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.