Question: What is a “float-down?”
Answer: Last week we covered mortgage vocabulary, here is one we missed that comes up with loan transactions, “float-downs.”
Most lenders have a policy that if interest rates drop after you have locked in your mortgage rate and cost that you may under certain conditions be able to relock your mortgage at a lower rate and/or cost, this is known as a “float-down” of your rate.
When you lock in your rate the lender will honor the rate and terms as long as you receive loan approval and are able to fund the mortgage on or before the lock expiration date, regardless of how high the mortgage rates may have climbed in the open market. For instance in May 2013 when rates climbed a half of a percent or more, those borrowers who were locked in prior to the rates spiking funded their loans at the rate and terms where they had locked in.
When you lock in that interest rate the lender pre-sells your mortgage in the market, making a delivery commitment to investors—be it through Fannie Mae, Freddie Mac or a jumbo mortgage investor. If those commitments are broken the lender is penalized and usually there is a trickle-down effect to the originating entity that broke the lock. So if the commitment is made and then rates drop lenders recognize they need to have a mechanism in place to present a lower rate to the locked in client or risk having borrowers go to other lenders for lower rates and therefore burning their commitments.
As a result most lenders have a float-down policy that does not transfer the entire drop in interest rates to their clients in a down rate environment but usually splits the difference between the current market and the lock in rate and terms.
As mentioned above every lender has different terms and conditions for floating down and interest rate, and some mortgage types may not even be eligible. Typically the conditions for a float down are:
These conditions may vary, some jumbo loans for instance require a greater spread than the 0.25% that is required for most conventional mortgages, some lenders will only float down on the date that loan docs are drawn.
As a matter of the process on every mortgage before ordering loan documents I check the lock in rate for the mortgage and compare it to the current market to see if eligible for a float down. There have been times when the float down opportunity is close enough that we may delay loan docs for a day or two to see if market momentum will carry us to a lower rate, or perhaps adjusting the price or credit on a loan just a little bit can provide a decrease in rate that makes sense for the cost.
Regardless of a rate float down policy or practice in most instances it is wise to lock in your interest rate and terms as soon as possible in your transaction to hedge against interest rate increases. As the many people who were floating into the first week of May 2013 can attest, rates can go up like a rocket and usually come down like a parachute.
Hedge against your rate increasing while in escrow, and with some down side opportunity if rates do drop significantly while you are in escrow it is the financially wise and responsible move to make almost always.
Next week we will cover rate extensions.
Have a question? Ask me!
Remember, with Dennis it’s not just a mortgage, it’s your complete financial picture.
Last week we had data on new housing starts in July, this week we find out how those homes are selling. And the data shows not as much as expected. Following upward revisions to new home sales the prior two months July’s total came in below expectations and below June’s sales. Interestingly the South is dragging the sector up with more new home sales than all other sectors combined. Year over year total sales are up 12.3% and the median price has edged up just under 3%. The news is positive for the economy given the number of units sold and any positive news is typically negative for lower mortgage rates.
Another key indicator for the economy is durable goods orders, described as “factory hard goods,” or things that last a while. The total number saw a huge increase from June, up 22.6% let by new aircraft orders (of which Boeing had an increase of 318% from June—yes more than triple the orders, some salesman is getting a nice bonus for the month) and by motor vehicle orders which climbed over 10% after dropping more than 1% in June. What does this mean? Durable goods orders lead to durable goods sales lead to increased employment in manufacturing leads to increased consumer income leads to increased consumer spending leads to higher economic growth leads to higher inflation should lead to higher mortgage rates.
Estimate number two for the economy was released on Thursday and the revised Gross Domestic Product for the second quarter was higher by 0.2% than the initial estimate. It is now estimated the economy had an annualized growth of 4.2% in the second quarter following the 2.1% decline in the first quarter. This is a pretty strong number and is a basis for the Fed to complete its unwinding of purchasing Treasury debt and mortgages and give the rate hawks more evidence that the Fed needs to increase rates sooner rather than later.
Final economic data for the month ended the positive news from the early part of the week and most of the month. Personal income in July saw lower growth than the prior two months increasing only 0.2%. More important to markets and forecasting was a surprising drop in consumer spending in July from June and May. Not just a slow down in spending but a drop as consumer spending decreased 0.1% for the month putting concern into the market as to second half growth for 2014. Consumer spending is 65-70% of total economic activity and a decline in spending impacts the total economy. This data is positive for lower rates and supports the arguments of those who feel rates should remain at extremely low levels for a prolonged period of time.
Rates for Friday August 29, 2014: By all economic fundamentals the news this week should have pushed rates higher from last Friday. We are not alone in this world however, and events abroad have investors worried heading into a long weekend causing a flight to safety as they purchase mortgages and other U.S. bonds. Russia’s invasion of the Ukraine with tank columns, Europe’s sharp decline in retail prices and continued escalation of the situation with ISIS in Syria and Iraq has led to a large move into mortgages late on a holiday Friday. As a result rates dip a bit from last Friday to where we were the prior week. The last few weeks have seen a little bounce back and forth on the conforming rate between 3.85% and 3.99% at the same cost.
FIXED RATE MORTGAGES AT COST OF 1.25 POINTS
30 year conforming 3.875% Down 0.115%
30 year high-balance conforming 4.00% Down 0.125%
30 year FHA 3.375% Flat***
30 year FHA high-balance 3.75% Flat***
Please note that these are base rates and adjustments may be added for condominiums, refinances, credit scores, loan to value, no impound account and period rate is locked. Rates are based on 20% down (3.5% for FHA) with 740 FICO score for purchase mortgages. ***FHA rates have credits available for closing costs at these rates and higher.
No more white shoes or slacks to those cocktail parties, end of the summer pool closing parties in those areas of the country where pools will need to be emptied for winter and the unofficial end of summer are wrapped up with our Labor Day weekend. Officially signifying the end of summer and the start of the academic year is the start of the college football season, and of course those whose kids like mine are starting their new grades this coming week.
That long arc of forever summer has finally touched down for the kids, one is not so happy and the other is excited to get going—into high school. Leslie and I are now officially parents to a Long Beach Polytechnic student and member of the marching band. Our autumn Friday nights for the next several years will be spent cheering on the Jackrabbits and of course admiring the band. At least I’m going to see some of the best high school football and athletes during this period.
I better go buy some green and gold gear.
Have a great week,
Question: What does _______ mean?
Answer: Last weekend
Leslie went to a writer’s conference and in telling me about one of the
presenters she said the speaker spoke about a writer’s device of using a minor
character to illicit information from central characters---essentially letting
the central character define something without looking obvious. Think of a
reporter interviewing a police officer to get information on a crime scene and
explain certain cop lingo and phrases.
Leslie’s comments regarding this device caused a light
bulb to go off in my head, “aha! I get a question every week about what does
this word or phrase mean, what is this abbreviation…” This week’s question of
the week section, courtesy of my lovely wife, is a glossary of sorts for common
terms and words in our industry.
LTV or Loan To Value is perhaps the most important factor
in a mortgage application package. Every loan is defined first by its loan to
value, or LTV, and then other guidelines and policies for the program are
applied. The percentage of your property’s value that is covered by the
mortgage is your loan to value. If your LTV is 80% then your loan balance is
80% of the value of the property, and you have 20% equity. On a $400,000 home a
90% LTV would be $360,000.
Equity is the portion of your home that is free of any
liens, or the portion of your value that you don’t owe to the lender. As seen
above your equity is the difference between your home’s value and what you owe.
If you had no closing costs and sold your home for $425,000 and your
outstanding mortgage balance is $350,000 then you would receive $75,000 in
Net Equity is what you would receive after you sold your home
and paid your closing costs, realtor commissions, transfer tax, escrow and
title fees, termite inspection and repairs, etc. As a rule of thumb when you
are selling your home if your listing contract has a 6% commission for the
realtors then your costs of sale should be around 8%, if the commission is 5%
then your costs will be around 7%. So your net equity is going to be your sales
price less the 6% less your loan balance. If you owe $400,000 on your home and
sell it for $500,000 with a 6% commission then your net equity will be:
$500,000 less $40,000 (8% for closing costs) is $460,000 less your $400,000
loan balance results in net equity to you of $40,000.
PMI or Private Mortgage Insurance is required on
conventional mortgages with a LTV of 81% or higher. PMI is insurance that you
pay for that protects the lender, and allows you to purchase your new home with
less than 20% down payment. The purpose of PMI is to compensate the lender if
you go into default and the lender foreclosures. The lower your down payment
the higher your PMI premium.
Mortgage, also known as a conforming mortgage, is used to define
mortgages underwritten with the guidelines of Fannie Mae or Freddie Mac and
eventually purchased by one of the mortgage conduits. Conforming mortgages are
the most common mortgage in the United States and have loan limits based on geographic
location of the property. After the housing and mortgage markets melted-down
Congress, which charters Fannie and Freddie, created a dual market for
conventional mortgages with split loan limits. In most of coastal Southern
California the loan limits are $417,000 for conforming single family residence
mortgages and $625,500 for “high-balance” mortgages. Lenders sell their
conventional mortgages to Fannie Mae and Freddie Mac who then sell them as
bonds in what is known as the secondary market.
FHA is the Federal Housing Authority, a government agency
under the Department of Housing and Urban Development. FHA insures mortgages,
FHA does not fund mortgages. Mortgages funded by lenders using FHA guidelines
are eligible for mortgage insurance coverage from FHA and these mortgages can
then be sold to Ginnie Mae (similar to Fannie or Freddie but only sells
government insured mortgages in the secondary market). FHA has loan limits
similar to Fannie and Freddie, though the maximum loan is $729,000. FHA mortgages
have lower down payment requirements, 3.5% is the minimum, and have much higher
mortgage insurance premiums than PMI. Generally FHA mortgages have easier
qualifying standards than conventional mortgages, part of the reason the
mortgage insurance costs to the borrower are higher.
Ratio, or DTI, is used to qualify borrowers and calculates
percentage of your gross income that goes to paying your debt, or credit
payments, including your new housing payment. The higher your DTI the larger percentage
of your income is being used to make your debt payments. As part of the
creation of the Consumer Financial Protection Bureau were certain requirements
that would have to be enacted for the mortgage industry to follow when funding
mortgages. One of the newer requirements is a DTI limit of 43% for loans that
are not conforming or FHA. This means that if your monthly gross income is
$6000 then you can qualify for a new mortgage if your new housing payment,
including taxes and insurance, plus your other debts, car and student loans,
credit cards, cannot exceed $2580 per month. Higher DTIs can sometimes be
mitigated with what are known as compensating factors, such as high
post-closing cash reserves or low LTV.
PITI, pronounced Pee-Eye-Tee-Eye not Pity, is the term
used to define your total monthly housing payment covering your Principal,
Interesting, Taxes and Insurance.
MBS or Mortgage Backed Securities are mortgages that have
been pooled by Fannie Mae, Freddie Mac or other conduit and sold as bonds in
the secondary market. The price MBS get on the open market determines the
interest rates you pay on your mortgage. As MBS prices go higher interest rates
go lower and vice-versa. So you can get a Fannie Mae mortgage on your home and
buy Fannie Mae Mortgage Backed Securities for your retirement account and pay
Like any industry the mortgage industry has its own
language and lexicon and at times can be confusing. When discussing mortgage
options if there are terms or words you are not sure what they mean stop the
conversation and ask what they mean. You are engaging in a process to contract
for a very high amount of debt, it is important that you understand fully what
your options are and the results of those options. This includes understanding
the vocabulary and terminology being used to lay out those options.
Treat your mortgage process like kindergarten, don’t
be afraid to ask any questions.
Remember, with Dennis it’s not just a mortgage,
it’s your complete financial picture.
economic data this week starting with the release of the Consumer Price
Index for July. Tracking the Producer Price Index data for July CPI showed
little growth for the month, with consumer prices up only 0.1% for the month
and up 2.0% since last July. The increase in prices is below what the Fed
considers ideal and could point to a slowing in economic growth. Slow growth in
CPI favors lower mortgage rates as it indicates a slow economy and reduced
pressure on the Federal Reserve to raise rates.
housing starts in July were a surprise jumping significantly from June up
over 15% from the prior month after June saw housing starts decline 4% from
May. The news had many pundits say housing markets are coming back from a slow
spring, however one month a market does not make and for new housing starts so
far we have one month. In general strength in growth of new housing starts
would be impetus for higher rates as it signals a strengthening economy.
the new home data on Tuesday, Thursday data for existing home sales for
July was released and the slow climb in sales continues. July homes sales
exceeded expectations and grew from the prior month for the fourth month in a
row. Total sales for July were down 4.3% from July 2013 but the median price is
up 4.9% from last July. The news should be negative for lower interest rates as
stronger housing sales reflects a stronger economy.
released this week were the minutes from the Federal Reserve Open Market
Committee meeting three weeks ago. Nothing new to report, Fed policy makers are
still eyeing a fairly soft labor market and speculation is that sometime in the
next six to eight months they will begin to slowly raise the discount
rate—which will ripple through to other interest rates such as mortgages, autos
and credit cards. The news was met with a yawn by investors who heard nothing
new and have already priced into their strategies rate increases from the Fed.
Friday August 22, 2014: In what is becoming a pattern, a very strong
increase in Mortgage Backed Security (MBS) prices last Friday was followed by a
drop on Monday on opening. The fall continued on Tuesday as investors took
profits from the higher prices in the market and moved into equities over the
week. Showing the strength of the trading range we have been in for a few
months MBS prices after falling off the top of the range then bounced off the
bottom late in the week and pushed back into what has been the comfort zone for
mortgage investors. The result is after last week’s dip in rates the market has
rebounded back to where there have been the prior six weeks.
30 year conforming 3.99% Up 0.115%
30 year high-balance conforming 4.125% Up
30 year FHA high-balance 3.75% Flat***Please note that these are base rates and adjustments
may be added for condominiums, refinances, credit scores, loan to value, no impound
account and period rate is locked. Rates are based on 20% down (3.5% for FHA)
with 740 FICO score for purchase mortgages. ***FHA rates have credits available
for closing costs at these rates and higher.
As you read this I am in Minnesota for a quick weekend
trip for a memorial service. In the early 1950’s my dad left Tulsa one summer
to attend camp in Minnesota. An only child he bonded with his counselor, Jim
Bredemus and a lifelong friendship began. Later in the decade my dad married
Nancy Kennedy and his pal Jim married his own Nancy and they started their own
camp on the shores of Steamboat Lake in Minnesota. While the Smith’s were in
Oklahoma having and raising babies, the Bredemuses spent their summers in
Minnesota running a camp and the rest of the year in Kansas. Over many years
our families would meet in Kansas, Oklahoma, Arkansas for camping trips and in
the summers in Minnesota. Jim and Nancy’s camp grew and they grew from a girls
camp on Steamboat Lake to adding a boys camp adjacent to the Boundary Waters Canoe
Area at the end of the Gunflint Trail near the Canadian border. The older
Bredemus kids became the counselors for my sister, brother and I and a second
generation of Bredemus and Smith counselors and campers spent summers together.
The past seven years my nephew Jack has spent summers at
Camp Gunflint, his counselor and director of the camp Dan Bredemus, son of Jim
and Nancy’s oldest son Terry, and for the past five years my girls, Blaire and
Jenna, have spent summers at Camp Birchwood where Terry is director, Nancy runs
the store and Terry’s daughter Molly has been a counselor for my girls. The
third generation of Smith and Bredemus campers and counselors.
This spring Nancy passed away. Tomorrow at Camp
Birchwood Jenna, my brother Michael and I will be at Nancy’s memorial service.
As these happens due to divine intervention, happenstance or just coincidence
depending on your belief, tomorrow is also my mother’s birthday. My mom passed
away in 1980, my dad this past March, Jim Bredemus several years ago and now
Nancy Bredemus is gone as well. The first generation has left us physically but
the legacy they have left behind that is lasting through two more generations
of love and friendship bind our families together. I am grateful for the camps
that Jim and Nancy built and the friendship of Jim Bredemus and Dana Smith that
started over sixty years ago in the woods in Minnesota that we will celebrate with
their children and grandchildren tomorrow.
We’ll be back on Monday.
Question: How much should my down payment be?
Answer: With most
questions I get from clients and real estate professionals their question
triggers several questions from me in order to work our way to the answer that
is best suited to the client. Such is the case with our question of the week,
how much should your down payment be when you are purchasing your new home.
In the last two weeks we covered piggy-back transactions and compared piggy-back transactions with transactions using mortgage insurance for buyers who are purchasing with less than 20% down
Many buyers are limited as to how much down payment
they need for a transaction due to the limit on how much money they have. Other
buyers have more flexibility with down payment from the minimum required for
the mortgage program for which they are applying to putting 20%, 30% or more
into the purchase.
If you are fortunate enough to be in the latter
category the instinct for many people is to put as much down as possible to get
the lowest mortgage possible. An aversion to debt, to monthly payments, to
paying interest is not uncommon—especially following the mortgage and housing
market collapses several years ago.
However, is converting a significant amount, perhaps all or almost all,
your liquid assets into illiquid equity in property the best financial move for
you in the long term? Would you be better served with a lower down payment,
higher mortgage balance and higher monthly payment? Perhaps, but let’s answer
some questions first.
First we need to begin with the understanding that getting
cash out of a bank account, or many different types of investment accounts, is
a lot easier and cheaper than converting your equity into cash at a later date.
To access equity from you home you either need to obtain a second mortgage or
HELOC that has transaction fees and a either a higher fixed rate or an
adjustable rate, fund a cash out refinance of your primary mortgage which has
transaction fees and possibly a higher rate than what your rate would be in
today’s market or sell your home.
With this in mind here are some of the questions to be
answered to determine your down payment:
Do you have a definite need for a large sum of cash in
the near or medium future? Child(ren) attending college? Planned major
remodeling project on your new home after moving in? Opportunity to buy into
ownership or partnership at your business?
With your new housing payment and expenses what will
be your ability to put aside money for savings, investments, retirement? Will
this ability be severely impacted by a higher mortgage payment and retaining a
large sum of money in those accounts you currently have?
How long do you intend to be in the property? Is it a
five to ten year plan until your children finish high school and you will down
size or move out of the area? Are you planning on retiring in ten to fifteen years
at which point you will be selling the home? Is your intention to live in the
home for several years and then retain it as a rental/investment property and
then purchase a new primary residence?
When making major financial decisions, such as how
much of a mortgage to carry on your new home determined by how much of your
savings you use for down payment, it is important to consider all of your “what-ifs”
and do the math on those what-if propositions. If you have one or more children
heading off to college in the near future will you have enough money to cover
tuition, housing, books, and incidentals? If you are retiring in seven years
and will be selling your home and moving out of the area and/or downsizing will
you be better off in the long run retaining more money in your investments earning
compound interest and dividend reinvestments? If your intention is to purchase
a new home in several years and rent out the current home will you be able to
save enough for the down payment on the new home in the time frame you have
given yourself—keeping in mind real estate prices will probably be higher?
down payment may be the best option for you and your family, but it may not be
depending on your goals and objectives in the future. Before committing to your
down payment and mortgage amount let me help you analyze your needs, goals,
objectives and abilities to help put together the best mortgage program for you
and your family.
Have a question? Ask me!
major pieces of economic data this week. Leading the way was release of
retail sales data for July, which was a disappointment for the second month in
a row showing zero growth for the month. Auto sales declined for the second
month in a row. Following a pretty good second quarter of consumer spending the
third quarter is off to a poor start which will revise some estimates for GDP
growth for the quarter lower. Lower retails sales is positive for lower
interest rates as it shows low consumer spending which composes 65-70% of the
unemployment filings for last week increased 21,000 to a total of 311,000
people filing initial claims for unemployment insurance. This is the highest
number of filings since late June. High unemployment filings are positive for
lower mortgage rates.
received the data for the July Producer Price Index (PPI) which is what
producers pay for their goods and services, essentially the wholesale cost of
items. The index saw an increase of only 0.1% for the month following a
stronger 0.4% growth in June. Lower PPI generally leads to lower CPI (Consumer
Price Index, what you and I pay for goods and services) which generally leads
to lower mortgage rates. Tempering the PPI data was a fairly strong increase in
manufacturing in July, which pushes rates higher as it is an indicator for
stronger economic growth and employment.
Friday August 15, 2014: Frequent readers of the Weekly Rate & Market
Update are aware of trading ranges that define markets for Mortgage Backed
Securities (MBS) which determine our rates. Prices for MBS bounce around inside
a trading range for a period of time and then based on investor demand or
sentiment due to market conditions, economic or political news and profit and
investment objectives we can see a breakout above the range (leads to lower
rates) or below the range (leads to higher rates). Two weeks ago I mentioned we
saw a break below the long trading range MBS had been within and then trading
came back within the range. Last week I mentioned MBS had broken out of the range
on Friday to the high side and if sustained into the week could lead to a new,
higher range and a drift down in interest rates. Well the breakout did not hold
on as MBS opened lower on Monday and Tuesday. Wednesday on the retail sales
news we started to see prices creep up. Today with the PPI numbers MBS broke
through the top of the range again, but with strength and momentum. As usually
happens with such breakouts to the high side lenders will hold off on passing
through all of the gains to borrowers with lower rates, however there is some
lowering on rates with the big move.
FIXED RATE MORTGAGES AT COST OF 1.25 POINTS30 year conforming 3.875% Down 0.115%30 year high-balance conforming 4.00% Down
0.125%30 year FHA 3.375% Flat***30 year FHA high-balance 3.75% Flat***Please note that these are base rates and adjustments
may be added for condominiums, refinances, credit scores, loan to value, no
impound account and period rate is locked. Rates are based on 20% down (3.5%
for FHA) with 740 FICO score for purchase mortgages. ***FHA rates have credits
available for closing costs at these rates and higher.
I made the comment earlier in the week that a lot of
productivity was lost this week as people logged into YouTube to watch
sketches, scenes and routines of Robin Williams. His brilliance made him one of
the top comedians of all time. Quite often when someone passes away there are
the obligatory “what a great guy…” comments, some you may read with skepticism.
With Williams however the volume of stories from people in and out of the
industry about how he treated everyone, from people on the street to the crews
on his movies and backstage at events tell of a man who was a great guy. He
will be greatly missed.
Of the many clips I have used to pare my own
productivity this week was this one that I hope you enjoy as it speaks to many
levels of Robin Williams the man and the entertainer. Robin Williams with the troops in Kuwait, 2007.
Question: Should I use mortgage insurance for my transaction or
a “piggy-back” mortgage?
Answer: Following up
on last week’s explanation of what is a piggy-back, this week we compare the piggy-back to using
mortgage insurance for those with less than 20% equity in their purchase or
refinance transaction. (For those unfamiliar with mortgage insurance or who
want a detailed explanation here is Weekly Rate & Market Update from October 18, 2013 explaining mortgage insurance
and how it works.)
The answer to the question, whether it is better to
use mortgage insurance or a piggy-back is the same to many question and one my
kids could probably give: Do the math!
It is a bit more complicated than just a math problem
as other factors need to be accounted for in the decision, such as comfort with
changing payments, ability to pay additional amount above and beyond minimum
payments, expectation for future home values are just some to consider. Let’s dive in.
Before looking at the math let us consider that
mortgage insurance for conventional loans has three options, as discussed in
the Update linked above: lender paid mortgage insurance with a higher interest
over the life of the loan, single premium financed mortgage insurance with a
higher initial loan balance, and monthly mortgage insurance with a monthly
premium. Of the three options only the final option, monthly premiums, has the
ability to go away in the future.
This is an important factor when deciding if you wish
to obtain mortgage insurance or use a piggy-back. The standard guideline is
that if you have had your mortgage for twenty-four or more payments and
payments have been made on time and (AND) your mortgage loan to value is less
than 80% of the then current market value as determined by a report from an
appraiser who is approved by the lender, then you can have the mortgage
insurance removed from your monthly payment.
On the piggy-back transaction the monthly payment will
not go away until the debt is paid in full. As well most piggy-back
transactions use a Home Equity Line of Credit (HELOC) as the financing vehicle
for the second, or piggy-back, mortgage. Unlike a fixed rate second a HELOC has
a variable rate tied to the Prime Rate and typically there is a margin added to
the rate. Our most popular and successful HELOC used for a piggy-back
transaction has a rate of Prime + 2.24%. Today the Prime Rate is 3.25% add the
margin of 2.24% and the rate is 5.49%.
One feature many homeowners like, at least initially,
is that the minimum payment on the HELOC is interest only. This minimum payment
typically continues until ten years into the mortgage when the payment changes
to fully amortize the mortgage for ten remaining years. This causes the payment
to increase dramatically as it becomes principal plus interest, unless you have
paid down the principal.
Because the interest rate is tied to the Prime Rate
the rate you will pay is adjustable, whenever the Prime Rate changes so does
your interest rate and your minimum payment. The question on the Prime Rate is
not if it will go up, but when, which begs the question, by how much? Common
wisdom is the rate will begin to go up next year and many feel we will see a
series of increases totaling approximately 0.50% per year (one-half of one
The math problem if one has the option between
financing with mortgage insurance or a piggy-back is based upon monthly
payment. Which option will give me the lower payment? And for how long?
Below are three charts that compare options for
a couple purchasing a $450,000 home with 10% down with a 30 year fixed rate
mortgage at 4.25%. For the mortgage insurance option the couple will have one
mortgage of $405,000; for the piggy-back option the couple will have a first
mortgage of $360,000 and a HELOC for $45,000 (totaling $405,000 in mortgages).
As you can see in the first chart (Mortgage
Insurance) the payment for principal and interest on the mortgage and the MI
payment are constant through the first 48 payments. The assumption I have made
is that the home will increase in value at 2% per year so the couple will be
able to eliminate their MI payment after 48 payments due to the decline in
principal of their mortgage and increase in home value. Then after providing
approved appraisal to their lender they drop their mortgage insurance and save
$165.38 per month (almost $2000 per year).
Looking at the second chart (Piggy-Back) I
assumed the Prime Rate would increase half a percent per year for three years,
from payment 13 through 48. As you can see the payment goes up modestly per
year, a little under $20, and over four years the payment increases just over
$55 per month. However as you can see the balance on the HELOC remains at
Chart three (Monthly Payment Differential)
compares the monthly payment difference between having a monthly MI payment or
a monthly piggy-back payment, as you can see the piggy-back has a lower monthly
payment through the thirty-sixth payment. The far column shows the cumulative
savings of having a piggy-back versus using mortgage insurance for your
purchase. As you can see after you have lived in the home for four years you
have saved over $5000 by making interest only payments even if rates have
increased 1.5% during that time. However, you still have a $45,000 balance.
The final chart (Pay Differential Into HELOC)
looks at what happens to your HELOC balance if instead of putting the monthly
savings into your pocket each month you instead put it into your HELOC payment.
As you can see by making the same payment as you would if you had an MI payment
after four years you would lower your mortgage balance by over $7000. However,
after making $18,000 in payments you would still owe almost $39,000.
Back to our question, should you finance using mortgage
insurance or with a piggy-back? As you can see from the charts the answer to
that question lies in what you strongly feel will be your financial position in
four to five years and realistically, not “well…maybe…”, how long you may own
Other factors to consider are your income path,
if you have the ability to pay down large chunks of the HELOC with bonuses or
commissions, and your honest assessment of your financial discipline.
As with most of the questions asked about
mortgage situations there is no quick and easy answer, nor is there usually one
that is clear cut for every client.
news week, which afforded a bit more space to the MI v Piggy-Back
information above. The only economic news of significance to the mortgage
markets was the weekly release of unemployment claims, for which 289,000 were
filed last week. This is near the post-recovery low in weekly claims and the
four week average is the lowest since before the Great Recession. Ordinarily
this news would be negative for mortgage rates but investors are only mildly
interested in such data at the moment.
markets is once again geopolitical events. President Obama’s announcement
that he has authorized air strikes in Iraq to protect civilians trapped on a
mountain top by Islamic State fighters has investors wary of a wider conflict,
disruption to markets and as such engaged in the traditional “flight to safety.”
(“Flight to safety” is the basis for investors to move out of stocks which
carry greater risk than bonds and into bonds. American bonds, be it U.S.
Treasuries or Mortgage Backed Securities (MBS) are considered among the safest
investments and at times of international crisis or economic uncertainty
investors increase their purchasing of bonds which results in lower interest
rates). Obama’s announcement coupled with the end of the temporary cease fire
between Hamas and Israel coupled with continued concerns of the situation
between Russian and Ukraine have the global markets less concerned with how
many Americans filed unemployment last week and more concerned with how and
where there can protect their assets.
Friday August 8, 2014: Last week we broke out of our long term trading
range for Mortgage Backed Securities to the downside and then creeped back into
the range. Today MBS have broken out of the range to the upside on the news of
possible (actual?) airstrikes in Iraq. The trading went to the highest levels
since early June, when the position lasted for three days before dropping and
creating the range we have been in. Already today investors have taken profits
and moved MBS close to falling back into the trading range we have experienced.
If the market can stay above the trading range through closing today, and if MBS
prices can hold above the current trading range well into or through next week
we should see lower rates next Friday. Keywords: “if” and “should” My instinct is that profit taking will occur
and we will slip back into the trading range. Lenders cautiously holding onto
the MBS increase in pricing and have not put into lower rates on their rate
sheets, rates flat from last Friday.
30 year conforming 3.99% Flat
30 year high-balance conforming 4.125% Flat
Please note that these are base rates and adjustments
may be added for condominiums, refinances, credit scores, loan to value, no
impound account and period rate is locked. Rates are based on 20% down (3.5%
for FHA) with 740 FICO score for purchase mortgages. ***FHA rates have credits
available for closing costs at these rates and higher.
Forty years ago today President Richard Nixon
addressed the country announcing he was resigning as President of the United
States. I was twelve years old and on a backpacking trip with other kids at our
camp and two counselors, Terry and Jeff. We were on Isle Royale, an island and national park in Lake Superior. On the
night of August 8, 1974 our campsite was on the shore of Lake Superior and
there was a large pier where a very large luxury yacht was docked. A few days
before when we were in Gran Portage, Minnesota where we boarded the ferry to
Isle Royale and saw news that Nixon’s Presidency was nearing an end.
Not long after we had set up camp that afternoon either
Terry or Jeff walked out the luxury yacht. Upon returning we were told that
President Nixon was going to make a statement that night and it could be his
resignation and the owner of the yacht had said if we wanted to watch from the
dock we could. I was the only camper interested in the process and that evening
walked out the pier and stood on the dock watching the President announce he
was resigning from office. It was surreal for anyone, especially a twelve year
As we walked back to the camp with the darkness
creeping across Lake Superior Jeff said, “we’ll never forget this.”
Thankfully we live in a nation where regardless of how
the office is transferred from one occupant to the next, be it election,
resignation or assassination the transition has always been peaceful.
Here is the speech, the famous line occurs at 2:58, most sets probably
clicked off at 3:30.
Question: What is a “piggy-back?”
Answer: A “piggy-back” is a mortgage transaction that involves two loans. Popular in the lead up to the housing melt down in 2008, the piggy-back transaction is making a comeback, albeit very minor compared to its popularity as the housing bubble grew.
I will explain what a piggy-back is and how it works and then its uses in today’s market.
A piggy-back transaction is a primary mortgage, the first, funded with a secondary mortgage that usually has a much smaller loan amount. Typically the second mortgage is a Home Equity Line of Credit, or HELOC, but it can also be a fixed rate mortgage. The loans are funded at the same time and called a first and a second not because of the size of each loan but because one loan is recorded first, and therefore has first priority on title should there be a default and the property goes into foreclosure.
An example: You are purchasing a $600,000 with 10% down payment. You may get one loan for $540,000 or your may decide instead to opt for a piggy-back transaction with a $480,000 first and a $60,000 second mortgage.
Why would you decide to utilize a piggy-back transaction? In the current market the primary use of the piggy-back has been for “jumbo” transactions---those transactions where the primary loan would be higher than the Fannie Mae/Freddie Mac high balance loan limit ($625,500 for much of Southern California) and the borrower has available 10% down payment, or if a borrower has 10% down payment and wishes to avoid mortgage insurance (next week I will discuss mortgage insurance).
There are few lenders in the market that will lend over $625,000 for a 30 year fixed rate mortgage without at least 20% down payment. Therefore is you are buying a $750,000 home and have $75,000 for your down payment you can get a $625,000 30 year fixed rate mortgage and a $50,000 second mortgage. You have the advantage of a 30 year fixed rate mortgage, you have the advantage of leverage and you have the advantage purchasing the home you want within your financial capabilities.
Increasingly we are seeing some clients who opt for the piggy-back transaction to avoid mortgage insurance, for instance purchasing a $650,000 home, putting $65,000 down, getting a 30 year fixed rate mortgage for $520,000 and a second mortgage for $65,000. Next week I will provide comparisons for the two options and the benefits and detriments of both.
To recap, a “piggy-back” transaction is one in which two loans are used to purchase, or possibly refinance, your home instead of just one mortgage.
Roller coaster week for mortgages as economic news, international events and Fed speak all caused major moves in equity and bond markets. Headline news has been the drop in the Dow Jones Industrial Average which dropped 300 points yesterday and is down 3.5% from Tuesday and closed yesterday at its lowest level since early May. While the Dow has been dropping for the most part so have Mortgage Backed Securities (MBS), until today (MBS prices drop rates go up). This is a bit odd as usual as typically when stocks go down so do rates and vice-versa, this week there were a few days when both investors sold off both stocks and bonds and went into cash.
There are many causes, excuses, for the action this week. Economically we had some minor news early in the week, pending home sales (decent number of homes but down 1.1% from May), consumer confidence (very strong mostly on higher income expectations), Case-Schiller home prices for May (down 0.3% for month and up 9.3% from last May—but the year over year is declining monthly). On an ordinary week these pieces of data would have an impact on mortgage rates, this week however there were merely inside the paper below the fold news items.
Wednesday was the source of the tumultuous week. Early in the day when the Bureau of Economic Analysis released the initial 2nd Quarter Gross Domestic Product (GDP) data. You may recall that the first quarter showed a decline in GDP of 2.9%. The second quarter showed a very strong rebound from the weather impacted first quarter contraction with very robust 4.0% growth for the quarter. This news alone pushed MBS prices down (rates up) as investors took it as a sign that the Federal Reserve would raise short term interest rates sooner rather than later.
Piling on the Wednesday news was the release of the minutes from the recent Federal Reserve Open Market Committee meeting (FOMC) in which the Fed governors discuss their policies and future moves. There was nothing in the comments that were unusual—the Fed did not announce that they would be increasing rates in December or May, but investors pushed by the GDP data and declining markets accelerated their selling pushing markets down further.
From a rational viewpoint (yes, I am putting myself up as “rational”) the FOMC announcement is a carbon copy of the last few months’ announcements. Policy rates (Fed discount rate) unchanged (Fed will keep discount near zero), Fed will continue to taper its purchases of mortgages and Treasuries (which it has been doing for months), policy rates are to remain low for a “considerable time” after the bond purchases end (stated in every announcement since 2008 I think), emphasis on labor market which while improving “there remains significant underutilization of labor resources” (labor markets aren’t that great), housing seen as remaining slow (repeat of prior months’ comments). Add it all up and Fed speak was same-old-same-old. Absent any other news and mortgage rates might drop on the comments, however with antsy investors looking to beat the market the sell windows were active.
Some stability returned today, at least to the mortgage and bond markets, as the Labor Department released the employment report for July. After an increase in almost 300,000 jobs in June the economy slowed job growth in July adding 209,000 jobs to the economy with only 198,000 in the private sector. In July the unemployment rate rose to 6.2%. So one day after the Fed comments on a strengthening labor market data comes out that belies some of the comment to verify the concerns that the Fed has in “underutilization of labor resources.” Investors took the news as not pushing the Fed to increase rates sooner rather than later and as a result we have seen a strong rebound in MBS markets today wiping out most of the losses incurred since Tuesday’s close.
Rates for Friday August 1, 2014: We broke out of trading ranges this week to the low side (higher rates) which created the opportunity for continued decline and establishing a new trading range lower than our recent, and long, range for MBS prices, and therefore rates. The market bounced however which put trading back into the prior range. Remaining in the range through early next week will be key to continuing our long run of stable mortgage rates.
I commented early in the week for those in Southern California if you closed your eyes you could picture yourself in Lahaina….mid 80’s for temperature and low 70’s for humidity….except we were not in Lahaina. We, Leslie and I, were prepping our house for full fumigation (i.e. the circus tent covering entire home) which meant bagging food, medications, of course the booze in the bar, moving plants outside and off porches, all in the nice subtropical heat with no air conditioning. And of course moving it all out means moving it all back in. The good news is our friends at Euro Termite did a great job and we discovered our “cooling” systems worked as evidenced by our shirts saturation.
We had not had our home fumigated since we moved in August 1998, and that is probably a bit too long to go in Southern California without knocking out the little critters. If you have been in your home for some time without having a termite/pest inspection I recommend you have it done and despite the considerable “un-fun” aspect of the process protecting your structure with eradication measures.
On the plus side you do throw out a lot of stuff that accumulates.
Happy, happy weekend for the Smith Family as our daughters return on Sunday after being at camp in Minnesota since July 7th. Be nice to lose control of the television, hear “oh Daddddd” twelve times a day and be reminded that I’m weird!
Dennis C. Smith, California Bureau of Real Estate Broker #00966315; NMLS #296660
Stratis Financial Corporation, California Dept. of Real Estate Broker #01269597; NMLS #238166