nothing to laugh at. Let’s hope that the FHFA is up to managing them until Congress finally acts.

Housing Finance Reform at a Glance

The Urban Institute has posted its November Housing Finance At A Glance.  This is a really valuable resource. The introduction provides a nice overview of recent developments in the area:

With a sweeping midterm election victory for the GOP, the path to legislative GSE reform got considerably narrower. Thus, the focus for reform turns to the FHFA and FHA, where we expect significant movement in the coming months. Over the past six months, the FHFA has asked for input on a variety of issues, and we have commented on them all: guarantee fees and loan level pricing adjustments, Private Mortgage Insurance Eligibility requirements (PMIERs), the single security, and affordable housing goals.
The FHFA has made a concerted effort to open the credit box, strengthening the provision by which lenders are relieved from much of their put-back risk and raising the maximum loan-to-value ratio for some GSE loans from 95 to 97. Both will help expand access without unduly increasing GSE risk. FHFA Director Mel Watt has indicated in recent speeches that work is underway to further clarify reps and warrants, with more guidance on the sunset provision, an independent resolution process for put-back disputes, and remedies short of a put-back for lesser mistakes.
As our new credit availability index indicates, these actions to open the credit box are very important. Our index shows that post-crisis loans have half the credit risk of loans made in the 2000-2003 period. The GSE channel is particularly tight, with about a third of the risk of the 2000-2003 period. This is corroborated by the data in our special feature, which shows that only 8.3 percent of recent Fannie loans (page 34) and 7.4 percent of recent Freddie loans (page 36) have FICOs under 700, compared to 35-37 percent in 1999-2004.
On the FHA side, there have also been initiatives to open the credit box, as outlined in the Blueprint for Access program. Since then, the FHA has released the initial critical draft chapters of their guidebook and a draft of the taxonomy of defects. Many hope to see lower mortgage insurance premiums to broaden access and lessen the risk of adverse selection as better credit flees to the less costly GSEs. Given that their actuary now projects that the FHA’s Mutual Mortgage Insurance Fund will not reach the statutory reserve requirements until 2016, however, such a move is far from certain.
Risk Sharing Developments
The GSEs continue to broaden their risk sharing activities, now turning to front-end risk sharing deals. Prior to this month, they had focused exclusively, and with much success, on laying off risk already on their books, known as back-end risk sharing. Fannie has laid off risk on 7.5 percent of their book of business and Freddie on 11.9 percent of theirs (page 21), both far exceeding the requirements of the Conservatorship Scorecard. The GSEs started including mortgages over 80 LTV in these transactions in May.
This month saw a very meaningful step in bringing private capital back into the mortgage market: the first front-end risk sharing deal, JPMorgan’s Madison Avenue Securities 2014-1 (page 21). JP Morgan warehoused loans made by JP Morgan Chase bank, then sold them in bulk into a newly issued Fannie Mae MBS, presumably for a very meaningful reduction in guarantee fees. JP Morgan retained the first 4.75 percent subordinated interest, and a 26.88 bps servicing strip that absorbs losses before the subordinated interest. The risk on the 4.75 percent subordinated interest was sold in the capital markets in the form of credit linked notes. Redwood Trust is also reported to be contemplating a front-end risk sharing transaction.
Front-end risk sharing bears important similarities to the private capital/catastrophic insurance structure contemplated by many GSE reform proposals. It is thus an administrative opportunity to experiment deliberately with a truly reduced government footprint in the conventional mortgage market. (3)
I am very excited by the possibility of putting private capital in a first loss position for residential mortgages and agree with UI that the stars are aligning, at least a little bit, for this to become a reality. Many interests will need to be balanced for this to move forward, but politicians of all stripes should be worried about leaving Fannie and Freddie in limbo for much longer.

Insuring Mortgages Through the Business Cycle

Mark Zandi and Cristian deRitis of Moody’s, along with Jim Parrott of the Urban Institute, have posted Putting Mortgage Insurers on Solid Ground. They wrote this in response to the Private Mortgage Insurance Eligibility Requirements set forth by the FHFA. While generally approving of the requirements, they argue that

Several features of the rules as currently written, however, would likely
unnecessarily increase costs and cyclicality in the mortgage and housing markets.
With a few modest changes, these flaws can be remedied without sacrificing the
considerable benefits of the new standards. (1)

I would first start by reviewing their disclosure:  “Mark Zandi is a director of one mortgage insurance company, and Jim Parrott is an advisor to another. The authors do not believe that their analysis has been impacted by these relationships, however. Their work reflects the authors’ independent beliefs regarding the appropriate financial requirements for the industry.” While, I understand that the authors believe that their views are not impacted by their financial relationships with private mortgage insurers, readers will certainly want to take them into account when evaluating those views.

The authors argue that FHFA’s requirements are procyclical, that is they become more burdensome just as mortgage insurers are facing a distressed environment. This could contribute to a vicious cycle where mortgage credit tightens because of regulatory causes just when we might want credit to loosen up. This is certainly something we should look out for.

They also argue that the FHFA’s requirements will increase mortgage insurance premiums unnecessarily because they increase capital reserves too much. I find this argument less compelling. The Private Mortgage Insurance industry has typically done terribly in distressed environments from the Great Depression through the 2000s. Not only have there been failures but they have also reduced their underwriting of new insurance just when the market was most fragile.

But there are certain shaky assumptions built into this analysis. For instance, they argue that Private Mortgage Insurance companies will need to maintain their historical after-tax return on capital of 15%. But if the business model is shored up with higher capital reserves, investors should be satisfied with a lower return on capital because the companies are less likely to go bust. That is, instead of increasing premiums for homeowners, it is possible that higher capital requirements might just reduce profits.

The authors write that while “the increase in capital requirements is clearly warranted, there are certain features of the requirements as currently drafted that will increase mortgage insurance premiums unnecessarily, running counter to the aim of policymakers, including the FHFA, to encourage greater use of private capital in housing finance.” (2-4) Policymakers have lots of goals for private mortgage insurance, including having it not implode during down markets. An unthinking reliance on private capital is not what we should be after. Rather, we should seek to promote a thoughtful reliance on private capital, taking into account how we it can best help us maintain a healthy mortgage market throughout the business cycle.

Good Data for the FHFA

The Federal Housing Finance Agency released a White Paper on the FHFA Mortgage Analytics Platform.  By way of background, the White Paper states that

The Federal Housing Finance Agency (FHFA) maintains a proprietary Mortgage Analytics Platform to support the Agency’s strategic plan. The objective of this white paper is to provide interested stakeholders with a detailed description of the platform, as it is one of the tools the FHFA uses in policy analysis. The distribution of this white paper is part of a larger effort to increase transparency on mortgage performance and the analytical tools used for policy analysis and evaluation within the FHFA.

The motivation to build the FHFA Mortgage Analytics Platform derived from the Agency’s need for an independent empirical view on multiple policy initiatives. Academic empirical studies may suffer from a lack of high quality data, while empirical work from inside the industry typically represents a specific view. The FHFA maintains several vendor platforms from which an independent view is possible, yet these platforms tend to be inflexible and opaque. The unique role of the FHFA as regulator and conservator necessitated platform flexibility and transparency to carry out its responsibilities.

The FHFA Mortgage Analytics Platform is maintained on a continuous basis; as such, the material herein represents the platform as of the publication date of this document. As resources permit, this document will be up dated to reflect enhancements to the platform. (2)

This platform is a very welcome development for exactly the reasons that the White Paper sets forth.  Academics have a very hard time accessing good data on the mortgage markets (its usually expensive, untimely, limited).  Industry interpretations of data typically have agendas.

A sampling of the Platform’s elements include:

  • Performing Unpaid Principal Balance
  • Scheduled Paid Principal Balance
  • Unscheduled Paid Principal
  • Dollars of New 90 Day Delinquencies
  • Non-Performing Balances
  • Property Value of Non-Performing Loans (30-31)

Let us hope that the Platform offers a transparent and flexible tool to track this very dynamic market.