Weekly Rate & Market Update 8-12-16
Question of the week: I have a Fannie Mae loan, why am I not making my payment to Fannie Mae?
Answer: It has been a while since we did a review of how the mortgage rate markets work and with many new readers of the Weekly Rate & Market Update time for a primer on interest rates and mortgages. This will be the first in a several part series covering how mortgage markets work, how rates are decided and the relationship between rates and points.
At their core all loans are alike, they are a liability for you and an asset for someone else, your monthly expense is someone else’s monthly revenue. Whether a credit card, auto loan, student loan or mortgage the mechanics are essentially the same—you borrow money, agree to pay a certain rate of interest and to pay an agreed upon payment by a certain time.
After this basic lender-borrower relationship things get a bit complicated with mortgages. Long gone are the days of you getting your mortgage from your local bank and then going in on the first of each month and paying at the teller window. Today, it is almost certain that whoever funds your mortgage will not be the owner of the mortgage after a short period of time, and there is a good chance that someone else will end up collecting your mortgage payment in the future. Why? Because of “secondary markets.”
Here is how the secondary markets work. Note, for this exercise I am using Fannie Mae, however Freddie Mac or Ginnie Mae could be substituted for Fannie Mae wherever mentioned.
First from the borrower’s side: You call me at Stratis Financial and indicate you are buying a home and need a mortgage. We go through the application process and the result is we fund a $400,000 conventional, Fannie Mae mortgage for the purchase of our home.
We then sell the loan and the “servicing rights” to a large lender. (Servicing is the act of collecting payments from the borrower.)
The lender then puts your mortgage into a “bundle” with other mortgages. When a bundle is big enough, say $30 million of mortgages, it is then sold to Fannie Mae, with the lender retaining the servicing rights.
Fannie Mae then issues a bond type instrument called a Mortgage Backed Security (MBS) that is sold on the open market to investors, which could be individuals, insurance companies, hedge funds, mutual funds or pension funds (for instance in 2014-15 fiscal year CalPers held approximately $800 million in MBS).
From the investor’s side: You are looking to diversify your investments and want to purchase an investment with a fixed rate of return and less risk and volatility than many stocks hold, essentially a bond type investment. Looking at the returns on U.S. Treasury offerings and Mortgage Backed Securities you see a higher rate is paid on the MBS investments. You invest in MBS investment with rate of return of 3% on Fannie Mae mortgages. Every month you receive a payment for principal and interest on your investment.
Your investment income is paid by Fannie Mae with funds received for the mortgages in your investment from the servicer of those mortgages. The servicer receives the funds to pay Fannie Mae from individual borrowers making the monthly payments on their mortgages.
So the mortgage payment from the homeowner in Lakewood, California can ultimately be received by an individual investor in Des Moines, Iowa, or a government pension program in Brisbane, Australia.
You may have a Fannie Mae loan, but Fannie Mae does not own your mortgage, that is owned by an investor elsewhere. Fannie Mae is the conduit that provides capital, i.e. money, from investors to lenders so they can fund mortgages for homeowners. They are then the conduit to pass the homeowner’s monthly mortgage payments from the lenders to the investors. Instead of individual investors striking separate deals with thousands of lenders for their mortgages a more efficient market is created by investors purchasing MBS from Fannie Mae and lenders selling their mortgages to Fannie Mae.
The advent of the secondary markets had several positive effects for homeowners: standard underwriting across the country, more access for mortgages since you are not limited to your local bank or credit union, tremendous liquidity in the market so there are always funds available for mortgages and ultimately because of all these factors cheaper mortgages for homeowners.
It may not be the proper analogy but think about the mutual funds you own in your retirement account. Rather than going out and doing the research and purchasing stock in hundreds of different companies, collecting dividend payments and then reinvesting in the stocks, constantly analyzing the companies whose stock you own to see if they are performing as you expected and allow for the proper diversification in your account, you simply purchase shares of different mutual funds that have different objectives. The mutual fund then does the heavy lifting of determining which companies best fit the objective, switching investments through the years, and collecting and distributing dividends, etc. Similar to how mutual funds have made investing cheaper and more efficient for investors, so too have the secondary markets made obtaining home loans for investors cheaper and more efficiently.
For a look at how Mortgage Backed Securities started I strongly suggest watching The Big Short, or reading the book penned by Michael Lewis (who has several good books on financial markets and companies).
Next week we will look at Fannie, Freddie and Ginnie.
Remember, with Dennis it’s not just a mortgage, it’s your complete financial picture.
Negative economic data closes the week. After a strong increase in wholesale prices in June (up 0.5%) a complete reversal in the Producer Price Index in July, dropping 0.4%, puts doubt into the strength of any economic growth. Year over year wholesale prices are down 0.2%. The news is very friendly for lower mortgage rates.
Wholesale prices were not the only July disappointment. Retail sales for the month of July were virtually flat, 0% increase. Consumers spent money on automobiles but little else, taking autos out of the data and retail sales dropped 0.3% from June. This news is of concern as consumer spending accounts for 60-70% of economic activity in the United States, slumping retail sales can be the harbinger for future economic contraction. The flat retail sales in July is positive for mortgage rates.
Rates for Friday August 12, 2016: After a sharp spike in rates late yesterday Mortgage Backed Securities markets settled back down today on the poor economic news. Perhaps the best thing you can say about interest rates is, “they are boring…” Rates remain unchanged from last Friday and where they have pretty much been for the past six weeks.
FIXED RATE MORTGAGES AT COST OF 1.25 POINTS
30 year conforming 3.25% Flat
30 year high-balance conforming 3.50% Flat
30 year FHA 3.00% *** Flat
30 year FHA high-balance 3.25% *** 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 may have no points and credit towards closing costs, changes daily.
The Smith home is whole again with the return of our daughters from their four weeks at camp. How quickly the rhythms and energy can change when two teenagers are return!
I don’t know about you but the Olympics are giving me some sleep deprivation as I stay up well past my normal bedtime to watch incredible feats of athleticism and exciting finishes! I’m sure I’m not the only wishing NBC would put their pre-taped coverage of the big events earlier in the evening—of course those who want those events as late as possible are the ones paying the bills for NBC.
Enjoy the games!
Dennis
