Simply The Best Loans

Conundrum is defined as “A paradoxical, insoluble, or difficult problem; a dilemma.”

Since many experts are wondering how short-term rates are going up while long-term rates are continuing to remain at records lows, it’s no surprise that those of us who do not study the economy for a living find it confusing. In researching for a clear, yet concise explanations, CNN.com provided the following:

When short-term yields become higher than long-term yields, it is called an inverted yield curve. An inverted yield curve has preceded the nation’s last two economic recessions.

The Federal Reserve has boosted short-term interest rates nine straight times since last June to 3.25 percent, and the central bank gave little indication that it would pause its monetary tightening campaign when it again raised last week.

Despite those increases, long-term Treasury yields have not risen in kind and are in fact below where they were when the Fed started raising short-term rates last summer.

Fed Chairman Alan Greenspan has called that a conundrum, and economists have struggled to predict whether the Treasury market is set to tumble, which would push yields higher. Bond prices and yields move in opposite directions.

Long-term yields have remained low despite a year of fed fund rate hikes, causing short- and long-term yield levels to move closer together. This is known as a flattening yield curve.

Traders may have held onto bonds in the face of rising short-term rates because they believe the hikes mean the Fed has inflation well in hand. Inflation hurts bonds by eroding the value of the fixed-income investment.

When the yield curve inverted in 2000, two-year yields exceeded 10-year yields by a little more than half a point.

As terrorist bombs struck throughout London on Thursday, the bond market rallied and stocks dropped, yet by Friday, the Dow improved as recent unemployment rates were reported as the lowest they’ve been in 4 years. In the past, an inverted yield curve in the bond market has been followed by economic recession. While there are many factors which could reduce the possibility of recession, John Herrmann, director of economic commentary for Cantor Viewpoint, stated

“Rather than portending recession, a flat curve reflects slow economic growth in Europe and Japan, particularly in relation to stronger U.S. growth, as investors worldwide have been snapping up long-term Treasuries as a flight to quality.

“Links between global economies are stronger now, and the flat curve reflects that,” Herrmann said.

Overall, as market activity fails to follow historic patterns, it is possible new economic trends can be expected as global economic activity continues to show us “it’s a small world, after all.”

Despite the Federal Reserve’s recent increases in short term interest rates, the bond market has continued to be strong and mortgage interest rates have continue to remain at their record lows. Why?

Some reports indicate that baby boomer investors have consistently been choosing bonds over stocks as a safe investment. In the US, Europe and Japan, those reaching retirement age are buying longer-term treasuries, from 10 to 30 year bond notes. The result, an inverse movement of increased prices and lower yields.

Since bond prices and yields are the driver for mortgage interest rates, mortgage rates have continued to creep downward even as the Fed’s rate went up. Should this investment trend with the baby boom generation continue, mortgage rates could drop even more. David Rosenberg, Merrill Lynch’s chief North American economist considers this trend as having “already started. It’s a global development.”

For those of us that bought our first houses when mortgage rates were in the double digits, this is difficult to imagine. However, Stephen King of HSBC Holdings Plc in London reports, that baby boomers are “more likely to be interested in avoiding capital losses than making capital gains, pointing to a wholesale shift out of equities into bonds.”

All that being said, it seems that the fears and predictions of mortgage rates shooting back into double digits by the end of the year may have been premature.

Last Thursday, Alan Greenspan testified before the Joint Economic Committee of Congress. In his statements, Greenspan referred to the US economy as being on “reasonably firm footing”, but indicated that interest rate increases would probably continue to keep inflation in check.

Other issues identified included: imbalances and uncertainties regarding the yawning US budget and trade deficits, slow wage growth, rising oil prices, and concern that housing prices are overvalued across the nation.

However, during the same week, Greenspan also “asserted there was no national housing bubble, but that the overheated housing market is more properly described as ‘froth’.”

“There do appear to be, at a minimum, signs of froth in some local markets,” Greenspan said. He added, “the apparent froth in the housing markets may have spilled over into the mortgage markets.” And the mortgage and housing situation is “clearly without recent precedent.”

All that being said, are we bubbling or frothing?

I believe that even if mortgage rates begin to go up, the average American will be more likely to invest in a home before investing in other things. Along with the real estate boom across the country, there has been an increase in available information educating consumers of the benefits of homeownership versus renting.

Boom or bust, the average American aspires to homeownership and I don’t think that’s likely to change.

When you’re shopping for a mortgage and your financial picture requires an unusual program from a lender, you will usually find yourself paying a higher than market interest rate on the loan. Does this mean that you might have to consider a less expensive house because the loan you need has a higher rate? Sometimes.

There are programs out there for almost every borrower, even those with credit issues. What the borrower needs to realize is that for every “concession” you want the lender to make to you in underwriting, the lender wants something in return, normally higher interest.

You want a 100% financing? Fine. It can cost up to a half point or more than if you put some money down. You want interest-only payments? Okay, the lender will probably charge some additional discount fee or increase your rate. You want stated income or stated assets? The risk is higher to the lender so the lender charges more.

So many people see advertisments for a particular rate on TV or the internet and they assume, because there is no explanation on the advertisement, that it’s available to every borrower. However, what they don’t realize is, to get that rate they have to have everything the lender wants….good credit, good income, little to no debt, and plenty of assets.

I have actually had people tell me they expected to get the lowest advertised rate, put no money down, and pay no closing costs when they have no money in the bank, limited income and poor credit. It doesn’t work that way.

I’ve also had people tell me they want to buy a $300,000 house, put no money down, pay no closing costs and have a monthly payment of not more than $800. No matter how low interest rates are, this is not a feasible scenario.

So, if the mortgage you qualify for has a rate that makes the payment on the $250,000 house you want more than you can comfortably afford each month, it would be better to decide on a $175,000 house. Then you have a mortgage, save on taxes and plan to move up a few years down the road, rather than continue to rent.

When clients balk at this notion, I explain that if they buy the $175,000 house today and make $1200 a month payments, a few years down the road they will have equity in the property and have experience significant tax savings during that time. If they continue to rent for 3 years, they have gained nothing and saved nothing. In some instances, it may even cost them more.

When we shop for anything, it can be difficult to restrain ourselves from considering a purchase that is more than we can afford. Buying a house is no different. The easiest way to avoid disappointment, when what you want and what you can afford don’t match, is to get qualified BEFORE you begin to look at property.

Know going in what type loan you can get, what rate you’ll have to pay and what price range house will fit your budget on a monthly payment basis. Then only look at properties that fit your criteria. You will be happier with the results in the long run.

Remember, home ownership is a great thing, being “house poor” isn’t. You want to enjoy owning a home, not just work to make the payments on it.

Believe it or not there are times the interest rate is unimportant when you are getting a loan. Right now everyone is caught up in trying to explain what Greenspan calls the “conundrum”. The National Association of Realtors’ chief economist, David Lereah, is reported as saying,

Not only have mortgage interest rates declined, but an expected rise in the second half the year will be slower than in earlier projections.

With the rate on 30 year fixed mortgages dropping below 5.5%, almost a full percentage point less than this time last year, when would someone purchasing a new home not want to worry about the interest rate?

If you are a first time homebuyer and have been paying premium rental fees, you will save money by purchasing a home no matter if the interest rate is 5.5 or 6.5. Depending on your income and tax bracket, the interest rate would have to hit double digits for you to question whether or not you would experience savings. It is almost always cheaper to own home than to rent, especially if you earn over $40,000 a year and have no dependents.

If you have specific circumstances which make your loan program a niche item, your rate won’t be as low as current market but if it allows you to meet your overall financial goals, then you want to do the loan despite a higher rate.

I tell my clients routinely that they have to look at the big picture of what they are trying to accomplish. If the higher rate program helps them better meet their financial needs, then the rate doesn’t matter.

The Fed responded yesterday to the question concerning potential real estate bubbles breaking across the country. The past few years of record low interest rates coupled with very high appreciation, in many markets, have some analysts predicting an extreme downturn in residential housing prices as interest rates go up.

Additionally, some analysts have been predicting interest rates soaring into double digits by the end of the year. The proposed result: homeowners would find their properties are no longer valued at the price they paid and, since many purchased their homes with adjustable rate mortgages, interest-increased payments would become unaffordable.

Over the last few years, with rates dropping to record lows, interest-only loans became extremely popular. Many of my clients opted for an interest-only payment based on the assumption that rapid appreciation would create equity in the property. I have seen incredible appreciation in the area I live, with some properties doubling in value in less than ten years.

With an interest-only payment, borrowers are able to buy a much more expensive house and still manage the payments. While I don’t agree with many of the “doom and gloom” folks expecting interests rates to reach such levels borrowers are no longer able to purchase homes, I also don’t think the extreme appreciation many areas have experienced in recent years will continue.

Do I think real estate in these areas is going to depreciate? Probably not. Greenspan said yesterday that, historically, periods of depreciation in real estate values are actually very rare. So are interest-only loans a risk?

As with any other investment, the amount of risk depends on the individual. What may be very practical for one borrower could be very risky for another.

Example #1: An established commission sales person with a fluctuating income gets an interest-only loan in order to ensure in low-commission times they have least payment possible. Then, when commissions are collected the sales person pays a a lump sum directly to the principal. The sales person has figured out the amount of principal payment he/she would be making each month with a full payment loan. He/she pays that amount or more to the principal of the loan periodically. The sales person is still creating equity in the property by reducing the principal balance on the loan, but has lower payments each month. An interest-only loan in this scenario is low risk.

Example #2: The borrower chooses an interest-only loan so that he/she can buy a more expensive house. He/She has other revolving debt and little-to-no savings. The borrower is assuming equity will build in the property through appreciation, not by reducing the principal balance of his/her loan. The borrower gets transferred or loses a job after a year or so. In trying to sell the house, the borrower discovers that he/she can not sell the property for enough to cover the sales expense and payoff the loan. The borrower basically owes more than or, at best, equal to the property’s value. This is a high risk scenario.

Since no one can guarantee what future market conditions are going to be, the borrower must in all instances plan for “worse-case”. Examples of “worse-case” could be: lower than expected appreciation, interest rates adjust upward too quickly creating negative amortization, or the property has to be sold for unexpected reasons and there is no equity.

Anyone considering an interest-only loan program should discuss it with their broker and/or other financial advisors. The borrower needs to be confident that his/her reasons for chosing the interest-only program will outweigh the potential worse-case scenario. His/her financial planning should include making periodic payments to the principal balance of the loan to ensure he/she is building of equity in the property.

According to The Chicago Tribune , mortgage rates have reached a new low, which is great news for buyers on the market now. The Associated Press wrote that “[r]ates on 30-year and 15-year mortgages this week dropped to their lowest levels since late February.”

Here’s what this development means for home buyers and real-estate investors:
“

As long as inflation is held in check there is little or no pressure to push mortgage rates higher,” said Frank Nothaft, Freddie Mac’s chief economist. Despite high fuel prices, “core” inflation–which excludes food and energy costs–seems to be fairly tame, he said.

Mortgage giant Freddie Mac reported Thursday in its weekly survey that rates on 30-year, fixed-rate mortgages averaged 5.71 percent, down from 5.77 percent last week.

Analysts attributed the decline in mortgage rates to reduced fears on the part of investors that the economy might face an outbreak of inflation.

Already this week, rates dropped to 5.27 percent from 5.33 percent last week for a 15-year, fixed-rate mortgage. If you are getting ready to refinance, this could be the time for you!

continued-
In order to save money and maximize the services offered by almost all major banks, you can set up bi-weekly payment plans yourself. If you bank online, this process is even easier. If not, you can visit your local branch and get assistance there to create this payment schedule.

First, look at your monthly mortgage payment (including escrow if you are impounding for taxes and insurance) and multiply it by 12. Once you have that number, divide it by the number of paychecks you receive in a year whether it’s 24 or 26 or 52. Set up an automatic draft for that amount to be drafted from your account and paid to you mortgage each payday.

Second, and this is very important, you must make sure you are ahead in your payments by at least 2 weeks, preferably a whole month, before you set these drafts up. Do not start these drafts at the beginning of a month assuming that you will stay current because you may not.

The way some banks process their automatic drafts, especially when they are first being established, may result in a 2 to 3 week delay for your mortgage lender to actually receive a payment from the bank. If your timing is off at all, it could result in the lender either charging you late fees or worse reporting a late payment on your credit record. Late mortgage payments are one of the most derogatory credit issues you can have on your credit report.

This is easily avoided. The best way to do it may make budgeting for a few weeks a little difficult if you’re already having money issues but the reward is well worth the extra tightening you might experience in the short term. (And it is still less expensive than paying the mortgage company a set up fee.) You need to pay your entire monthly mortgage on the first of the month as you usually do and, at the same time, start your first draft payment.

So, in essence, you are making a payment and a half or so that first time, so you are a half or so payment ahead in the beginning. By the next paycheck around two weeks later, you are making another half payment to the mortgage and now you are a month ahead in your payments. Now, as time goes forward, your mortgage is having the principal reduced every 14 to 16 days and you are always paying a month ahead.

With this strategy, you will reduce your mortgage quickly, have an easier time budgeting your mortgage payments and you will never have to worry about a late payment.

A later post will provide a checklist for easy reference when you start your bi-weekly payment schedule.

Many mortgage companies offer bi-weekly payment plans which are designed to help you budget for your mortgage payment more conveniently and payoff your mortgage early. Any bi-weekly payment plan will help you pay your mortgage off sooner, however, very few bi-weekly payment plans are actually making bi-weekly payments.

What the lender actually does is collect a bi-weekly draft from you but the payment is still applied in a lump sum once a month to your mortgage. This does pay down your principal quicker because it essentially results in one extra payment being made directly to your principal balance each year. You are not, however, getting the benefit of having a payment applied to your mortgage on a bi-weekly basis, even though you have had it deducted from your bank account that way.

This sounds confusing and, in fact, it is. If you are not very savvy about payment schedules, you could read all the information provided by most lenders offering these programs and not realize many of these important facts. Most lenders who offer these programs charge an enrollment fee of $250 or more. In addition, they also charge a processing fee of sometimes as much as $9.50 to $11.50 per draft of your checking/savings account. This can add up to over $500 per year in fees alone. I don’t know about you but, given the choice, I’d rather write checks myself and use that extra $500 to pay down my principal balance.

Don’t get me wrong, these programs will enable you to pay off your mortgage more quickly, but for far less than $500 a year, you can create the same effect and pay the extra money you’re not spending on fees to your mortgage principal.

Unless the your mortgage lender is offering the bi-weekly payment plan for a one time set up fee (which is usually a result of banks charging them a fee to set up automatic draft payment), there is a better option which you can set up yourself.

Tomorrow’s post will tell how to set up bi-weekly payments yourself.

Freddie Mac today released the results of its Primary Mortgage Market SurveySM (PMMSSM) in which the 30-year fixed-rate mortgage (FRM) averaged 5.78 percent, with an average 0.6 point, for the week ending April 28, 2005, down from last week when it averaged 5.80 percent. Last year at this time, the 30-year FRM averaged 6.01 percent.

The average for the 15-year FRM this week is 5.33 percent, with an average 0.6 point, down from last week when it averaged 5.36 percent. A year ago, the 15-year FRM averaged 5.35 percent.

Five-Year Treasury-indexed hybrid adjustable-rate mortgages (ARMs) averaged 5.20 percent this week, with an average 0.5 point, down from 5.22 last week. There is no annual historical information for last year since Freddie Mac only began tracking this mortgage rate at the start of this year.

One-year Treasury-indexed adjustable-rate mortgages (ARMs) averaged 4.21 percent this week, with an average 0.6 point, down from last week when it averaged 4.26 percent. At this time last year, the one-year ARM averaged 3.75 percent.

(Average commitment rates should be reported along with average fees and points to reflect the total cost of obtaining the mortgage.)

“The market was disappointed on the news of lower consumer confidence and lower orders for durable goods,” said Frank Nothaft, vice president and chief economist. “These numbers suggest that the Fed will remain restrained in its practice of raising short term rates, which may be an indication the Fed doesn’t see inflation to be as great a threat as the markets previously had thought it would be.

“And when inflation is thought to be in check, mortgage rates naturally drift downward as they did this week.”

Freddie Mac is a stockholder-owned corporation established by Congress in 1970 to create a continuous flow of funds to mortgage lenders in support of homeownership and rental housing. Freddie Mac purchases mortgages from lenders and packages them into securities that are sold to investors. Over the years, Freddie Mac has made home possible for one in six homebuyers in America.