Good Riddance 30-Year Fixed Mortgage? Not So Fast…

Peter
J. Wallison’s recent article in the Wall Street Journal on government support
of the residential housing market (“What’s So Special About the 30-Year
Mortgage?
“) is an interesting academic exercise but it has no relevance to
the reality of the U.S. housing market.

While
it is true that, for many years over the life of a 30-year loan, most of the
payments go to interest and not principle, if we were to remove the tax
deductibility of the interest paid
(regardless of the term of amortization) as
some have suggested, we would remove another 33% of value from the American homeowner,
based on the marginal rate at the Federal level of 28% and the average State
and local tax rate of 5%.

 

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Reports Continue to Show Home Price Declines

CoreLogic and Lender Processing Services
(LPS) have each released their most recent Home Price Indices.  CoreLogic’s HPI covers December; LPS’s covers
the month of November.  Here is a quick
review of each.

LPS found that the average home price
for transactions during November was $199.000, down 0.6 percent from the
October average.  This is the fifth consecutive
month that this index has declined. 
Preliminary information on December sales indicates that the HPI might
have lost another 0.8 percent during that month.

When the market peaked in June 2006 the
total value of the U.S. housing inventory covered by LPS was $10.8
trillion.  The value has declined 30.6
percent to $7.5 trillion since that time.

Price changes were consistent across the
country, increasing in 13 percent of the ZIP Codes in the database.  Higher priced homes had somewhat small price
declines than those in the middle and low price categories with the range from
high to low covering only 13 basis points.

CoreLogic issues two sets of indices,
one including sales of distressed properties, the other excluding those
sales.  The HPI for all sales decreased
1.4 percent in December and was down 4.7 percent on an annual basis, the fifth
year in a row that this HPI has declined.   
The Index covering market sales was 0.9 percent higher than in December
2010 which, Core Logic says, gives an indication of the impact distressed sales
are having on the market.  The HPI excluding distressed sales posted its first month -over-month
gain since last July, rising 0.2 percent. 

Of
the top 100 Core Based Statistical Areas as measured by population, 81 showed
year-over-year declines in November compared to 80 that were down on a monthly
basis in November compared to October.

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Homeowners Continue Shift Away from Cash-Out Refinancing

Homeowners who refinanced their homes during the fourth
quarter of 2011
either refinanced for about the same amount or actually brought
cash to the table according Freddie Mac. 
Fewer than 15 percent of those who refinanced during the quarter
increased their loan amount by 5 percent or more.  This is the lowest percentage of “cash-out”
borrowers in the 26 years that Freddie has been tracking the statistics.  During those 26 years covering 1985 to 2010
the average percentage of cash-out borrowers was 46 percent.

Thirty-seven percent of refinancing homeowners took out new
loans of approximately the same size as the old loan but nearly half (49
percent) actually brought cash to the table, reducing the amount of the new
loan to a median ratio of .74 of the old loan. 
The percentage of “cash-in” borrowers is also a 26-year record.

The fourth quarter figures are a stark contrast to the
pattern of refinancing during the last years of the housing boom.   During
eight consecutive quarters (Q4 of 2005 to Q3 of 2007) cash-out loans exceeded
80 percent of all refinancing and in none of those quarters did more than 8
percent of homeowners reduce the size of their mortgages when refinancing.

Borrowers who refinanced achieved a new interest rate about
1.4 percentage points lower than their old mortgage, a 26 percent improvement.  These borrowers will save a median of $2,700
during the first year if they have a $200,000 loan.

The 15 percent who did cash out took an estimated $5.5
billion in net equity out of their homes, representing 3.0 percent of the total
refinanced.  This was down from $5.6
billion and 3.7 percent in the third quarter. 
Adjusted for inflation this was the lowest level since the third quarter
of 1995.  During the peak period for
cash-out refinancing, the second quarter of 2006, homeowners cashed out $83.7
billion through refinancing, 31.1 percent of the total value of all transactions.   

Freddie Mac said that the mortgages refinanced had been in
place for a median of four years and the underlying collateral had decreased in
value by a median of 4 percent during that time.  The Freddie Mac House Price Index shows about
a 23 percent decline in its U.S. series during that four year period.  Thus, Freddie Mac says, “Borrowers who refinanced in
the fourth quarter owned homes that had held their value better than the
average home, or may reflect value-enhancing improvements that owners had made
to their homes during the intervening years.” 
This statement does not seem to recognize the possibility these
borrowers had been able to refinance solely because their homes had held value
and thus self-selected their loans for analysis.   

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HUD AWARDS $3.6 MILLION IN CHOICE NEIGHBORHOODS PLANNING GRANTS

WASHINGTON – U.S. Department of Housing and Urban Development (HUD) Secretary Shaun Donovan announced today that 13 communities across the U.S. will receive $3.6 million in Choice Neighborhoods Planning Grants. (See attached list (PDF)and project summary for this all of the grantees (PDF).)

Housing Assistance 2012: Another Herculean Task for the FHA

Beginning the 37th month of his presidency, the Obama Administration today announced a laundry list of new programs to help struggling homeowners, crack down on abusive lending practices, make mortgage documents easier to read, convert REO to rental, and other assorted initiatives.  Some require Congressional approval; others are a work in progress, and a couple can begin quickly.
 
At the heart of the announcement is a broad new refinance program with the venerable FHA stepping in (once again) to help save the mortgage market by offering current but underwater non-FHA borrowers another lifeline.
 
Concurrently, the Administration appears to be on the verge of a broad-based “REO-to-Rental” initiative by announcing a pilot project to be led by FHFA, HUD, and Treasury.  I think the Administration is smart to move this initiative forward as they certainly have the political cover through last year’s RFI process.  They asked for comments and suggestions and reportedly received thousands of responses.  They can now say we are implementing what America said they wanted.   Of course, we do not yet know exactly how it will work.
 
Lawmakers and mortgage industry professionals have previously questioned whether or not FHA can handle yet another herculean task.  Recall in 2007 when the mortgage market sputtered and into 2008 when new higher loan limits were unveiled, FHA saw its share of the mortgage market jump exponentially in a matter of months. What was a $350 billion book of business in 2005 has today mushroomed to $1 trillion with more than 7.4 million homes with FHA insurance.
 
Since presumably these would be riskier borrowers (higher LTVs and underwater) it remains to be seen:

  1. If Congress will give FHA the authority to increase its current LTV caps.
  2. How OMB will “score” the proposal thus dictating the mortgage insurance pricing?
  3. Will proposed new bank fees and presumably higher premium revenue off-set the expected “cost” to FHA?

FHA is reportedly considering placing these loans in an insurance fund separate from its current Single Family books of business, but could ultimately require the FHA to invoke its “permanent indefinite” budget authority to keep it afloat (as opposed to the self-sustaining Mutual Mortgage Insurance fund).
 
That said, the Administration indicated the cost of these programs will “not add a dime to the deficit” and will be off-set by a fee on the “Largest Financial Institutions.”  (Note: Congress might have an opinion here.)
 
Since FHA has not in recent memory refinanced borrowers with LTVs in the 120-140 range (presumably one of the groups targeted by the Administration), I think it will be difficult to estimate the performance of these loans over time and thus their impact on FHA’s actuarial foundation regardless of which fund they place them in.  While the FHA “short re-finance” program announced in 2010 allowed a 115% CLTV, it has had very little participation thus making it difficult to gauge performance relative to what could be even higher LTV participants.
 
It should be noted that the Administration is targeting borrowers who have made 12 consecutive payments so one could argue that despite the fact they are underwater they have been able to afford their mortgage payments – presumably in some cases for several years.  So does that mitigate some of the potential risk meaning that they will certainly be able to afford reduced monthly payments?  But again, given FHA’s limited experience with borrowers outside their established guidelines and requirements predicting their performance with any degree of certainty is difficult at best.
 
And assuming those previously non-FHA borrowers default on their new FHA loan, who do you think will now be at-risk with an underwater property?  Again, the Administration stated these programs “will not add a dime to the deficit” – I hope they are right.
 
FHA’s actuarial soundness has been rocked by the on-going erosion of house prices nationwide which has led to three consecutive years of declines in their capital reserve ratio.  The best medicine for FHA is house price appreciation and the positive ripple effect of increased value to their housing portfolio.  But they have been waiting three years for that to happen.
 
Welcomed news as part of this new refinance program is they would be removed from an FHA lender’s compare ratio within Neighborhood Watch (FHA’s public database of lender’s default rates compared to its peers in a given geographic region).  That said, I suspect FHA will establish a separate category of compare ratios for this book of business, as it did for Negative Equity Refinances and the Hope For Homeowner (H4H) program.
 
So while this action will remove a potential barrier to participation, lenders should be cautioned that performance will still matter and they should stand ready for increased scrutiny especially by the HUD OIG.
 
I give the Administration credit for launching another round of housing assistance as too many homeowners continue to struggle.  Putting politics aside on the surface it appears to be the right and proper thing to do, however it remains to be seen the level of participation (and degree of Congressional acceptance) and ultimately what cost, if any, to the taxpayers – most of which have grown weary of the nagging housing crisis.
 
Note: We will continue to follow this initiative with keen interest as it makes its way through Congress and will offer periodic updates as developments warrant.

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