Why are rates so low, I have a guess

As most consumers know because they have been pounded on by national lenders, rates continue to live in uncharted territory. Back in April there was a swing up in reaction to the fed exiting the Mortgage Backed Securities market. Within a couple of weeks though we returned to the 5% range.

Then, Europe ( spcifically Greece ) began having problems with generating enough tax revenue to pay all its' bills. As with the beginning of the mortgage meltdown anything even remotely associated with Greece was perceived as having the same issues. While that was not entitrely the case the perception that the EuroZone was not a safe place to invest had folks looking elsewhere to put their money.

Enter the US MBS market and a flight to safety, or the perception of it. Ask any borrower in the last 18 to 24 months and to a fault they will all say how difficult it was to get approved. After all the twists and contortions in the mortgage industry underwriting standards have become much more stringent and these instruments were or appeared to be effectively insured by the US Government. Investors simply were looking for a safe haven and the MBS market has provided that.

As much as investors loved the incredible returns on their MBS plays in the 00's now the MBS market is giving them something they want more, safety and security. If I were an institutional investor looking to make up for the mistakes of the last 5 years it might be that going back into MBS's would be the way to go. It might seem odd to go back to the thing that caused the issue in the first place but I would hazard a guess that now that these securites are so antiseptic or sterile they look pretty spiffy.

No rates are not down because the banking system is going to hell or that there is some evil plot by the banks to take over the world. As Karl Denniger is fond of saying, that's moon bats and tinfoil hat talk.

ARMs and I/O Loan Changes

A new wrinkle has been introduced to ARMs and Interest Only loans that will have a huge impact on those wanting to use these instruments. Going forward a borrower will be underwritten on the payment associated with the highest possible payment. This is a major change as for the most part borrowers have been underwritten using the start rate until now.

These changes are significant in that now a borrower must qualify for a a short term conventional ARM ( less than a 5 year fixed period ) on the greater of the fully indexed rate or the current note rate +2%. Today that means a borrower that wants a 3/1 Intermediate Term ARM that has a rate of 3.5% will have to qualify at 5.5%, a rate that is 1/2 % above the current 30 year fixed note. My experience of late has been borrowers wanting to use these loans have an exit strategy that will occur well before the reset. Plus they are financially savvy enough to manage their money and understand all the implications of their choice of product.

I/O loans are being made over as well. Higher minimum FICO scores to qualify ( 720 ) and a whopper of a requirement of having up to 24 months in payment reserves after cash to close is accounted for. I/O loans have already been pretty well beaten up with other restrictions in the recent past that have made them look like an ugly step child anyway so I can't believe that this new requirement will do much in terms of people not qualifying.

All these changes are really designed to ensure that the borrower has a true capacity to repay the loan. But in the case of the I/O changes I have to believe it is the beginning of the end for these products. Just like the first changes to PayOption ARMs and 2nd liens to 100% CLTV  the requirements are becoming so restrictive no borrower will want to monkey with them. As always Freddie Mac will eventually follow Fannie Mae, sooner or later.

No surprise to those of us in lending that these have been instituted. These are a continuation of the mandate that borrowers show a capacity to repay a loan, just like the good ol' days. Plus Fannie and Freddie have to find new ways to keep their income up from new loans to make up for the fact they are losing their asses on all the bad ones they ate up in the 2000's.

Wa Mu and the "Power of Yes"..what the heck?

I have had the opportunity to talk to several people about the changes in lending in the last 3 years and 2004 to 2007 seem like a bizarro fantasy land. Consider for a moment the following actual loans that were done:

Purchasing a duplex as a non owner occupied investment with a 80/20 ( 100% finanacing ) combo. Buyer put $1000 in earnest money and seller covered the buyers' closing costs. All for the seller paid closing costs. It's the buyer's money coming to the table loan or not. May as well spend it where it garners the biggest benefit.

No doc loan, AKA the infamous NINJA loan ( No income No Job, No Assets ) to 95% financing. No mortgage insurance on a primary residence. Borrower provided their name, SS #, address and phone number and allowed a credit report to be pulled. These were really No No's. I still don't think these are such a bad idea for the right borrower, just not everybody.

Cash Out Refinance of a single family investment property to 85% of the appraised value...6 months after purchase. The property "appreciated" 22%.. Things that make you go "hmmmm".

Sounds weird that these could get done. Sounds even stranger that when these loans were available there was always another lender out there that was going to go one better than the competition. Countrywide's reps would say, " send it and we will get it done ", and they did. WaMu and their subprime side Long Beach Mortgage took the cake though. I don't WaMu ever saw a loan they couldn't sell. All of us in Real Estate were drinking from the fire hose. Now we get to share a garden hose.

Rates .. up, up and away!

Off we go! As predicited by many ( me included ) rates have begun their run up after the Fed has now exited the MBS market. In November of 2008 when the program was announced 30 year interest rates dropped 1% in a day. While rates didn't jump back up 1% on Wednesday when the program ended there had been indications that they would move up.

Now after 18 months of rates at or below 5% all of us wroking with residential buyers now get to be grief counselors when a borrower hears that they won't be getting the same rate as their neighbor who purchased or refinanced recently. If a borrower didn't lock their rate last Monday it's too late.

I expect that we will see an upward trend to somewhere in the 5.5% to 5.75% range over the next week or so. Already in the last 10 days the 10 year treasury is up .306% and climbing. Rememebr while the 10 year is not the only marker for 30 year mortgage rates it is one that allows for a "quick and dirty" check of where rates could be going.

Price vs Rate---Focusing on the right aspect

Where will home prices go in the future? In most markets in the US it is unlikely we will see any more radical deterioration in home prices. Data suggests flat or slighlty rising home prices on a natioanal scope with some markets going up and fewer going down.

I would suggest that a more important question to be asked is: Where will rates go? And that's really easy to answer...up. Rate increases will have a bigger effect on a buyer's ability to afford a home ( or not ) than where prices will go. So as we talk to potential buyers about what the future holds I will almost always focus on rates.

Why? For one simple reason. In order to offset an increase of 1% in an interest rate on a 30 year term loan a borrower's loan amount would have to drop by approximately 10% to keep the same approximate principle and interest payment. For almost every borrower,  payment, not the price is the major determinant in what to pay for a home. When I talk to borrowers they don't ask me what they should pay for a home they ask what payment the payment will be. Are they shopping price or rate?

Tax Time Advice--Watch those deductions

Well not exactly tax advice but a caution on how taking deductions can limit your ability to borrow later on.

As most self employed folks know conventional lending can be a challenge. Taking all the deductions you are allowed tends to limit your borrowing ability. Even though someone can be bringing in literally hundereds of thaousands of dollars a year if they follow the rules they can avoid paying taxes on that income. The issue is that these deductions are a "hit" to the borrower's income in an underwriter's eye. The solution is to limit your use of deductions ( yes pay the damn taxes, it's a quality problem to have ) so as to not box yourself out of the ability to borrow down the road.


For those that are W2 employees there is a tax deduction trap that many don't know about, 2106 unreimbursed employee expenses. Any of these deductions are looked at just like an ongoing debt obligation like a car payment, student loan or credit card payment. These can be a killer for a potential borrwer because they don't expect it to be a hit to income. As an example, I had a borrower take 43,000 miles in unreimbursed expenses at .55 a mile. The effect on the tax return was no doubt a positive one, Uncle Sam gave the borrower back every dime that had been taken in withholding. But...the underwriter hit them for $1182 a month for the "ongoing" obligation basically wiping out 1/2 of the income to qualify for a loan. Yes the underwriter gave back .22 a mile in their analysis but it was too great an obstacle to overcome.

The tax time advice?  You should be talking to your mortgage professional about the implications of taking ALL of your allowed deductions BEFORE you file. Once the IRS has your information it is set in stone.

Rates are going up, who cares?

As anticipated the Fed announced this last week that the facility used to purchase mortgage backed securities will be wound down at the end of this month. This along with a couple of other "manipulators" has kept rates in the 5% range since late November 2008.



Advice to potential buyers and refinancers, get em while they are hot or expect rates in the high 5%'s or low 6%'s. Not that I would suggest a potential client buy a home or refinance just because of a particular rate. I am not a mouthpiece for the National Association of Realtors and I don't believe anytime is a good time to buy a home.



The conversation that every potential borrower should have with themselves is the one that cannot be based on any perceived sense of the state of the market. A borrower's metrics should be based on their personal situation:

Can my household budget handle the potential costs of maintaining a home beyond the mortgage payment? After all, not being a renter means you pay for the water heater that goes out on Christmas eve.

Am I buying the home to live in or as an investment? If you are going to live in it then I would challenge the theory that it is an investment that will offer you any rate of return over a short period of time that could be perceived as investment grade.

Does the use of the tax credit make sense to my situation? It may surprise some to learn that a few borrowers look at getting $8000 in exchange for a $200,000 mortgage as a bad idea. Can't say I have very many arguments against that.



Those of us older than 30 know that rates now are historically low. Even at 6% or 6.5% they would still be classified the same. I would expect if rates were to spike in the next few weeks the pool of potential borrowers will dry up. At least until they reset their expectations of where rates are. At which point, they will come back.