Saturday, January 10, 2009

Media Hype Creates Mortgage Expectation Bubble

News stories are only covering half the facts on falling interest rates, creating unrealistic consumer expectations.

BLOOMFIELD, MI – Everywhere you turn today is news about how low mortgage interest rates have fallen. Whether newspapers or internet, you can find coverage on the topic. People are talking about mortgage rates on the radio, TV, at work, everywhere.

The trouble is, all is not as the media so simply portrays it.

As the chart above show, this is the fourth major drop in interest rates Americans have seen since 1982. Back in 1982 mortgages were very labor intensive with handwritten applications, documents done on typewriters and everything sent by what we now call, “snail mail”. From application to closing could easily take 8 weeks, often longer. Many homebuyers took advantage of the increased purchasing power as a result of the lower rates, but many more existing homeowners took advantage of the lower rates to lower their mortgage payments.

With each successive drop in interest rates since then, consumers have benefitted from the increased use of technology by the mortgage industry. Computers, faxes, websites and email have all sped up the mortgage process, making mortgages cheaper, dramatically easier to obtain and increasing product options – until now.

The refinance opportunity that started at the end of 2008 brings the lowest rates in over 50 years, but it also brings challenges not seen in over 30 years.

Falling home values, tightening lending criteria, fewer loan programs & options, higher down-payment requirements and more, are challenges many borrowers have never experienced.

You’d never know this though from following the media hype about the drop in interest rates. Most articles about the topic rarely mention that borrowers face a brave new world of qualifying for these low rates.

Reality Check
Traditionally, the mortgage rates lenders offered were the same for all borrowers as long as they qualified for the corresponding mortgage program. Either the borrower had the credit, income and assets to qualify or they didn’t. That all changed on March 1, 2008 when FNMA announced Loan-Level price Adjustments (LLPA) on their products to compensate for increased risk.

Effective June 1st of 2008, even though a borrower may qualify for a mortgage program, their mortgage rate now depends on their FICO score, Loan-to-Value of the property and on refinances - more for taking cash out. At the extremes, some borrowers may pay up to three discount points more than others (keep in mind a discount point is not a percentage point).

Imagine the surprise of millions of borrowers being told they’re approved for their mortgage, but not at the advertised rate they applied for.

Unfortunately, it gets worse. On December 29, 2008, FNMA announced major changes to their LLPA’s that go into effect April 1, 2009. Because of the lag time from application to close and then lender delivery to FNMA, many lenders have announced they will implement these higher costs January 12th.

Want to finance a condo? If you finance more than 80% of the value it’ll now cost you an additional 0.75 in discount points regardless of your credit score. How about taking some cash out of your home? It could cost you as much as three additional discount points. There are now also hits for manufactured homes and subordinate financing.

The timing of this FNMA announcement is very odd in light of the Feds actions in buying Mortgage-Backed Securities to lower mortgage rates. One part of the government is trying to lower rates to help the housing market, while another part is raising the cost of those same rates.

Another bit of news the media has neglected to report is that “no-cost” refinances are almost a thing of the past. FNMA and the banks are changing the pricing model of the industry to discourage these types of transactions. Why? To stop what’s called, “portfolio runoff”. The rates offered by the industry have built-in assumptions that once a loan is closed, it’ll stay on a lender’s books for at least a minimum number of months. In previous refinance “booms”, lenders got burned by borrowers refinancing every 2-3 months and lost a lot of money. So, borrowers looking to refinance will have to either roll refinance costs into the loan amount or pay them in cash.

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