All Forum Posts by: Sandra S.

@zackkarp, thank you! It was shared with me by my lender and I asked him who to credit. I was told MBS Highway, which I now see I didn't include on this post. (I did on my FB page, but missed it here). Thanks! This caliber of article is way above my pay grade! 

The Coronavirus Meltdown

The current Coronavirus crisis is having a critical impact on the Mortgage Industry, which could potentially make the 2008 financial crisis pale in comparison. The pressing issue centers around capital that’s required by Mortgage Lenders to be able to function and meet covenants that are required for them to continue to lend.

Here’s How The Mortgage Market Works

Let's begin with the mortgage process. A borrower goes to a Mortgage Originator to obtain a mortgage. Once closed, the loan is handled by a Servicer, which may or may not be the same company that originated the loan. The borrower submits payments to the Servicer, however, the Servicer does not own the loan, they are simply maintaining the loan. This means collecting payments and forwarding them to the investor, paying taxes and insurance, answering questions, etc. While they maintain or "service" the loan, the asset itself is sold to an aggregator or directly to a government agency like Fannie Mae (FNMA), Freddie Mac (FHLMC), or Ginnie Mae (GNMA). The loan then gets placed inside a large bundle, which is put in the hands of an Investment Banker. That Investment Banker converts those loans into a Mortgage Backed Security (MBS) that can be sold to the public. This shows up in different investments like Mutual Funds, Insurance Plans, and Retirement Accounts.

The Servicer’s role is very critical. In order to obtain the right to service loans, the Servicer will typically pay 1% of the loan amount up front. The Servicer then receives a monthly payment or “strip” equal to about 30 basis points (bp) per year. Because they paid about 1% to obtain the servicing rights and receive roughly 30bp in annual income, the breakeven period is approximately 3 years. The longer that loan remains on the books, the more money that Servicer makes. In many cases, the Servicer might want to use leverage to increase their level of income. Therefore, they may often finance half of the cost of acquiring the loan and pay the rest in cash.

Servicer Dilemma

As you can imagine, when interest rates drop dramatically, there is an increased incentive for many people to refinance their loans more rapidly. This causes the loans that a Servicer had on their books to pay off sooner…often before that 3-year breakeven period. This servicing runoff creates losses for that Mortgage Lender who is servicing the loan. The more loans in a Mortgage Lender’s portfolio, the greater the loss. Servicing runoff, or even the anticipation of it, can adversely impact the market valuation of a servicing portfolio. But at the same time, Lenders typically experience an increase in new loan activity because of the decline in interest rates. This gives them additional income to help overcome the losses in their servicing portfolio.

But the Coronavirus has caused a virtual shutdown of the US economy, which has created an unprecedented amount of job losses. This adds a new risk to the servicer because borrowers may have difficulty paying their mortgage in a timely manner. And although the Servicer does not own the asset, they have the responsibility to make the payment to the investor, even if they have not yet received it from the borrower. Under normal circumstances, the Servicer has plenty of cushion to account for this. But an extreme level of delinquency puts the Servicer in an unmanageable position.

“I’m From The Government And I’m Here To Help”

In the Government’s effort to help those who have lost their jobs because of the Coronavirus shutdown, they have granted forbearance of mortgage payments for affected individuals. This presents an enormous obstacle for Servicers who are obligated to forward the mortgage payment to the investor, even though they have not yet received it. Fortunately, there is a new facility set up to help Mortgage Servicers bridge the gap to the investor. However, it is unclear as to how long it will take for Servicers to access this facility.

But what has not been yet contemplated is the fact that a borrower who does not make their very first mortgage payment causes that loan to be ineligible to be sold to an investor. This means that the Servicer must hold onto the asset itself, which ties up their available credit. And with so many new loans being originated of late, the amount of transactions that will not qualify for sale is significant. This restricts the Lender’s ability to clear their pipeline and get reimbursed with cash so they can now fund new transactions.

Mark To Market

This week - Due to accelerated prepayments and the uncertainty of repayment, the value of servicing was slashed in half from 1% to 0.5%. This drastic decrease in value prompted margin calls for the many Servicers who financed their acquisition of servicing. Additionally, the decreased value of a Lender’s servicing portfolio reduces the Lender’s overall net worth. Since the amount a lender can lend is based on a multiple of their net worth, the decrease in value of their servicing portfolio asset, along with the cash paid for margin calls, reduces their capacity to lend.

Unintended Consequences

The Fed’s desire to bring mortgage rates down isn’t just damaging servicing portfolios because of prepayments, it’s also wreaking chaos in Lenders’ ability to hedge their risk. Let’s look at what happens when a borrower locks in their mortgage rate with a Mortgage Lender. Mortgage rates are based on the trading of Mortgage Backed Securities (MBS). As Mortgage Backed Securities rise in price, interest rates improve and move lower. A locked rate on a mortgage is nothing more than a Lender promising to hold an interest rate, for a period of time, or until the transaction closes. The Lender is at risk for any MBS price changes in the marketplace between the time they agreed to grant the lock and the time that the loan closes.

If rates were to rise because MBS prices declined, the Lender would be obligated to buy down the borrower’s mortgage rate to the level they were promised. And since the Lender doesn’t want to be in a position of gambling, they hedge their locked loans by shorting Mortgage Backed Securities. Therefore, should MBS drop in price, causing rates to rise, the Lender’s cost to buy down the borrower’s rate is offset by the Lender’s gains of their short positions in MBS.

Now think about what happens when MBS prices rise or improve, causing mortgage rates to decline. On paper the Lender should be able to close the mortgage loan at a better price than promised to the borrower, giving the Lender additional profits. However, the Lender’s losses on their short position negate any additional profits from the improvement in MBS pricing. This hedging system works well to deliver the borrower what was promised, while removing market risk from the Lender.

But in an effort to reduce mortgage rates, the Fed has been purchasing an incredible amount of Mortgage Backed Securities, causing their price to rise dramatically and swiftly. This, in turn, causes the Lenders’ hedged short positions of MBS to show huge losses. These losses appear to be offset on paper by the potential market gains on the loans that the lender hopes to close in the future. But the Broker Dealer will not wait on the possibility of future loans closing and demands an immediate margin call. The recent amount that these Lenders are paying in margin calls are staggering. They run in the tens of millions of Dollars. All this on top of the aforementioned stresses that Lenders are having to endure. So, while the Fed believes they are stimulating lending, their actions are resulting in the exact opposite. The market for Government Loans, Jumbo Loans, and loans that don’t fit ideal parameters, have all but dried up. And many Lenders have no choice but to slow their intake of transactions by throttling mortgage rates higher and by reducing the term that they are willing to guarantee a rate lock.

Furthering the Fed’s unintended consequences was the announcement to cut interest rates on the Fed Funds Rate by 1% to virtually zero. Because the Fed’s communication failed to educate the general public that the Fed Funds Rate is very different than mortgage rates, it prompted borrowers in process to break their locks and try to jump ship to a lower rate. This dramatically increased hedging losses from loans that didn’t end up closing.

Even Stephen King Could Not Have Scripted This

It’s been said that the Stock market will do the most damage, to the most people, at the worst time. And the current mortgage market is experiencing the most perfect storm. Just when volume levels were at the highest in history, servicing runoff at its peak, and pipelines hedged more than ever, the Coronavirus arrived.

Lenders need to clear their pipelines, but social distancing is making it more difficult for transactions to be processed. And those loans that are about to close require that employment be verified. As you can imagine, with millions of individuals losing their jobs, those mortgages are unable to fund, leaving lenders with more hedging losses and no income to offset it.

What Needs To Be Done Now

Fortunately, there are many smart people in the Mortgage Industry who are doing everything they can to navigate through these perilous times. But the Fed and our Government needs to stop making it more difficult. The Fed must temporarily slow MBS purchases to allow pipelines to clear. Lawmakers need to allow for first payment defaults, due to forbearance, to be saleable. And finally, the Fed must more clearly communicate that Mortgage Rates and the Fed Funds Rate are not the same.

We have faith that the effects of the Coronavirus will subside and that things will become more normalized in the upcoming months.

@Charlotte Casey our in house lender advised us that they are artificially raising their rates to slow the overwhelming demand for financing. Purchase Deals will take 45-60 days to close and refi’s could take 90 days.

I don't know how to analyze this bad boy. Can anyone assist? 1970 livable/rentable mobile home. Needs new interior paint, nicotine remediation and flooring. Asking price is $140,000 with the seller willing to carryback $50k. Seller terms negotiable. Rents for $1350 approximately. Ultimately, after some more time appreciating, I'd tear this down and build new construction to sell. Right now, old mobile homes in this area are being torn down and new houses are going in their place, then selling for $350k. Cost to build new is high around here - I figure it'll cost me about $160k.  My first problem is the BP calculator won't let me do a 64% loan. Second area of confusion is how to analyze the return if I hold it for a few years and then build. If I demo'd and built now, I'd only net about $20k. That margin is too tight for my comfort. I'd wait until I could make at least $50k, which will likely be a few more years. Another potential approach is that I have someone looking for a place to live right now that has $160k cash but no income, so she can't get a loan. I'm thinking there has to be a house-hack solution in here somewhere!

@Tim Herman Thanks for the pro tips! I updated my calculations here. https://www.biggerpockets.com/...  Not sure if the link will work or not. I need to take this analysis a step further though, and figure out the profitability if I can build on the lot that comes with it. That's the potential honey pot. I'm trying to wrap my mind around analyzing the two different projects together - a rental and a spec house. 

Your numbers are probably more realistic and less pie in the sky than mine. I'll re-run it with thoseI am primarily going after the lot to develop it and sell it, while hopefully cash-flowing on the house. To complicate matters, it's an estate and the Personal Rep needs to net a certain amount to get out from under the seller-carried loan. It's a messy one, but I know this area well and see opportunity.  

Your numbers are probably more realistic and less pie in the sky than mine. I'll re-run it with those. However, I am primarily going after the included lot to develop it and sell it, while hopefully cash-flowing on the house. To complicate matters, it's an estate and the Personal Rep needs to net a certain amount to get out from under the seller-carried loan. It's a messy one, but I know this area well and see opportunity.  

View report

*This link comes directly from our calculators, based on information input by the member who posted.

Your timing is perfect! I am wanting to employ this strategy but can't figure out how to do the proper calculations. I'm looking at a particular property now that was subdivided into 4 lots and they're asking $200k for the package of 4. 

I can do site prep and build 4 modest houses for about $160k each and the finished value of each house would be about $275,000. 

Rents would be about $1650/month. 

I've developed two parcels so far and sold them for great profit, but it's time to start holding houses for future wealth. 
Is there a calculator on BP that works for this, or do you have your own approach that you could share? Do I somehow do the BRRR calculator?

Your timing is perfect! I am wanting to employ this strategy but can't figure out how to do the proper calculations. I'm looking at a particular property now that was subdivided into 4 lots and they're asking $200k for the package of 4. 

I can do site prep and build 4 modest houses for about $160k each and the finished value of each house would be about $275,000. 

Rents would be about $1650/month. 

I've developed two parcels so far and sold them for great profit, but it's time to start holding houses for future wealth. 
Is there a calculator on BP that works for this, or do you have your own approach that you could share? Do I somehow do the BRRR calculator?