Dennis' Mortgage Blog

Question of the week:  Courtesy of Marilyn Kalfus of the Orange County Register; her daily blog Huntington Homes is very informative for all, but especially for those in the Huntington Beach market.    Her question:  Are you seeing more owner carry-backs and how do they affect transactions?

Answer:   We are seeing a rise in owner carry-backs.  They are not on a significant number of our purchase transactions, but they are on the rise.  An owner carry-back is when a seller takes a portion of their equity in the form of a second trust deed, deferring payment of that equity until a later date and collecting interest payments from the buyer. 

“Back in the day…” owner carry-backs were not that uncommon.  If a seller had significant equity, there was a strong rate attached to the note they were carrying and the buyer had a solid financial profile it was not unusual for a seller to carry back a 2^nd trust deed in the transaction.  With the advent of institutional 2nds, primarily Home Equity Lines of Credit (HELOCs) starting in the late 1990;s and exploding in supply in the early 2000’s the owner carry-back became a thing of the past. 

Of course the explosion of institutional 2nds led to more competition among lenders and higher and higher loan to value products, until just about everyone had a HELOC that would go to 100% loan to value.  When the credit markets turned and the housing market followed the losses to lenders with extensive portfolios of high loan to value home equity loans skyrocketed. 

No more institutional 2nds.  Some banks and credit unions offer them to customers, not many for purchases and most do so with much lower loan to values than they did three years ago.  Hence, the renewal of the owner carry-back.

The guidelines for owner carry-backs are pretty simple. 

FHA:  First, they are not allowed on new FHA financing, however a seller with an existing FHA loan may sell to a buyer who assumes the existing FHA mortgage and the seller may carry back a portion of the remaining equity. 

Conventional:  Fannie Mae and Freddie Mac allow seller carry-back financing as part of a purchase transaction.  The maximum combined loan to value can be up to 95% depending on FICO score, but many lenders put on an overlay reducing the maximum to 90%.  The maximum first trust deed, or primary mortgage, from the lender cannot exceed 80% loan to value.  So the typical transaction is 10% down, 10% seller carry-back and an 80% new primary mortgage.

The terms on the note to the seller must have a minimum monthly payment of interest only.  The interest rate must be “consistent with the market”, i.e. no zero interest notes.  The loan term must be for at least five years, if shorter the buyer must demonstrate ability to pay off the loan as part of the approval.  For example if a seller carries back a $50,000 for three years, the buyer must show they will have at least $50,000 in liquid assets after the close of escrow.  The note must be recorded through escrow as part of the transaction.

Benefits:   To the buyer the benefit of an owner carry-back is the opportunity to avoid mortgage insurance without putting 20% down.  Or if the buyer is anticipating a large amount of cash in the near future, perhaps the closing of another property, settlement of an estate, annual bonus, the buyer can pay off the note early and have a smaller remaining primary loan.

To the seller the benefits are supplemental income from the interest payment and/or securing a buyer for their property in a difficult market. 

Risks: The biggest risk to the buyer is the balloon payment that is typical with seller carry-backs.  Will you have the funds or ability to pay off the note when due in 5 years? 

The obvious risk to the seller is the buyer not paying on the note and/or not being able to pay off the note when it comes due. 

Owner carry-backs, while still rare, are becoming more prevalent in the market as they can facilitate some buyers and sellers coming together. 

Thanks for the question Marilyn!

Have a question for me?  Ask me!

The big news this week was the formal announcement by the Federal Reserve Board of Governors that they would cease their Mortgage Backed Security (MBS) purchase program on March 31^st as planned.  By March 31^st the Fed will have purchase $1.25 Trillion in MBS.  The purpose of the program is to keep home mortgage rates low and help the housing markets.  During the implementation of the program the Fed has purchased 80% of the MBS on the market.

What has been the impact?  The Fed announced the program in November 2008.  At the time the base rate I have used consistently for this weekly update was at 5.875%.  The week after the announcement the rate dropped 0.25% to 5.625% and kept dropping until mortgage rates had dropped a full one percent in four weeks.  At that time the Fed had not purchased any MBS but had merely made the announcement.  As the purchase program got under way we saw the conforming fixed rate drop to 5% or below for all but nine of fifty-two weeks.  Pretty strong impact.

What’s next?  This is where some of the current debate begins.  Because the Fed was buying almost all of the MBS on the market, can/will the void be filled by other investors when the Fed leaves the market?  Will the unlimited funding provided by the Treasure for Fannie and Freddie make this a mute discussion as they will not need to put as many MBS on the market to remain capitalized?  What is expected by most observers/pundits/47 year old econ majors is that rates will increase when the Fed stops buying MBS, and also in the days/weeks leading up to the program ending.

Today big news with announcement that the GDP for the 4^th Quarter 2009 grew at 5.7%.  That is very positive economic news.  What is interesting is that the economy grew so much in the 4^th quarter while millions of jobs were being lost.  As many have been saying the recovery from this economic recession will be “jobless” as companies contract, find new efficiencies in technology vs. labor and increase per worker productivity before hiring new employees. 

This week in rates continued to bounce between levels of resistance and support, unable to break through either way.  A mid-morning rally today as funds flow out of stocks and into bonds and MBS has given us a slight gain from last Friday on most of our rate indices. 

Rates for Friday January 22, 2010:

FIXED RATE MORTGAGES AT COST OF 1 POINT*

30 year conventional 4.75%                              Down 0.125%

30 year conforming-jumbo 5.000%                   Down 0.125%

30 year FHA    4.75%                                      No Change

30 year FHA jumbo 5.000%                            Down 0.125%

Please note that these are base rates and adjustments may be added for condominiums, refinances, credit scores, loan to value, and period rate is locked (i.e 45 days instead of 30 days).

Please note that rates quoted are based on average of several lenders for a purchase transaction with 20% down payment and a minimum FICO score of 740; APR is not quoted as it is dependent upon specific loan amounts, lenders and services selected.  Numbers provided are for comparative purposes only.

We wrap up the first month of the new decade this weekend.  What do you think of the decade so far?

Have a great weekend, let me know how I can be of service to you,

Dennis