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3-23-18: What should I look for in a Home Equity Line?

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Question of the week: What should I look for in a Home Equity Line?

 

Answer: With equity building, rates rising and prices continuing to climb we are getting more and more inquiries from clients looking for Home Equity Lines of Credit (HELOC) to remodel homes or for other purposes.

 

Before getting a HELOC some questions I have clients answer to be sure that is the correct route for them to go to meet their needs:

 

  • Can you accomplish what you want with a cash out refinance? The rate on a refinance may be lower than a HELOC, and depending on your current rate and payment may be better in the long run. Yes your rate may go up but it will be fixed and over time you may be paying less for the funds you need.

 

  • If you are looking to remodel and/or add on to your home is what you want in your home available on the market? Instead of converting your two bedroom one bath to a three bedroom two bath home, can you buy the home you want in today’s market? What is the cost of the new home? How do the payments compare to your final costs after the remodel? Do you want to live with a contractor handing you coffee and a newspaper every morning for several months?

 

  • Do you know how a HELOC works?

 

If you go through your due diligence and a HELOC is what you need, what should you look for when comparing different options on the market?

 

Before we discuss what to look for a quick primer on how a HELOC works. This is not a fixed rate loan, it is adjustable and it can adjust at any time. As a rule the base rate for your HELOC is the Prime Rate (what a bank charges its clients with the lowest risk is the standard definition). Prime is not tied to anything, in the past different banks have had different Prime Rates and they were all published in financial media, today most banks have the same Prime Rate. When does the Prime Rate move? Whenever a bank feels it needs a better return on its loans, typically when one major bank changes its rates all other follow.

 

For the past few decades banks have moved their Prime Rate in conjunction with the Federal Reserve’s Federal Funds Rate, the rate banks charge to borrow from each other through the Federal Reserve. This week when the Fed increased the funds rate by one-quarter of one percent (0.25%) banks immediately increased their Prime Rates, as a result the Prime Rate went from 4.5% to 4.75%. As the Prime Rate increases and decreases so does the rate on your HELOC.

 

HELOCs then operate like a credit card, you have a credit limit and can borrow within that limit and pay back as much as you like at any time, and you have a minimum payment due every month based on your balance. If you have a HELOC with a $100,000 limit and borrow $25,000 then you owe at minimum the interest on the $25,000 every month (some banks have a 1% repayment rule, or interest only whichever is greater). As long as your HELOC line is open to drawing against it you can run the balance up and down as often as you like within the credit limit.

 

 

If you get a HELOC is your rate the Prime Rate? Maybe, but most likely not. This leads to one of the important factors about a HELOC you need to know when comparing options:

 

  • What is the margin? We discussed that your rate is tied to the Prime Rate, but that is not necessarily your rate. Your rate will be the Prime Rate plus a margin. The margin is a fixed amount throughout the loan. Perhaps the bank is running a special and you can get Prime with no margin, but generally there will be a margin anywhere from a quarter percent (0.25%) to one and a half percent (1.5%) or higher depending on many factors. What is important to you is what is the margin. If Prime is at 4.75% and you have a 1% margin to start your rate is 5.75% on whatever balance you have outstanding—until the next time the Prime Rate moves at which point your rate will adjust. Whatever your margin is added to Prime is your rate, the margin will remain fixed but your rate adjusts with Prime.

 

  • What determines the margin?
    • First and foremost your margin will be determined by your credit score. The higher your score the lower the margin, which makes sense. If you have a lower credit score you are considered a higher risk than someone with a higher score, so your margin maybe 1.5% while someone with a much higher score may have a margin of 1%.
    • Second, what is the amount of money you are looking for? It seems counter-intuitive but generally the more you want as your maximum limit the lower your margin may be. If you get a line for $50,000 the margin maybe as high as 2%, but if you get $250,000 it may be 1%.
    • Third, what is the total loan to value? If your home is appraised at $600,000 and you owe $300,000 then the loan to value (LTV) is 50%. If you want an equity line for $100,000 the total LTV will be 67% (300,000 + 100,000 = 400,000 divided by value of 600,000 is 66.66666% or 67%). If you want an equity line of $180,000 then the LTV is 80%. Generally, the higher the LTV the higher the margin.

 

  • What are the terms of the HELOC draw and repayment period? Is your line open and available for use for ten years, fifteen, twenty? If the line is shut down for use before the balance is due what are the repayment terms for the final years of the loan? Can you continue to make interest only payments? Does the loan become fully amortized for the remaining term of the loan? Is there a potential balloon payment? These are very important terms to know as they will dictate what your financial obligations will be in the future. If the loan begins to fully amortize for five years after you use it for ten will you be able to make those payments (for instance you have $80,000 balance and your rate is 6% when the HELOC shuts down and is fully amortized your payment at that rate would be about $1550 per month)? What if it has a balloon and you did not do a good job of making principal payments, where will you come up with $80,000, $125,000 or even $25,000, when the time comes.

 

Before getting into a HELOC look at what will happen in the future, know how your rate will be determined by knowing the margin, know how you will have to repay the debt in the near term but equally important later in the loan when the repayment terms may change.

 

HELOCs can be very beneficial financial instruments, but like all financial tools they work best when used properly.

 

If you have any questions about HELOCs or want some help deciphering different options being presented to you please do not hesitate to contact me for assistance.

 

As well, if you currently have a HELOC and are concerned about your rising interest rate and possible repayment challenges in the future (i.e. fully amortized payment and/or balloon payment) please call me to discuss options for refinancing and if that is an option that makes sense for you and your family.

 

Have a question? Ask me!

 

Rate moving news this week did not come from our usual sources of economic reports from various government or private agencies. The first announcement was the Federal Reserve Open Market Committee (FOMC) that it was raising the fed funds rate by one-quarter of one percent (o.25%), which as discussed above resulted in an increase in the Prime Rate to 4.75%. The rate increase alone had no impact on mortgage rates as the markets had fully anticipated the move and it was already priced into our rates a long time ago. What can move mortgage rates are comments from the meeting and Fed Chair Jerome Powell that may indicate the Fed will engage in three more rate increases this year instead of the previously announced two more increases. There were no comments or statements that indicated a change in the rate increase schedule for 2018 and markets reacted somewhat favorably.

 

Yesterday the Trump Administration announced tariffs of about $50 billion worth of certain Chinese imports. The immediate announcement caused stock markets to drop about 2% and the sell-off proceeds were put into bonds and mortgages, leading to a dip in rates. Later as considerations were given to possible retaliation from China one target stands out—U.S. debt. China is the largest holder of United States Treasury bills and bonds, with almost $1.2 trillion. Should China start a significant sell off of their holdings it will cause rates to climb, how much would depend on how much debt China wants to bring to market. The potential retaliation from China caused rates to reverse yesterday into correction mode after their initial dip.

 

Rates for Friday March 23, 2018: Some movement in the price of conforming rates this week, but we end the week steady from last Friday. On the higher side we saw the high-balance conforming rate (loans from $453,101 to $679,650) gave back their brief dip from last week. Rates are volatile for many reasons and I expect rates to have more pressure to move up than down, I retain my mantra of locking as soon as you can through your escrow period.

 

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

30 year conforming                                            4.25%       Flat

30 year high-balance conforming                      4.5%         Up 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.

 

 

Regular readers of the WR&MU know this last section is usually something personal going on in my life. It is a bit longer than the usual short paragraph or two, but I hope you indulge me and give it a read.

 

Many of you know I am a member of the Rotary Club of Long Beach. I am proud of my membership, not only in our local club that contributes tens of thousands of dollars to assist local non-profits every years, has purchased hundreds of thousands of dollar in books for local schools and every year provides hundreds of thousands of dollars in scholarships to students at Long Beach City College and Cal State Long Beach; but also proud to be part of Rotary International.

Rotary International could be looked at as the primary organization responsible for the nearly complete eradication of polio around the world. Taken on as a primary mission in the 1950’s, Rotary clubs around the world raised funds and volunteers to vaccinate children from Boise to Bangkok, Tulsa to Tunisia. Today there are only a few new cases of polio every year and Rotarians continue to administer the vaccine around the globe to the disadvantaged.

 

Lack of easily accessible clean water is incredibly debilitating to a community. Disease denies children to opportunity to go to school or adults to work, lack of sanitation and ability to properly clean increases the spread of disease. Some villagers, almost always women and their daughters, spend hours each day walking to and from the nearest source of water—not clean but water. Agriculture is poor, if existent, due to lack of water available for irrigation. In sum, it is practically impossible to turn around a community that is under-educated, in poor health and lacking economic activity if it has no clean water source.

 

With the overwhelming success in fighting polio the organization began to look at how it could impact the world again. Water. Clean water for everyone has become a universal cause for Rotarians. Millions of people around the world do not have access to clean water to drink, cook or clean with. Our club is very active in this effort and this past year some of our members were key players in raising funds and partnering with Water Underground to drill wells for four villages in Mozambique.

 

Below is link to  a video of one village on the day its well was tapped and fresh water came shooting from the ground. This was one of the wells our club was primarily responsible for funding. Watch these villagers and consider how so very fortunate we are to have some we consider so simple, getting water to drink, cook or clean with, from a tap.

 

After this video was shown at our club meeting Wednesday those present quickly made donations to pay for one more well in Mozambique. Sometime next year another village of a few thousand people will dance in the water shooting from the ground.

 

Here is the video (click on the “Watch our 2017 film” box embedded in the bottom of the video on the home page). Take a few minutes to watch it, you will be glad you did.

 

Have a great week,

 

Dennis

3-16-18: What is the difference between Fannie Mae and Freddie Mac?

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Question of the week: What is the difference between Fannie Mae and Freddie Mac?

 

Answer: Before we look at the differences between Fannie and Freddie a quick recap as to what they are. Fannie and Freddie are currently owned by the United States government and regulated by the Federal Housing Finance Agency. When you hear or read about “conforming” or “conventional” mortgages, know the reference is to Fannie and Freddie mortgages.

 

Here is how they work. When your conventional mortgage funds the lender will bundle your mortgage with tens of millions of dollars of other mortgages and sell them to Fannie Mae or Freddie Mac. They will then create a bigger bundle, think hundred million, and sell Mortgage Backed Securities (MBS) to investors. So your home loan in Cypress, California becomes an investment for the Shreveport Municipal Employees Pension Fund.

 

Side note: investors purchase MBS as an alternative to US Treasury bonds or other long term fixed rate investments. When investors are buying MBS rates go down, when they are selling, or not buying, rates go up.

 

When investors purchase the MBS of conventional mortgages they do so with the understanding that all the mortgages in their investment have been underwritten and funded under the guidelines of either Fannie or Freddie, depending which on whose mortgages they are buying.

 

To review, your mortgage is underwritten to either Fannie Mae or Freddie Mac underwriting guidelines, after it is funded by the lender it is sold to whichever entity whose guidelines were used to approve the loan, it is then sold as part of a larger package of mortgages to investors.

 

The differences between Fannie and Freddie comes down to their underwriting guidelines. For decades Freddie was known for somewhat looser underwriting standards, in the past few years Fannie has altered several of its guidelines to align with the Freddie guidelines.

 

There differences between the guidelines between the two are not many but useful to know when certain situations arise. For instance for income qualifying Freddie may only require one year tax returns in situations where Fannie may require two years. Certain property requirements are easier for loans going to Freddie as well—for instance we recently had an issue with a property that had a shared private road, Fannie Mae has some challenging requirements regarding maintaining that road whereas Freddie Mac does not have any requirements. Certain instances of how credit and debt are considered, use of co-signers and funds can also vary between the Fannie and Freddie guidelines.

 

If we go into all the differences your eyes will roll back in your head, actually after a few you will quit reading, but there are enough differences that somewhat frequently we will determine to use fund a loan using Freddie guidelines instead of Fannie, or vice-versa, because we need to in order to get the loan approved and funded.

 

Have a question? Ask me!

 

Prices and sales dominated economic news this week. Inflation was subdued in February, the Consumer Price Index rose 0.2% from January and was up 2.2% from last February; strip out volatile food and energy prices, which is what the Fed does when gauging inflation, and prices were up 1.8% from 2017 which is below the Fed’s target 2.0% inflation rate. Wholesale prices were also benign with the Producer Price Index also up 0.2% for the month and 2.5% for the core rate (less food and energy). The price data does not support the Fed looking to alter its stated course of three rate increases of 0.25% this year. Also not support more aggressive rate increases was the retail sales report. Retail sales dipped 0.1% in February from January, a bit counter to expectations with strong job growth and rising wages; an interesting aspect of the report was that nonstore sales jumped 1% from January.

 

Proceed with caution is the advice for the coming week. On Wednesday the Federal Open Market Committee will announce its decision on whether the Federal Funds rate is being increased. The overwhelming consensus is the Fed will bump the rate 0.25% at its meeting, the first of three expected for the year. This rate increase is already priced into the mortgage markets so if there is a 0.25% increase there should be no impact on mortgage rates. Key word in that sentence? “Should.” If the expected rate increase is what is announced, investors will then read with great interest the statement accompanying the rate announcement. Is there any statement regarding following labor markets more closely, concern or attention to wage inflation, changes in expectations for economic growth? Investors will be parsing the statement to see if there is a hint, or a hint of a hint, that the Fed may have four rate increases this year instead of the expected three, or that one or more of the hikes could be 0.5% instead of 0.25% their reaction will be to sell of bonds and Mortgage Backed Securities and we will see rates jump up on Wednesday afternoon.

 

Rates for Friday March 16, 2018: Conforming rates hold steady for another Friday and we see high-balance rates (loans between $453,101 and $679,650) dip after three flat weeks.

 

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

30 year conforming                                            4.25%       Flat

30 year high-balance conforming                       4.375%      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.

 

Arghhh. Why  did I change my bracket at the last second and put in Arizona to make the Final Four instead of Virginia? Because I over-thought it. It’s a mistake I try to avoid in business and working with clients—don’t over think, the solution is right there just implement it—but when it comes to trying to predict sporting events I tend to over-think which is good for my friendly competitors but frustrates me.

 

A great weekend to be a bar owner with St. Patrick’s Day falling on a Saturday night. I am going to assume the take in the collection plates on Sunday morning will be a directly reciprocal to the take in the tills of the drinking establishments on Saturday night. According to Wallethub.com beer consumption tomorrow will be 152.5% greater than usual, and Guinness sales will be 819% higher. I tend to enjoy Guinness throughout the year, why restrict such a fine beverage to only one day? Not only will purveyors of Guinness benefit from the Irish holiday, but so will cabbage sellers and transporters as the cruciferous vegetable sees a 70% increase in shipments the week of the green.

 

Have a fun, and safe, St. Patrick’s Day,

 

Dennis Cleary Smith (now you know what the “C” is for!)