Mortgages: Purchasing Power versus Conservatism

We’ve been thinking a lot about mortgages lately. Something that jumps out at us is just how much of an opportunity the combination of declining mortgage rates and falling home prices has created for buyers.

Interest rates for 30-year fixed mortgages were around 6% during the early and mid-2000s when we bought our house. Those same loans are now available for interest rates of 4% or less, and 15-year fixed mortgages are available for just over 3%.

But what does this mean in practical terms? How can a buyer use this to their advantage?

First, consider a buyer with fixed monthly budget for the principal and interest payments of their mortgage of $1,800. Here is how much a buyer could pay back in the mid-2000s for a home within the $1,800 per month budget if they had the cash for 20% down, 10% down and 3.5% down.

30-Year Fixed mortgages from the mid 2000s

I don’t know how much interest rates varied based on the down payment amount back then, so that assumption may not be exactly right. But I am often surprised that in today’s market everyone gets a very similar interest rate no matter how much the put down – as long as their credit is good – so let’s go with it for now.

Fast forward to today … how much additional purchasing power does a buyer have when lower interest rates are factored in? Keeping the monthly budget at $1,800 we can see that the buyer with 20% down can spend almost $100,000 more. Which, when the falling prices are considered, is a meaningfully better home than they could get for the same monthly payment in the mid-2000s. Those with 10% and 3.5% down also see a bump in their buying power and an ability to get into a nicer homes.

Today's 30-year Fixed Mortgages

Buyers also have the option to go more conservative. Rather than using low interest rates to increase their purchase price, buyers can instead cut the length of their mortgage in half with a 15-year fixed rate loan.

Current 15-Year fixed mortgages

The shorter mortgage does decrease the amount that buyers can spend, but some of that decrease is offset by the declines in market values since the mid-2000s. Sticking with the 20% down buyer, they are now looking at a $320,000 home instead of a $375,000 home. In most local towns that will not be quite as nice a property, but it’s a modest step down rather than a dramatic one. Is it a worthwhile tradeoff for debt averse buyers? Definitely.

It’s an interesting exercise to consider the possibilities, though not a perfect analysis. We’ve excluded the property tax and homeowners insurance escrows for the moment, since they vary from town to town. Both have undoubtedly risen since the mid-2000s, and do factor into the monthly budget. Even so, there is still an opportunity here.

Most buyers seem to be sticking with the 30-year fixed loan for their purchases. Existing owners tend to be the ones refinancing down to the 15-year mortgage, cutting 10 or more years off their loans while taking on a modestly higher payment.

My parents said something over the weekend that put this in a different kind of historical perspective. We were talking about the short-term rate of less than 3% that we’re trying to take advantage of, and they noted that they had never had a mortgage rate of less than 8% on any of their homes. Kinda makes the 6% and change where we started our journey seem reasonable…


Related Posts
The Appraiser is Coming!
Mortgage Rates and the Fed
Refinancing Our House
Refinancing Our House – Journey Underway
Refinancing Our House – Journey Completed
Mortgage Rates are Low
To Refinance or Not to Refinance (Part 1)
To Refinance or Not to Refinance (Part 2)

Our 2011 Predictions

Elizabeth Park Looking Over the Pond House Gardens Towards the Lawn Bowling ClubIt’s the second half of January, and we haven’t even published any predictions for the year. Shame on us! The point of predictions is to get them out there early so that everyone has already forgotten about them by the time the real action starts. That way you don’t get egg on your face when the exact opposite happens. But if you get it right, then you can smugly point back to your calls and say, “See, should have listened to me.”

The overall real estate environment can be charitably described as unfavorable over the past few years. It’s been characterized by falling prices, decreasing sales volume, and tightening credit as the overall economy works through a financial downturn. Buyers have been far more reluctant to make a big real estate purchase despite the Federal stimulus and the very low mortgage rates. Part of it is undoubtedly less confidence in their personal financial security, the concern that they could be laid off tomorrow. At the same time people no longer believe that real estate prices will always increase, so they’re less interested in sweating out the first few years of big mortgage payments in hopes of being rewarded with quick appreciation and home equity.

Our research shows that the number of single-family home sales in Hartford County peaked in 2005 at just over 9,000 properties. Sales quickly fell to the lower 6,000s by 2008, and remained about there in 2009 before falling to the upper 5,000s for 2010. Single-family home prices didn’t peak until 2007, fell 14% in two years, and then rebounded a bit in 2010. It’s still not clear to us why the average home price increased this year, though it’s encouraging that they didn’t fall further. Our current theory is that the mix of sales changed to included more larger (higher priced) homes.

Looking Forward
We don’t see any major changes in the big picture story, so we expect 2011 will bring more of the same. Local employers seem relatively stable in that there have not been major layoff announcements recently, but lots of people are still looking for work. And thrift continues to be a virtue, so the rank and file are less likely to reach for a larger home. We think the number of deals will remain in the vicinity of 6,000 for the year, and that prices will be flat-to-down for the region overall. We expect mortgage rates to continue to slowly rise, though not jump so much that buyers feel their purchasing power has been taken away. Basically, we expect that it will be another year in which homes have to be priced and marketed well in order to sell.

That said, we have some disagreement about the specifics. Rather than settle it internally, we thought it would be more fun to have a public airing of differences, so that bragging rights can be established at the end of the year.

Number of Transactions
One of the largest differences in the market between then and now is the number of transactions. Neither of us believe that they will return to previous levels, but we do have a bit of disagreement over the direction they’re heading.

  • Amy: Sales volume is going to stay flat or go down versus 2010 for Hartford County … it’s going to get worse.
  • Kyle: Sales volume is going to stay flat or go up slightly versus 2010 for Hartford County … we’re stabilized and rebounding.

Mortgage Rates
The Federal Reserve’s current Quantitative Easing program is clearly not holding mortgage rates down. So how high will they go in the coming year?

  • Amy: Interest rates will fluctuate between 5% and 6.5% during the year. The slow increase will cause some buyers to pull the trigger sooner than they had otherwise planned.
  • Kyle: Interest rates will increase, though it’s not clear to me how high they’ll go. As long as inflation fears don’t take off, they should remain low enough for people to actually get mortgages.

Bonus Predictions

  • Amy: Short sales are going to be a lot more common. I am not a fan of short sales because my buyers wait and wait for months to hear back from the bank, never do, and eventually move on out of frustration.
  • Kyle: The requirement that all condo associations update their FHA approval will cause delays for buyers. Condo associations are run by volunteers. Ideally their management companies, professional property managers, will make sure the associations understand the benefit of being FHA approved, but I’m sure there will be some complexes out there that just forget to go through the process.
  • Kyle: This year there is no obvious real estate storyline, like there has been for the past few with the Federal Home Buyer Tax Credit. But as an industry, selling is easier when there is either a big carrot or a big stick out there, so I have no doubt one will be manufactured. I’m thinking that after a couple years of credit carrot, we’re going to be transitioning to the stick this year. Two leading candidates are “Buy now before prices start to rise” and/or “Buy now before mortgage rates rise.”

We’ll see what happens … it’ll be an interesting year in Greater Hartford real estate!

Readers, do you have any predictions? Related to real estate or in general?

Refinancing Our House- Journey Underway

Hartford City HallLast week I wrote a post about trying to refinance our house. We’re well underway at this point and hope to close in the next 45 days or so, as long as everything goes as planned.

All four lenders that I initially called responded quickly to the voicemails I left them. Three were brokers that have several banks available to them and one was a local credit union.

They all said that they’re getting lots of refinance calls these days. I indicated that we would be interested in refinancing from a 30-year fixed rate mortgage to a 15-year fixed rate mortgage, we had enough equity in our house to refi and our credit scores were strong. The main unknown for us would be income requirements because we are both self employed and lending requirements have changed regarding the required documentation for self employed individuals.

All of the lenders I spoke with indicated that we should have no problem moving forward with a refinance, even with our self employment status. Our income history was strong enough, we would just need to submit more documentation (full tax returns, income statement and balance sheets) than a traditionally employed person. You know, people that work for The Man.

Some would be able to have the process done in as quickly as 4 weeks, while others indicated they were closing 60 days out now because of such a backlog with the paperwork processing of all the files they were closing. We weren’t too concerned about closing in 30 versus 60 days, just as long as we could lock our interest rate.

Surprisingly, all of the lenders had almost identical estimates for closing costs. None would be charging us points. Some could lock us right away, while others had to wait until the appraisal was done. We ended up going with a lender that gave us a 60-day rate lock and the lowest rate.

Three of the lenders quoted us a rate of 3.875%. The rate we ended up locking at? 3.75%. Whoo hoo! Better than our little financial models we concocted were using. So our overall savings on interest would be an additional $2,500 lower than what we budgeted. A grand total of $112,500 that we won’t have to pay some stinky bank. Double whoo hoo!

What’s happening at this point is reams and reams of paperwork. Lot of documents for us to read through and sign. Also lots of financial documents from us to scan and upload to the lender’s system. Next week is our appraisal. There’s actually plenty of data in our neighborhood for the appraiser to use. I have a value in my head for our house which I think is pretty conservative. We’ll see if they meet or exceed it. However, they’re apparently coming from New Haven, which makes me think that they don’t know Hartford all that well, so we’ll see what they come up with. We’ll let you know how that goes next week and I’ll talk more about the appraisal process then.

The Latest on Mortgage Rates

Mortgage RatesTime for an update on mortgage rates! 

As has been written in this space before (here and here), mortgage rates are currently being driven by inflation expectations.  The Federal Reserve has been focused on supporting the economy by lowering short-term interest rates at the expense of the dollar, which is one cause of inflation (another major one being the huge demand for oil/energy in China).

The graph on the left compares mortgage rates for 30 year fixed loans, in blue, to the rates for 10 year Treasury Bonds, in green.  For the second half of 2007 and the beginning of 2008 they moved in lockstep.

After a series of aggressive government actions in late January, and then the Bear Stearns “deal” in March, Wall Street finally realized that the Federal Reserve would continue to cut interest rates to support the economy.  Whatever it takes.  Thus inflation is a real concern.  This can be seen in the chart as both the blue and green lines find bottoms and beginning to increase (higher rates).

An immediate question that jumped out at me: Why did mortgage rates jump even more than the Treasury rates in 2008?  One factor at play is the difference in duration of the two loans.  30 year fixed mortgage rates are far more sensititve to inflation than 10 year Treasury bonds because they extend 20 years longer.  I’d have to do some serious math to figure out how much of the impact can be explained by duration, so let’s just say that it is one factor and others are also possible.

Last week there was an important shift in the government’s position.  Ben Bernanke, Federal Reserve Chairman, said that the Federal Reserve Board is “attentive to the implications of changes in the value of the dollar for inflation and inflation expectations.”  This is the first direct acknowledgement that inflation is of concern, and Wall Street intepreted the statement to mean that there will not be any more interest rate cuts.

For us in the real estate market, Mr. Bernanke’s statement seems to have hurt more than helped.  Wall Street has reacted by bidding up interest rates – they seem to be using his statement to support their fears that inflation could increase.  Higher mortgage rates tend to hurt sellers as the purchasing power of buyers decreases.

Of course all of us already knew that inflation was beginning to hurt, and if you didn’t, then you must not be driving or watching the news…