Click chart to enlarge, and see more Quantitative Easing 101 links below.

SEE ALSO:
- Quantitative Easing 101 (part 1): Timeline
- Quantitative Easing 101 (part 2): Dollar Impact
- Quantitative Easing 101 (part 3): Inflation Impact
- Quantitative Easing 101 (part 4): Consumer Q&A ]]> http://thebasispoint.com/2011/06/23/quantitative-easing-rate-recap-timeline/feed/ 8 http://thebasispoint.com/2011/06/20/limits-on-mortgage-interest-deductions-for-refinancers-cash-buyers/ http://thebasispoint.com/2011/06/20/limits-on-mortgage-interest-deductions-for-refinancers-cash-buyers/#comments Mon, 20 Jun 2011 16:21:08 +0000 TheBasisPoint http://thebasispoint.com/?p=10688 Recent existing home sales reports remind us that cash buyers are on the rise. In May, 30% of existing home sales were all-cash deals, down only slightly from 31% in April, and a record 35% in March.

Is it more beneficial to pay cash for a home? Depends on your expected time horizon in the home, and what return you could otherwise get for that cash. Here are some things to consider. Refinancers, pay attention too: if you’re increasing your loan balance, you WON’T increase your loan interest deductions.

(1) Current rates are 4.625% for a 30yr fixed or 3% for a 5yr ARM. If you’re in a 33% tax bracket, your after-tax 30yr rate is 3.09% and your after-tax 5yr rate is 2.01%.

(2) If you financed at those rates and invested the cash, can you beat 3.09% or 2.01% investment returns after fees and taxes?

(3) If you’re paying cash with intent to finance later to take advantage of mortgage interest deductions, you have two problems:

(i) Mortgage interest deductions are limited to the IRS “acquisition debt” limit. They define deductible debt as debt taken at the time of acquiring the home. If you get a loan more than 90 days after buying the home, mortgage interest isn’t deductible.

(ii) You’d then be doing a cash-out refinance loan instead of a purchase loan. Depending on your equity position, cash-out rates can be as much as .375% higher. Also cash-out loan restrictions might prevent you from taking your desired cash amount back out.

Cash buyers (and refinancers) should think through and research this fine print with mortgage, investment, and tax advisors.

Look forward to (and need!) your feedback as you get periodic emails so we can continually improve. Below is a sampling of TheBasisPoint’s daily content (including the fun stuff) that emails are pulled from. Thanks again to everyone for supporting us!

MARKETS & HOUSING CONTENT
- WeeklyBasis: market recap & outlook with rates, published Saturdays

- DailyBasis: daily views on hot market & regulatory topics

- Fundamentals: daily economic stat roundup

- Originations: daily links to web’s best consumer-friendly market insights

FUN STUFF
- Pop Culture: superficial and deep takes on movies, TV, books, web

- Workplace: anecdotes and snark on everyone’s least/most loved pastime

- bTunes: music matching market moods

- Media Analysis: views on everyone’s primary obsession

So let’s review mortgage basics for new buyers and especially experienced buyers who need a refresh given new lending complexities of the past two years. Here’s how lenders analyze you, how the buying process works, and how mortgage rate markets work.

A good mortgage advisor will do a 30-60 minute consultation with you and lead with data collection. They can’t help you set objectives or make recommendations without your profile. Of course you have to be comfortable with their style, then you’ll provide these items (verbally first, then documentation):

-Personal information including birth date, marital status, number of children and ages. Loan applications are Federal documents and require this data. Good loan agents use it to help with family and retirement planning.

-Residence history for at least two years. If renter, rent payment is needed. If owner, all mortgage, insurance and tax figures are needed.

-Employment and income for at least two years. If you receive commissions or bonuses, you need two years of figures—all lenders average variable income (including self-employed income) over two years. Full tax returns for two years are always required, including business taxes if you’re a business owner.

-Asset balances including all checking, savings, investment, and retirement accounts. If you move money among accounts, you must provide all accounts even if you’re only using one account for the down payment, because the lender will review every line item on two months of full account statements and ask to paper-trail large deposits and withdrawals. Here are specific rules if you’re using gift or retirement funds for down payment.

-Debt payments and balances for credit cards, mortgages, student loans, car loans, alimony, child support, or anything else.

-Social security number: A good loan agent can use the verbal debt information to estimate your credit score which is needed for loan qualifying and rate quotes, but eventually you’ll need to provide your social security number so lender can verify with a credit report.

Borrower pre-approval is a combination of credit score, down payment, and your total (housing and non-housing) debt relative to income. So collecting this information (verbally first, then documentation) enables your loan agent to:

(1) Provide written estimates purchase showing prices and down payments you qualify for, monthly budget (with rates), and tax benefits.

(2) Pre-qualify or pre-approve you for a loan. Both phrases mean the same thing.

Now comes property pre-approval. Loans are made based on borrower AND property profiles. So after you are pre-approved and start home shopping, you or your Realtor must tell your lender about each property you’re serious about so they can also pre-approve the home.

For a single family home, a loan agent should screen the property (before you write an offer) for any deferred maintenance, pest reports, un-permitted additions, or known structural defects. Some of these issues are ok to lend on, but you need to know before you get into contract.

For a condo, a loan agent should screen the property for owner-occupancy ratio of the building, budget, commercial space, and homeowners association litigation. Loan approval depends on these factors, so again: make your lender find out before you’re in contract.

Rate locks require a borrower’s social security number AND a property, so you must be in contract to buy a home before you can lock a rate.

Home mortgage rates are derived daily from yields on mortgage bonds. As mortgage bond prices trade up and down each day, bond yields (or rates) move inversely. So if economic news is bad, bonds get bought, prices rise, and yields (or rates) drop. And if economic news is good, bonds sell, prices fall, and rates rise.

All U.S. lenders update mortgage rates throughout each day based on whether mortgage bonds are trading up or down on the day’s economic data.

A good loan agent will brief you on each given week’s economic outlook and update written estimates as rates move during your shopping process. They’ll also advise on what market factors will impact rates when you get into contract, so you can decide when to lock a rate.

The official approval process begins when you’re in contract to buy a home.

That’s when your loan agent assembles the property documentation—appraisal, title report, inspections and condo docs as necessary—with what they already have for you, and presents the full loan package to their bank underwriter for formal approval.

If your loan agent follows a detailed pre-approval and documentation process as noted here, the formal underwriting approval process should be smooth.

If they don’t, the process is really just beginning when the bank underwriter gets the package.

Let’s look past the promos to see if biweekly mortgage payment programs are smart or a ripoff.

A biweekly mortgage payment plan simply means you’re making half your mortgage payment every other week. It’s sold to you as a way to pay off your mortgage early using your same budget.

But your monthly budget is expanded slightly because paying half your mortgage every other week means you’re making 26 payments. This is the equivalent of 13 mortgage payments per year instead of 12.

It’s true you may not feel that budget difference since you’re just chopping your mortgage payment in two and paying each portion every other week. It’s also true that you’ll end up paying your loan off five to six years early and saving tens or hundreds of thousands.

For example, if you have a 30yr fixed loan of $408,500 at 4.5% and a payment of $2069.81, a biweekly plan would save you $59,314 and you’ll pay your loan off in 25 years.

Or if you have a 30yr fixed loan of $1,050,000 at 5.375% and a payment of $5879.70, a biweekly plan would save you $215,204 and you’ll pay your loan off in 24 years.

HERE’S THE CATCH: institutions charge $350 to $500 set up fee plus $1.50 to $3.00 for each biweekly payment processed.

Relative to the savings, you could argue these fees are worth it. But here’s how to accomplish the same goal with zero fees: the exact mathematical equivalent of a biweekly payment program is making a thirteenth payment per year.

In the $408,500 loan example above, your principal+interest payment is $2069.81 twelve times per year. If you pay this amount a thirteenth time each year, the entire $2069.81 is applied to paying down principal, and you’ll pay off your loan five years early.

It doesn’t matter if you pay $2069.81 in extra principal month-to-month or do it once per year, the end result is the same. Again, it’s the mathematical equivalent of the biweekly program.

Your monthly mortgage statements have an option enter an ‘Additional Principal’ payment each month.

So if you paid the entire thirteenth payment once per year in December, your December payment would be for $4139.62 (twice your normal mortgage payment), and you’d enter $2069.81 in the ‘Additional Principal’ category.

If you want to space that thirteenth payment over the year, you divide your $2069.81 payment by 12, and enter the resulting $172.48 in the ‘Additional Principal’ category each month.

Whether making additional principal payments monthly or all at once, you just need to make sure your lender applies it correctly when you review your next statement.

Using this method, you’ll accomplish the savings goal of a biweekly payment plan without the fees.

Gift Funds: You can use gift funds from a family member as money for a down payment. You and the family gift donor must both sign a lender Gift Letter verifying the funds are in fact a gift. For most loans the donor must also provide proof of their ability to gift, usually in the form of a bank statement. As for tax implications, Gift Tax is imposed on donor, not receiver. Any individual can gift any other individual $13k per year tax free. So a married set of parents can each give $13k to their single child for a total of $26k. Or that same set of parents could gift to a married couple for a total of $52k. Then the balance needed for any gift funds beyond those amounts can still come tax free under the $5m lifetime exclusion for gift tax under 2011 estate tax law.

401(k) Loan: You may borrow up to 50% or $50,000 of your 401(k) funds for a down payment, whichever is less. Rates on 401(k) loans are set by the institution that administers the 401(k), and today are between 4.75% and 5.25% amortized over 30 years. On a $50,000 loan at 5.25%, the payment would be $276. This is far more advisable than paying taxes and penalties for early withdrawal. The part you borrow is removed from whatever it’s invested in and placed in an interest-bearing account. So you lose some but not all of your ability to stay invested. If you leave the employer administering the 401(k), you have 90 days to repay the remaining loan balance or it’s counted as an early distribution, subject taxes and penalties.

IRA Withdrawal: You can withdrawal $10,000 in down payment funds from a traditional IRA penalty free but not tax free. So you’ll get the whole $10,000 when you take it out, but you’ll have to pay federal and state capital gains taxes (about 35% total) on the next tax filing cycle. If you liquidate more than $10,000, 20% of the overage will be withheld for taxes (but taxes will eventually be about 35%). On top of this, federal and state penalties are about 12.5% on anything above $10,000.

Roth IRA Withdrawal: Roth IRA contributions are made with after-tax dollars so you can withdraw your contributions at any time for down payment (or any other reason) with no tax liability. But if you withdraw any capital gains your Roth accumulates beyond your contributions, there are more rules. When buying a home, you can withdrawal $10,000 of capital gains with no taxes or penalties. After that initial $10,000, any withdrawals from capital gains are taxed as income and have a 10% penalty unless two things are true: (1) the withdrawal occurs after five full “tax years.” A “tax year” begins January 1 of the contribution year, even if the contribution is made on December 31. (2) You’re a first-time homebuyer, which is defined as someone who hasn’t owned a principal residence for three years. Owning a rental property or a vacation home doesn’t disqualify you. Also, if you’re looking to help a spouse, child, or grandchild who is a first-time homebuyer, you can make a tax-free, penalty-free Roth IRA withdrawal of up to $10,000.

Always consult tax, mortgage, financial planning, and estate advisors regarding your specific profile.

3 Loan Reform Options
Fannie and Freddie buy most U.S. loans up to $729,750 after banks close them, giving banks liquidity to make new loans more quickly. It also means banks can keep rates lower because Fannie and Freddie package the loans into bonds so risk is shared by securities markets. FHA goes one step further: in exchange for lender and borrower paid mortgage insurance fees, they actually reimburse lenders if the loan goes bad, which enables lenders to offer even lower rates to consumers. The 3 reform proposals for these 3 government entities are: (1) reduce government’s home loan role to only support lower income families and rely on private markets to fill the Fannie and Freddie role, (2) involve government only in crisis, or (3) expand the FHA insurance concept to include the whole market. The market and political reality is that home finance in the U.S. will be some combination of these three options.

Near-Term Loan/Rate Changes
Due to political risk for all parties, we won’t see huge changes in home finance before the 2012 presidential election, but we will see Fannie and Freddie buying less from banks. Congress will likely reduce the loan caps Fannie/Freddie are eligible to buy from $729,750 to $625,500 by October. This will send the right signal to private investment firms that Fannie/Freddie market share is decreasing and give them confidence to start buying these loans from banks. After a 3.5 year drought, private investors are already beginning to buy loans again, but for now it’s Jumbo loans above $729,750. Setting up these Jumbo loan buying relationships with banks now will pave the way for expanding the relationship to lower loan amounts when Congress begins reducing loan caps later this year. For the next couple years, it means steady rates and more availability for large loans, and also slowly replaces Fannie/Freddie.

The End of 30-Year Fixed?
One fear of eliminating Fannie & Freddie is that private investors won’t have a tolerance for 30-year fixed loans, so they’ll only offer consumers loans fixed for 5, 7, or 10 years. This would mean a buyer who wants to own their home long-term must get a new loan at (potentially higher) market rates in 5, 7, or 10 years. The fear is rooted in how banks manage risk. Since rates swing so much, they prefer not lock their entire portfolio into low rates for the long term. In doing shorter-term loans, they can keep borrowers’ rates closer to market rates over time. However the Jumbo deals investors and banks are making right now are mostly for 30 year fixed loans. This suggests some faith in the ability of securitization to mitigate risk, and bodes well for availability of competitive 30-year mortgages even in a post Fannie/Freddie era.

All rates discussed are 30yr fixed rates on single family home loans up to $417,000, and assume at least 20% down payments. Rates are lower for bigger down payments. Rates are higher for condos and loan amounts above $417,000.

How Rate Markets Work
Home mortgage rates are derived daily from yields on mortgage bonds. Here’s what that means: A bond is like a loan. A bond investor is the lender and a bond issuer like Fannie Mae is the borrower. The investor pays Fannie Mae a certain price for the bond then receives an annual interest payment (called a yield or rate) on that bond they own. As mortgage bond prices trade up and down each day, that yield moves inversely. So if economic news is bad, bonds get bought, prices rise, and yields (or rates) drop. And if economic news is good, bonds sell, prices fall, and rates rise. All U.S. lenders update mortgage rates throughout each day based on whether mortgage bonds are trading up or down on the day’s economic data.

Rate Summary: Early Crisis to Present
Rates can swing .25% to .5% day-to-day as mortgage traders decide whether to buy or sell based on the day’s data. But rates do eventually conform to broader economic trends. The accompanying chart shows that rates were 6.7% in July 2007 because most traditional economic indicators signaled that our economy was healthy.

The crisis began July 2007 as subprime loans and funds started going bad, but the chart shows rates weren’t drastically impacted until November 2008, when markets for home loans, business loans, bank-to-bank loans, and most other forms of credit were collapsing. So the Fed did something it had never done before. They said they’d prop up housing by buying billions (which ended up being $1.25 trillion) in mortgage bonds to bid bond prices up and rates down.

It worked and rates dropped to 5.09% by January 2009. Besides some volatility you can see on the chart, rates stayed at that level until their buying ended March 2010.

Then two things pushed rates to as low as 4% by early-October 2010: (1) global bond investors panicked about Europe’s debt problems, sold European bonds, and bought U.S. mortgage bonds, and (2) the Fed said they’d announce more bond buying in November 2010.

But in November 2010 the Fed said they’d buy Treasury bonds instead of more mortgage bonds. This along with a moderately improving U.S. economy caused mortgage bonds to sell off, pushing rates up to the 4.75% to 5% range today.

U.S. Economic Outlook
Most 2011 projections for core U.S. economic stats are as follows: economic growth of 3.0% to 3.5% (currently 3.2%), consumer inflation of 1.5% (currently 1.1%), unemployment of 9% (currently 9.4%), and home prices to remain about the same (currently at mid-2003 levels). Flat jobs are justified because companies will hire conservatively until they see sustained economic growth (measured by GDP), and the high end of GDP projections at 3.5% isn’t much better than today. Flat housing is also justified because mass foreclosures on homes worth less than their mortgages will continue. And if consumer inflation rose to 1.5%, it’s still within the Fed’s 1-2% comfort zone.

But U.S. business inflation is hotter at 4% today, and recent manufacturing surveys show an expectation that prices will continue rising. Also China’s consumer and business inflation is now 4.6% and 5.9% respectively. Hot inflation causes bonds to sell and rates to rise.

Then there’s the ongoing European debt crisis which may continue to help our mortgage bonds and rates. Also a U.S. state and local government debt crisis is brewing, but the market reality is that troubled regions will likely get federal assistance even though many are against that. This situation might also help rates in 2011 as municipal bond investors seek safety in mortgage bonds.

2011 Rate Outlook: 5.5% to 5.75%
Based on all of these offsetting inputs, rates should rise about .75% by the end of 2011, putting us at 5.5% to 5.75% (which accounts for +/-.25% average short-term rate volatility). For near-term perspective, remember that July 2007 rates were 6.7% in an economy perceived to be healthy. For long-term perspective, the average 30yr fixed rate since official records began in 1971 is 8.89%.

Private Mortgage Insurance Comeback?
As FHA mortgage insurance (MI) hikes are coming, private MI companies have relaxed guidelines. Depending on your loan amount and where you live, different private MI options allow for a loan to go up to 90% or 95% of your home’s value. And private MI is a bit cheaper than the newly proposed FHA MI premiums. Private MI has no up-front premium and most monthly premiums range from .5% (for a loan up to $417k) to .8% (for loans above $417k). Private mortgage insurance companies have also had tough times in recent years, so they are very strict on loan approvals. They have special rules for a borrowers credit score and history, they scrutinize the home’s value closely, and they take a bit longer to approve loans. But with FHA rules changing, private MI will become another option to consider for borrower with less than 20% home equity.

Home prices started falling in 2006 but it wasn’t until 2007 that the full impact of loose credit was felt. Loans made to unqualified (mostly U.S.) borrowers underpinned bond funds around the globe and countless derivatives were created from those bonds. Because of this, Nouriel Roubini was one of the first economists to note that “we have a subprime financial system, not a subprime mortgage market.”

Below are key rate milestones of the financial crisis along with key milestones in real-time media development—the correlations are coincidental but show that, as the crisis escalated, so did the chatter. Also below is a chart to show rates along this timeline (click chart for full size).

April 2, 2007: Credit crunch apparent when New Century, one of the largest U.S. subprime mortgage lenders, failed. Twitter’s tipping point was two weeks prior, March 14-18, when Twitter went from 20,000 to 60,000 tweets per day at the South By Southwest music festival. Average 30yr fixed conforming rates were 6.18%.

June 22, 2007: Two Bear Stearns subprime hedge funds collapsed. Apple’s iPhone, widely considered the catalyst of real-time media, released seven days later on June 29. 30yr fixed rates were 6.66%.

August 6, 2007: American Home Mortgage, the 10th largest U.S. mortgage lender, failed, triggering a global credit market freeze and a series of overnight Fed rate cuts from 5.25% in September 2007 to 1% in November 2008. 30yr fixed rates were 6.57%.

November 24, 2008: Realizing that drastic overnight rate cuts throughout 2008 weren’t helping long-term mortgage rates, Fed announced $500b mortgage bond buying program. 30yr fixed rates were 6.09%.

January 1, 2009: Fed’s mortgage bond buying program began. Twitter stats reported 100 million tweets per quarter in 2008. 30yr fixed rates were 5.05%.

March 18, 2009: Fed increased mortgage bond buying program to $1.25t. Two weeks later (and again in November 2009), 30yr fixed rates hit 4.78%, the lowest since official records started in 1971.

March 31, 2010: Fed mortgage bond buying program ended. Rates moved up .25% in two days. Varying reports showed 25-35 million iPhones sold in 2009. Twitter stats showed 4 billion tweets in the first quarter of 2010. 30yr fixed rates were 5.125%.

June 7, 2010: iPhone mania reached new peak when Apple (fresh off surpassing Microsoft in market cap on May 26 to become the world’s most valuable tech company) announced iPhone 4 with two cameras, video calling, and multitasking to run several apps simultaneously. After May 6 Greece bailout triggered European debt crisis, global investors flocked to U.S. mortgage and Treasury bonds four straight weeks. The rally again drove 30yr fixed rates down to record lows of 4.78%.

August 12, 2010: Up to this day, U.S. economy posted two months of weaker jobs, GDP, home prices, and consumer sentiment. Mortgage and Treasury bond rally continued full steam. Twitter said it has 65 million tweets per day (which is 23.7 billion annualized). 30yr fixed rates set a new all-time record low of 4.44%.

Which brings us to today: Some say the U.S. is bankrupt. But for now U.S. Treasury and mortgage bonds remain the safe haven of choice for global investors. As such, consumers who qualify for home loans are enjoying the low rates that result from this unprecedented mortgage bond rally.

Rates will rise from here, it’s just a matter of when. And the volume of chatter is certain to rise as technology continues to improve. So as you scroll headlines on your iPhone while sitting at a stoplight, remember to actually stop at some point to make sure you understand rate and property markets before making important decisions. Following TheBasisPoint on Twitter can help … now look up … green light!