Another day, another batch of Gloom-and-Doom stories in the news.  Remember to keep a level head — the media’s job, in part, is to sell newspapers and capture eyeballs.  Using the word “crisis” repeatedly is one way to meet that goal.

A few facts to keep it all in perspective:

1. There are still BILLIONS of dollars being lent to homeowners every single day.
2. In May, 98.3% of full documentation, “prime” conforming and jumbo mortgage payments were not 60 days late
3. In May, 99.5% of full documentation, “prime” conforming and jumbo mortgages were not in default

In other words, there is still a very low default for borrowers willing to submit tax returns, W-2s, bank statements, and other financial data along with their loan application.  This represents the large percentage of American homeowners and is why the mortgage “crisis” is not so bad for most people.

The credit market troubles with home loans are more “inconvenience” than “crisis” and, so far, are limited to those that are self-employed, are highly commissioned, have poor credit history, and/or are unwilling to document their financial world to a mortgage lender.

If you are feeling in any way overwhelmed, reach out to your loan officer for advice and opinion.  You’ll get better perspective from an industry insider than an industry reporter.

Source
Jumbo concerns in real estate markets
Amy Hoak
CBS MarketWatch, August 14, 2007, 6:00 P.M. ET
http://www.marketwatch.com/news/story/rates-jumbo-mortgages-rise-though/story.aspx?guid=%7BFDE8DFF0-86F7-4C4D-A217-877912918B6E%7D”>

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As we discuss over and over again, mortgage interest rates are determined by the price of mortgage bonds.  Nothing else, and nothing more.  The challenge in that truth is that mortgage bond pricing is not very accessible to the general public. 

This includes the press.

As a result, the media tends to use a government bond called the “10-Year Treasury Note” as a mortgage rate indicator because it tends to move in the same direction as mortgage bonds. 

Not knowing any better and making matters worse, a lot of loan officers also use the 10-Year Treasury Note as a benchmark.  This is dangerous to their clients.

Look at the data from today (as of 11:20 A.M. ET):

• 10-Year Treasury Note: + 53 basis points
• 30-Year 6.000% Mortgage-Backed Bond: - 19 basis points

If you were watching the 10-Year Treasury Note today, you’d think that mortgage rates would be decreasing over the course of the day instead of increasing. 

This same divergence has occurred several times in August and — for people watching the wrong indicator — may have led to costly rate lock errors.

The only security to watch with respect to mortgage rates each day is the price of mortgage-backed securities.

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Industry trade magazine Inside B&C Lending pegs the 2006 dollar volume of new sub-prime loans at $640 billion.  According to the Real Estate Charts chart above, 78% of those dollars were in 2-year adjustable loans.

A loan of this variety is often called a 2/28 (“two twenty-eight”).

A 2/28 originated in 2006 will reach its first adjustment period sometime in 2008.  Adjustments on sub-prime loans are typically 3% at the first adjustment, and 1.5% every six months thereafter until the “cap” of 7% above the original rate is reached.

Looking back to 2003-2006, a homeowner facing an upward adjustment in his mortgage rate could usually just replace the existing home loan with a new one, thereby avoiding the upward adjustment altogether.  This is commonly called “refinancing” your home. 

At present, though, this is a much more difficult proposition; there are considerably fewer mortgage products available for sub-prime borrowers to use. 

With fewer available products into which to change, the homeowner with an adjusting mortgage may have no choice but to swallow the higher rate after the two-year fixed rate period ends.

If your home loan is among the 78% of 2/28s originated in 2006 — even if you have a pre-payment penalty — it may be time to call your loan officer just to check out your options. 

Paying a little bit extra today on a new loan may be better than paying a lot on an adjusted mortgage tomorrow.

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It’s been on the news a few times lately, so let’s address a key misconception about the Fed and its relationship to mortgage rates.

The markets now anticipate that the Fed will lower the Fed Funds Rate within the next 45 days.  As a mortgage rate shopper, there’s not much reason to be interested.  That’s because the Fed Funds Rate is not directly tied to mortgage rates. 

The chart above is courtesy of HSH Associates and shows how the Fed Funds Rate has moved in relation to mortgage rates since June of 2004.  If there was a connection between the two, mortgage rates would have moved higher along with the FFR (brown) line.

The FFR is important because it’s used as a throttle for the economy.  The higher the rate, the harder is it to borrow money and/or finance “stuff”, and so, therefore, the lower the throttle.  When the FFR is lowered, it signals that the economy is slowing down too fast for the Fed and a little bit more “gas” is needed.

Economists are fearful right now that credit market turmoil will rapidly decelerate the U.S. economy and that is why they are calling for the Fed to lower the Fed Funds Rate.  A lower FFR could add some life to business and consumer spending and that is what propels our economy forward, of course.

Whether the Fed does, or whether the Fed doesn’t, expect mortgage rates to remain relatively stable regardless.  Interest rates on mortgages are set by the demand for mortgage-backed securities, not by the Fed Funds Rate.

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After all the volatility and talk of a global crumble, all of the major U.S. stock indices posts gains last week.  It just goes to show you what a strange roller coaster ride we’re all on.

Last week, the market bounced its way through:

1. The Fed’s press release stating that inflation is still a concern
2. Central banks around the world injecting gobs of cash into the global economy
3. A French bank halting withdrawals in several funds until the “true” value of the assets can be determined
4. Bleak outlooks from several high-profile U.S.-based lenders

And none of those items were based on scheduled economic data releases.

This week, by contrast, hosts a bevy of economic growth predictors that will hit the wires.  Continuing with today’s Retail Sales report, mortgage rate shoppers will get no rest from the recent see-saw action. 

Tuesday and Wednesday feature six releases between them, Thursday holds three, and Friday is capped with the University of Michigan Consumer Sentiment survey.

Until mortgage bond risk is re-valued by Wall Street, though, expect the data’s normal importance to be somewhat muted.  Rates should respond more to external factors like the ones we saw last week.

(Image courtesy: Pacific National Exhibition)

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Any security — stock, bond, or otherwise — has a specific risk associated with it.  Based on that risk, an investor decides whether or not the price is worth paying.  If the security is a “good value”, an investor will buy it.  If not, the investor will pass.

Until recently, mortgage bonds were considered a good value because the risk of the investment was relatively low compared to the reward (i.e. interest rate). 

If you’re wondering why markets are in disarray right now, it’s because the risk tagged to the mortgage bonds was dramatically underestimated.

Hindsight, as they say, is 20/20.

When homeowners began defaulting on home loans at a quicker pace than was expected, the risk attached to each mortgage bond increased.  Higher risk should mean higher return, but investor doesn’t have the right to change a homeowner’s mortgage rate.

As a result, the “reward” on mortgage bonds moved below the risk on which they were originally priced.  The bonds, therefore, are a losing bet and the investors either (a) tries to sell the bond at a lower price, or (b) holds the less valuable bond and hopes for a rebound.

The bigger problem in the markets is that — at least so far — the financial models used to determine mortgage “risk” were proven wrong.  Until new models are tested and “approved”, markets will continue to literally guess what a mortgage bond should be worth. 

This is the major reason why markets have gyrated wildly in August.  Investors have no idea what the true value of their mortgage bond investments is/will be.

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“If only I knew what my street was like before I bought the house!”

Ignore the statewide statistics, forget the city figures.  Phooey to the neighborhood.  Reinforcing the notion that all real estate is local, meet Street Advisor, the definitive guide to America’s many streets.

Unfortunately, there just hasn’t been enough helpful information catalogued just yet to make Street Advisor a powerful force.  That doesn’t mean you can’t be the first, of course. 

Participate in the Local Expert program, or just share what you for the fun of it. Leave comments about your block’s restaurants, upload photos of the streetscapes, and write about recent real estate sales activity.  As Yelp is to local businesses, Street Advisor is to, well, streets. 

Stop by and add to your street’s official Street Advisor review.

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The Fed left the Fed Funds Rate unchanged again today for the ninth time in a row after 17 consecutive hikes.

The Fed once again highlighted inflation containment as its chief concern while noting that pressures on the economy appear to be moderating. 

This is good news for holders of home equity lines of credit and credit card debt — both products’ interest rates are based on Prime Rate, a derivative of the Fed Funds Rate.

Not surprisingly, the Fed also gave a nod to the recent gyrations in stock and bond prices, although it did not state whether that is a strength or weakness to the overall economy.

Mortgage rates were flat after the Fed’s fairly neutral remarks.

Source
Parsing the Fed Statement
The Wall Street Journal Online
August 7, 2007

http://online.wsj.com/mdc/public/page/2_3024-info_fedparse_shell.html

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The stock market bounced back yesterday from Friday’s losses, adding 287 points.  There wasn’t much activity in mortgage rates, though, which remained relatively flat.

Right now, it’s all eyes on the Federal Open Market Committee and their 2:15 P.M. ET press release. 

For as many people that want the Fed to make a powerful statement about the current state of credit markets, there are an equal amount saying that reduction in mortgage money for homeowners is “free markets in action”.

Pundits don’t disagree on everything, though.  Nearly all believe that the Fed will leave the Fed Funds Rate unchanged at 5.250%.

The Fed’s primary concern, of course, is to keep inflation at tolerable levels and the Fed Funds Rate is its primary weapon in that fight.

When the Fed believes that inflation is running too hot, it raises the Fed Funds Rate to increase the cost of borrowing for businesses.  This, in turn, raises the cost of borrowing for individuals which curbs spending and, therefore, slows down the economy.

The Fed meets eight times annually and raised the Fed Funds Rate at 17 consecutive meetings beginning June 2004 (1.000%) through June 2006 (5.250%).  The Fed has not changed FFR since.

(Image courtesy: Wall Street Journal)

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In a week in which several high-profile mortgage lenders closed their doors, not all news was bad. 

Mortgages rates for home loans bought by the quasi-government groups Fannie Mae and Freddie Mac actually dropped a bit. 

If you only watched the news, or market commentary on CNBC, though, you likely have the wrong idea about what is really going on within mortgage markets.  According to the people paid to sell subscriptions and/or advertisements, this is the worst melt-down in the history of the bond market. 

According to more level-headed observers, however, corrections like this are a normal and regular event. 

Large hedge funds (like those from Bear Stearns making headlines) made bets on the economy and those bets are losers right now.  And, whenever large losses occur on Wall Street, other players try to limit their exposure to the same type of loss.

Yes, there are plenty of homeowners whose lives will be impacted by the snap-back in available credit, but many can get help before the proverbial hammer drops. 

If there is a lesson to learn here for the average person, it’s that “now” is always a smart time to reach out to your financial planner to create a savings plan and limit exposure to the whims of Wall Street trading.

This week, the only major announcement will come from the Federal Reserve and their Tuesday meeting.  The Fed is widely expected to leave the Fed Funds Rate at 5.250%.

Without economic news, expect markets to react to external factors such as oil prices, commodity prices, and Wall Street sentiment.

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