Archive for category: Economy

Question of the week:  How do unemployment benefits and proceeds from the Payroll Protection Program (PPP) impact mortgage qualifying?

Answer:  Approximately 26 million Americans are receiving unemployment benefits (UB). Earlier this month when the CARE Act went into effect $350 billion was allocated for businesses under the Payroll Protection Program (PPP), and this week a supplemental bill allocated another $310 billion for the program.

While these programs are doing a lot to help people today, what is the longer-term impact of receiving those funds, and from a mortgage perspective what is the positive or negative if you apply for a mortgage in the future?

For purposes of this conversation I will be using Fannie Mae underwriting guidelines as they are the basis for most other mortgage programs.

As a rule, income used for mortgage qualifying is income that appears on your tax return, i.e. taxable income. There are some exceptions, but income not on your tax return is not going to be used to qualify for your loan.

Unemployment benefits are taxable at both the state and federal level. Does this mean that you can use these benefits for mortgage qualifying? Yes, no, maybe.

Income must be of a “constant and continuing nature” to be used for qualifying. Constant is defined as having been received for two years and continuing means it will be received for at least three more years. Like most guidelines there are some exceptions to this guideline, for instant spousal support has to be shown as being received for six months before it can be used to qualify.

For UB Fannie Mae will use the income of it is “seasonal.” For instance I have had educators who are not paid every summer and claim file for UB. We presented a history of receiving the income and it is allowed for income qualifying.

As for currently receiving UB, Fannie it cannot be used unless it is seasonal, but…. “Unemployment compensation may be used in qualifying a borrower for a high LTV refinance loan whether it is seasonal or non-seasonal.” While this is a Fannie guidelines most lenders will have an “overlay” in which there underwriting guidelines supersede Fannie’s. In prepping for this week’s update I contacted a few of our lenders and they indicated it is very unlikely they would include a current recipient of UB that are non-seasonal as income.

What if you receive UB now, go back to work in a few months and then apply for a mortgage? There is a very likely chance your income will be used to qualify for a mortgage. The gap in employment is easily explained as job loss due to the Covid-19 pandemic, you are back at work and earning again.

Having UB in your income history is not a factor to automatically deny income or a loan. What is the history before the UB income and what is your current income are what is important. 

To recap, while unemployment benefits are taxable income, unless you can prove it is seasonal income current recipients will not be able to use the income to qualify for a mortgage.

Onto the second part of our question, is than an impact for small businesses that receive loans from the Payroll Protection Program?

No. There is no benefit, but there could be a negative.

The purpose of the PPP is to enable businesses to retain their employees and payroll through the C-19 pandemic. Businesses can receive up to two and a half times their monthly payroll (calculated as the average for the prior twelve months with some modifications) for the period from February 15, 2020 to June 30, 2020 in the form of a loan. If the business can show that the funds were allocated properly to retain employees and the business operations (a percentage can go for office space costs, etc) then the loan can be forgiven in total or in part.

Loans that are forgiven are considered taxable income. Under the CARE Act and its follow up there is a provision that the IRS will not tax amounts forgiven under the PPP. Further, the IRS code prohibits taking deductions against forgiven income to prevent double-dipping on tax savings. However, not only did Congress amend the tax code to have PPP forgiveness tax free, but also to enable deductions of expenses covered by the PPP, i.e. payroll and benefits to employees.

PLEASE NOTE Because the IRS will not be taxing the forgiveness as income does not mean the states will exempt the PPP loan forgiveness from their tax codes.

Many/most state have what is called “IRC conformity,” which means the state tax code conforms to the Internal Revenue Code of the federal government.

Now it gets a little murkier. Many states, about twenty, have a “rolling conformity,” which means their state tax codes automatically rolls with the changes in the IRC unless the state passes a law to exempt parts of the IRC and establishes separate tax codes for those exemptions.

Many states, also about twenty, have “static conformity,” which means their state codes conform to very large parts of the IRC as it was written in the past, but not at the moment. These states must update their codes on an annual basis to conform with the IRC, so they are always at least a year behind.

California is a static-conformity state. California has not voted to have its state tax code conform with the IRC since 2015. Why? California did not want its tax code impacted by the Tax Cuts and Jobs Act of 2017. For California businesses to have PPP loan forgiveness not taxes by the State of California Sacramento must pass a bill specifically stating the State will adopt the IRC on PPP forgiveness into the tax code. Depending on how you hold your business (C-Corp, S-Corp, Sole Proprietorship, etc) your tax on PPP loan forgiveness can be up to 12.3%.

From a mortgage qualifying perspective there is no benefit from the PPP in regards to income. If the loan is forgiven it will not be used as income.

There can be however a detriment depending on whether all, part or none of the PPP loan is forgiven and you are required to repay the loan. The detriment is that the loan payments will be on your tax returns and decrease your net income. While the rate on the PPP loans is a very low 1%, the balance must be repaid over a two-year term. If you received a $20,000 PPP loan and none of it was forgiven then you will have $20,000 as a liability on your balance sheet and any amounts paid in a tax year will reduce your income. This reduces the amount of income you have for mortgage qualifying.

It will be interesting as the pandemic isolation orders roll through the economy to see what, if any, mortgage guidelines are adapted regarding income qualifications. My feeling is that there will be very little, or no, changes as income verification has been very consistent up until the early 2000’s when Fannie and Freddie loosened up income requirements and began mass approval of mortgages without verifying income and again after the housing market meltdown and subsequent passage of the Dodd-Frank Act in 2010.

Have a question? Ask me!

Part of the CARE Act required mortgage servicers of Fannie and Freddie mortgages to grant loan deferments, or forbearances, to borrowers impacted by the Covid-19 pandemic. Essentially telling loan servicers they have to enable borrowers to miss payments. What was not in the CARE Act is a mechanism by which the servicers of mortgages do not have to pay Fannie and Freddie the principal and interest on the loans granted deferments due to federal law.

The Federal Housing Finance Authority (FHFA) sort of helped the issue this week by aligning Fannie Mae’s collection of loan payments from mortgage servicers with Freddie Mac’s collection policy. FHFA announced that mortgage servicers need to advance only four months of payments on mortgages payments missed by borrowers in forbearance due to Covid-19 deferrals, after four months the servicers are under no obligation to advance scheduled payments. While this is some help to servicers it does not go far enough to retain liquidity in the mortgage industry, especially for smaller entities.

The Mortgage Bankers Association has called for a federally backed liquidity facility to enable loan servicers access to funds to bridge their collection of mortgage payments and payments that must be sent to Fannie and Freddie. This would ease the cash-flow problems of servicers, enabling them to fund more mortgages to help families able to refinance to lower their payments or purchase their new homes. With Congress on a spending spree it seems reasonable that a major part of our economy would receive some assistance to borrow funds to enable mortgages to continue to be funded. “Reasonable” and legislative bodies are not always thought of in the same sentence without a prefix, “un-.”

Rates for Friday April 24, 2020:   The gap remains between 30-year fixed “vanilla” mortgages and other products. It will likely last until liquidity issues in the secondary markets are settled and investors develop a taste for a bit more risk. In the meantime, rates slip down again this week for purchase transactions. Note, rates below are for purchases, refinance rates differ.

FIXED RATE MORTGAGES AT COST OF 1.25 POINTS LOCKED FOR 45 DAYS:

30 year conforming                                            3.125%     Down 0.125%

30 year high-balance conforming                    3.50%       Down 0.125%

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 with 740 FICO score for purchase mortgages.

Last Friday I received a nice email from Jeanine, long-time reader of the WR&MU and Realtor. She wrote in reply to my closing statement to the effect that from decay comes growth.

She wrote that there is a flower that only grows and blooms out of the ashes of wild fires. “I am hopeful ‘out of the ashes flowers,” she wrote, “ will be a metaphor for our continued concern for each other after we emerge from isolation.”

What a great message, and I and most everyone share this hope with Jeanine.

I did what we all do these days and Googled Jeanine’s “out of ashes flowers” and discovered the flower only grows in California, and only grows after wild fires. It is the Fire Poppy.

Thank you Jeanine for your bringing the Fire Poppy to my attention and your nice note, and thank you to everyone who sends me comment, questions, suggestions and just checks in after receiving the Weekly Rate & Market Update!

Have a great week,

Dennis

Past Weekly Rate & Market Updates can be found on my blog page at my website www.DennisCSmith.com/my-blog

Question of the week:  Why did rates go up after the Fed lowered rates?

Answer: Two weeks ago our question of the week was, “What is the impact of the Federal Reserve cutting rates?”  The answer section discussed how the surprise rate cut made by the Fed on March 3^rd impacted mortgage rates with investors buying up Treasuries and mortgages pushing rates lower, and why they had this reaction.

 In the commentary I included a link to my WR&MU from October 2018 “How Does the Federal Reserve Impact Mortgage Rates?”.

The simple one-word answer to that question was, “Indirectly.”  That is because, contrary to many people’s belief, the Federal Reserve does not control mortgage rates. The only rate the Federal Reserve directly controls is the Federal Funds rate, the rate banks charge each other to lend over-night. Banks borrow money from each other over night so they can have the reserve amounts they are required to have depending on the amount of their deposits. Dennis’ Bank is required to have $2 billion in reserves, as the day is closing it has only $1.85 billion in reserves. The bank borrows $150 million dollars from Bank of Smith at the Federal Funds rate. The next day the loan is re-paid with interest.

As discussed in prior editions of the WR&MU, when the Fed changes its rate there is typically a ripple effect though the financial industry with other rates changing. The rate that most often moves in conjunction with the Fed Funds rate is the “prime rate.”

The prime rate is the rate banks charge their best commercial clients, usually very large corporations. There is no universal prime rate as every bank can determine this rate for themselves, however historically they all use the same rate. The prime rate as a rule is 3% above the Fed Funds rate.

The prime rate is the base rate used for most commercial and consumer loans, but not mortgages. If the prime rate goes up or down your credit card rate, student loan rate or auto loan rate may change. As well, if you have a Home Equity Line of Credit, that rate changes with prime as almost every bank’s rate for a HELOC is “prime + x.” As the prime rate goes up and down so does you HELOC rate.

Back to our question of the week, why did rates go up after the Fed lowered its Fed Funds rate to zero on Sunday?

There are many, many factors impacting financial markets in the current environment. As discussed many times, of the different areas for investment the two most closely related historically are equities (stocks in corporations) and fixed-rates (bonds and mortgages). The historical relationship is that investors either engage in some risk and purchase equities, or buy assurance and purchase fixed-rate assets with a fixed return.

An investor has one-million dollars. The economy is going well so the investor purchases stock in one or more companies with the expectation that they will have strong growth and profits making their companies more valuable. There is risk that something may happen to impact the economy, or specific companies or sectors where those companies operate, that could cause the companies to lose business, see declining profits and lose value.

An investor has one-million dollars. The economy appears to not being doing as well as it was and there is some question as to whether companies will grow and continue to show as much profit, so the investor purchases a combination of bonds issued by different government agencies and Mortgage Back Securities (MBS) which are provided a fixed return at a certain percentage of the investment. As long as the investor holds the bonds and MBS they know they will receive the same return every year.

The Federal Reserve raises rates when the economy is growing rapidly, or the Fed anticipates it will grow rapidly in the not-to-distant future, in an effort to keep inflation at an acceptable level so the growth does not suddenly get choked off by consumers not being able to afford to purchase as many goods and services.

Conversely, when the Fed feel the economy is slowing, or will slow, it lowers rates to encourage borrowing and spending.

On Sunday the Fed cut its Fed Funds rate to zero. As part of the announcement it also stated it would purchase $700 billion in U.S. bonds and Treasury note, and mortgages. The latter action is known as “Quantitative Easing,” which was done by the Fed several times during and following the Great Recession. The purpose of the QE programs is to put liquidity into the markets to keep cash flowing through the economy. As mentioned above, banks have reserve requirements. If they cannot sell some of their loans they cannot make any more loans. If banks cannot make loans the economy stops. The Fed is telling investors, “we are absorbing $700 billion in fixed rate assets.” The Fed is putting $700 billion into the economy.

There were some other more in the weeds actions announced by the Fed on Sunday which dealt with banks borrowing money and exchanging debt. All the actions had the same intent, keep funds flowing and calm investors with the goal of flattening markets and getting investors to follow the Fed and purchase fixed-rate assets. Which ideally would then cause them to re-enter the equity markets as well.

When the markets opened on Monday investors thumbed their noses at the Fed. Why?

The primary commentary was that the Fed did too much. While the Fed thought a huge move, cutting rates to zero and funneling almost one-trillion dollars into the markets, would have a positive result, investors wondered what was left?

The phrase I read that best described the market reaction was that the Fed fired all its bullets and don’t have any left.

What investors wanted from the Fed was a measured response with the announcement that it was prepared to act in the future if necessary. Last week I commented that I thought the Fed would lower rates by three-quarters to one percent (it lowered by 1%) and begin a QE policy. They did both of these, but investors were looking for a lower rate cut and not as large of a QE  purchase program.

Why? Investors feel that if the impact of the COVID-19 on the economy ripples deeper and longer the Fed does not have any more moves it can make along the way to ease the slide and support the flow of funds in the economy.

The Fed Funds rate after the cuts is 0%-0.25%. The only rate cut left is to go into negative rates whereby banks are paid to borrow money. Huh? “Dear Bank of America, we will pay you 1% to borrow $1 billion from us so you can lend that $1 billion out to your clients at a rate of 1%.”

That is one reason rates have jumped since the Fed announcement. Another reason is lenders are crammed to the gills with mortgages shoved into the pipelines starting in mid-January when rates began to drop. One analyst estimated that the mortgages locked with lender from mid-January to the first week of March was as much or more than the industry has funded in some years. I mentioned in a WR&MU a few weeks ago that lenders were raising and lowering rates throughout the day to control the amount of loans they could take in. With rates significantly higher over the past two weeks loan volume has declined accordingly.

Another reason rates have increased is because there are liquidity issues in the market. Lenders are running up against their limits on warehouse lines; lines of credit used to borrow money to fund loans that are then sold. The secondary market is where mortgages are packaged and sold in bulk as Mortgage Backed Securities. As mentioned above, investors are not fleeing to the safe returns of bonds and mortgages, so the MBS market is sluggish making it challenging for lenders to sell their mortgages.

These are the some of the reasons the Fed made the moves it made, to loosen up the markets and get the funds flowing. However, investors are not satisfied.

On the other side of the coin, equities, investors have been waiting for a very bold move by Congress with a stimulus package. As I write this there are bi-partisan negotiations for such a package that could top $1 trillion. Will that be bold enough? It might be as the Dow has improved very slightly since Wednesday as talks on the package have neared conclusion to lead to a bill for President Trump’s signature.

The big concern is obviously the “R-word,” recession. It was over a decade ago that the Great Recession occurred, one that many Americans were too young to understand, and one that too many remember all to well. That is the question everyone is asking, “will this be like 2008?”

The definition of a recession is two or more consecutive quarters with a shrinking economy.

There are three primary components to a recession that determine its impact: length, depth and breadth. How long will the recession last? How deep will it go, i.e. how negative will be economic activity? How wide will it extend, i.e. how many and what industries will be primarily impacted?

The Great Recession covered a period of eighteen months, December 2007 to June 2009. At its depth the Gross Domestic Product, the measure of our economy, was 4.3% lower than when the recession started. The breadth of the recession was very wide, primarily because the cause was the collapse of the housing markets across the country. Close to 65% of Americans own their own home. Because of this no area of the country was spared a drop in home values, and a loss of personal wealth as a result.

If COVID-19 does initiate a recession the three questions are vital to the economic impact and the recovery. Length, depth and breadth will determine how long, once the recovery begins, it will take for the economy and markets to be back to where they were before any such recession began—lets say March 1^st if this quarter is the first quarter of two successive quarters of negative GDP.

The amount of change week-to-week, day-to-day, even hour-to-hour has created tremendous uncertainty, which creates raw emotions and concern. I am amazed at what has transpired over the past two weeks, like I am sure everyone reading this is as well.

Looking forward, I feel that when the quick reactions over the past two weeks or so are over, when a large stimulus package is passed, and nerves calm down, we will see a flattening in the markets. As well, when the rebound happens it could, should in my opinion, be fairly strong. Our economy was very strong going into March. Consumer confidence was high, job markets were high with wages outpacing inflation. Homeowners had growing equity secured by low rate, low risk mortgages that they qualified for using their real income. All these factors support, in my opinion, short, shallow and narrow.

Have a question? Ask me!

Rates for Friday March 20 2020:  As mentioned above, rates jump again this week. I pulled rates about 11:00 this morning, and the conforming rate was at its highest since last May and the high-balance rate was at its highest since December 2018. The last time rates climbed this high from a bottom was in 2018 when it took from January to October for the high-balance rate to climb from 3.875% to 5.125% and the conforming to climb from 3.75% to 4.875%.

FIXED RATE MORTGAGES AT COST OF 1.25 POINTS LOCKED FOR 45 DAYS:

30 year conforming                                            3.875%    Up 0.50%

30 year high-balance conforming                   4.50%       Up 0.50%

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 with 740 FICO score for purchase mortgages.

I have a topic that I have been wanting to share as a few people have asked about it regarding the new credit scoring algorithms. I have been holding off to provide some insight on what is happening that I hope is helpful. My primary intent for the WR&MU is to educate, hopefully through the environment we are in now that is the case.

This morning on our walk with the dog I told Leslie I am thinking about a regular Lunch and Learn about Loans. My idea is to on a regular basis convene a meeting using Zoom to talk about topics I discuss in the WR&MU. Using Zoom would enable an interactive environment and those who participate being able to ask questions. Let me know if this interests you and I will look to put something together.

Part of the idea is from a few Zoom meetings I have had and knowing that we are all social distancing so many of us gregarious types are looking for contact with others outside the home.

Click here with a quick reply if you would be interested.

What are you doing while staying at home with the family? Here is a really neat site that have virtual visits to many attractions around the world, from museums to aquariums to classes for you and the kids. Virtual school activities. The other day I got lost in the Musee D’Orsay site looking at paintings.

For the Smith household, Leslie has decided that she is converting our stay-at-home situation into a Bed and Breakfast. This evening there will be mulled wine and a cheese plate in the living room. Tomorrow I think there will be watercolor painting by the pool before lunch and in the afternoon a walk through the neighborhood with a contest to see who spots the most number of different types of birds.

Reach out to those you haven’t seen or spoken to in a while. Check in with neighbors. Look forward when it is okay to shake hands or even better hug one another.

Have a great week,

Dennis

Past Weekly Rate & Market Updates can be found on my blog page at my website www.DennisCSmith.com/my-blog

Question of the week:  What is impact of the Federal Reserve cutting rates?

Answer: In normal times…the Fed will generally signal in advance its general direction and timing on when it will move its discount rate (rate it charges banks to borrow from the Fed). Because of this the markets, stock and fixed-rate (bonds and mortgages) will react accordingly in advance of any rate announcement. When the rate change is announced it often results in interest rates for mortgages to move in the opposite direction—contrary to what one would think would happen.

For instance, in 2017 the Fed kept stating it would be raising rates through 2018. Not only that it would raise rates but when and by how much. Investors reacted accordingly, knowing the rate changes were coming, so when the Fed did raise rates as expected there was little to no change in mortgage rates or other markets. Mortgage rates climbed through 2018 as the Fed kept increasing its rates and economic news was positive. Before the final Fed rate increase in 2018 rates began to drop, partially on economic data and partially because the Fed was announcing only one more rate increase in December and then no plan to change rates in 2019. Investors were reaction was to the unlikeliness that rates would go up again in the near future, and because they would not go up they could go down. Their reaction was a cause for rates to drop into the summer of last year.

That was normal behavior by the Fed and the markets. As a rule, the Fed does not like to surprise markets with unannounced rate cuts as the result could be over-buying and over-selling in either stock or fixed rate markets.

The Fed announcement of a rate cut earlier this week was a surprise. Not only that the rate cut was made without their being a meeting of the Federal Open Market Committee (who makes the rate decisions), but that the rate was not changed in the normal 0.25% (one-quarter of one-percent, or twenty-five cents on one hundred dollars), but was dropped one-half of one percent (0.50%).

The double surprise of the rate cut and the size of the rate cut sent investors scurrying to cover their ass-ets. They sold off on stocks, causing equity markets to drop; and purchased bonds and mortgages causing rates to drop. Some felt there was over-buying and selling and reversed directions, causing stocks and rates to climb. Then they changed direction again…Through the week the daily changes in markets have had wild swings up and down. Exactly the type of behavior the Fed is concerned about if an unannounced rate change is made, and why future rate changes are either announced or strongly hinted at so investors and markets are prepared.

Overall, the impact on mortgage rates has been positive with rates slipping through the week for most products. Note however, that the decline has as much to do with the reason the Fed suddenly lowered rates as the actual action by the Fed.

Concerned about the impact of Covid-19 (aka coronavirus) on the economy, the Fed slashed rates in the same manner it would to stave off a recession. As we saw in the last few weeks, investors were expressing their concern about the economic impact of the virus and its spread by selling off stocks and equities cause large drops in those markets. The Fed was trying to bolster markets with its cuts and try to bring some confidence to markets.

Ordinarily, Fed rate cuts do not have an immediate impact on mortgage rates. This week, by making an unannounced rate cut that is twice the amount the Fed typically moves rates, the Fed’s actions has impacted rates.

For those interested here is Weekly Rate & Market Update from October 2018 “How Does the Federal Reserve Impact Mortgage Rates” that goes into much more detail on the Fed, how it works and impacts rates and markets.

Have a question? Ask me!

Workers continue to gain. The Labor Department released job data for February this morning, and it was all positive. The economy added 273,000 jobs in the month, well ahead of the consensus estimate of 165,000 additions. After slipping up to 3.6% in January, the unemployment rate slipped back down to its 50 year low of 3.5% in the month. Average wages also continue to grow, with 0.3% gain February; wage gains continue to outpace inflation. The news would normally be mortgage rate unfriendly and lead to speculation of the Fed increasing rates due to the continual strength of the job markets, however the global concern over the Covid-19 outbreaks wipes out any positive economic news as it pertains to rates and markets.

Rates for Friday March 6, 2020:  Rates continue to decline as the concern over Covid-19 still have impact on investors. On our side of the industry we are seeing a very interesting phenomenon, one I cannot remember the last time I have seen this. On any given day, for a particular rate we can see a spread between five or six lenders of up to a point and a half (1.5%) in fee. For instance, if you have a $500,000 mortgage, when we look at a rate at 3.00%, the cost for the mortgage that we pay the lender can vary from no cost to as much as a cost, to us, of one and a half percent—which would equate to $7500; again that is the cost we would pay.

Lenders are shifting their costs dramatically from day to day in order to control the number of mortgages being submitted for underwriting and funding as the volumes being generated by the lower rates are stressing every point of the mortgage process. As mentioned above, the labor markets are very tight so hiring to help with load management is extremely hard, and there is the issue if a lender staffs up for the current volume, will the volume still be consistent by the time new workers are trained and fully functional?

Different products have also seen large swings in variances. For instance, while 30 year mortgage rates have dropped, 15 year mortgage rates have been fairly constant with some slight dips.

All that said, we have lenders this week presenting us with rates that are a bit lower than last Friday. For the first-time in a long time I have had to alter the rate chart below as we reached the bottom rate on the Y-axis.

How long with this last? It depends on when investors feel confident in the impact of the Covid-19 virus, which means when governments and those who spread the news of every new case being diagnosed feel the spread is somewhat under control or not as big of a threat. Once that happens we should expect a very large reversal in investors behavior causing equity prices and interest rates to climb—likely very rapidly.

FIXED RATE MORTGAGES AT COST OF 1.25 POINTS LOCKED FOR 45 DAYS:

30 year conforming                                            3.00%    Down 0.125%

30 year high-balance conforming                   3.125%   Down 0.125%

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 with 740 FICO score for purchase mortgages.

Thank you to everyone who reached out to me after last week’s two pieces of commentary on my views regarding the Covid-19 reporting and reactions and elections and the media. I enjoyed hearing from some long-time clients and WR&MU readers and engaging in conversations on those subjects and more.

Don’t forget to push your clocks ahead an hour when you go to bed Saturday night—if you still have any clocks that do not set automatically. I will spare you my thoughts on moving the clocks twice a year, except to say I favor picking one standard and sticking with it. Here is a link to some interesting facts about daylight saving time, eight quick items, that I found interesting.

Have a great week,

Dennis

Past Weekly Rate & Market Updates can be found on my blog page at my website www.DennisCSmith.com/my-blog

Question of the week:  A look back at the ‘10’s decade from the lens of mortgages and the economy.

 Answer:  Last week we took at look back at 2019 for mortgages, housing and the economy. This week let’s take a look back to the beginning of the decade and compare it to the end of the decade.

We started the decade with the economy in the early stages of recovering from the Great Recession. While the recession ended in June 2009 (a recession is defined as two or more quarters of economic contraction, or negative Gross Domestic Product growth, a recovery starts when there is positive GDP growth after two or more months of negative GDP growth). Despite the economy starting to grow six months earlier, 2010 saw continued increases in unemployment and decline in housing prices for most of the country. The onset, depth and length of the recession were the result of a collapse in real estate markets across the economy that had been fueled by very easy to obtain mortgages.

One of the first results of the recession was the implementation of new policies for mortgages funded through Fannie Mae, Freddie Mac, using FHA or VA financing and eventually all lenders. As I said at the time, underwriting guidelines went back to the way they were when I started in the industry in 1987—you had to prove your income, verify your funds for down payment and closing costs were your own or source where they came from, and the property you were borrowing or refinancing had to have its value supported by an appraisal. While there has been some relaxing in underwriting guidelines over the past decade, most of the fundamentals remain the same for borrowers looking to obtain the least risky mortgages in regards to rates and terms.

Let’s look back at the data from 2010 and compare to today’s numbers and environment.

As we did last week, we will start with mortgages and interest rates. A big change in the mortgage market from 2010 is the maximum loan limits for Fannie Mae and Freddie Mac. In 2006 the conforming loan limit was raised to $417,000 and it stayed at this limit until 2017 when it was increased to $424,100; in 2020 the conforming loan limit will increase to $510,400. In 2008, to encourage home buying and enable more homeowners to refinance Fannie and Freddie added the “high-balance” loan limit for properties in high cost areas, such as Los Angeles and Orange Counties. This limit initiated at $729,750 for single family dwellings. In 2020 the new high-balance limit will be $765,600.

The decade started with the conforming mortgage rate at 5.125% (using the same parameters I use each Friday for rates in the WR&MU, purchase of a single family residence with 20% down and a borrower FICO score of 740). We end the decade with the conforming rate at 3.50%, and the conforming rate being at or below 4% for three-quarters of the year.

January 2010 saw the median priced home in the State of California selling for $284,600. Statewide the median home price bottomed out in February 2012 at $268,810. As mentioned last week the median home price in California in November 2010 was $589,770, 107% more than the at the beginning of the decade and 120% higher than the bottom in 2012.

More locally, as mentioned last week the median home prices in November 2019 for Los Angeles and Orange Counties were $594,840 and $822,000, like the state median, these prices were up significantly from January 2010. The LA County median price was $316,698 a decade ago, up 88% today from January 2010. Orange County’s median price was $527,477 in 2010 and has increased 56% from the median price to start the decade.

A very large factor in our economy this decade has been the actions of the Federal Reserve. To support the mortgage market, keeps rates low and push economic growth the Fed engaged in a few maneuvers. First and foremost it dropped its discount rate, used by banks to borrow money from each other, to near zero. This caused the Prime Rate, used by many lenders as their benchmark for consumer loans, to drop to 3.25% in December 2008 and remain at that level until December 2005. Today the Prime Rate is 4.75%, down from a post-recession high of 5.5% in August 2019.

Of much greater impact, and significance was the “Quantitative Easing” policies of the Fed. In November 2008 the Fed began purchasing Mortgage Backed Securities (MBS, these investment instruments are composed of bundles of millions of dollars of residential mortgages, mostly from Fannie Mae and Freddie Mac) and U.S. Treasury notes. By purchasing these investments the Fed kept money flowing through the debt markets enabling lenders to continue to make mortgages. The plan was to purchase $600 billion in mortgage debt (MBS) and $100 billion in other debt, mostly U.S. Treasury notes. By March of 2009 the Fed had accumulated $1.75 trillion, well beyond its initial target, and expanded the QE program, purchasing another $750 billion in MBS and $400 billion in Treasuries and other debt. By June 2010 the Fed’s balance sheet had grown from $870 billion in August 2007 to $2.1 trillion.

As the Quantitative Easing ended the  Fed, and others, were criticizing banks for not lending enough, banks countered that there were not enough credit-worthy borrowers. This led the Fed to start what became known as QE2. Starting in November 2010 and continuing to July 2011 the Fed purchased another $600 billion in MBS.

During this time the economy was growing, unemployment slowly began to level off and employers were slowing hiring instead of firing. Not fast enough for the Fed however. In September 2012 another Quantitative Easing process began. QE3 started with the Federal Reserve purchasing $40 billion per month of MBS, in December 2012 the Fed upped the amount to $85 billion per month, reduced the purchases of mortgages to $65 billion per month in July 2013 and stopped the policy in October 2014.

In 2017 the Fed began slowly selling off some of it assets to “normalize” its balance sheet. The selling stopped in august 2019 and the following month the Fed’s balance sheet hit a post-recession low of $3.8 trillion, today the Fed holds $4.2 trillion in mortgage, Treasury and other debt, almost four times the size in 2007.

This is significant moving forward because $4.2 trillion sitting in the Fed’s accounts is $4.2 trillion additional dollars in our economy, and enables the Fed to have even greater control over the economy than it has every had before. Keep in mind the Fed, ostensibly accountable to Congress, really isn’t and acts independently.

Some hard economic data numbers for the past decade for those who are data geeks like myself.

In 2007 the unemployment rate was 5.0% and inflation was a very robust 4.1%. Unemployment rose to 9.3% to start the 2010’s and was at 1.5%. In 2011 the nation experienced its twenty-sixth consecutive month of more jobs leaving the economy than being created.

Despite the recession ending in 2009, the year ended with GDP at 2.5%. By the end of 2010 the GDP was growing at 2.6%, through the 3^rd quarter of 2019 GDP was growing at 2.1% on an annualized basis.

We are experiencing economic history as 2019 will be the eleventh straight year of economic growth, the longest period in history. Will 2020 see a recession and break the historic streak? As I mentioned in last week’s WR&MU I do not think a recession is in the cards for 2020 unless some catastrophic or unexpected event occurs.

We have come a long way since 2010, economic and emotionally as workers and consumers have gone from fear to economic optimism and stability. What will the next decade have for us?

Have a question? Ask me!

Rates for Friday December 27 2019: It’s over! After ten straight weeks of no change in the conforming mortgage rate from Friday to Friday we see a change from last week. Mostly because of the mid-week Christmas holiday and light trading the conforming rate has dropped from last week, the high balance rate is also down.

FIXED RATE MORTGAGES AT COST OF 1.25 POINTS LOCKED FOR 45 DAYS:

30 year conforming                                            3.50%     Down 0.125%

30 year high-balance conforming                    3.75%    Down 0.125%

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 with 740 FICO score for purchase mortgages.

Reading through some of my Weekly Rate & Market Updates from 2008, 2009 and 2010 I found myself experiencing some of the feelings I had back then. In the first week of October 2008 the stock market plummeted, it ended the day down 30% from the year before. Leslie, the girls and I were on vacation in Scottsdale and as I watched the numbers come in on the alerts I had set up on my phone my stomach was in knots and my head was light. That evening I told Leslie, “this is really bad. I don’t know what we are going home to, what our future will be for Stratis if this continues.”

We made it through, not without some pain. Stratis never laid off an employee, though we did go to four day work weeks with our staff. Thankfully, we have had, and continue to have, great staff—almost everyone who was with us in 2008 is still with us. Because our business model has always been to concentrate on long-term fixed mortgages and quality over quantity, we have been able to retain our excellent referral bases from past clients and professionals in the real estate and other industries.

It has been quite a decade and we thank everyone who has stuck with us and Stratis Financial through not only the past decade, but the one before that.

I hope everyone had a wonderful Christmas and/or Hanukah with plenty of good times with family and friends. Cheers to 2019, to the 2010’s and for the joy and prosperity 2020 and beyond will bring to each of us.

Have a great week,

Dennis

Past Weekly Rate & Market Updates can be found on my blog page at my website www.DennisCSmith.com/my-blog