Who REALLY Can Benefit From Lower Mortgage Rates?

Who can benefit from lower rates?  The answer is ‘a small fraction as in the past’.  I am already seeing analysts reports come out saying things like ‘if rates drop to 5.25% then 6 million people will be eligible to refi’ and ‘this will save the purchase market and builders’.  This in not correct and I will explain why in detail in this post.

First, I am glad to see mortgage rates dropping but it would have been nice to see them drop naturally vs artificially as a result of ‘announcements’ and ‘leaks’ from government agencies. I have always said there are only two ways to quickly stabilize housing prices - a) bring back all of the exotic loans lost in 2007 b) gave everyone 300% raises. These are obviously not going to happen but illustrate how much of a jam the housing market is in.

The only way to ‘fix’ the housing market with the financing available today is for home prices to drop and for the default crisis to end. Both have to happen fast and at the same time. All of this government interference to date has caused nothing but confusion and negative sentiment towards the sector. Home prices have still collapsed and show no signs of bottoming any time soon. Home prices will get back to their historic relationships with rents and incomes eventually and interventions like this only prolong the pain.

The government is trying to control interest rates through talk and selective purchases of mortgage securities that have not kept pace with US Treasuries by any stretch. Real interest rates have been falling yet mortgage rates were staying elevated - spreads widening. Last week it was announced that the Fed would buy $100 billion in debt and $500 billion in actual Agency mortgage backed securities. Of course the market assumed this would be done all at once within 24-hours but as we learn more it is a several quarter plan that will likely be used to control spreads ‘challenges’ like we were seeing before the announcement.

On a sidebar, I maintain that these ‘announcements’ are not so much about lower rates for you and me.  Rather better executions for Bill Gross and Foreign Central Banks who are stuck with trillions of Agency mortgage paper and have been sellers for months in favor of US Treasuries. I am sure you saw Bill Gross threaten the Treasury on national TV before the Fonie and Fraudie bailout. Essentially he said ‘fix Fannie/Freddie bonds or I will tell my large clients not to buy anything for a long time’. Within a couple of days F&F were in conservatorship and their debt ‘effectively’ backed. There is still no ‘explicit’ guaranty, which is likely the reason you do not see a mad rush into this sector as you have the Treasury market so they felt more government meddling was needed. Time will tell if this is just all talk but as of now Paulson was effective in bringing down base-rates for perfect borrowers from 6% to about 5.5%. However, the latest chatter of 4.5% is more fantasy than reality. I will be shocked if we ever see it.

The housing market cannot be fixed with artificially low interest rates. Remember, we still have millions in the foreclosure pipeline and mortgage defaults at all time highs. The latest wide-scale mortgage modification attempts fall very short of being a permanent solution. As long as borrowers are defaulting and losing homes to foreclosure we will be in a housing crisis.

Let’s Pretend

But let’s pretend for a moment that there were not two to three times the number of homes going into default and foreclosure than selling each month.  Who out there can actually take advantage of these lower interest rates? Analyst with their antiquated modeling systems seem to think that at 5.5% a refi and purchase boom will ensure that will solve the housing crisis. I maintain this is a different world and interest rates do not mean what they used to.

WHO REALLY CAN BENEFIT FROM LOWER RATES

REFINANCE

During the boom years when rates slammed down 50bps like we saw last week, it seemed that the entire nation would refi or re-refi at once. Refi’s drove the mortgage industry during the bubble years and loan officers lived for the next refi boom that seemed to come ever six months or so. Purchases ran a distant second making up 20% of activity at best.

Serial refinancing as values soared double digit percentages per year was a massive stimulus to the consumer, housing market and broader economy. With each refi came lower payments in the case of a rate & term refi; much lower payments when a borrower switched programs from a 5/1 interest only to Pay Option ARM; or lots of cash from a cash-out refi. Combining an existing first and second mortgage into a larger first mortgage and then adding a new second mortgage every year gave homeowners a major liquidity shot in the arm that was used from everything from vacations, plastic surgery, cars, jewelry and remodeling.

Now with values down in the bubble states on average near 50% in the past 18 months, most homeowners and serial refinancers are underwater or ‘near’ underwater meaning they can’t refi. In CA for example, 60% fit this profile. These homeowners are dead to the mortgage sector. In other bubble states negative equity is worse.

Of the 40% that have a low enough loan-to-value to play ball, many made no mistakes during the bubble years and could be in a 5% to 5.5% 30-year fixed right now. Rates have to go much lower for these people to want to reset a loan with 26-years left to 30-years. Also within the 40%, not all have the LTV under 80% and credit score over 740 that allows them to take advantage of the vanilla base-rates. Remember, in the past year credit guidelines have tightened so much that unless the borrower’s profile is nearly perfect, they do not get the best rates.

There are significant adjustments that take base mortgage rates much higher which did not exist a couple of years ago for LTV’s, credit scores, loan type, purpose (and more) that are outside of the small vanilla box. During the bubble the box was huge where a 580 and 700 credit score could get the same rate from the GSE’s. Now there would be a rate hit of 1% or more if the borrower could even qualify. Then there are those in exotic Pay Option ARMs and alike that don’t want out regardless of where fixed rate loans go. Remember, index values underlying these loans such as the MTA, CMT, Treasury and LIBOR are falling making these loans attractive. A refi into 5.5% or even 4.5% means a payment increase, which is a tough sell. Additionally, there are the folks who went stated income/asset that can not qualify regardless of how low full doc Agency rates go.

Lastly, If the borrower has a second mortgage, as millions do, that they needs to be kept in place the rate can jump at a minimum from 5.5% to 6% making a refi potentially out of the question.

Two years ago when rates dropped, there was a nationwide refi-party that was absolutely stimulative to the housing market and overall economy. Now, my research shows that of all homeowners in the bubble states, less than 20% can actually benefit from rates dropping when you remove the parties outlined above. I naturally focus upon the bubble states because of their massive population and home owner bases and because no national housing market or lending upswing will occur without these states participating. Scratch the refi-boom.

MOVE-UP BUYER

Move-up buyers were the largest segment of buyers during the bubble years, as folks always wanted something bigger, newer or in a better location. Each quarter brought about new and innovative loan programs designed by the investment banks to bring payments and down-payments lower making homes more affordable. With very little down required and housing rising double-digit percentages per year it was easy to sell, pocket the cash above the loan payoff and buy the better home with little to no money down and a lower payment if you chose a Pay Option ARM for example. The new home was furnished on easy credit terms from their favorite furniture chain. EVERYONE qualified due to stated income, no ratio and no doc loans. Now, the move-up buyer virtually non-existent because most can’t sell for what they owe; can’t sell for what is needed to extract the large down payment needed to buy the new home given today’s financing; or can’t qualify for a mortgage on the home they presently live in let alone a larger mortgage without an exotic or liar loan. Scratch the move-up buyer.

FIRST-TIME BUYER

First time home buyers in their early to mid 20’s are a group that can benefit from lower rates. However, historically they were one of the smallest housing market segments. Now the question is, how many 20-something’s have a large down payment, 2-year job history, very little debt and good enough credit score to take advantage of the low base rates available?

This group as a whole will not be able to get the low base-rates being thrown around because they are not seasoned borrowers. An LTV and credit score that was considered ‘Super-Prime’ two years ago can result in a 1.5% hit to the rate bringing them from 5.5% to 7% very quickly.  While the 7% rate may fall further, I believe that this group is more price-sensitive and looking for a ‘great deal’ on a foreclosure-related property vs waiting for rates to drop to buy. This seems to be the case with most buyers given over half of all home sales in the bubble states come from the foreclosure stock.

RENTER

Renters can also benefit from lower rates but the same rules apply as with First Time Buyers. This segment also has historically been one of the weakest, as many are renters for a reason. In many cases those reasons prohibit them from buying.

SECOND HOME/INVESTMENT BUYER

Once again, it is more about getting a ‘great deal’ on a foreclosure related sale vs hitting an interest rate level that prompts a purchase for this group. For those not paying cash, most investors have significant interest rate adjustments on their loan taking the rate up substantially over 5.5%. For investment properties, the 3-point hit for LTV’s above 75% alone takes the 5.5% to 6.75% - most will have multiple hits.  The second/vacation home buyer can get more aggressive rates than investors, but I sure hope that economists are not staking their reputation on vacation home buyers saving the housing market.

Well, there you have it. This is my take on lower rates. While naturally lower rates are good for everyone, there is a fundamental problem with our government spending money to artificially push mortgage rates lower. Remember, it was artificially low rates on exotic loan programs that were one of the reasons we got here in the first place.

Posted in Categories: Contributor, Economy, External Research, Housing, USA.

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