THE BASIS POINT

Future of Mortgages, part 4: Dire View Of Post Fannie/Freddie World

In stark contrast to the last installment in our series, a grim post Fannie/Freddie world is predicted by Mad Hedge Fund Trader. Click image for info on who wrote the full post, and his key excerpts with future home price and mortgage rate estimates are below.

Like all market views, the author’s points are worth considering, but before panicking about his future estimates, understand that the author is incorrectly discussing today’s rates. He says “you might get a jumbo loan for a 100 basis point premium over a convention FHA loan under $729,750.” First, that spread is 75 basis points (or .75%) today, not 100: zero-points FHA 30fix is 4.75% today and zero-points 30fix jumbo is 5.5%. Second, a jumbo loan doesn’t have mortgage insurance. An FHA loan has minimum mortgage insurance of .85% (and will be 1.1% as of April 18), so effective FHA rate is 5.6% (4.75% + .85%) for at least five years. So today, the premium required for a government guarantee brings a government-backed loan to the same price as a private loan. As for the author’s exaggeration of the underwriting process, we’ll chalk that up to humor rather than market commentary.

What will a fully privatized home loan market look like? Try a lot more expensive. That is where you find the jumbo market, which is already fully privatized, as there was never a government mandate to finance the homes of millionaires.

If you have a FICO score over 750, move all of your assets to you lender, including your IRA, 401k, 529 plan, and all of your securities business, you might get a jumbo loan for a 100 basis point premium over a convention FHA loan under $729,750. If you don’t jump through all these hoops and refuse to offer your first born child up as collateral, expect to pay a premium of up to 250 basis points, or 7.5% at today’s rates. This is why abandoned McMansions have soared across the land like a great blight, and can be rented for 30% of the cash flow demanded by an outright purchase.

What does this mean for residential real estate prices? I’ll attempt some quick, back of the envelop calculations here. Raise the cost of financing by 40%, and you can knock 40% off the value of your property. That is off of today’s prices, which are already down 40%-60% from the 2007 peak, depending on your neighborhood.

This will inevitably lead to a secondary banking crisis and another stock market crash. If you are wondering about those Armageddon type forecasts that have the Dow plunging down to 3,000, this is the intellectual foundation behind them. That is when we find out how much freedom really costs.