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Low, Low, Low Mortgage Rates

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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.”

Owning v. Renting Smackdown

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photo by Agardikevin00

Forbes quoted me in Are You Really Just Throwing Your Money Away When You Rent? It reads, in part,

There are a number of reasons for wanting to buy a home over renting and most are valid. Some people want to buy because their current rental unit may have restrictions on owning a pet, while home ownership would, in most cases, not have this limitation. Others want to diversify their assets beyond the stock market. Still others may be pressured by friends and family – loved ones may claim you are simply throwing your money away if you rent, but with owning, you could be building equity every month.

Is this really true?

You Are Building Equity As A Homeowner, But…

It is true that you are building equity each month as a homeowner. However, the amount of equity you’re building is equivalent to the portion of your monthly mortgage payment that goes toward paying down principal.

Because most mortgages are structured to have a uniform monthly payment for the life of the loan, in practice, this means that your early payments will consist of more interest than principal. So while you are paying down principal and building equity, you may not be building as much as you imagined.

For example, let’s say you had a 30-year fixed rate mortgage with an interest rate of 4% and a starting loan balance of $500,000. Your monthly payment would be $2,387, but just 30% of this payment or $720 would go toward “building equity” during the first month. Over the first five years, less than 35% of your total mortgage payments go toward paying down principal (i.e. about $48,000 out of $143,000 of total payments).

Scott Trench, director of operations at real estate investment social network BiggerPockets, added, “Yes, equity can make you feel good, but it’s not really money you can use freely until you’ve sold the property. And if you end up selling in a down market, you may not end up realizing as much equity as you expected.”

*     *     *

The Transaction Costs Are Large For Buying!

The costs of buying and selling real estate are significant, and those costs don’t go toward building equity either.

“Buying a house entails many transaction costs that add up to three, four, or five percent of the price of the home and sometimes even more,” said David Reiss, a professor who teaches residential real estate at Brooklyn Law School. “Many advise that homebuyers should have at least a five-year time horizon or they risk having those transaction costs eat into any gains they were hoping to get out of the sale of their home. Even worse, those costs can lead to a loss, if the local market is soft.”

 On a $500,000 home purchase, three to five percent of closing costs translates to $15,000 to $25,000 – not an immaterial amount of money. When you ultimately sell your home, you may have to pay another three to five percent in closing costs or more.

That’s why your expected time horizon in a home is one of the most important factors to consider when deciding whether it is the right time for you to buy. A longer time horizon gives your home a better opportunity to realize sufficient price appreciation, to offset those large transaction costs.

Republicans Ready for GSE Reform?

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Richard_Shelby,_official_portrait,_112th_Congress

Senator Richard Shelby (R-AL)

Senator Shelby (R-AL), the Chair of the Senate Committee on Banking, Housing and Urban Affairs, sent a letter to the U.S. Government Accountability Office regarding the future of Fannie Mae and Freddie Mac, sometimes known as the “enterprises.” It provides an interesting roadmap of Republican thinking about the appropriate role of the federal government in the mortgage market:

the FHFA [Federal Housing Finance Agency] has taken steps that appear to encourage a more active, rather than a reduced, role in the mortgage market for the enterprises. These steps include issuing proposed rules regarding the enterprises’ duty to serve, creating principle [sic] write-down requirements, lowering down-payment requirements, allowing allocation of revenues to the national housing trust fund despite the enterprise having no capital, and other actions. Moreover, the development of the common securitization platform, a joint venture established by the enterprises at the FHFA’s direction, raises a number of questions about the FHFA’s stated goal to gradually contract the enterprises’ dominant presence in the marketplace.

Initially, the purpose of the FHFA’s efforts, such as the common securitization platform, was to facilitate greater competition in the secondary mortgage market, but now it appears that the FHFA is no longer taking steps to enable the platform to be used by entities other than the enterprises.  Likewise, lowering the down-payment requirement for mortgages guaranteed by the enterprises will make the enterprises more competitive with others in the mortgage market, not less. Overall, these FHFA actions raise questions about the goals of the conservatorship and whether its ultimate purpose has changed.

To better understand the impact of these changes, I ask that the GAO study and report the extent to which the FHFA’s actions described above could influence:

  • The enterprises’ dominance in residential mortgage markets;
  • A potential increase in the cost of entry for future competitors to the enterprises;
  • Current and future financial demands on the Treasury;
  • Possible options for modifying the enterprises’ structures (1)

As I have stated previously, Congress and the Obama Administration have allowed the FHFA to reform Fannie and Freddie on its own, with very little oversight. Indeed, the only example of oversight one could really point to would be the replacement of Acting Director DeMarco with Director Watt, a former Democratic member of Congress. It is notable that Watt has continued many of the policies started by DeMarco, a Republican favorite. That being said, Shelby is right to point out that Watt has begun taking some modest steps that Democrats have favored, such as funding the housing trust fund and implementing a small principal-forgiveness program.

Housing finance reform is the one component of the post-financial crisis reform agenda that Congress and the Executive have utterly failed to address. It is unlikely that it will be addressed in the near future. But perhaps the FHFA’s independent steps to create a federal housing finance infrastructure for the 21st century will galvanize the political branches to finally act and implement their own vision, instead of ceding all of their power to the unelected leaders of an administrative agency.

 

Savings from a 15 Year Mortgage

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MONEY CASE 5

MainStreet quoted me in Choosing a 15-year Mortgage Can Save You Thousands of Dollars. It opens,

Matt DeMargel and his wife, Misti, never considered obtaining a 30-year mortgage, because the amount of interest they would pay would equate to 60% of the cost of their house.

Instead, the public relations executive opted for a 15-year mortgage when he bought a 2,542-square foot home in Kingwood, Texas, a suburb of Houston.

“I hate debt, even the so-called ‘good kind’ of secured debt,” he said. “We are working to pay off our mortgage in five years. Even if we pull that off, we will have paid more than $30,000 in interest over that five year period.”

Dave Ramsey, a personal finance expert who is host of a radio show, said he always advocates choosing a 15-year fixed rate mortgage when buying a home.

“When you have a 15-year mortgage, it costs just a few dollars a month more,” he said. “It’s only 20% to 25% more per month than the traditional 30-year mortgage, but it saves you 15 years of your life in debt.”

The amount of money homeowners can save from paying less interest can easily help fund a large portion of their retirement, but determining whether a 15-year mortgage is right for your household can be more complicated.

Benefits of a Shorter Duration

Depending on your goals and lifestyle, a 15-year fixed rate mortgage is the quickest way to owning your home. If one of your plans is to receive a much lower interest rate, then choosing a shorter interval will meet your objective, said Brook Benton, a vice president at Atlanta-based PrivatePlus Mortgage.

“A 15-year loan is typically the lowest fixed rate you can obtain,” he said. “If you like the security of a fixed rate and the payment fits into your budget, this product is a home run.”

Paying off a mortgage quickly is a priority for some homeowners who detest shelling out more money for interest. If a consumer borrows $200,000 over 30 years at 4.17%, he or she will pay just over $150,000 of interest, said Craig Lemoine, an associate professor of financial planning at The American College of Financial Services in Bryn Mawr, Pa. A homeowner who opted for a 15-year note would pay a slightly lower interest rate of 3.29% and his total interest payment drops to around $53,600. (Even a 15-year note at the same rate of that 30-year loan would generate just under $70,000 in interest.)

“A reduction of lifetime interest paid can be quite attractive,” Lemoine said. “The lure of a shorter note is the vision of a paid-off home in 180 months. The emotional satisfaction is tantalizing.”

While you receive the benefit of a lower interest rate, a 15-year mortgage commits consumers to higher payments. If it fits within your overall budget, then paying more each month should not be a concern.

This route is also advantageous for homeowners who are refinancing their mortgage or contemplating downsizing to a less expensive or smaller home, said David Reiss, a law professor at Brooklyn Law School.

Homeowners who have lived in their house for a few years and want to refinance their mortgage should consider a 15-year note, because they have likely “paid down a significant amount of principal,” Reiss said. A combination of a lower interest rate and the possibility that the homeowner is now earning a higher salary means the monthly payments could be manageable, he said.

Salary Needed for a House in 27 Cities

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HSH.com has posted a study to answer the question — How much salary do you need to earn in order to afford the principal, interest, taxes and insurance payments on a median-priced home in your metro area? The study opens,

HSH.com took the National Association of Realtors’ fourth-quarter data for median-home prices and HSH.com’s fourth-quarter average interest rate for 30-year, fixed-rate mortgages to determine how much of your salary it would take to afford the base cost of owning a home — the principal, interest, taxes and insurance — in 27 metro areas.

We used standard 28 percent “front-end” debt ratios and a 20 percent down payment subtracted from the NAR’s median-home-price data to arrive at our figures. We’ve incorporated available information on property taxes and homeowner’s insurance costs to more accurately reflect the income needed in a given market. Read more about the methodology and inputs on the final slide of this slideshow.

The theme during the fourth quarter was increased affordability.

Home prices declined from the third to the fourth quarter in all of the metro areas on our list but one. But on a year-over-year basis, home prices have continued to trend upward.

“Home prices in metro areas throughout the country continue to show solid price growth, up 25 percent over the past three years on average,” said Lawrence Yun, NAR chief economist.

Along with affordable home prices, mortgage rates fell across the board which caused the required salaries for our metro areas to decline (again, except for one).

“Low interest rates helped preserve affordability last quarter, but it’ll take stronger income gains and more housing supply to help meet the pent-up demand for buying,” said Yun.

On a national scale, with 20 percent down, a buyer would need to earn a salary of $48,603.82 to afford the median-priced home. However, it’s possible to buy a home with less than a 20 percent down payment. Of course, the larger loan amount when financing 90 percent of the property price, plus the need for Private Mortgage Insurance (PMI), raises the income needed considerably. In the national example above, a purchase of a median-priced home with only 10 percent down (and including the cost of PMI) increases the income needed to $56,140.44 – just over $7,500 more.

This sounds like a pretty reasonable methodology, but there are a lot of assumptions built into the ultimate conclusions. They are generally conservative assumptions — buyers will get a 30 year fixed rate mortgage instead of an ARM, buyers will have 28% debt ratios. I would have liked to see some accounting for location affordability, because transportation costs can vary quite a bit among metro areas, but you can’t have everything.

As always, I am particularly interested in NYC, the 24th most expensive of the 27 cities.  NYC requires an income of $87,535.60 to buy a median home for  $390,000. By way of of contrast, the cheapest metro is Pittsburgh, which requires an income of $31,716.32 to buy a median home for $135,000 and the most expensive was San Francisco, which requires an income of $142,448.33 to buy a median home for $742,900.