It has become common for builders and real estate agents to require a pre-qualification or pre-approval from a lender prior to working with them on the purchase of a home. This is done so that the builder or agent doesn’t spend a lot of time with someone who will not be able to get a loan. It also helps the potential buyer by letting them know home much home they can afford at the beginning of the buying process.

Pre-qualification and pre-approval are not the same thing.  A pre-qualification is just a quick snapshot of the potential buyer’s position based on income and credit. It merely tells them how much money they might be able to borrow based on the information that they provide. A pre-approval is different in that it goes much further. The lender will generally go through the verification process. In addition to checking credit they will verify income and employment and perform other parts of the underwriting process. A pre-approval is the lender’s way of saying that if the property appraises at a value that meets their criteria of loan-to-value and the buyer makes the required down payment, the loan is approved.

Not So Fast

The collapse of the real estate market and price drops in many areas have caused lenders to decline loans for many buyers who had been pre-approved. This has caused problems for both buyers and sellers. A buyer finds a home that they like and puts a deposit down and the seller is happy to have found a buyer. Both are surprised when the bank denies the very loan that they had pre-approved because of changes in the real estate market.

In Las Vegas there has been an epidemic of this happening in the high-rise condo market. Buyers who had been pre-approved had placed many of these luxury condos under contract. However, in the time between contract and the completion of construction real estate prices had plummeted and the lenders refused to honor the commitment. The developers have been left holding the bag on many completed units. Buyers who had arranged their own financing rather than use loans arranged through the builder have lost substantial deposits in many cases because they were unwilling or unable to complete the purchase. This situation has forced many of the projects into bankruptcy or left them teetering on the brink of insolvency.

Turning It Up A Notch

It’s bad enough when this happens to an individual who is trying  to

Image via Wikipedia

purchase a home. It’s even more problematic when it happens to a companythat is building a $3.1 billion resort. Fontainebleau Las Vegas had secured commitments from multiple lenders on the $800 million in financing that was needed to see the project through. Unfortunately the lenders decided to pull the plug on the project just as it is nearing completion. The lenders include some of the biggest names in the industry such as Bank of America, JP Morgan Chase, Deutsche Bank, Royal Bank of Scotland and Barclays Bank. At stake are 3,300 construction jobs and over 6,000 jobs when the 3,815 room resort opens in October of this year. The developer has filed a lawsuit (article) in an effort to get the lenders to honor their agreement.

This is just the latest blow to Las Vegas. The area had been rocked by the stoppage of the $4.8 billion Echelon Place and problems with the $8.7 billion City Center project. The area is one of the hardest hit by the recession with unemployment over 10% and at or near the top of the nationwide foreclosure rankings. Just as area residents are wondering “what else could go wrong” something does.

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Tags: city center, Echelon Place, Fontainebleau Las Vegas, real estate

Existing home sales rose 5.1%  in Feburary to a stronger than expected pace of 4.72 million units.  This is the latest in a series of tiny whispers or as Larry Kudlow calls them “mustard seeds”  that we may indeed be in a bottoming process. The other signs include:

• Homebuilders are breaking ground on new homes again
• First-time jobless claims are falling
• Inflation is present and, therefore, deflation is not

This is great news for a real estate market that has really seen nothing but gloom and doom for the past 2 years. It also confirms my suspicion which I wrote about in another post  that we are seeing meaningful signs of a bottom in housing.

Should the economy continue trend stronger through the summer, it will likely fuel stock market gains, drawing cash away from mortgage bonds. This would lead mortgage rates higher — perhaps for good.

Today’s levels are artificially low, after all, supported by government intervention more than economic fundamentals. After the Fed’s Wednesday afternoon announcement, rates fell to all-time lows before recovering sharply into the weekend on economic optimism and fears of inflation.

With mortgage rates still below 5%, and prices still down 15% from a year ago, it is starting to look like this may fast becoming one of those rare “windows of opportunity” to buy a new home in a great school district at a phenomenal price.  Homebuyers with good credit, a steady job and a little down payement money should have no trouble qualifying for a mortgage.

(Image courtesy of: Arizona Mortgage News)

To pre-pay or not to pre-pay that is the question!

Whether ’tis nobler in the mind…okay, I am not a huge Shakespeare guru, but I do fancy myself a mortgage finance guru.

Today I want to talk about whether it is a good idea to prepay your mortgage or not. I will be using some information from an economic study from the federal reserve. For those of you who like to “really get in there” the study was released by the Chicago Fed in 2006 Called “The Trade off Between Mortgage Prepayment and Tax Deferred Retirement Savings” Here is a link.

There are some key concepts that I like to point out when I get asked this question (which is a lot) when helping homeowners make this decision.

1. Home equity has a 0% rate of return (as a matter of fact the value of those dollars sitting idle in the property actually loses value due to market forces such as currency devaluation and inflation). What I mean by that is home equity increases either from you paying yourself back principal or as a function of the property appreciating. Whether you have a $100,000 loan against a property worth $100,000 (100%LTV) or you have a $10,000 loan against the same $100,000 property (10% LTV), if it appreciates by say 10% in a year, the equity gain is the same: $10,000.
2. Mortgage interest is simple interest and the money you invest is compounding. What does that mean? Completely ignoring the tax implications for now, let’s say that you are paying 7% on a $100,000 interest only loan (as most HELOC’s are for the first 10 years) The employment cost (more on this in a sec) on that borrowed capital for the first year is $7,000.  Now, let’s say that you took that $100,000 and invested it and managed to earn 5% on that money. So you earned $5000. So you end up with -$2000. Not a good deal right? But hang on, in year 2 you are earning that 5% on 105,000 or $5250 and you are still only paying $7000 a year in interest. Year 3 you are still paying $7000, but you earn 5% on $110,250 or $5512.50.  The punchline is that if you ran this calculation out for 30 years you would have earned a net(interest earned-interest paid) of over $200,000 (assuming the interest rate stays constant which HELOC’s do not–they are based on the prime rate which is the fed funds rate +3%.  The fed funds rate changes as the federal reserve raises and lowers rates). This strategy really works the best if you have a fixed rate for 30 years to take away the interest rate risk. If the loan is amortizing, the interest you pay actually decreases every year while the interest you earn grows every year.  You also have to be able to make the payments on the mortgage comfortably. All the compound interest in the world doesn’t do you any good if you cannot afford to make the payments. Please keep in mind, this is a very simplistic example. There are entire books written on this very idea.
3. Everything in life is 100% financed. What that means is that you either pay an employment cost which is the cost of employing someone else’s capital (in this case the mortgage rate) or you self-finance and pay an opportunity cost. A simple way to conceptualize opportunity cost is: every time you turn left, you deny yourself the opportunity to turn right. In this context, every dollar you put into the home is a dollar that you don’t have to pay interest on but is also a dollar that you cannot earn interest on. The opportunity cost also extends to the risk of job loss or injury (as we discussed in the post Ron alluded to in his answer) so there are “layers” of risk when identifying opportunity cost.
4. When you deduct interest (assuming you are not subject to AMT) you do so at your earned income tax bracket (can be as much as 35% federal).  For those who are very detail oriented, you can read all about the deductibility of mortgage interest in Publication 936 of the internal revenue code. Here is a link: www.irs.gov/pub/irs-pdf/p936.pdf When you earn interest on investments and leave the money in there for at least 1 year and a day, you will pay long term capital gains tax.  The top capital gains tax rate is currently 15%  (changing after 2010 to 20% top bracket unless changes are made by congress). What does this mean? Well, let’s say that you are paying a 7% interest rate and you are in the top earned income tax bracket, your effective payment rate after tax is:  4.55%. Let’s further assume that you can earn 7% in an investment which is taxed at capital gains rates. Your effective rate of return after tax is: 5.95% a positive spread of 1.4%. That may not seem like alot, but it adds up to a 30.77% Internal Rate of Return. That is pretty good in my book. Keep in mind that this is a simplistic example, it is merely intended to illustrate a complicated idea known as tax arbitrage.
   
   DISCLAIMER:The actual rates may be more or less and your own personal tax situation may be different–consult your tax advisor always to make sure that my crazy rhetoric would actually apply to you in the real world.

5. What is the meaning of debt free? Is it having absolutely no debt or is it having enough assets in the left pocket to pay off the liabilities in your right pocket at any time. In other words, if you have $100,000 in liquid assets and a $100,000 mortgage. You are effectively debt free or at what I like to refer to a your “Freedom Point” which is the point at which your assets are equal to your debts. Given the uncertainty of the future, I personally would like to have the cash (if I can afford the employment costs comfortably) in my pocket rather than in my house if, say, lending guidelines change and I no longer can refinance to get the cash, I lose my job, I get injured and cannot work, or home values drop. If the value of your home drops below where your mortgage balance is and you have separated the cash, you can cover the shortfall if you need to sell, and maybe have even earned a little interest along the way. If the money is in your home, you have lost that wealth it until values return to their previous level–remember, gains are not profits until they are realized.

Now, if you did pay down your HELOC, that would save you the interest payments on that $10,000. At 6.49% assuming an interest only payment, you would save $54.08/month. The question is you need to answer is “does that $54.08/month stretch my budget?”  As I said before, a HELOC is not a fixed rate (although many times you can fix certain portions of your balance, but we will discuss that at another time) so if rates went to say 10%, it would cost you $83.33/month.

Bottom line is that there is no right answer

Everyone has different financial philosophies and different risk tolerances. You need to decide what is best for you.  Many people make decisions about the best thing to do simply based on “conventional wisdom” rather than the economic facts. The problem with conventional wisdom is that tax laws change, lifestyles change, and the value of a dollar changes. Hopefully through our conversations on Bigger Pockets, we can raise our financial IQ so that we can make informed rational decisions about how best to utilize our hard earned cash.

Consumer confidence reached an all-time low and 100,000 Americans were issued layoff notices last week, each playing a role in the mortgage market’s relative worsening. />

For the third consecutive week, mortgage rates rose and average loan fees increased, too.

Amid all of the negative economic news, however, there were two bright spots worth identifying and discussing. They show that country may be closer to economic recovery than expected.

First, the supply of “used” homes for sale fell from 11 months to 9 months nationwide. This suggests that homebuyers are re-entering the housing market in force, a signal that home prices are nearing equilibrium.

And, second, the nation’s GDP — a measurement of the country’s complete economic footprint — didn’t fall by nearly as much as what the experts had predicted. A positive surprise like this makes us wonder about what else the Doomsday Economists may be wrong.

We won’t have to wonder long.

With this week comes copious amounts of data, legislation and rhetoric to influence mortgage rates. Some of the news-bites that mortgage markets will digest this week include:

• The Personal Consumption Expenditures Index report. PCE is a preferred inflation measurement and inflation is the enemy of mortgage rates. A high reading will pressure mortgage rates up.
• Retail stores report on same-store sales.
• The Pending Home Sales report. This notes the number of “homes under contract” and is a good gauge for buyer interest and the general health of housing.
• 20% of the S&P 500 firms will report earnings.
• Congress is expected to vote on the Stimulus package.

The biggest impact on rates, however, could come on Friday with the release of January’s jobs report. Employment data is always market-mover and with the press giving so much attention to layoffs lately, expect Wall Street to be extra jittery it.

Markets expect the economy to have lost a half-million jobs last month.

(Image courtesy: Wall Street Journal Online)

Tags: Economy, GDP, mortgage rates, recession

After a strong start Monday and Tuesday, mortgage markets suffered alongside stock markets in the latter half of last week, leaving mortgage rates higher on the week overall.  Market losses were especially steep Friday and mortgage rates headed into the long weekend on a strong uptick.  Regardless, the reasons that mortgage rates rose last week are ancient history, in most respects.  Today, the new presidential administration begins and economic expectations reset. Mortgage bond traders are now looking at Capitol Hill and wondering what the pending stimulus package will look like, and how many dollars will it include.  This is an important time for home buyers and rate shoppers, too, because stimulus is generally believed to be harmful to mortgage markets. This is for two reasons:

1. Stimulus draws money to the stock market from the bond market, pressuring bond prices down and, therefore, mortgage rates up.
2. Stimulus requires the “printing of money” which devalues the U.S. Dollar and everything denominated in it. This includes mortgage bonds and rates respond by rising.

In other words, as the scope of the stimulus package increases, it becomes more likely that mortgage rates will rise in 2009.  Aside from Beltway Politics and commentary, there isn’t much to impact mortgage markets this week. We’ll see the latest earnings from a handful of financial firms and tech bellwethers including Google, Microsoft and IBM. And, on Thursday, we’ll be treated to some housing data from December.  But, with expectations set so terribly low for everything economic, markets will likely shrug off any data that doesn’t scream that the recession is over. Instead, be on alert to lock a rate. In a changing political environment, mortgage rates can move quickly and it’s best to be prepared.

In 2009’s first full week of trading, mortgage bond markets traded back-and-forth, eventually closing the week improved overall.

Weekly mortgage rates fell for the first time since mid-December.

The most anticipated news of last week was Friday’s jobs report. According to government’s press release, the economy shed another 524,000 jobs in December, raising 2008’s total job losses to 2.065 million.

This is the largest annual job loss since 1945, the press reminds us. However, as one more reason to look beyond the headlines, today’s workforce is three times as large.

Other important notes included the release of the Fed’s minutes from its 2-day meeting in December. In it, the Federal Reserve said that inflation should remain low through early-2010 — a good development for home buyers and homeowners because inflation is linked to rising mortgage rates.

This week, the market-moving data doesn’t start until Wednesday, but with a fair number of Fed members making public appearances, a case of “loose lips” can lead to mortgage rate volatility. The most notable appearance is Fed Chairman Ben Bernanke’s speech in London today. There are 10 speeches in all.

Despite the barrage of negative economic news, however, mortgage rates remain low. If you have yet to join the Refinance Boom, make a call to your loan officer to see if your home loan is eligible. keep in mind that fees for mortgages have risen as of today.

(Image courtesy: USA Today)

With home prices falling across most parts of the country, investors in real estate are finding good value in certain rental properties. Unfortunately, they’re also finding it harder to get approved for a home loan.

After getting stung by defaults, conforming mortgage standards for non-owner occupied home loans tightened dramatically last quarter.

One major change was the reduction in the total number of homes Fannie Mae or Freddie Mac will finance for any one borrower.

Prior to the chance, the number of financed properties could be as high as 10. Today, that number is 4, stinging investors with large real estate portfolios. Going forward, buying properties isn’t the problem; financing them with conforming mortgage money is.

Another guideline change mandates larger downpayments.

Versus early-2008, when a real estate investor could buy a home with 10 percent down, today’s investor is required to pay 15. But, as an added wrinkle, few private mortgage insurers write policies against rental homes anymore, rendering the 15 percent downpayment insufficient. The de facto requirement, therefore, is now 20 percent down.

And then came the fees.

As part of its “pay-for-risk” pricing model, Fannie Mae added mandatory fees to all of its investor property mortgages this year. Based on loan-to-value, the fees are:

* 75% LTV or less: 1.750 percent of the borrowed amount
* 75.01 - 80.00% LTV : 3.000 percent of the borrowed amount
* Greater than 80% LTV : 3.750 percent of the borrowed amount

So, if your personal plan includes the purchase of investment properties in 2009, consider the impact that tighter conforming guidelines, larger downpayments and higher fees will have on your bottom line.

All things considered, now may be a good time to make that rental property bid. Sure, prices may fall going forward, but increased acquisition costs may wipe out the long-term gains.

Don’t let this deter you from investing in real estate though. There are some very clever ways that you can creatively finance your investment properties. Seller financing, subject to financing and private money lending are just a few of these options. To your success in 2009!