Mortgage News: March 2007

Friday, March 02, 2007

Time to Get Rid of the "Pig" from Your Mortgages Back?

As you know, thousands of home buyers over the last few years have used a piggyback mortgage such as a 80/20 or 80/15.

Many of the second mortgages were based on an adjustable rate mortgage indexed on the ever increasing Prime rate.

Over the last 24 months, the prime rate has increased from 5.5% in Feb. of 05 to 8.25% currently. Many of the second mortgages are now fully-indexed at rates well over 10.00% with the first mortgages of 6.5% or higher.


If you have an adjustable rate mortgage you really need to understand what this means. Here is the calculation for fully-indexing a mortgage:

Index + Margin = Mortgage Rate
Index = Prime rate, Treasury Bill, LIBOR, etc
Margin = Arbitrage spread of the mortgage lender. Typically 2.5% - 7.5%.
Index (prime rate - 8.25%) + Margin (say 3.00%) = 11.25% Mortgage Rate.

For some, this may be an excellent opportunity to refinance considering that the effective "blended rate" of their first and second mortgages may be higher than the current mortgage rates of a single loan.

Blended rate is the actual monthly payment costs of both mortgage loans.

Here is an example assuming a $550,000 purchase using a 80/20 piggy back mortgage. View piggyback mortgage calculator.

First Loan: $440,000 at 6.5% = $2,781
Second Loan: $110,000 at 10.0% = $965

So assuming the current jumbo mortgage rate is 6.75% most people would not think of refinancing since the mortgage rate is .25% higher than they are currently paying. But here is why it's important to review your mortgage.

Using this blended rate mortgage calculator, you can see that combined (or blended) mortgage rate is actually: 7.20%

So if you can refinance your existing two mortgages which are 2 years old into a new single loan at say 6.7%, you would actually save .5% a year in mortgage interest on $550,000, which is $2,750 a year or $229 a month.

You would have a few options with this money.

A) You can deposit $229 a month into a savings account like hsbcdirect which is currently paying 6%. $229 a month will compound to a savings account of $16,286 in just 5 years, $37,945 over 10 years and $231,413 over 30 years.

B) You could get a 25 year loan at 6.75% and have monthly payments of $ 3,800 which is only $54 a month more but could save you a 36 months of $3,800 or $136,000 in future mortgage payments.

C) You could use the savings to pay down high rate credit cards.

D) You could support your Starbucks habit of two venti lattes a day.

E) Fund your kids piggy bank.

If you are currently in the above scenario, use the mortgage calculators indicated to determine if you should get rid of the pig and save some bacon.

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Thursday, March 01, 2007

Freddie Mac - Dropping the Bomb on Sub-Prime Loans and Possibly Real Estate Prices

Couple days ago, Freddie Mac announced changes to it guidelines which will take effect on Sept. 1, 2007. This is due to the demands of OFHEO the Interagency Guidance on NonTraditional Mortgage Products release from October last year. Freddie reponded, Fannie as yet to do so?

So regrading the Freddie Mac response, which may be a very good indicator of things to come from all other lenders and it's impact will be felt everywhere. Here is one of the two main highlights:

Freddie Mac’s new requirements cover what are commonly referred to as 2/28 and 3/27 hybrid ARMs, which currently comprise roughly three-quarters of the subprime market. Specifically, the company is requiring that borrowers applying for these products be underwritten at the fully- indexed and amortizing rate, as opposed to the initial "teaser" rate.

What's important.

A) Borrowers must qualify for loans that are underwritten at the fully-indexed and fully amortized rate... not the "Teaser" rate.

How big is this. Here is where I commented on this in the past but we will review it again because the new guideline is saying "fully amortized" AND "fully indexed" on 2/28 & 3/27 which previously qualified at the "start rate", within the last month at the fully amortized rate but now at the fully indexed.

So, using a scenario: 2/28 Interest Only, 600 FICO score can go 50% income to debt ratio, 80% LTV.

Current start rate would be: 7.750% interest only. The LIBOR index as of today is 5.032 and a margin of 5.5%.

So let's see the impact of this for borrowers who have $500 in revolving debt and makes $60,000 a year. Note that I'm not including property taxes and insurance as this varies around the country and this example is to simply show the impact.

Qualifying at start rate as done for the last three years:

50% income to debt means they qualify for payments of $2,500. From this we deduct the $500 in revolving.

$2000 is the interest only P.I. payment the borrower qualifies for a maximum loan of: $309,000 at 7.75% interest-only.

Now, under new Freddie Mac Guidelines at the fully-amortized and fully indexed rate.
First let's calculate the fully indexed rate. We must perform this calculation:

Index + Margin = fully indexed rate.

6 month LIBOR - 5.032% + Margin - 5.50% = 10.32% fully amortized and fully indexed rate vs. 7.75% interest only.

So assuming the same $2,000 monthly payment the borrower now qualifies for a maximum loan of: $221,980

A max of $221,980 vs. $309,000... ouch.

As you can see from this, it drops the borrowers qualifying by 28%, less loan... less house.

So again, buyers will qualify for loans that are 28% less... that's a huge number.

So now onto the second main point from the release:

The company also will limit the use of low-documentation products in combination with these loans. For example, the company will no longer purchase "No Income, No Asset" documentation loans and will limit "Stated Income, Stated Assets" products to borrowers whose incomes derive from hard-to-verify sources, such as the self-employed and those in the "cash economy." There will be a reasonableness standard for stated incomes.

Many buyers over the last three years of used the "stated income" loans, especially borrowers whom are actually employed with a company and receive w-2's. Many of this borrowers who technically have verifiable income used these "stated income" loans in order to be able to qualify for a large loan amount by falsely stating an inflated income.

Hence the reason why these types of mortgages are often called "liar loans".

My personal feeling is that this was the fuel to the dramatic increase in real estate prices over the last three - four years.

So recent homes buyers who really made $45,000 a year used a "stated income loan" and stated that they made $60,000 in order to be able to qualify for the required larger loan amount.

If we apply this to the above scenario that same borrower would now have to state an income of over $78,000 to qualify within the 50% income to debt ratios.

That is an increase of over $18,000 or a 30% increase in the income actually necessary to qualify... not going to be very believable or smart.

This causes another problem, where all the salaried people that have used this type of loan to purchase a property above their means, may no longer qualify for any type of refinancing, as they technically no longer qualify for a mortgage if they must go full doc. and verify their income. This makes them stuck with fully-indexed at 10% or higher.

From the sub-prime wholesale loan representatives in California and data I've seen, the stated income 2/28 loan made up as much as 60% of all subprimes loans funded in California.

This is especially true in high-cost areas where home prices are so high, these programs where the only way for people to buy a home... unforetunately a home they cannot afford.

So what is the impact?

Real estate prices are driven by basic supply and demand principals.

From 2001-2004 there was low inventory (supply) of homes for sale and high demand (due to low mortgage rates and relaxed guidelines) - prices go up.

Today, supply is high and demand is low - prices should go down.

Supply of homes for sale is skyrocketing across the nation. You still have the builder supply of approximately 1 million "must sell" homes and the massive inventory of existing homes for sale.

Soon you will have additional "must sell" inventory of bank REO properties to add to the equation.

With the tightening of mortgage credit such as the Freddie Mac guidelines you will also see the drop in demand from borrowers because they can no longer qualify for homes at the current prices based on the new mortgage financing guidelines.

This means that home prices will drop.

How far? Who really knows but in order for home sellers to reach the 20-30% of the buyers market represented by the sub-prime loans, they will need to drop 25% or more.

This is not out of the question considering Sarasota-Bradenton Florida has already dropped 18.2% in one year.

Additionally, keep in mind that in the last three years millions of borrowers have purchased homes using these "stated income" loans... take away the stated-income loan and how are these people going to refinance to avoid the increase payments of the adjusting 2/28 mortgages?

How are home buyers going to react when they have to use traditional mortgage qualifying guidelines and they realize they cannot afford a home?

Share your thoughts on this situation.

View the entire Freddie Mac Response

Here is a video from PBS commenting on the issue.

Use these mortgage calculators to help you calculate your payments.

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