Florida Loan Advocate

OK, Apparently not Everyone is Getting it?

What am I talking about?  How mortgage interest rates are driven.  I continue to see so-called experts, politicians, etc. stating that a Fed rate cut will help adjustable rate holders.  That is not the reality.

What drives mortgage rates are Mortgage Backed Securities (MBS).  These are the bonds that are a "package" of home loans that are sold on the secondary market.  Just as regular bonds trade, MBS trade on an open market and are subject to market forces, not what the Fed does with their rate.  In fact, many times mortgage rates move in the opposite direction as the Feds!

So, reality is very simply that the Fed cutting rates will not have a direct effect on mortgage interest rates.

That being said, some mortgage holders may benefit from a Fed rate cut.  If you hold a HELOC, that rate is typically tied to the Prime Rate, which is simply the Fed Funds Rate + 3 percent, you will see a small drop.  Also, anyone carrying a credit card balance will likely see a drop in that rate as well.

However, homeowners needing to refinance will not likely see a drop in the rate due to the Fed rate cut.  Adjustable Rate Mortgage (ARM) holders may not receive a benefit either.  Why?  Those rates are not directly tied to the Fed Funds Rate or even the Prime Rate.

If you are an ARM holder, take a look at what your index is doing.  LIBOR (London Interbank Offered Rate), which does typically follow the Fed rate, is actually  drifting higher right now.  A Fed cut may drop this slightly as well, so those coming due for an adjustment on a LIBOR based loan may benefit, but it is not a guarantee either.

Other indices used a lot are not determined by the Fed rate.  They are driven by economic data which shows inflationary pressures. 

So, if you are an ARM holder and you are coming due for an adjustment, take a look at your index and what is driving that rate.  Then look at your loan documents to see what your margin is.  Add the two together and you will have what your rate is about to become.

If you are looking to refinance, make sure you are dealing with a professional that is watching the Mortgage Backed Securities markets, and I mean in real time.  They can provide guidance on whether or not to lock or float your rate, potentially saving you a considerable amount of money.

Currently, you probably want to lock anything that is nonconforming as these loans are not trading favorably.  However, if you are seeking a conforming loan, you can check my Florida Mortgage Daily blog for my daily guidance.  Don't rely solely on my site or recommendations only though as your situation may require a different approach. 

Are McMansions in Danger of Losing Their Tax Benefits?

Leave it to a Democrat, and one named Dingell for that matter, to screw up the economy even more.  Yes, this dude wants to draft a bill that would eliminate the mortgage interest deduction on homes over 3,000 square feet (my own home will get a new survey of 2,999 if this happens). 

The Michigan Democrat (Rep. John D. Dingell) who heads the Energy and Commerce Committee expects to introduce comprehensive climate change reform legislation once the House returns next month.  He stated that the bill will week to "remove the mortgage interest deduction on McMansions - homes over 3,000 square feet."  He is also seeking to impose hefty new federal taxes on gasoline.

He believes that the controversial proposals are essential to achieving the environmental goal of reducing carbon emissions by 60-80% by the year 2050.  "In order to address the issue of climate change, we must address the issue of consumption...We do that by making consumption more expensive", Dingell said. 

Is this guy for real?  Who elected him?  Is it any wonder people are fleeing Detroit right now?

He goes on to mention that houses, like autos, long have been known to contribute to greenhouse gas emissions through heating, cooling, electrical usage, etc. not to mention the roads and highways needed to make far-flung subdivisions accessible to buyers.

I guess this guy is a few sandwiches short of a picnic as he thinks this is going to help.  All this is going to do is drive people in the opposite direction and bring the US economy to a screeching halt. 

People will not stop wanting to live where they want to live or driving for that matter.  They will cut back on other things that they want in order to "get by".  The real estate market, like it hasn't been beaten up enough already, will see even more decreases in value.

Then, let's take a look at gasoline taxes effects on other industries.  All prices will go up across the board as production costs will rise, again not deterring production but rather passing the expenses on to the consumer.  Airlines, already overtaxed, would go through more turmoil just as their recovery is building.  Truckers will be overburdened by expenses. 

The list goes on and on, but the reality is that the whole economy would likely stop, unemployment would go nuts, and the the popular word on the street, "recession", would hit full force.

OK, I may be blowing things out of proportion as I am not an economist, but this guy does need to get his head cleared out.  I am concerned about the attempt to eliminate the mortgage interest deductibility, not just for myself, but for the majority of homeowners out there.  Not every "McMansion" according to his description, is high-valued.  Many, in fact, are less than $250,000, so it will hit Middle America really hard to lose this valuable deduction.

As for the other issues in the bill, let's just hope the bill doesn't get past.

Does a Fed Rate Cut Lower Mortgage Rates?

I continue to get numerous emails and phone calls asking if mortgage rates are going to drop in the future.  Particularly interesting is the number of these inquiries that state they heard that since the Fed is going to cut rates then mortgage rates will go down as well. 

So, what is the truth?  The truth is that mortgage rates are solely dependent on Mortgage Backed Securities (Mortgage Bonds) and have nothing to do with the Federal Funds Rate and certainly not with the Discount Rate that you keep hearing in the news and how they are being cut.

Generally speaking, Mortgage Backed Securities actually trade opposite of what the Fed does to their rates.  So if the Fed cuts the Fed Funds Rate, mortgage rates are likely to increase in reality, though that does not always happen. 

Why is that?  It is all about demand.  When the Fed cuts rates, the rate of return (yield) is lowered.  Since investors are looking to maximize their rates of return, they want higher yields and will likely sell off Mortgage Bonds until the yield on them are appealing again.  Simply put, if yields are low then investors will take their money elsewhere until yields return to an appealing level. 

Now, one nice thing is that bonds compete on a global level, so with all of the "fallout" from the liquidity crisis happening around the globe, our bonds are still very attractive for many foreigners.  That will keep demand high and will likely keep our Mortgage Bonds trading in a fashion leading to lower rates ahead. 

Now, there are  some types of mortgages that the Fed Funds Rate will affect.  Since the Prime Rate is simply the Fed Funds Rate plus 3 percent, anyone with a Home Equity Line of Credit (HELOC) will see a change the next month.  Also, since LIBOR typically tracks closely with the Fed Funds Rate, those in Adjustable Rate Mortgages (ARMs) that use LIBOR as the index will likely see a change at their next adjustment period. 

One other nice thing about a cut in the Fed Funds Rate will be seen in our credit card statements.  We will all see a decrease in the interest since those rates are based on the Prime Rate as well.  Those who carry monthly balances will be happy to see at least a little savings.

To recap, the changes in the Fed Funds Rate does not affect mortgage rates, at least not directly.  Market forces, particularly demand for Mortgage Backed Securities, are what drives the interest rates on mortgages. 

If You Want to Know Where Interest Rates are Headed, Watch the Right Stuff

While I have mentioned this on other blogs before, I feel the need to ensure readers of this blog understand what truly drives interest rates.  You see, with all of the turmoil happening, I have had many questions about where I see interest rates headed.  The always seemed surprised when I said the Federal Reserve has nothing directly to do with it.

You see, Mortgage Backed Securities are the only thing that drives interest rates, nothing else.  Since they are bonds, you need to understand this point...if bond prices go up, interest rates go down and vice versa. 

Since Mortgage Bond quotes are not readily available, including to the media, other securities are used in a vain attempt to see what interest rates are doing.  So, most of the media, and even the vast majority of mortgage professionals, use the 10-year Treasury Note as a gauge due to the ease of accessibility.  Tune into CNBC, Bloomberg or other financial media and you are going to see a ticker showing it.

While the T-Note tends to follow the Mortgage Bonds most of the time, there are, in fact, numerous times when they act complete opposite of each other.  It is kind of like comparing American Airlines with Southwest Airlines in trading.  Many times they trade the same direction, but plenty of times they don't.

Thursday was a prime example of how opposite Mortgage Bonds can be compared to the T-Note.  At one point, the T-Note was up 103 basis points while Mortgage Bonds were down 12.  For those of you who are watching the wrong indicators, it could have cost you, or your clients, a lot due to rate lock errors.

So, if you were expecting interest rates to fall on Thursday, they didn't.  However, Mortgage Bonds did manage to get themselves a little higher at the end of the day.  I do provide daily market updates on my other blog, but even those are dependent on my time and are only current at the time of posting.  Things can, and do change rapidly in the markets, especially in current times.

So, to drive the point home, if you, or your mortgage professional are not following Mortgage Backed Securities in real time, then it could be costing you.

Will the Mortgage Industry Follow the Likes of the Airline Industry?

With all of the lenders falling apart right now and the troubles that have shown their ugly head at Countrywide, I fall back to my first career as an airline pilot for guidance.  Yes, troubles have been nothing new to either industry and the cycle of turmoil that affected airlines over the last two decades have similarities to that of the mortgage market meltdown.

Since the late 1980s, airlines had been both down, up, and down again with them now returning an upward trend.  During this time frame, multiple "big name" airlines, as well as smaller air carriers, have gone under or merged into other airlines.  Names like Pan Am and Eastern disappeared from the airways.  Others like TWA and USAirways have been bought out and merged into other airlines.  A few, like United, Northwest and Delta have gone through the bankruptcy process, reorganizing into smaller, more competitive carriers. 

American Airlines arose as the only legacy carrier to avoid the bankruptcy process.  Meanwhile, Southwest Airlines and many newer "low-cost" carriers like Jet Blue gained ground on the heels of 9/11.  The most interesting correlation between the two industries can be found in the recovery of the airlines from such a disaster as 9/11.

After 9/11, the airline industry came to a screeching halt (basically no flights for several days).  After several days, flights began again, but fear kept passengers from traveling and so planes flew empty.  It took months before the fears of traveling by air subsided and passengers began to return.  So many changes happened in record time, not even the governing agencies could keep up with them.

Time passed, forward several years later, and what has happened?  A few more airlines are gone, consolidation has occurred, major cost cutting has developed and the industry adapted.  Now, we are seeing record numbers of passengers traveling, load factors are through the roof, and even profits can be seen again.

So, how similar is it to what is happening in the mortgage industry.  The similarities are amazing.  While it isn't a 9/11 type event, the current liquidity crisis is having major impacts on the industry.  We have already seen many "big name" lenders fall and many others are rushing to protect themselves just like happened in the airlines.  We will likely see more lenders fall in the future as well.

But look again at what happened to the airline industry.  Several airlines stepped up to fill the gaps as the dynamics of the marketplace changed.  Those that were not well prepared for the change faced bankruptcy or went under.  Some were lucky enough to get merged with someone else saving many jobs in the process.

We will likely see the same things, or at least similar changes, happen over the next few years, but rest assured, other lenders will fill in the gaps, new lenders will form and the industry will recover, just like the airlines did.

Will Countrywide be the Next Victim of the Mortgage Market Meltdown?

The big question of the day is where will Countrywide, the nation's current leader in mortgage originations, be at the end of the year.  A bigger question may even be...will they exist at all?

That's right, as I have mentioned before (on at least one of my blog's), Countrywide may end up facing the same fate as American Home Mortgage (was the #10 lender) did a couple of weeks ago.  When AHM went down for the count, the media went into a frenzy (I was even quoted in a Marketwatch article).  Imagine what will if Countrywide goes belly up.

Today, CW took out their last $11.5B of available loans from a group of about 40 banks.  With their access to money drying up, their own bonds are quickly facing "junk" status and are have already been downgraded to Baa3 from A3, placing its bonds in the lowest investment grade status.  Moody's stated that those are in danger of falling into junk status at any moment.

So, how does that translate to CW's future?  Well, if they do fall into junk status, that is an indication that the likelihood of an investor getting their money back would be low and would likely mean CW is going to enter bankruptcy, if not worse.

The problem is not so much with the inability to get loans from other lenders as much as the mass panic that would spread across the mortgage and real estate markets in the light that "not even the #1 lender could escape".

The likely fallout from a CW BK would be a disaster throughout the housing market due to buyers not wanting to buy anymore or simply do not qualify as the guidelines keep changing.  Homeowners caught in a financial crisis themselves could be facing BK because they cannot refinance now.  Many other "impacts" could occur as well.

So, is it doom and gloom?  Not really.  Where one lender fails, another picks up.  That means that while guidelines may change, chances are you can still find a loan to meet your needs, it just may take a little more time.

Current State of Mortgage Financing...What's Going On?

Chances are you have watched or read in the financial news over the last few days and have seen a lot of angst and consternation surrounding the current state of the mortgage industry.  One of the lenders, American Home Mortgage, parent company of American Brokers Conduit and was in the #10 spot for lenders, was forced to fold.  So, what is really going?  Maybe a more important question is, what does it all mean to you?  So, let's go through all of the details and definitions to help you fully understand the truth behind the headlines.

In recent years, many homeowners obtained financing with somewhat "non-traditional" or "non-conforming" ways.  The reasons for needing these types of loans varied whether it was poor credit, inability to document income or any other factor that did not meet "conforming guidelines.  These loans are often called "Subprime" or "Alt-A", meaning they were somewhat riskier in nature than your A credit, prime or traditional loans.  Another type of loan that is "non-conforming" even though the borrower's credit and income are fine is the "jumbo" loan, which means the loan is for greater than $417,000, the maximum loan currently allowed by Fannie Mae (FNMA) and Freddie Mac (FHLMC).  If loans cannot be pooled together a sent to FNMA or FHLMC, they are pooled together using money from private institutions.   

Most non-conforming loan product rates have jumped significantly higher in the last week. Here's the inside scoop. 

The end investor for Subprime or Alt-A loans will charge a premium for taking on a pool of these loans, because they know that traditionally, they might have a higher rate of default and delinquent payments within that risky pool. But lately, default and foreclosure has been on the rise - partly due to the fact that with credit tightening and a soft real estate market, many troubled homeowners are unable to refinance or sell in order to get out of trouble. So now, these end institutions are demanding a much higher "risk premium" for taking on these pools of loans, as they see the rates of default are climbing higher.  This is exactly what my quote in an article released yesterday by MarketWatch showed.

But since these institutions are purchasing these pools of loans sometimes months after the borrower has actually closed at a given rate, this increase to the risk premium means that instead of paying $101K for a $100K loan that will bear interest, they may only be willing to pay $95K for that $100K mortgage to account for the risk. Multiply that times thousands upon thousands of loans...and you have millions upon millions of dollars in loss for the company trying to sell the pool at a much lower price than they were expecting. This is called a "liquidity crisis", and is exactly what happened to American Home Mortgage - there was no mismanagement, but they simply got caught holding too many "hot potato" loans, forced to sell them at massive losses...and eventually they had to make the decision to close the doors and stop the bleeding.

Further, even when a lender is able to take some losses, they may be subject to a "margin call", the same as can happen to stock investors. This means that as their losses and risk premiums increase, the value of their loan portfolio decreases. As the value decreases, the credit lines that are secured by those portfolios begin to issue margin calls as the value of the asset that they are secured on is now diminished.  So for the big lenders, as their portfolio is losing value due to increased risk premiums and losses...the margin calls start coming in, and they are required to pay down their balances. In turn, this means that they have less availability to fund their new loans, which then exacerbates the problem.

In response to seeing this situation play out in the demise of American Home Mortgage, lenders of other non-conforming loan products increased their interest rates dramatically almost overnight to be better prepared - and likely over-prepared - for increased risk premiums down the road. Even though loans above $417K are not presently suffering from increased delinquencies like the Subprime and Alt-A loans are, these rates popped higher as well, because they are being purchased by smaller private entities that can't afford to take on any margin of risk.

What happens next, and what should you do now?

The present situation will likely settle out over the coming year, and the rates on products that have moved so significantly higher now should trend lower down the road as delinquency rates stabilize. But here are a few important things to do right now.

First, even if you are not presently in the market for a home loan of any type, contact me to make sure that your credit standing is as solid as possible. Many people I talk to about home loans didn't expect they would have a need, and didn't plan in advance to ensure their credit would qualify them for the best possible financing. With no immediate need for a home loan, time is on your side...why don't we take a few minutes together and just make sure you are prepared, should a need arise down the road?

Next, if you are in the market for a home loan, or know someone who is - know that now is time to be working with a real qualified professional who can keep you informed of changes in the market and get your loan funded quickly. Now is NOT the time to be playing the risky game of trying to scour the entire nation to find someone who promises to save you a paltry amount on costs, or deliver a rate that seems too good to be true. Your home and your financing are just too important, and times have changed. I am here to help and advise during these volatile times - and would welcome calls from you, your friends, family, neighbors or coworkers.