Weekly Rate & Market Update 8-26-16
Question of the week: Why are there different prices for the same loan?
Answer: There is a difference between price and rate, it is an inverse relationship.
On the graphic above the dollar sign, $, representing the cash needed to close your transaction, includes down payment (if applicable), loan points, loan fees, appraisal, escrow and title charges, all the costs and money needed to close. On the right is the interest rate sign, %, this represents your monthly mortgage payment; your monthly payment goes up and down as the rate goes up and down.
As you can see by the teeter-totter, if your cash to close goes up your interest rate (and payment) go down. If your interest rate (and payment) go up your cash to close goes down. A simple relationship exists between the cost of your transaction and your monthly cost of the mortgage.
So to answer the question there are different prices for the same loan because you can choose to have a lower interest rate and monthly payment, or have a lower cost for your transaction and cash needed to close by having a higher interest rate and therefore higher monthly payment.
We have all heard the ads for “no cost” refinances, there are costs but they will not be paid by you in cash but rather will be paid for you by a higher interest rate.
How does this work, who pays the costs?
We do, the lender, pays the costs. The base costs for refinances are approximately $3000 to cover loan fees, escrow fees, title fees, recording fees, etc. We do not pay these fees on a no-cost refinance just because you asked or we are really nice (we are really nice but not enough to go paying $3000 out of pocket for everyone). As the interest rate increases we are paid what is called a rebate, or yield spread premium, for the higher rate. We use this premium from the higher rate to pay the fees on the transaction.
That is one way a loan can have different costs and rates. The other is what is known as “tiered pricing.”
Not all loans are the same, nor borrowers. Because of this there are pricing adjustments for different factors in a mortgage file: FICO scores, type of property, type of transaction, loan-to-value.
A borrower with 800 FICO scores purchasing a single family residence with 30% down payment getting a $400,000 mortgage will not get the same rate at the same cost as a borrower with 640 FICO score purchasing a condominium with 20% to use as a rental with a $400,000 mortgage. Since the investment condo buyer is a higher risk his cost for the same rate will be significantly higher.
How much higher? In the current market only Fannie Mae has guidelines for the condo investor and the “add-ons” to the loan from Fannie Mae are (in points**): 3.375 for investment property greater than 75% LTV, 0.75 for condo greater than 75% LTV, 3.00 points for FICO score between 640-659 and LTV between 75.01% and 80%. The total add-ons for the condo investor is 7.125 points. ** One point is equivalent to one percent of your loan amount, so if the loan is $100,000 one point is $1,000. In the example provided 7.125 points on a $400,000 mortgage is $28,500.
Using the teeter-totter, for the same price on their transactions the 30% down home buyer with excellent credit scores would have a rate of 3.25%. At the same cost the condo investor would have a rate of 5.00%. Both have a 30 year fixed rate mortgage, but tiered pricing results in a much higher interest rate for the riskier mortgage.
One of the most basic economic axioms is the greater the risk the greater the return. Such is the case in the mortgage industry where investors in Mortgage Backed Securities (covered in the August 8th Weekly Rate & Market Update, link on right margin of this page) will get a greater return for investing in the riskier condo mortgage than the less risky homeowner transaction.
When researching your mortgage make sure the definitions of “no-cost” are the same for everyone you may speak to, some include third party fees such as escrow and title and others do not. Ignore the terminology and get information on what your cost out of pocket, or added to your loan amount, will be for what rate. When you call me I will always give you the cost and the rate options so you can see the options available on your personal teeter-totter and make a decision that is best for you and your family.
Next week we finish our series on how mortgages work with a look why rates drop when the market is good and go up when it is bad—inverse to how stock markets usually react.
For those just catching up here is the series so far (links on the right margin of this page)
8/12/16: I have a Fannie Mae loan, why am I not making my payment to Fannie Mae?
8/19/16: What are Fannie Mae, Freddie Mac and Ginnie Mae?
Remember, with Dennis it’s not just a mortgage, it’s your complete financial picture.
Some mixed data this week. After leading the economy for the past few years it appears housing may be taking a breather. New home sales saw a sharp jump, a 12.4% increase from June—pushed most likely by discounted prices as the median price dropped 5.1%. The price decline pushes year over year prices down 0.5%. Existing home sales slipped in July 3.2% in sales from June and the national median price dropped 1.6% for the month—though still positive 5.3% from July 2015. The news is somewhat positive for mortgages, a slowing housing market can foretell a slowing economy since housing has been one of the few strong sectors in the economy.
A rebound in manufacturing provides a positive sign for the economy as Durable Goods Orders in July surged 4.4% after dropping 4.2% in June. Despite the jump in July orders the year to year data shows a decline of 3.3% in this index that is a key gauge to economic strength. The news is somewhat negative for mortgage rates, but only if the strong July increase is followed with an increase in orders in August.
Federal Reserve Chair Janet Yellen pulled out the same comments she has been using in 2016 when discussing future increases to the Fed’s rate to borrowing banks. To summarize: strong case to bump rates since labor markets are strengthening and economy appears to have prospects of moderate growth. When she said this in January everyone anticipated another rate increase in March. When she said it in February, March, April…everyone anticipated a rate increase in June. When she said it in July and now August….investors shrugged and asked, “where’s the wolf?”
Rates for Friday August 26, 2016: {yawn, stretch} What a boring rate market. As I have been writing for several weeks there is nothing happening in the economy to change the current investment patterns in Mortgage Backed Securities. Bond markets are floating within a very tight trading range which results in very (very) stable rates. In fact the 30 year conforming rate has been virtually flat since July 1st.
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.
School is starting next week but the season gets underway for us tonight. My kids, and many others, will be playing in the Poly High School Marching Unit tonight at Cerritos College when the Long Beach Poly Jackrabbits take on the Los Alamitos Griffins. I love Friday night high school football and looking forward to the start of the new season and the expectations that come with it. And also like seeing the hard work and results that show on the field at half time and in the stands from the Poly Band!
Have a great week,
Dennis
