It started in early March when, in the midst of the COVID-19 pandemic, Saudi Arabia and Russia initiated an oil price war – tumbling prices by 34% (down to $31.73 per barrel). Today this price war continues, with crude at only $20.71 per barrel. The pandemic and oil price combination has sent the stock market into a tailspin. With equity investors continuing their flight to safe-haven holdings, the DJIA has dropped almost 30% from the Feb. 12 high of 29,551.
Although 10-Year Treasuries (the rate that typically sets the direction of fixed mortgage rates) have averaged 2.27% over the past 5 years, a record low 0.318% 10-Year yield was recently reached.
But if mortgage rates usually reduce when investors flee the stock market, why did 30-year fixed mortgage rates increase from 3.15% to as high as 4.15% during this commotion???
For several reasons due to huge uncertainty, volatility and panic – all of which increased costs to lenders… which in turn were passed on to borrowers in the form of higher mortgage rates:
Here's the Point: In a market with unprecedented volatility, there are several reasons why mortgage rates actually go in a direction opposite to what you might expect.
Good question! Maybe the best place to start is to read what the experts are saying. But even before that, you’ll need to determine who you think the experts are and which are the most reliable.
Let’s assume for the moment that the national agencies listed below are the experts – since most people generally tend to rely on them for making interest rate projections. But now let’s have a look at their track records…
At the beginning of each year listed below, they made predictions of what the 30-year fixed mortgage rates would be in the fourth quarter of the same year. You will see that their 2018 predictions were much better than their 2019 predictions (rates listed are for the most qualified borrowers):
Mortgage Bankers Association (MBA)
Federal National Mortgage Association (FNMA)
Federal Home Loan Mortgage Corporation (FHLMC)
National Association of Realtors (NAR)
Average Prediction of the Experts:
Year-End Actual 30-Year Fixed Mortgage Rates:
If you had relied on the “experts” and rushed to purchase a home for $200,000 (with a 20% down payment) and locked in your interest rate at 4.6% at the end of 2018 (thinking that rates were headed to 5.1% in 2019), your monthly mortgage payments of principal and interest would have been $820. But had you waited to lock at the 3.7% 2019 year-end actual mortgage rate, you would have saved $84 per month or just over $1,000 per year in mortgage payments.
If you had you ignored the experts and waited to lock your interest rate until the end of 2019 (instead of the end of 2018), you would have saved over $30,000 of interest costs over the life of a 30-year mortgage!
Here's the Point: Do your homework before locking your rate. But when the timing and the numbers work for you, don’t second guess your lock decision (because even the experts get it wrong).
It would not be far-fetched to forecast a continued stock market rally from our new President’s proposed fiscal stimulus package – earmarking funds to revitalize our country’s infrastructure and military. Coupled with imposing regulatory and corporate tax reform, the resulting inflationary pressure is likely to be curtailed by the Federal Reserve in the form of cautious interest rate hikes over time.
The DJIA was 18,333 the day before he won the election – versus almost 20,000 today. It increased by 257 points or 1.4% to 18,590 on the day of his win. The media predicted the markets would plummet with a Trump victory. The very opposite happened.
10-Year Treasuries (the benchmark generally used to predict mortgage rates) were 1.88% the day before Trump won – versus almost 2.50% today. It increased to 2.07% on the day he won (a significant one-day change). The media predicted there would be a flight to quality investments with a Trump victory – in other words, investors would convert their stock holdings into more safe-haven bonds (thus, driving bond prices up and interest rates down). The very opposite happened.
Media sources now attribute the recent market rally to the long term policies put in place by the Obama Administration. Given their prediction pattern, shall we continue to consult with the media on interest rate projections?!
A temporary stock market rally is commonplace after an election. The focus now should be on whether Trump’s policies will add inflationary pressure – which, if so, will continue to put upward pressure on rates.
Free? I think not! But there are definitely “lender credits” available to you, depending on the interest rate you select. The technical term for this credit is “yield spread premium”. But is the lender passing this credit on to you, or are they keeping it – and therefore booking additional profit from your loan? This profit would be in addition to their processing fee, and results from the earnings spread they generate between what you pay them versus what it costs them to fund your loan.
The higher the interest rate you pay, the higher the credit to which you should be entitled – all of which can be applied towards offsetting your closing costs. In arriving at this credit, the lender factors in certain standard risk adjustments that are based on variables such as your credit score, loan amount, collateral type, and loan-to-value ratio. The lesson to be learned is that your lender should always fully disclose the amount of this credit – even if it is in the form of a reduced interest rate.
Recently I had a client who was able to increase his lender credit by simply taking a few steps to improve his credit score. After following a program of credit card debt reduction, his FICO score increased from 599 to 642. This favorably resulted in an increase to his lender credit of 1.25% of his loan amount – a savings of $2,500 which he was able to apply towards the closing costs on his $200,000 residential mortgage.
My client made the right decision last week. He decided not to refinance his mortgage – even though:
(i) he qualified for a better interest rate (because his credit score had improved),
(ii) the value of his primary residence was way up, and
(iii) he could have used some of the equity in his home to consolidate debt.
His credit score was 650 – lower than what he had hoped for, mainly because of some unavoidable late payments a while back. Keeping his loan-to-value ratio at 80% (to avoid mortgage insurance premiums), he was surprised to discover that, with his credit score, he would still be assessed 3.0% of the loan amount at closing. In addition, because he was looking to pull out some equity (i.e., obtain a new loan greater than his existing loan amount), the “cash-out refinance adjustment” would have been another 2.625%. Along with a couple of other incidental adjustments for loan size and overall risk profile, the cumulative risk adjustments would have been 5.85% of his requested loan amount – or $5,850 on a $100,000 loan.
Sure – I found a lender who would offset all of these costs. The problem was his interest rate would be no different than the rate he already had on his existing loan. Also, his principal amortization schedule would reset upon the commencement of his new 30-year mortgage. Therefore, the portion of his new monthly mortgage payment attributed to principal reduction would be less than what his principal payment was under his existing loan.
No You’re Not: Unless it has vacation/resort amenities and is 50+ miles away from your primary residence, it will be treated as an investment property and carry a higher interest rate].
No Sir: You can only have one FHA loan at a time and it must be on your primary residence (and besides, there are conventional financing programs that offer loans as high as 97% of value).
Not True: Depending on your ability-to-repay, Freddie Mac may only require one year of tax returns from your new business.
Incorrect Again: A parent/child profit-sharing relationship is deemed an “identity of interest” transaction, and the buyer is restricted to 75% loan-to-value when there is a non-occupying co-borrower.
Unlike “Fixed Rate Mortgages”, having an interest rate that remains the same for the entire loan term, rates on Adjustable Rate Mortgages (ARM’s) change periodically. You would think in a rising interest rate environment that locking your interest rate would make the most sense – to avoid higher monthly mortgage payments. Then why are ARM’s making a comeback?
To start, ARM’s have lower interest rates than 30-year fixed rate mortgages (so the monthly payment is lower, allowing borrowers to maximize their cash flow). ARM’s therefore offer more payment flexibility (not only can borrowers use the resulting savings towards personal expenses, but they can elect to make additional principal payments on their mortgage).
Plus, people generally do not stay in the same home for more than about 7 years. If you enter into a “7/1” ARM, this means that the interest rate is fixed for 7 years, and then the rate adjusts thereafter based upon prevailing rates at that time. Sound risky?
In the past, ARM’s were much riskier loans. Depending on the lender, ARM’s may have had:
All of these onerous terms changed with the onslaught of regulations after the housing crisis. Today, ARM’s “cap” the amount of rate increase at the time of the required adjustment – and the interest rate is prevented from increasing by more than 5% over the life of the loan.
Art Espinoza recently asked me to return to his radio show entitled “The Art of Investing”. Art is a respected financial advisor and wealth manager with offices in Vero Beach, Florida and Brookfield, Wisconsin, and his show airs every Saturday at 9:30 am on WAXE 107.9FM and 1370AM, or on iHeart Radio.
“I got caught in the housing crisis, so I’m not going to buy now unless it is a steal”
[Reality: They can’t afford to buy anything, and most of the low hanging fruit is gone anyway]
“I’m downsizing because I don’t need the space”
[Reality: Their income is not close to what it was, and their association fees are killing them]
“I’m nervous because interest rates have been so volatile”
[Reality: They lost most of their equity in 2008-09 and are scared to death of borrowing – even though rates remain at historical lows]
“As soon as we sell our home, we will finance the purchase of a retirement home in Florida”
[Reality: They will use their net proceeds to pay cash for the Florida condo]
Lately, when attending seminars, dinner functions, charity fundraisers, and other networking events, I hear a lot of people in real estate finance say: “It’s crazy busy right now”. But those are the people I don’t know that well. They stumble a little when I ask about the number of real estate loans they have closed and funded. Unless they are focused on helping people who require portfolio loans due to prior events that have detrimentally affected their credit (and there is a lot of this business right now), volumes on conventional financings are way down and banks are shedding staff as a result.