The Subprime Market Fiasco Part XVI

Another quarter has passed and the housing and mortgage markets are showing signs of life. Homes are more affordable than they have been in years, rates are low, and the government will most likely extend and expand the tax credit for home buyers.

The Housing Market
The overall consensus from most pundits is the housing market is at or near bottom and in many arrears has begun to show signs of a recovery. Existing home values have increased for several months and can be partly attributed to the first time home buyer credit. New home sales fell in September after 4 months of growth. Good news for those considering buying a new home, as a Senate committee voted on extending and expanding the credit to June 2010, increasing the maximum income to be eligible by a large amount, and expanding the program to include a $6,100 credit for existing home buyers who have owned their current home for more than 5 years. The bill still has to be voted on by the full Senate and House of Representatives, but sentiments are positive.

The greatest value decreases since 2006 highs have been in the sand states of Nevada, California, Arizona and Florida. Not surprisingly, these states were amongst the higher value growth states in the years prior to the downturn. Interestingly, most of these states foreclosure rates have begun to slow. A grey cloud hanging over the market is the expectation of further foreclosures in areas that have weathered the storm fairly well. This includes high end homes and is a result of the high unemployment rate and out of work home owners who have exhausted their reserves.

Interest Rates
The Fed’s continued purchase of 10 Year Treasury bonds and Mortgage Backed Securities (MBS) have kept rates low, probably artificially low. 30 Year fixed rate conforming loans are once again near 5%, and conforming Adjustable Rate Loans (ARMS) are in the 4’s. The 30 Year fixed Jumbo rates have finally dropped and are only .5% higher than conforming rates. This is the narrowest spread in over 1 year. There is renewed Jumbo activity as borrowers are taking advantage of either lowering their rates or converting to fixed rates from ARM’s in anticipation of higher interest rates in the future.

Rates are still driven primarily by credit score and loan to value, with other factors such as property type, occupancy and cash out also a factor. FHA activity remains strong as it is virtually the only source of high loan to value financing.

Longer term outlook for rates look higher as the Fed announced that they will not continue the purchase of 10 Year Treasury’s which has a direct effect on mortgage rates. In addition yesterday’s news of economic growth – even if stimulus driven – will begin to ignite talks of the Fed raising the overnight rate to head off inflation.

Government Help for Home Owners’ with High Loan to Value programs
Many of you have been waiting anxiously, as have I for the launch of the Fannie Mae/Freddie Mac refinance programs for loans up to 125% of value. Right now we can refinance loans formerly serviced by countrywide and owned by Fannie Mae or Freddie Mac up to a LTV of 105%. I have been told that we will be able to refinance any qualified loan owned by Fannie Mae or Freddie Mac up to 125% Loan to value sometime in November. I am keeping my fingers crossed that this time the date will not be pushed out. If you qualify for this program, please let me know.

Actions you should take.
If you are thinking of purchasing a house, do so in the next 8 months to take advantage of the government tax credit. Send me an email of give me a call and I will help you determine if you qualify.

If you have not yet refinanced, take a couple of minutes of your time and I will provide you with a cost benefit analysis that lays it out for you in black and white with dollar signs attached. If now is not the right time, I will also monitor rates for you and let you know when it is financially beneficial for you to do so.

The information I will need is as follows:
Estimated Property Value:
- Property Type (single family, condo,etc):
- Occupancy Type (primary residence, vacation, etc):
- State/County of property:
- First Mortgage Balance:
- First Mortgage Product (fixed, 5 Year ARM, etc):
- First Mortgage Rate:
- ARM Expiration Date:
- 2nd Mortgage Balance:
- 2nd Mortgage Rate:
- 2nd Mortgage Product:
- Was the 2nd mortgage acquired at the time of home Purchase?
- Estimated Credit Score

Please feel free to forward this newsletter to anyone you would like. I would also be happy to hear your opinions or answer any questions you or your colleagues may have. I can provide mortgages in any state but Texas, but I would be happy to offer a reference there.

Kind regards,

- Greg

The Subprime Market Fiasco Part XV

In the three months since I have updated my thoughts on the mortgage and real estate market, the biggest change has been – stability. Stability of interest rates, stability in home prices and stability in what to expect from underwriting in terms of mortgage approval. I will touch upon these subjects as well as a personal endeavor - the Pan-Mass Challenge, a 192 mile bike-a-thon to raise money for cancer research.

Mortgage Rates. – After hitting close to an all time low in early spring, conforming mortgage rates (<417,000) have drifted along in the low to mid 5% range for 30 year fixed, with occasional spikes and troughs. Although rates change daily, they have held pretty steady with no more that .25% change in any one week. 5 Year ARM’s dipped to the low 4’s for quite a while, and are now edging back towards 5%. The wild card in rates is what is known as loan level adjusters. The most critical of these adjustors are loan to value and credit scores, followed by cash-out transactions.

Jumbo rates (>$417,000) have finally started to come down. A 30 year fixed jumbo is now under 6%. Although the gap between jumbo mortgages and conventional mortgage rates is still wider than historical norms, it is narrowing. I can only assume this is due to banks becoming more comfortable with their own balance sheets, or because of higher confidence that the secondary market which purchases these mortgages to eventually open up.

The savior for many borrowers has been FHA loans. FHA allows for both high loan to value (up to 96.5%), and lower credit scores. Although these loans due require an up front mortgage insurance fee (which can be rolled into the loan balance), their rates are very competitive with conforming rates. As a tax payer, my fear is that this program has been a catch all, and will eventually have a lot of non performing borrowers. Hopefully the amount of up-front mortgage insurance collected will be enough to offset any defaults.

My optimism for continued low rates is not bright. With the amount of money poured into the economy by the Federal Reserve combined with the Fed’ purchase of mortgage backed securities and treasury bills, I believe interest rates are artificially suppressed. If you are thinking about refinancing or if you have an adjustable rate mortgage that is coming due within the next 18 months, I would urge you to do so now.

Many of you have joined my rate watch program so that I can monitor rates for you and alert you when rates drop and it is economically advantageous for you to refinance. I have added a new feature for those of you who want to follow rate trends on your own. Every morning, and occasionally intraday I receive a very short notification of change in pricing on 30 Year Fixed Rates, 5 Year ARM’s and FHA loans. This is not a change in rate, but a change in pricing which is what determines rate. I have established a twitter account, www.twitter.com/todaysinterest. You can visit the site to sign up, and I will tweet these changes to you so can monitor changes and trends yourself.

High Loan to Value Loans. Many borrowers are frustrated that they can not take advantage of lower interest rates due to their high loan to value. (value of the home/loan size). If your mortgage was formally owned by Country Wide, and you do not have mortgage insurance, I can now refinance these loans up to a loan to value of 105%. In the next few weeks, I should be able to refinance any conforming loan, regardless of who owns it or where it was originated, or whether it has mortgage insurance. I am very excited about this program as it allows people who are qualified to refinance into a lower rate to do so. I look forward to updating you further on this.

Mortgage Approval and Underwriting. A key to being approved for a mortgage is making sure your loan officer is organized and efficient and has the ability to present your documentation and credit profile in an easy to read and underwrite package. They should almost due the underwriter’s work for them. Underwriting and processing is overwhelmed with the number of files they need to manage, and they are also squeezed by pressure to submit perfect files to Fannie Mae and Freddie Mac that will not be kicked back to the bank. Once they are kicked back, the bank owns them on their balance sheets. Condominiums add an additional level of difficulty and navigation that the loan officer must manage. Condominium approval can be difficult and time consuming, and takes constant monitoring. If you loan office is not responsive in getting back to you with rates, pricing, scenarios, etc, chances are he or she will not manage the underwriting rigors well, and your loan will not close in a timely manner, if at all.

Real Estate Market. This week we finally had good news on both new and existing home sales. Both showed positive signs with price increases in most metropolitan markets from May to June. Enough so that many pundits are daring to say that we may be at the bottom of the real estate market. That is not to say there are not still pockets of instability, as real estate is still local. Some areas of the country have lost over 50% in one year, while others have remained close to flat. The average yearly decline was 17%. If your geography had a big run up, chances are it had a big fall as well. While high unemployment could have a lasting effect on consumer confidence to purchase a home as well as add to the number of foreclosures, anecdotally I am beginning to see more activities from buyer. I am almost confident we are at the bottom.

Pan-Mass Challenge – Last year many of my readers were kind enough to contribute to my first Pan-Mass Challenge Bik-a-thon. The PMC is a 2 day long 190 mile bike-a-thon from Sturbridge, Mass. to Provincetown. The event has raised $239 million since its inception, with a record $35 million raised last year. 100% of the funds raised in 2008 went directly to the Jimmy Fund and the Dana Farber Cancer Institute. The event raises half of the totally yearly revenue for the Jimmy Fund.

Last year was my first PMC. I was motivated by my own affection for the Dana Farber after being treated there for Hodgkins in 1986. I was also motivated by guilt for wanting to “give back” to the Dana Farber, but always finding excuses not to do so. I was finally motivated by my sister Ellen, who after we lost both parents and a sister to cancer over a span of 7 years, rode her first PMC in 2007.

This year’s ride is motivated by a parents’ worst fear, a child with the threat of cancer. In September this past year, my 17 year old son had to come home from high school in AZ to have a tumor removed from his inner thigh. While we were told that it looked benign, there were several sleepless nights waiting for the test results, and secondary confirmation from Mass General as the tumor “was very unusual” and needed to be looked at by a second specialist. The doctors have no idea what caused the tumor. Although I was fairly certain I would ride again this year, that episode solidified my commitment.

I need your help. I have committed to raising $4,000 for this years August ride, and I am asking you for your donation. We are all pulled by our desire to help various charities, and for many of us, the current economy is challenge enough. Whether you contribute $5 or $100, every little bit helps. The easiest way to donate is to log on to PMC.org, click the egifts logo, at the top left corner of the page, sponsor rider GD0062 (me), and give generously. Alternatively, you can send checks made payable to Dana Farber Cancer Institute to my home address: 61 Fisher Street, Northboro MA, 01532.

I was told my many people that I ran into or corresponded with that they meant to donate last year but forgot or got side tracked. Please give now while it is on your mind.

This year I am using tweeter to provide updates during the ride. If you want to follow my progress, join me at www.twitter.com/panmasschal. I will limit the frequency of tweets as not to be too obnoxious.

I tell many people that Cancer has been a blessing in disguise. It taught me I can get through any challenge, prioritize what is important, appreciate the people in my life, always do my best, have fun and never sweat the small stuff. Please help give others the same chance I had.

Thank you for your support.

Please feel free to forward this newsletter to anyone you would like. I would also be happy to hear your opinions or answer any questions you or your colleagues may have. I can provide mortgages in any state but Texas, but I would be happy to offer a reference there.

Kind regards,

- Greg

The Sub-Prime Mortgage Fiasco - Part XIV

We have seen some dramatic changes in the real estate markets, mortgage markets, and of course the stock markets since my last correspondence. I will try to be brief but informative in my narrative. I will start with the mortgage market as that is my primary expertise, and where most of your interest lay. I will touch upon interest rates; Fannie Mae and Freddie Mac loan level adjustors (points); pricing; and the two new programs announced recently to aid “at risk” home owners and those that are unable to refinance due to falling home values – or high Loan to Value ratio’s (LTV’s).

Interest Rates – Rates for conforming loans (those under $417,000, or in certain markets up to $727,500) have fallen back to historical lows – briefly touching 4.875% for those with excellent credit scores above 740 and LTV’s below 60%. As you may imagine, there were very few borrowers in this category. This low water mark was touched the morning the fed unexpectedly lowered their discount rate by .75% rather than the expected .50% cut. This rate was short lived, and seen as an over reaction. Rates again touched near 5% when the government announced their intention to dedicate specific monies of the purchase of mortgage backed securities. The base mortgage rate has fluctuated between 5.125% and 5.375% for the past 60 days.

Loan Level Price Adjustors – Fannie Mae and Freddie Mac have gone to a risk based pricing model using price adjustors based upon the profile of the loan and borrower. The two key components of the risk based pricing are loan to value and credit score. LTV’s are delineated between ranges of <60%,>75%, and multi-family homes. CREDIT SCORES OVER 740 NEGATE MOST OF THE LOAN LEVEL ADJUSTORS. Excellent credit has never been more important.

Pricing is the mechanism by which a bank gets paid when it sells its mortgages to Fannie Mae and Freddie Mac. Typically there has been a fairly linear increase in rate to a decrease in price. For instance, if there was a loan level price adjustor as mentioned above, this would be reflected as collecting the .25 points at closing, or collecting no points and increasing the interest rate by .125%. This linear relationship is very important in providing “no points, no closing cost” mortgages as banks have the ability to calculate the point equivalent of closing costs, and provide an option of allowing their customers to receive a higher interest rate without closing cost, or a lower rate with closing cost. For most of the past 60 days, the no closing cost option has been non existent as there was no linear relationship. Only full and limited closing costs options were available. In fact, the pricing was such that there was an incentive to pay points on top of closing costs to get the best rate/value. That is why you may have heard of so many people getting rates at 5% or better – they were usually paying points to do so. For the past week pricing has seemed to return to normal, with negative pricing available to absorb closing costs – and even some of the nasty loan level adjustors mentioned previously.

Many of you may have read about the Treasury’s “Home Affordable Modification” program, as well as the “Home Affordable Refinance program for those home owners with Fannie Mae and Freddie Mac mortgages with high LTV’s In a nutshell, the Modification program is for those “at risk” of foreclosure but have not yet missed a payment. “At risk” includes those who have an adjustable rate mortgage about to adjust to a higher rate, a lost job, have an LTV >105%, or show other financial hardship. You must also show you do not have the ability to pay the mortgage out of reserves, and the program is for owner occupied properties only. Modification includes the financial institution reducing the rate and/or principle balance owed to a level such that the borrowers housing debt (principal, interest, insurance and real estate taxes) equate to 38% of income. The government will then share in the cost of the bank or institution further reducing the debt to income ratio to 31%. In addition, if the borrower keeps current on payments, he or she will be rewarded with an additional $1,000 principal reduction each year for 5 years. Guidelines for the Home Affordable Refinance program should be out in early April. This will expand Fannie and Freddie’s ability to refinance loans owned by them, up to a LTV of 105%. I do not yet know what loan level adjustors or mortgage insurance may be, but should know within the next couple of weeks. If you fall into this category, please feel free to contact me. For the Loan Modification program, you must contact your loan service provider.

On a final note, if you are being squeezed by fallen home prices and tightening LTV requirements, as well as the hit by the loan level adjustors due to credit scores and LTV, consider an FHA loan. FHA still allows up to 96.5% financing, has no price adjustors for high LTV or low credit scores, and are the most easily refinanced mortgages there are if you need to do so. As long as you are paying your FHA mortgage on time, you can refinance regardless of your income or home value.

I have also taken advantage of the low interest rates for those of you in my “rate watch” program. Mortgage rates are at historically low levels. Feel free to contact me at any time to provide a refinanced analysis for you, and to add you to my program so that I can monitor the rates and timing or a refinance on your behalf.

I also appreciate all the referrals to friends, family, and co-workers that many of you have provided. Please keep them coming.

As always, I welcome your comments and suggestions.

Disclosure: The opinions expressed are my own and do not represent the positions, strategies or opinions of JPMorgan Chase.

Two priests who take pleasure in smoking are having difficulty reconciling their desire to smoke with their commitment to daily prayers. They decide it is best to ask their bishop for guidance. The first priest broaches the subject with the bishop at that evening’s dinner and as he feared the bishop’s response was a resounding disapproval. The next day the first priest encounters the second smoking in the courtyard while saying his morning prayers. “Didn’t you hear” enquires the first “I asked the bishop if it is okay to smoke while praying, and he told me it is not”. “Why there’s your mistake”, responded the second priest “I asked the bishop if it was okay to pray while I smoked”.

I am reminded of this story as I analyze the fall in housing prices over the past two years. After witnessing the carnage, the large number of defaults, lost equity, and the number of homes upside down on their mortgages, I asked myself “is home ownership a good investment”? Like the story, it is all about perception. Historically, home ownership has been promoted as part of the American Dream. Lately, the news about foreclosures, falling values, and lack of mortgage financing makes that dream appear to be a nightmare.

I visited many mortgage and financial planning sites that have “buy vs. rent” calculators, and as you may imagine, they all came up with different answers. Most of the calculators are very general and not robust enough to encompass all the variables that contribute to the answer. Therefore, I developed my own model that takes into consideration the following factors:
- Purchase price;
- Down Payment;
- Real Estate Taxes;
- Hazard Insurance;
- Maintenance;
- Mortgage Interest Rate;
- Mortgage Insurance;
- Adjusted Gross Income, marital status and related tax bracket;
- Return on Investment Savings;
- Home Appreciation;
- Inflation;
- Rent Expense

These variables substantially affect the findings. In my analysis, I assume a Boston area Home Value to Rent ratio of 23x, which is one of the worst in the country. I also presuppose the average real home appreciation price index since 1950 of 1.24%, the average yearly inflation rate of 3.789%, a 30 year fixed interest rate of 6%, and average yearly returns on investment savings of 6%, 8%, 10% (hard to imagine in this market). Using two different scenarios, my findings are dramatically different.

The first scenario is a $350,000 purchase with 10% down, married, earning $100,000 of adjusted gross income. At the end of 30 years, the equity in their home is 12% more than the value of their investment portfolio at a 6% investment return, but 15% and 43% less at investment returns of 8% and 10% respectively.

Scenario two, with a purchase price of $700,000, 20% down, married, and an adjusted gross income of $200,000 had a far greater purchase advantage with home equity gains 117% and 35% greater than the rental investment portfolio when assuming investment returns of 6% and 8% respectively, and only 5% less at an investment return of 10%.

Why such a large advantage for the more affluent homebuyer? The answer is the power of compound interest. Under the first scenario with only 10% down, the buyer is paying mortgage insurance for the first 6 years or until enough equity is built up to cancel the insurance. In addition, the 2nd buyer is in an effective tax bracket of 28% vs. 25%, providing an additional 3% tax shelter on interest payments – which again is more prominent in the earlier years of the mortgage. Compounding these early year savings provides the better returns.

In analyzing all the data over the 30 year time period of the mortgage, I found some very significant information that is useful in making a purchase decision.

1.) The cash flow requirement or homeownership is far more than just paying principal and interest. When the cost of real estate taxes, insurance and maintenance is included, plan on adding up to another 50% of P&I to cash flow needs.

2.) The largest component of home ownership cash outlay is principal and interest. However, this is also the greatest advantage vs. renting. If amortized over 30 years this cost is fixed and does not change while rent is subject to yearly increases. This has a dramatic effect on homeownership vs. rent cash flow break-even.

3.) The purchase cash outlay includes payment of principal, which in effect is investment or equity building. When this component is removed reflecting a “net cash” or “expense” outlay, the break-even between purchasing and renting is far shorter.

4.) When analyzing purchasing vs. renting there are 3 different break-evens that should be considered.
a.) Equity vs. Investment Value;
b.) Total Cash outlay;
c.) Net Cash outlay.

5.) “Mortgage Free”. Once the mortgage is paid off, the difference in monthly cash flow is dramatic, and only continues to improve. Perhaps we should all think differently when purchasing a home, and view it as security in our retirement years, and an asset for our estate. In deciding how much house to purchase, and what size mortgage, we should look at payments with amortization payments based upon a desired age to be “mortgage free”. This may be 30 – 35 years for a 30 year old, but 15-20 years for a 45 year old.

I have included a couple of charts that clearly illustrates both the cash flow aspects of purchasing vs. renting, as well as the home equity buildup vs. investment return.
If you are interested in developing you own personal purchase vs. rent scenarios using your personal variables and input, please feel free to email me and I will send you a template.

As usual, please feel free to forward this email along to anyone you think may have interest. Along that note, I thank all of you who passed along my blog information to your contacts who you thought may be interested in signing up for my commentary through my blog. I also received many direct email requests to simply be added to the distribution list. If your contacts prefer this method, please ask them to email me directly and I will add them.

Have a wonderful Thanksgiving.

- Greg

The Sub-Prime Mortgage Fiasco - Part XII

While last month’s message focused on the government takeover of Fannie Mae and Freddie Mac, the intervening month has provided us with the government take over of AIG, the bankruptcy of Lehman Bros., a controversial government bail out plan, a deepening and broadening systematic credit crisis that has spread worldwide, the loss of untold wealth in equity markets, and governments intervention throughout the world to prop up banks and financial institutions.

Although I have views on all of the above, the goal of my updates is to provide opinions and information on the mortgage and housing markets, so I will primarily focus on these areas.

Falling home prices, which initiated the credit crisis, are still at the heart of the financial crisis. The continuation of a negative feedback loop - tighter underwriting guidelines creating less qualified buyers which in turn creates less demand for purchases which leads to lower home values and more foreclosures and lower values and further tightening of guidelines…continues to take its toll. How do we stop this loop and continued slide? Market forces will solve some of the problems, as recent housing starts have reached there lowest level in almost twenty years. While this helps reduce housing inventory and aid in stabilizing pricing, it does have a negative effect on employment and the economy (but I don’t want to digress away from housing and mortgages).

Many pundits have stated that while Wall Street is being saved by the government, not enough is being done to help those with troubled loans. My thoughts are that dealing with the relatively few entities of Wall Street and finding a solution that will impact us all is a lot easier dealing directly with hundreds of thousands if not millions of individual home owners who if helped, only helps them. However, if action is taken to collectively help troubled home owners, it could help stabilize home prices, ease the credit crisis, and give us all a sense of security as to the value of one of our largest assets.

In the second presidential debate, the debates moderator Tom Brokaw asked each presidential candidate “…as president what sacrifices will you ask every American to make to help restore the American dream”? While each candidate provided their typical non-answer, it did get me thinking. The sacrifice I am willing to make is to support a plan to assist troubled home owners. This goes against every fiber of my being as I am a true believer in personnel responsibility. While a small percentage of troubled home buyers were “duped” into a mortgage that they ultimately could not afford, I believe the majority of troubled loans came as a result of borrowers obtaining a mortgage they simply could not afford, living beyond the means of their pay, or speculation on the housing market that did not bear fruit.

My plan, if I had any input, would be similar to McCain’s but with some major differences out lined as follows:
1) Purchase from Wall Street $200B - $300B of trouble mortgages at 90% of face value, not 100%.

2) Rewrite mortgages for qualified borrowers at the 30 Year Treasury Rate + 1% (currently this would be at a rate of about 5.25%) on a 30 year amortization.

3) Borrower’s note would be for the full note amount, not a discount, and I would add the closing costs and a 1.5% points for insurance to the loan balance similar to FHA Loans.

4) Mortgage interest would not be tax deductible.

5) Mandatory debt to income ratio’s not exceeding 40%.

6) If borrower could not qualify under new low rate, immediate and uncontested foreclosure.

7) Program could be administered through existing government agencies such as FHA.

I believe such a plan would have an immediate impact on both Wall Street and borrowers. It would limit the amount of further write downs of bad loans to 10%, and remove most of the loans that have already been marked down from bank balance sheets. It removes or limits the uncertainty and trepidation of further write downs by banks which is causing a reluctance to lend to one another. In many cases banks may even be able to post a profit instead of a further loss if they already wrote down the loans by more than 10%.

It would also dramatically slow the pace of foreclosures as billions of dollars of mortgages are rewritten to affordable terms. Many of these borrowers have or will adjust to mortgages at rates ranging from or increasing to 7% - 12%+.

Much of the money provided by the government (or taxpayer) would be recouped as the loans are paid off through maturity or when the property is sold. An obvious unknown is the gain from buying the notes at 90% of face value vs. losses from foreclosures on those that did not initially qualify or are foreclosed upon subsequently, as well as managing the administration of the process on only the 1% difference between borrowing costs and lending rate, plus the 1.5% in points. A second unknown is the character of the borrowers. Would they walk away from a new affordable mortgage if they still owed more on their homes than they are currently worth? An offsetting gain would be the loss of the interest deduction to these borrowers.

The only ones who do not benefit are the vast majority of us that pay our mortgages and other bills on time. Many would call this unfair, and it is. But I would support it.

With all that has transpired, there has been little impact on mortgage rates. Conforming loans (<$417,000) and jumbo conforming loans (vary by county) are still pretty decent with the rate on a 30 year fixed at 6.375% for the conforming, and about .25% higher for the conforming Jumbo. There is huge volatility, as the rates have swung from 5.875% 10 days ago, to 6.75% last week. Rates are also impacted by credit score and loan to value.

On the subject or conforming jumbo loans, if you are considering purchasing or refinancing to these new loan limits, there is a reduction in the maximum loan size allowed that will be announced in November. To take advantage of the current loan size, you must apply prior to November 1st.

Traditional Jumbo rates are horrendous 1% - 1.5% higher than conforming rates with the exception of the 5/1 Jumbo ARM - if you are a premium borrower – Credit score above 700, lower loan to value, excellent liquid assets, and strong debt to income ratios. If you fall within this category, you can still get a rate of 5.75% - 6% depending upon the day.

There is still a very large risk premium or spread built into mortgage backed securities. This spread should narrow as the credit crisis eases, and home values stabilize. There is also an unusual detachment between mortgage backed securities, the 10 year treasury, and equity markets. They have traditionally moved in a correlation to one another, but lately they have not – making anticipating mortgage rates on any particular day fairly difficult.

On a positive note, given the lackluster economy and falling commodity prices, I am no longer in fear of inflationary pressures. As many of my long time readers know, I had always viewed inflation as the greatest threat to rates.

As usual if you have any thoughts, comments, or questions, please do not hesitate to contact me.

Regards,

- Greg

Disclosure: The opinions expressed are my own and do not represent the positions, strategies or opinions of JPMorgan Chase.

The Sub-Prime Mortgage Fiasco - Part XI

While the last few updates have been nuances on a continued theme of the credit crisis, this month’s analysis focuses on a truly historic financial event – our governments take over of Fannie Mae and Freddie Mac.

Fannie Mae and Freddie Mac are the tail that wags the dog of the mortgage market. In fact they are almost half the dog, purchasing nearly half the mortgages originated. As Fannie Mae and Freddie Mac goes, so goes the mortgage market. It will be extremely important to keep an eye on both entities over the next few years as the outcome of their final disposition will have an effect on mortgage rates, politics, and perhaps your taxes.

Rates for conforming loans backed by Fannie and Freddie have fallen to their lowest level in several months and in the short term should stay favorable - other economic factors remaining stable. The lower rates are due to the reduction of the “risk premium” required by investors who purchase Fannie and Freddie bonds. While there was always an implied guarantee the government would back these entities if they were in financial trouble, the actual direct take over has lowed the risk premium by .5%.

Interestingly, the risk premium is still more than .5% over recent historical levels due to uncertainty and volatility related to the mortgage and housing markets. Once the housing market stabilizes and lenders are more confident in their collateral, the risk premium should fall further. I liken this to the National Football League adoption of a player salary cap. Player salaries are the largest expense for a team, and prior to the cap many owners were spending far too much on payroll. Some teams were losing significant money. These financially weak teams were a burden to the rest of the NFL, dragging down the value of all teams. With such cost uncertainty banks were reluctant to lend to football franchises. However, once the certainty of a fixed and capped salary expense was implemented, banks were more willing to finance teams and the value of all teams flourished.

Short term, the government is expected to pump up to $200 billion of dollars into Fannie and Freddie to support the purchase of new mortgages. It is hopeful that this increased liquidity will help keep rates fluid and spur some home purchase activity which will help stabilize the housing industry.

The Fed plans to increase the amount of mortgages held by Fannie and Freddie through 2009, and then begin to dramatically peer back their holdings, while deciding what to do with the two companies. This will have both political and perhaps economic bearing on home interest rates. If the government intends to completely privatize or shut down the companies leaving home mortgages entirety in the hands of banks and Wall Street firms, they will be asking the Private Sector to completely absorb 50% of the entire mortgage market. If these banks and institutions are as reluctant to lend as they are in the current market (Hence the expensive Jumbo mortgages that are not backed by Fannie and Freddie), we can expect higher rates in the future.

The flip side is many politicians would like to see Fannie and Freddie stay entirely in the hands of the government, and some have even expressed a desire to relax current lending standards to enable those who have been shut out of the purchase and refinance markets due to current tight credit could once again be eligible for mortgages. A government controlled Fannie and Freddie could keep mortgage rates low, with the risk of mortgage losses carried by taxpayers.

Additional good news on the mortgage front is the falling price of oil and other commodities. This has reduced my fear of runaway inflation which as I have voiced many times before, could increase rates dramatically. This is not to say that my inflation fears are gone, they are just on the back burner for now. Rising oil prices are just a hurricane, war, or strong global economic growth away.

The current falling rate environment has allowed me to convert several of you in my automated “rate watch” program to fixed rate products or new adjustable rate products in the last few days. While base mortgage rates are very low, “risk adjustors” which Fannie Mae and Freddie Mac have added to their pricing greatly affects the rate. The two most important adjustors are loan to value and credit score. If you are a participant in my program, please send me an email updating me as to your estimated home value, mortgage balance(s), and estimated credit score so I can provide you accurate analysis.

If you are not yet a part of my program, and would like me to monitor rates for you on a daily basis and contact you when you can lower your rate by refinancing and paying no points and no closing costs, please provide me the following information to the best of your knowledge.
1.) Estimated value of your current home;
2.) Property type (condo, single family etc);
3.) Occupancy type (owner occupied, second home, rental, etc.);
4.) Location of property (county, state);
5.) Balance on your current mortgage(s);
6.) Rates on your current mortgage(s);
7.) Current mortgage type – (30 year Fixed, 5 Year ARM, etc.) If adjustable, when does it adjust?
8.) Rate and Term or cash-out refinance. If you have a first and second mortgage and you would like to consolidate them, it is considered a cash-out refinance unless you acquired the mortgages at the same time, or you have not drawn down against the second mortgage in the last 12 months.
9.) Estimated credit score.
10.) Any other factor that you think is important that I know.

For more details on the “rate watch” program view my November, 2007 post on the subject.

Once again if you have any thoughts, comments, or questions, please do not hesitate to contact me.

Disclosure: The opinions expressed are my own and do not represent the positions, strategies or opinions of JPMorgan Chase.

The Sub-Prime Mortgage Fiasco - Part X

Good Day,

Since this month’s report contains mostly negative mortgage news, I will keep my analysis of the mortgage and real estate market fairly short.

In the past month, we have seen further deterioration of financial institutions balance sheets in the form of unexpected mortgage and credit related loss reserves, most importantly with Fannie Mae and Freddie Mac who purchase a majority of originated conforming loan size mortgages. The continued uncertainty and lack of stability in the credit markets has led to a limited appetite for mortgage backed securities, a lessened supply of credit facilities, increased risk aversion, and the need for Fannie Mae and Freddie Mac to increase their pricing to offset past losses – all of which contribute to higher interest rates.

And now the good news….

The FHA has really stepped to the fore by expanding their maximum loan amounts, while keeping required borrowers equity at 3%. Their credit score requirements are also a lot less severe than with traditional lenders, and fair to poor credit is not punished as severely. Of course as a tax payer it causes some concern to me.

At least in some geographic areas, the housing market is beginning to stabilize. For instance in the Boston Market prices actually increased moderately. In addition, June’s existing home sales increased 5% nationally. Hopefully this trend will continue and we will see the bottom of the housing market shortly. I believe that future foreclosure’s will be the driving factor in the housing market, as foreclosures both increases housing supply and drive down pricing as lender’s want to liquidate foreclosed upon houses as quickly as possible.

The psychology of the housing bust has affected most of us more than the reality. We all need a place to live, so the actual value of our homes while we are alive is almost irrelevant. It is mostly only our heirs who stand to loose if housing price have not rebounded by the time of our demise, and personally I plan to live along time.

Very few of us have should have been hurt by the decrease in home values. Those who have been effected are:
- Older home owners with plans on downsizing to a less expensive home;
- Those who own second homes or investment properties;
- Those who used their homes as a piggy bank and took out home equity lines to sustain a life style above their income levels;
- Those who purchased in the last couple of years and would like to move but owe more than their homes are worth, and do not have the excess assets to make up for their loss of equity.
- Those whose adjustable rate mortgages are at or near their adjustment dates, and can not refinance into a longer period loan due to lenders loan to value guidelines.

The rest of us actually benefit from lower housing prices as it makes housing affordable for first time home buyers, as well as for existing home buyers who want to move up to previously unaffordable neighborhoods. Vacation homes are now more affordable, and investment properties are now usually cash flow positive as a result of higher down payment requirements, and lower prices.

While we are all leery of increasing interest rates over the last several months, the drop in home values far exceeds the cost of higher borrowing.

As usual, I look forward to any thoughts and comments, as well as any referrals to friends, family, and co-workers. I would be happy to run numbers and prepare various analyses for you. If you are already working with a different Chase Loan Officer, please continue to give him or her your support.

Kind regards,

- Greg

Disclosure: The opinions expressed are my own and do not represent the positions, strategies or opinions of JPMorgan Chase.