Weekly Rate & Market Update 2-17-17
Correction: or rather addition, to last week’s question and answer about using assets for qualifying income. An important factor I did not mention is that many lenders require you have at minimum of at least $500,000 in assets in order to use assets for qualifying income.
Question: Why is the cost for a loan with 20% down more expensive than a loan with 10% down?
Answer: Doesn’t make sense does it?
It does if you are a mortgage lender, or Fannie Mae or Freddie Mac who is backing those 80% and 90% loan-to-value mortgages. Because if you are Fannie or Freddie you want to make money not loose money and one part of achieving that objective is to mitigate risk.
But isn’t it more likely that someone who puts 20% down less likely to walk away from their home and create a foreclosure than someone who puts 10% down? Yes, the person with more down payment is less likely to let their home go into foreclosure. However, as we saw during the housing crisis many families who lost their homes had purchased with 20% down, or more. Because of the cost of foreclosure to a lender, typically greater than 30% of the loan amount, the losses to a lender for a loan that originated as an 80% mortgage are greater than the losses for a loan that originated with a 90% mortgage.
Why? Mortgage insurance.
If your mortgage has a loan-to-value of 80.01% or greater the lender will require mortgage insurance. The purpose of mortgage insurance? Reimburse the lender a certain percentage of the loan amount should you go into foreclosure—that reimbursement is typically to 65% of the original loan balance.
Let’s say that Fred and Barney are purchasing homes next door to each other for $400,000. Fred is putting 20% down for a $320,000 mortgage and Barney is putting 10% down for a $360,000 mortgage. Barney is required to have mortgage insurance that adds $132 per month to his payment, but covers the lender for 25% of the original mortgage ($90,000).
Most studies show that a foreclosure costs a lender approximately 30% of the loan amount. In the above example the cost to the lender should Fred be foreclosed on is about $96,000. Add the cost of the foreclosure to the loan balance and the total is $416,000. Even if the loan balance has decreased and the home value has increased there is very little room for the lender to get out of the transaction at a break even. Should Barney go into foreclosure the cost to the lender will be about $108,000—but the lender will get a check for $90,000 and the lender will lose $18,000. But this is if Barney defaults on the first day of the loan and there is no change in property value.
Most foreclosures occur because there is not enough equity for the borrower to sell the property and pay off the loan. In the above example let’s assume that the biggest employer in town where Fred and Barney both work, Slate Rock and Gravel, shuts down. Thousands of residents in Bedrock have lost their jobs and unable to make mortgage payments. Prices fall 10% on Fred and Barney’s homes and each of them have paid down about $10,000 on their mortgages as the closing comes a few years after they bought homes and became neighbors.
Now Fred and Barney’s homes are worth $360,000, Fred owes $310,000 and Barney owes $350,000. Fred’s foreclosure costs the lender $93,000, plus his loan balance of $310,000 and the total cost to the lender is $403,000 on a home worth $360,000—the lender is looking at losing $43,000.
Barney’s loan balance is $350,000 and the foreclosure cost to the lender is $105,000, total for the lender is $455,000. The lender gets a check from the mortgage insurance company for $90,000 (25% of original balance), lender is now into the loan and foreclosure for $365,000, the lender is losing $5000 on the value of $360,000.
Why is the cost of the 90% loan less than the 80% loan? Because the loss exposure to the lender is less due to mortgage insurance. The lower the risk the lower the cost of the loan.
Remember, with Dennis it’s not just a mortgage, it’s your complete financial picture.
Lots of rate moving information this week. On the data side we had reports on the Producer Price Index, Consumer Price Index and Retail Sales for January. The big number for PPI was higher than expected and supports higher inflation, up 0.6%. However the support is a bit eroded when the numbers are dug into as the bulk of the increase was a spike in energy prices in January (up 4.7%). The year over year PPI growth remains steady at 1.6%. The Consumer Price Index data also exceeded estimates, also increasing 0.6%–also pulled up by energy costs. The big news in the CPI data is the year over year number showing price increases of 2.5%, above the Fed’s target of 2.0%. Retail sales in January were very strong, up 0.4%, despite a drop in auto sales. The retail sales jump is reflecting higher consumer confidence. Adding strength to the retail sales report was a very large revision upward in December sales to 1.0% growth for the month. The three reports provide very strong support to the Fed to raise its Fed Funds rate at its March meeting, and following the releases of the reports on Tuesday and Wednesday we saw a strong drop in Mortgage Backed Security (MBS) prices—which means rates increase.
Adding to the higher rate momentum was Fed Chair Janet Yellen’s tour of Senate and House committees giving testimony and answering questions. Her comments were about as close as a Fed Chair will come to saying “we are raising rates at our next meeting” as well she indicated the data appears to support multiple rate increases from the Fed this year. Ordinarily this would pop rates up, however we saw a Fed rate increase priced into the market during the rate run-up in November and December.
Rates for Friday February 17, 2017: Week to week stability remains the norm as we are unchanged for the third straight week as MBS rally on Thursday and Friday following the mid-week drop. The low prices in MBS (higher rates) on Tuesday and Wednesday equaled lows for the past six weeks and are showing as a point of resistance, we are in a tight range for rates so there is no advantage to floating and trying to beat the market at this point—lock when you can.
FIXED RATE MORTGAGES AT COST OF 1.25 POINTS
30 year conforming 4.00% Flat
30 year high-balance conforming 4.125% Flat
30 year FHA 3.50% Flat
30 year FHA high-balance 4.00% 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.
We got lucky with our French exchange student as we toured LA last weekend in perfect weather—she was Snapchatting and Instagramming to her friends in cold, wet France beautiful sunny beaches in Venice and Santa Monica and pictures showing the ocean and snow capped mountains from the top of the ferris wheel at the pier. This weekend, her last as she leaves for home Sunday, she is feeling a bit more at home with the weather.
Big storms are something I have always liked, and this weekend it appears I will be liking a lot. A reminder that with all the rain and storms this weekend and early next week, if you are thinking about buying a new home in the near future this is the time to look. Next weekend appears to be somewhat dry but in looking at homes you will find evidence of how they weathered the storms, any leaks, evidence of water coming onto the property or not draining properly around the house. Take advantage of the inclement weather to spot possible flaws in a home you may be considering to buy.
Enjoy being cozy with old movies and a fire this weekend as Mother Nature does what she does!
Have a great week,
Dennis
