Tag Archives: mortgage payment

Another Housing Bubble?

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Trulia quoted me in Warning Signs: Another Housing Bubble Is Coming. It opens,

Signs show another bubble coming. Some experts have a different opinion.

When the housing market crashed in 2008, it caused what came to be known as ”The Great Recession.” When the bubble burst, it ”sent a shock through the entire financial system, increasing the perceived credit risk throughout the economy,” according to a report published in The Journal of Business Inquiry.

The crash caused homes to lose up to half their value. People became underwater, owing more than their home was worth. And who wants to pay on a mortgage that’s larger than what the home could sell for? Although some people did just that, many more opted to short sell their homes or to simply walk away and have the bank foreclose.

Present Day

Fast-forward to 2016, and we are seeing hot, even ” overheated,” housing markets; bidding wars; rising home prices; and house flippers – all the signs of a housing bubble that’s about to burst. Are we repeating the mistakes we made before? Yes and no. Let’s explore four reasons the housing bubble burst and whether we’re experiencing the same conditions today.

1. Easy Credit

Before the 2008 crash, credit was easy to get. Pretty much, if you were breathing, you could get a mortgage loan. This led to people getting mortgages who ultimately couldn’t afford to pay them back. They lost their homes, and this contributed in large part to the housing crisis. Today the situation is different. ”Credit is still much tighter than it was before the financial crisis,” says David Reiss, professor of law at Brooklyn Law School. ”This is particularly true for those with less-than-perfect credit scores.” He explains: ”There are almost no no-down-payment loans as there were in the early 2000s. Those defaulted at incredibly high rates.”

But what about Federal Housing Administration (FHA) loans? They feature ”low down payments, low closing costs, and easy credit qualifying.” Those are the very features that should sound some warning bells. But before you get too alarmed, keep in mind that the FHA has been making loans to people who do not qualify for a conventional mortgage since 1934. ”While there are low-down-payment loans available from Fannie, Freddie, and the FHA, their underwriting standards appear to be higher than those for low-down-payment products from the early 2000s,” says Reiss.

2. Low Interest Rates

Mortgage rates have been low for so long that you might not realize that was not always the case. In 1982, for example, mortgage rates were 18 percent. From 2002 to 2005, the rates stayed at about 6 percent, which enticed people to take out mortgage loans. And in 2016, we’re seeing historic lows of under 3.5 percent. If rates go up, we might see housing demand and housing prices fall.

3. ARMS

Before the housing crash when home prices were rising fast, many people were priced out of the market with a fixed-rate mortgage because they couldn’t afford the monthly mortgage payments. But they could afford lower payments that were possible with an adjustable-rate mortgage – until that rate adjusted up. In 2005, 38.5 percent of the mortgage market was ARMs. But in 2015, that amount has dropped considerably to 5.3 percent.

4. A Buying Frenzy

There’s an old story that before the stock market crash of 1929, Joseph Kennedy, Sr., sold his shares. Why? Because he received a stock tip from a shoeshine boy. Kennedy figured, the story goes, that if the stock market was popular enough for a shoeshine boy to be interested, the speculative bubble had become too big.

Before the housing crash, this country saw a home buying frenzy similar to what happened before the stock market crash. Everyone from lenders to rating agencies to investors (foreign and American) to investment bankers to home buyers was eager to get into the mortgage game because house values kept rising. Today, we are seeing a similar buying frenzy in some markets, such as San Francisco, New York, and Miami . Some experts think that the price increases of homes in those areas are not sustainable. They say that because heavy foreign investment in those areas is part of what’s driving up prices, if those investments slow or stop, we could see a bubble burst.

So what do some experts think?

David Ranish, owner/broker for The Coastline Real Estate Group in Laguna Beach, CA, says: ”There are concerns about another housing bubble, but I do not see it. The market could stabilize, but a complete collapse is highly unlikely.”

Bruce Ailion, an Atlanta, GA, real estate expert, says,” ”Five to six years ago, I was a buyer of homes. Today I am a seller.”

David Reiss says, ”It is probably a fool’s game to predict the future of the housing market or whether we are in a bubble that is soon to burst.”

Owning v. Renting Smackdown

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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.

What Are Mortgage Borrowers Thinking?

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The Consumer Financial Protection Bureau (CFPB) and the Federal Housing Finance Agency (FHFA) have released A Profile of 2013 Mortgage Borrowers: Statistics from the National Survey of Mortgage Originations. While sounding dull and perhaps a bit dated, this document is actually an extraordinary overview of the much discussed but rarely seen mortgage borrower. And while the information is from 2013, it provides a good baseline for the post-financial crisis and post-Dodd Frank world we live in.

Historically, it has been difficult for government and academic researchers to get comprehensive data about mortgage borrowers. The impetus for this report was the Housing and Economic Recover Act of 2008 which requires the FHFA to conduct a monthly mortgage market survey. In the long term, this survey will help policymakers respond to the rapid changes that are so common in our dynamic mortgage market.

The National Survey of Mortgage Originations (NMSO) focuses on

mortgage shopping behavior, mortgage closing experiences, and other information that cannot be obtained from any other source, such as expectations regarding house price appreciation, critical household financial events, and life events such as unemployment, large medical expenses, or divorce. In general, borrowers are not asked to provide information about mortgage terms in the questionnaire since these fields are available [from other sources]. (1)

Here are some of the findings that I found interesting, albeit not always surprising:

  • Mortgage shopping behavior differed significantly by borrower characteristics and by whether the consumer was also shopping for a home at the same time as the mortgage. (14)
  • First-time home buyers differed significantly from repeat home buyers in their mortgage search behavior and repeat borrowers differed significantly in their mortgage search behavior depending on whether they were refinancing or purchasing a home. (14)
  • Slightly more than 40 percent of all respondents reported having a difficult time explaining the difference between a prime and a subprime loan. (16)
  • Overall about one- quarter of borrowers reported that they could not explain amortization or the difference between the interest rate and APR on a loan.(18)
  • Roughly one in five borrowers had to delay their closing date. (26)
  • In general, respondents believe that mortgage lenders treat borrowers well. (35)
  • Fifteen percent of respondents expected to have difficulties in making their mortgage payments in the next couple of years. (44)

There are a lot more interesting nuggets about the subjective views of borrowers in the report. I hope that later reports offer more analysis that ties this information into other objective sources of data about borrowers and their mortgages. How well do they know themselves and how good are they at predicting their ability to maintain their mortgages over the long-term?

Tax Refunds Into Mortgage Payments

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TheStreet.com quoted me in Investing Your Tax Refund Instead of Spending It Boosts Retirement Savings. It opens,

Ramping up your emergency cash fund or IRA with your tax refund is a better option than spending it on a new smartphone or vacation.

Three out of four taxpayers received a refund of $3,000 in 2015. Although many consumers look forward to this windfall each year, it is not a “cause for celebration,” said Joe Jennings, a wealth director for PNC, a Pittsburgh-based financial institution.

“If you are receiving a large refund check, it actually means that you have loaned money to the government throughout the year and the next year the government is paying you back without interest,” he said.

Adjusting your withholdings is a good strategy if your refund exceeds $1,000. Changing the number of exemptions on your W-4 means you will net more income from each paycheck.

Bankrate.com, a North Palm Beach, Fla.-based financial content company, found that 31% of Americans who receive a tax refund this year plan to save or invest it. The survey revealed that 28% will use the funds to pay down debt, 27% will spend it on necessities like food/utility bills and 6% will splurge with a shopping spree or vacation.

Some consumers view the refund as a method of forcing them to save money each year or a way to pay down existing debt such as credit card balances with high interest.

Pay Off Existing Debt

Use your refund check to pay off as much as your credit card or student loan debt as possible since the amount of interest you are paying each month adds up quickly, said Jonathan Bochese, director of resolution services for Tax Defense Network, LLC, a Jacksonville, Fla.-based tax resolution company.

“The best use for any tax refund is to use it to pay off high interest revolving debts,” he said.

With the current low interest rate environment in money market funds and CDs, paying down debt is a no-brainer.

“If you can only make 3% on your investment and your debt is at a higher rate, pay off the debt,” said Carl Sera, a portfolio manager with Covestor, the online investing marketplace and managing principal of Sera Capital Management, a registered investment advisor in Annapolis, Md. “Don’t make it a habit to receive a tax refund, because it is money you have lent the taxing authority at a zero interest rate.”

Homeowners who do not have any other debt should pay down their mortgage by making an extra payment or two instead of stashing the refund in a savings account that is only receiving minimal interest, said David Reiss, a law professor at Brooklyn Law School.

“By doing so, you are making the equivalent of a pre-tax return of the interest rate on your mortgage,” he said. “If your mortgage has a 5% interest rate and your savings account has a 0.1% interest rate that is like getting a 4.9% higher rate of interest without taking any risk at all.”

Risky Rent-to-Own

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The Pittsburgh Tribune-Review quoted me in Rent-to-Own Option for Home Shoppers Rife with Pitfalls, Experts Caution. It opens,

Finding the right rental house was more difficult than Phyllis Lombardi anticipated.

“It’s hard to find a big enough house that allows pets, for the number of people we have in South Fayette,” said Lombardi, 45. She and her husband have four children living at home.

The Lombardis are moving because the owners of the house they are renting want to sell. But the couple isn’t ready to buy. The husband’s income was cut by more than half when they relocated to the Pittsburgh area several years ago, and they are repairing their finances after a short sale on a home.

Finding no rentals in South Fayette that meet her criteria and price, Lombardi is going with an option suggested by her real estate broker: Pick a house for sale on the market and do a rent-to-own contract with an investor who would buy it.

Rent-to-own agreements require prospective buyers to pay rent with an option to purchase the house at a later date, usually within two to five years. It can broaden the options for people with checkered credit histories who think they might soon be in a position to buy.

But it is an industry with a lot of shady operators and which can prove costly to prospective buyers who are not careful, said David Reiss, a professor of law at Brooklyn Law School.

“In some cases, these programs are based on the idea of hope springs eternal,” Reiss said. “But a large percentage of them are likely to fail.”

The terms of these contracts vary, but renters often pay a premium above market price, with a portion of that going toward the eventual cost to buy the home.

Many times, renters reach the end of the agreement and are still unable to buy, forfeiting everything they have paid — rent, fees and any premium toward the purchase price — to the owner and walk away with nothing, said Max Beier, a real estate attorney Downtown.

“Traditionally, what you’re going to have in these agreements is a default provision that’s pretty harsh,” he said. “Commonly, you’re going to lose 100 percent of the equity you’ve paid.”

And many don’t come with the same renter protections. For example, maintenance and upkeep costs are often the tenant’s responsibility — just as if they owned the home.

Also, the penalty for late rent payments tends to be more severe than the standard 5 percent for a late mortgage payment, and even cause someone to be kicked out of the home, Reiss said.

“The rights you have as a tenant in a rent-to-own situation are not as clear and not as good as if you were a homeowner,” Reiss said.

Rates up in ARMs

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Marriner S. Eccles Federal Reserve Board Building

TheStreet.com quoted me in Fed Hike Means Adjustable Rate Mortgages Will Rise and Increase Monthly Payments. It opens,

The first interest rate hike by the Federal Reserve in nearly a decade means consumers can no longer take advantage of a zero interest rate environment. Particularly challenged will be homeowners who have adjustable rates and stand to face higher mortgage payments.

Record low mortgage rates are set to be thing of the past as the Fed raised rates by 0.25%, which appears to be a nominal amount initially. Of course, consumers need to consider the cumulative effect of the central bank’s decision to increase rates periodically over a span of two to three years. The consecutive rate hikes will affect homeowners with adjustable rate mortgages when they reset, which typically happens once a year.

“The initial interest rate move is very modest and consumers will see a corresponding increase in their credit card and home equity line of credit rates within one to two statement cycles,” said Greg McBride, chief financial analyst for Bankrate, the North Palm Beach, Fla. based financial content company. “The significance is in the potential impact of whatever interest rate hikes are put into effect over the next 18 to 24 months.”

The Fed will continue to raise rates several times next year since yesterday’s move is not a “one and done” move, said Robert Johnson, president of The American College of Financial Services in Bryn Mawr, Pa. The Fed will likely follow with a series of three to four rate increases in 2016 if the economy continues to improve. The central bank could raise interest rates to a total of 1.0%, which will cause mortgage rates, auto loans and credit card rates to rise in tandem.

Adjustable rate mortgages, or ARMs, are popular among many younger homeowners, because they typically have lower interest rates than the more common 30-year fixed rate mortgage. Many ARMs are called a 5/1 or 7/1, which means that they are fixed at the introductory interest rate for five or seven years and then readjust every year after that, said David Reiss, a law professor at Brooklyn Law School in N.Y. The new rate is based on an index, such as the prime rate or the London Interbank Offered Rate (LIBOR), as well as a margin on top of that index. LIBOR is used by banks when they are lending money to each other.The prime rate is the interest rate set by individual banks and is usually pegged to the current rate of the federal funds rate, which the Fed increased to 0.25%.

The prime rate is typically used more for home equity lines of credit, said Reiss. LIBOR is typically used more for mortgages like ARMs. The LIBOR “seems to have had already incorporated the Fed’s rate increase as it has gone up 0.20% since early November,” Reiss said.

“The prime rate is influenced by the Fed’s actions,” Reiss said. “We already see that with Wednesday’s announcement that banks are increasing prime to match the Fed’s increase.”

The main disadvantage of an ARM is that the rate is only fixed for a period of five or seven years unlike a 30-year fixed rate mortgage, which means that monthly payments could rise quickly and affect homeowners on a tight budget.

Over the course of the next couple of years, the cumulative effect of a series of interest rate hikes could take an adjustable mortgage rate from 3% to 5%, a home equity line of credit rate from 4% to 6% and a credit card rate from 15% to 17%, said McBride.

“This is where the effect on household budgets becomes more pronounced,” he said.

Homeowners should start researching mortgage rates and refinance out of ARMs and lock into a fixed rate, said McBride. The 0.25% rate increase equals to a payment of $0.25 for every $100 of debt.

Since many factors impact the interest rates of mortgages, consumers need to examine the actual benchmark used by their lender since some existing interest rates already priced in some of the anticipated rise in the federal funds rate, said Reiss. While ARMs expose the borrower to rising interest rates, they typically come with some protection. Interest rates often cannot rise more than a certain amount from year to year, and there is also typically a cap in the increase of interest rates over the life of the loan.

An ARM might have a two point cap for one year increases if the introductory rate of 4% increased to 6% in the sixth year of a 5/1 ARM, he said. That ARM might have a six point cap over the life of the loan, which means a 4% introductory rate can go to no higher than 10% over the life of the loan.

 Based upon the current Fed increase of 0.25%, a homeowner with a $200,000 mortgage would pay an additional $40 a month or $500 a year when the rate resets.

“While this is not chump change, it is also not immensely burdensome to many homeowners,” Reiss said. “The bottom line is that it is worth figuring out just how your ARM works so you can understand what your worst case scenario is and then plan for it.”

Expanding the Credit Box

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Tracy Rosen

DBRS has posted U.S. Residential Mortgage Servicing Mid-Year Review and 2015 Outlook. There is a lot of interest in it, including a table that demonstrates how “the underwriting box for prime mortgages slowly keeps getting wider.” (7) The report notes that

While most lenders continue to originate only QM [Qualified Mortgage] loans some have expanded their criteria to include Non-QM loans. The firms that are originating Non-QM loans typically ensure that they are designated as Ability-to-Repay (ATR) compliant and adhere to the standards set forth in the Consumer Financial Protection Bureau’s (CFPB) Reg Z, Section 1026.43(c). Additionally, most Non-QM lenders are targeting borrowers with high FICO scores (typically 700 and above), low loan to values (generally below 80%) and a substantial amount of liquid reserves (usually two to three years). Furthermore, most require that the borrower have no late mortgage payments in the last 24 months and no prior bankruptcy, foreclosure, deed-in-lieu or short sale. DBRS believes that for the remainder of 2015 the industry will continue to see only a few Non-QM loan originators with very conservative programs.

CFPB ATR And QM Rules

The ATR and QM rules (collectively, the Rules) issued by the CFPB require lenders to demonstrate they have made a reasonable and good faith determination, based on verified and documented information, that a borrower has a reasonable ability to repay his or her loan according to its terms. The Rules also give loans that follow the criteria a safe harbor from legal action. (8)

DBRS believes

that the issuance of the ATR and QM rules removed much of the ambiguity that caused many originators to sit on the sidelines for the last few years by setting underwriting standards that ensure lenders only make loans to borrowers who have the ability to repay them. In 2015, most of the loans that were originated were QM Safe Harbor. DBRS recognizes that the ATR and QM rules are still relatively new, having only been in effect for a little over a year, and believes that over time, QM Rebuttable Presumption and Non-QM loan originations will likely increase as court precedents are set and greater certainty around liabilities and damages is established. In the meantime, DBRS expects that most lenders who are still recovering from the massive fines they had to pay for making subprime loans will not be originating anything but QM loans in 2015 unless it is in an effort to accommodate a customer with significant liquid assets. As a result, DBRS expects the availability of credit to continue to be constrained in 2015 for borrowers with blemished credit and a limited amount of cash reserves. (8)

The DBRS analysis is reasonable, but I am not so sure that lenders are withholding credit because they “are still recovering from the massive fines they had to pay for making subprime loans . . ..” There may be a sense of caution that arises from new CFPB enforcement. But if there is money to be made, past missteps are unlikely to keep lenders from trying to make it.