Archive for the 'Mortgages' Category
Mortgage Rates Increasing on Inflation Fears
Mortgage rates have ticked upward over the past few days in response to market activity around the 10-year Treasury Bond. According to BankRate.com, the average interest rate for a 30-year fixed mortgage has increased from 5.00% to 5.39% in just a few days.
An article in today’s Wall Street Journal goes so far as to proclaim that “Mortgage Rates Surge, Sap Hopes.” They cite similar interest rate figures from a different source and quote two people from Greater Hartford about the impact on their refinancing activities. One, a mortgage banker, has put about 50 refinancings on hold because the higher rates make the deals non-economic.
Conversations about the economy have been focused on avoiding a recession over the past year. Last February we wrote a post about the balance between recession and inflation, tying it to mortgage rates. At that time the Federal Reserve was lowering short-term interest rates in hopes of avoiding a recession. We reached a critical point in September, resulting in bank bailouts and other Federal interventions to support the economy.
The trigger for the recent rise in interest rates seems to be increased confidence in the economy. The stock markets have rallied since hitting lows in early March, suggesting that investors are more willing to take on risk. Moving into riskier investments has two primary consequences:
1. Selling pressure on the safe-haven securities that investors poured their money into when the future looked bleak. US Treasury Bonds are a major safe-haven asset due to widespread belief that the US Federal Government cannot default on its obligations. Selling pressure on bonds causes their value to go down, but their yield (interest rate) to rise.
2. Concern about future demand for the tremendous amount of US Federal Government debt, which takes the form of US Treasury Bonds. There is already a considerable supply available in the market, and more is scheduled to be auctioned to support the various stimulus programs. If demand decreases, then the government will be forced to offer higher interest rates in order to attract buyers.
Investors have reversed course and are now concerned that the Federal Government is doing too much. They are creating too large a deficit. They are issuing too much debt. They are ultimately printing too much money. Investors fear that all of these things will lead to inflation. Yesterday’s Wall Street Journal cover article goes into more detail about how all these pieces interact.
So what is a home buyer to do?
The first thing to realize is that even after the recent increase, mortgage rates are still very attractive from a historical perspective. We’ve had a number of years of low rates that were enabled by all of the fancy risk-spreading techniques that ultimately collapsed.
Looking back since 1990, Federal Housing Finance Board data shows that mortgage rates used to be higher – generally 7% or above before 2002. Maybe they’ll head back to those levels; maybe they won’t.
Buyers currently engaged in a search should make sure their price range is appropriate for the current interest rates, and would still be okay if rates rose a little more. You don’t want to be in the position where you find a home at the top of your price range but can no longer afford it because of a mortgage rate increase.
If buying a home is important to you, then you should proceed as planned. Maybe you won’t lock in your rate at the absolute low. But in 3 years you might be very happy with the rate you received. And if this is a temporary spike, and rates move lower again, you will always have the option to refinance.
$8,000 First Time Buyer Tax Credit Change
In keeping up with the latest news, there was been a significant change in one of the current Administration’s tax credit programs. Yesterday, the Secretary of HUD announced that FHA is going to permit its lenders to allow home buyers to use the $8,000 tax credit as a down payment when obtaining a government insured mortgage.
This is a change in the way that the program had been setup when it arrived as part of the American Recovery and Reinvestment Act of 2009. The law states that qualifying homebuyers may claim up to $8,000 (or $4,000 for married individuals filing separately) on either their 2008 or 2009 tax returns. Before this change, homebuyers would have to wait until they filed their 2008 or 2009 returns to receive the credit. Now, FHA consumers can access the homebuyer tax credit fund when they close on their home loan so that the cash can be used as a down payment.
The details on this are not scheduled for release until next week. We’ll have a more in-depth post on this next week, but wanted to get the information out there, as this can significantly impact the market for some buyers. Yay!
West Hartford Sales Contracts
Real estate activity in West Hartford feels like it has really picked up over the past few weeks. Agents are buzzing around like busy bees, and houses are going under contract. We’re seeing some homes sell very quickly after they are offered for sale, and we’re seeing multiple buyers compete for properties. There is clearly still broad interest in living in West Hartford.
I was curious to see if the data supported our “feel” for the market, so I decided to try to look at the number of homes that went under contract in the town of West Hartford since the beginning of the year. My initial plan was to plot the number of contracts written on a week-by-week basis and then compare that to last year. Unfortunately, I was foiled by the MLS data source. We are only allowed to see the date on which a property went under contract after the listing agent moves it to “Deposit” status.
Properties flow through five standard categories in the MLS during the sales process. They go from “New” to “Active” to “Show” to “Deposit” to “Closed.” The “New” status helps flag new inventory for agents and lasts for a maximum of 7 days before a property is automatically moved to “Active.” Homes that are considered “for sale” are in either “New” or “Active” status. Once an offer has been accepted, the listing agent sets the status to “Show,” which means that buyer’s agents can still show the home to other potential buyers just in case the current deal falls apart. Since most deals stay together, we don’t typically show properties in “Show” status. There are no formal rules about when a property moves to “Deposit” status, but most agents wait until the mortgage commitment contingency has been satisfied.
Which brings me back to my data problem. Most of the recent contracts have not achieved “Deposit” status, so I’m not allowed to see the date on which it went under contract. All I can see is that of the 176 contracts that have been accepted so far in West Hartford in 2009, that 52 have closed already, 53 have reached Deposit status, and the remaining 71 are in Show status. Circumstantial evidence that there has been a flurry of deals, but nothing concrete.
The research got me thinking about the number of contracts written each month versus the number of closings during that month. Agents do a lot of work in the spring, but the results don’t show up until later when the closings actually happen. And West Hartford in particular seems like a town where people like to close during school summer vacation. Below is the number of contracts written versus the number of closings for each month in 2008.
From January through May, the number of contracts exceeded the number of closings by a considerable margin. In June, the number of closings nearly doubles, setting the stage for more closings than contracts through September. Contracts written has a final hurrah in November, followed by a spike in December closings.
The real estate market is busiest when buyers and sellers are agreeing to contracts. That’s when the action is for the agents too – we have to be able to keep up with all of our buyers and sellers. Once the contract is in place, the focus shifts to the inspection, mortgage and legal team members as buyers work through their purchase contingencies on their way to closing.
The time between a buyer and seller signing a purchase contract and the actual closing can vary considerably. What’s hidden in the chart above is that contracts written earlier in the spring tend to close more slowly than average. And contracts written over the summer tend to close more quickly than average.
Although every situation is different, contracts written during March, April and May take noticeably longer to close than those written in July and August. There’s not really any way to prove motive, but the trend seems to support the hypothesis that closings are intentionally scheduled within the summer school vacation if possible. Deals negotiated in the spring extend the closing, while deals negotiated during the summer accelerate it. Deals negotiated when the summer school vacation is not in play cluster around 40 days to close.
So there we have it – a meander through real estate purchase contracts, MLS statuses and days to close. The data seems to support my mental models about both when the real estate market is most active and that West Hartford buyers and sellers tend to work around the summer school vacation. Hopefully I’ll remember to look into my initial question once the 2009 data is available…
To Refinance or Not To Refinance (part 2)
Yesterday we went over some of the reasons why the current low interest rates are unlikely to spur a dramatic wave of refinancing activity. However, trying to capture a lower interest rate may make sense for homeowners that have equity in their property, strong credit scores and available cash. Today we’re going to run some numbers to try to quantify the benefit of a lower interest rate.
Assumptions
1. Homeowner purchased a home one year ago using a 30-year fixed mortgage at 6.5%.
2. Homeowner will refinance into another 30-year fixed mortgage at a lower interest rate.
3. Refinancing will cost $2,500 in non-recoverable closing costs.
4. Ignore situation-specific factors like PMI, and unaffected factors like taxes and insurance.
Question
Would the homeowner benefit from refinancing?
Analysis
The key to understanding if a refinancing is worthwhile is comparing the savings in the monthly mortgage payment with the up-front closing costs. As long as the monthly savings are sufficient to quickly pay off the initial investment, then the homeowner benefits. I created an Excel worksheet to compare the initial investment to the monthly savings and then use those two values to calculate how long it would take for the monthly savings to pay off the closing costs.
The chart above shows how many months of lower payments (savings) it would take to offset the initial $2,500 in closing costs. Each row represents a mortgage amount (not home price) and each column represents a potential new interest rate for the refinanced loan. For example, if I had taken out a $300,000 mortgage last year at 6.5%, and refinanced to a 5.25% rate, then it would take 12 months of lower payments to recover my investment in closing costs.
Discussion
The benefit of refinancing clearly depends on the size of the mortgage. Larger mortgages have higher payments, so cutting the rate means larger monthly savings. Since the closing costs are generally independent of mortgage size (assuming the lender rolls their fees into the interest rate), the payback period is shorter for larger mortgages.
We can also see that the payback time is relatively short. If you could drop your rate by 1.0% (from 6.5% to 5.5%), then you would make back the closing costs within 2 years (24 months) for mortgage amounts all the way down to $200,000. This is another way to say that refinancing would be valuable as long as you are planning to keep your current mortgage for at least 2 years.
Finally, we should also mention the option of paying points to the lender. The points can be assessed for either origination costs or as prepaid interest. Points as prepaid interest generally allow borrowers to get lower interest rates. Paying points changes the dynamic of this calculation because they should be thought of as additional closing costs. These calculations are based on mortgages with zero points.
Despite being a simplistic approach to calculating the benefit, payback is very intuitive to most homeowners. Readers with a background in finance and/or investing may be tempted to enhance the calculations to also consider the time value of money. While I concede that this calculation may slightly overstate the value of refinancing, the difference is small for most people – perhaps a month or two. The two scenarios I can imagine where the time value of money would be an issue are if you have to pass up an incredible investment opportunity to pay closing costs, or if you believe the United States is going to experience very high inflation rates. If you have inside information about either, please feel free to send it my way.
Conclusion
A quick calculation based on a likely scenario shows that there is a benefit to refinancing, and that you don’t have to live in your home forever to capture it. If you are serious about this option, it is important to work with a mortgage professional that can first confirm that you are qualified to refinance in today’s lending environment, and then can walk you through the various options. As I mentioned yesterday, Amy and I know some quality mortgage people – don’t be afraid to ask!
Update: Changed the reason for ignoring PMI in Assumption #4 based on comments.
To Refinance or Not To Refinance (Part 1)
That is the question. Whether ’tis nobler to suffer the slings and arrows of higher monthly interest payments, or to take arms against the current mortgage, and by refinancing, to end it.
Interest rates are back down to historic low levels. The chart at left is from Bankrate.com and shows the average interest rate for 30-year fixed mortgages in Connecticut over the past 5 years. Large mortgage rate drops historically lead to a boom in refinancings, though this time may be a bit different for a few reasons.
1. Many people refinanced back in 2004-2005. There are fewer people paying an interest rate that is considerably higher than current rates.
2. Credit requirements are tighter now. Some borrowers that would like to refinance, and would benefit from lower payments, no longer qualify for a new mortgage.
3. Mortgage products have changed. Lenders are not offering the same variety of products as they were back in the housing “boom” days so borrowers would have to bring additional down payment cash to the closing.
4. Appraised values are falling. Lenders require appraisals before funding a loan because they want to be sure that they know their level of risk, as measured by the Loan-to-Value ratio (LTV). Falling appraisals also lead to borrowers bringing additional down payment cash to closing.
5. Cash is required. In addition to any cash required by the previous two points, homeowners also need to have cash available to pay for the closing and to establish new escrow accounts (for insurance and taxes) while they wait to receive the proceeds from their old escrow accounts.
6. People’s attitudes have changed. As a country we seem less inclined to talk about our financial situations, which should result in fewer refinancings motivated by social pressure to keep up with the Joneses.
With these factors as a backdrop, the first question to consider is whether you CAN refinance. If there is any doubt, and you are serious about trying, then consult a professional. There are plenty of mortgage brokers and mortgage bankers that would be willing to review your personal situation. Amy and I would be happy to provide recommendations for those that do not know someone they can trust.
Tomorrow we’ll continue on the same topic, but actually get into the numbers to see just how much money you could save by refinancing to a lower interest rate.