History Is A Teacher – Cuts To The Fed Funds Rate Lead To Mortgage Rate Hikes

 

When the Federal Open Market Committee adjourns from its two-day meeting today, it is widely expected to lower the Fed Funds Rate.

This does not mean that mortgage rates will fall. 

In fact, using history as an indicator, we should expect mortgage rates to rise if the Fed Funds Rate falls.

Remember: The Fed Funds Rate is an overnight interest rate between banks; mortgage rates are long-term rates based on the bond market.  These are two very different animals.

The FOMC’s press release hits the wires at 2:15 P.M. ET.

Homeowners Rejoice! New Homes Sales Data Is Weak

If you only read headlines this past week, you may have missed two very important points.

The first story relates to Housing Starts.  Housing Starts measure the number of new homes entering the construction phase.  The headline blared “Housing starts plunge to 16-year low“.

If you are a homeowner, this is terrific news. 

Because home values are governed by Supply and Demand, fewer homes built means that home demand has a chance to rebalance against home supply. 

This places upward pressure on home prices nationwide.

When Housing Starts drop, it says more about weakness in builder sentiment that it does about the state of the housing nationwide.  Housing Starts are at all-time lows because builders want to sell the product they have before putting more product on the market.

The second story was yesterday’s New Home Sales figures.

The headline read that “US new-home sales slide in record plunge” but, again, let’s look a little deeper.

New Home Sales are defined as homes that are newly built.  Stated differently, it specifically counts the number of homes sold that were once classified as “Housing Starts”.

If Housing Starts falls, therefore, we can expect New Home Sales to fall, too.  The two data points count the same housing inventory at two different points along a timeline.

These two stories are related but neither should be construed as bad news.  As builders cut back on the supply of homes, it should create an increase in relative demand.

For homeowners, this is a positive development.

(Image courtesy: New York Times)

The Week In Review (January 28, 2008) : What To Watch For

Mortgage rates change from day-to-day, but last week’s volatility was a record-breaker. 

After drooping through Tuesday and then skyrocketing Wednesday and Thursday, mortgage rates retreated slightly on Friday. 

By weeks’ end, rates were at their same levels from mid-December.

This is in contrast to Tuesday, just after the Fed’s rate cut and before the stock market rally.  Mortgage rates had been touching near four-year lows for some home loan products.

This week could be equally hectic because heavy economic data it hitting the wires, and because the Federal Open Market Committee is meeting.

The major activity gets started Tuesday with the Consumer Confidence report. 

Markets care about this survey because recessions tend to be self-fulfilling prophecies — if people believe it will happen, it generally does.  Therefore, if average Americans are feeling worse about the economy, it may cause stocks to sell-off to the benefit of mortgage rates. 

Notice from the graph above how confidence plunged through the second half of last year.

On Wednesday, the FOMC adjourns from its two-day meeting. 

What the Fed does will not be as important as what the Fed says.  Markets will dissect the FOMC’s press release for clues about our economy’s strength.  If the statement cautions about dramatic weakness in the economy, expect mortgage rates to fall on the absence of inflation.

Then, on Thursday, markets get treated to the Personal Consumption Expenditures report.  The PCE is a Cost of Living index and is the Federal Reserve’s favored inflationary report.  If “normal living expenses” are increasing, it should create upward pressure on mortgage rates.

And lastly, on Friday, the Bureau of Labor Statistics releases the jobs report for January. 

Markets are expecting an improvement on December’s figure and if that adjustment is greater than expected, mortgage rates will rise on the belief that the economy is not as weak as previously reported.

It will be a busy week like last week so it pays to think in terms of “payment” instead of “rate”.  If you’re in the market for a mortgage and your proposed payment is within budget, consider locking in advance of this data-laden week.

(Image courtesy: The Wall Street Journal Online)

Real Estate Term : Negative Amortization Home Loan

(Pronounced: NEGH-ah-tive am-ohr-tih-ZAY-shun)

Negative amortization is the process by which a loan’s principal balance increases on a month-over-month basis. 

This is in contrast to a “typical” amortization schedule in which the principal balance decreases.

Negative amortization is an optional feature on some home loans. 

These mortgages are usually referred to by the brand names “Option ARM”, “Pick-a-Payment”, or “Payment Option ARM”. 

Many industry veterans collectively call refer to these types of mortgages as “Neg-Am” loans.

When a Neg-Am mortgage statement arrives each month, the homeowner can choose his preferred payment structure. 

1. Pay the minimum balance due only
2. Pay the interest due only
3. Pay the principal + interest payment on a 30-year amortization schedule
4. Pay the principal + interest payment on a 15-year amortization schedule

Choice #1 is like making a “minimum payment” on a credit card. It is the only option that adds to the principal balance so, therefore, it is the only negative amortization option of the four payment choices.

In this sense, negative amortization is a choice and not a certainty.

In the early 2000s, Neg-Am loans grew popular as home affordability products.  Many homeowners made the minimum payment each month and found that their mortgage balance had swelled. 

Some of these homeowners lost their homes.

Because of their complex structure and potentially devasting consequences, NegAm home loans have been dubbed “nightmares” by several media publications. 

However, many sophisticated homeowners have successfully applied NegAm loans to help meet their financial goals.

Like all home loans, NegAm products are a better fit for some homeowners than others.  Some likely candidates include:

• 100%-commissioned salesperson who want better control over tax deductions
• Owners of multiple investment properties who want better control over cash flow
• Investors who seek leverage in real estate and who clearly understand market risk

Homeowners with questions about negative amortization loans should seek counsel from a qualified mortgage professional.

The Specifics – Part 2 of Reverse Mortgages

The specifics and eligibility requirements: 

• Homeowners/borrowers must be age 62 or older and occupy the property as their principal residence
• Property must be a single-family or a two-to-four unit dwelling
• No income, employment or credit qualifying restriction.
• Property must be owned free and clear or have a remaining mortgage balance which can be paid off by a reverse mortgage
• Property must meet HUD minimum property standards. In some cases, home repairs can be made after the closing of a reverse mortgage.
• Townhomes, detached homes, condominium units, planned unit developments (PUDs) and some manufactured homes are eligible

Maximum Loan Amount

The maximum loan amount is based on the following factors:

• Appraised value of the home
• Age of the youngest homeowner
• County in which the property is located
• Current interest rate

Generally speaking, the older you are, the more your home is worth and the lower the interest rate, the more you’ll be able to borrow.

Previous posts in this “Applying For Your Loan” series:

• What The Heck Is A Reverse Mortgage? – Part 1 of Reverse Mortgages

How The Stock Market Rally Was Terrible For Mortgage Rates

The Dow Jones Industrial Average surged 631.86 points in the last three hours of trading yesterday as traders piled into equities.

Fueling the rally?  The bond market. 

For as much as stocks gained today, bonds lost.  Including mortgage bonds.  The dramatic sell-off created a huge swing in mortgage rates and erased nearly all of 2008’s rate improvements.

This is one reason why it pays to be aware of your home loan.  That way, when markets change and a doorway to payment reduction opens, you can quickly step through it. 

As yesterday illustrated, with mortgage rates, opportunity is often fleeting.

With stocks poised to rise again today, it should likely happen at the expense of bonds.  Mortgage rates are trending higher, too.

(Image courtesy: The Wall Street Journal Online)

What The Heck Is A Reverse Mortgage? – Part 1 of Reverse Mortgages

I don’t do Reverse Mortgages, however I do get a lot of questions regarding them. While not a Reverse Mortgage specialist, I have studied and learned a lot about them over the years. Hopefully this series will prove to be both helpful and informative. It is based on the most common questions my clients have asked over the years.

What Is a Reverse Mortgage?

It’s for:

• Individuals age 62 or older.
• Own the home they live in (property in which reverse mortgage will be attached).
• Owe either a minimal amount on their mortgage balance (or)
• Own it free and clear. 

For homeowners fitting this criteria, a reverse mortgage program can be a powerful financial vehicle one can use to receive extra income. A reverse mortgage allows an individual to leverage (borrow) the equity they’ve accumulated in their home without repaying the loan for as long as they live in the property. Instead of making monthly payments, qualified individuals receive monthly payments from their lender! That’s the “reverse” part.

Cash Flow During Your Retirement!

A reverse mortgage can be a powerful way to make the equity acquired in a home work for you. Today, there are more homeownership options for retired individuals and couples than ever before. Whether you’re looking to pay off bills, or would just like additional income to enjoy retirement, a reverse mortgage may be the answer for you!

Why Get a Reverse Mortgage?

Income received through a reverse mortgage can be used for a variety of purposes. Just like a regular refinance, you are not restricted in how to use the funds.

Below are a few examples of the potential uses for funds received through a reverse mortgage:

• Supplement retirement income
• Medical expenses
• Invest in CDs, annuities, long-term care insurance
• Make much needed home repairs or improvements
• Pay for in-home care
• Pay property taxes
• And more…

Reverse Mortgage vs. Traditional Mortgages or Home Equity Loans

A reverse mortgage is the opposite of a traditional mortgage. With a traditional mortgage or home equity loan, you borrow a large amount of money and make monthly payments. You must also have a sufficient debt-to-income ratio to qualify and make monthly mortgage payments.

A reverse mortgage pays you and is available regardless of your current income or debt-to-income ratio. With a reverse mortgage, you borrow small amounts – monthly or at other intervals through a line of credit. Payment is required only once, at the end of the loan, typically when you no longer occupy the home as your principal residence.

Benefits

For many older homeowners, a reverse mortgage is an effective way to convert home equity into flexible, tax-free (consult your tax adviser) income. The benefits are numerous:

• Continue to live in and own the home.
• Obtain immediate cash advances in addition to monthly income.
• Receive tax-free income from the cash advances.
• Adjust your payment option to meet your current circumstances.
• Enjoy the flexibility of determining how you wish to receive your cash disbursements: fixed monthly payments, a line of credit, a lump sum cash advance, or a combination of the plans.
• Have peace of mind knowing that you and your heirs have no personal liability for the repayment of the loan since it is secured solely by your home.
• Repay the loan at any time without penalty.
• Relax knowing that you owe nothing until after you no longer occupy the home as your principal residence.

Disadvantages

• Reverse mortgages tend to be more costly than traditional loans because they are rising-debt loans. The interest is added to the priprincipal loan balance each month. So, the total amount of interest owed increases significantly with time as the interest compounds.
• Reverse Mortgages are typically more costly to set up than other types of loans 
• Reverse mortgages also use up all or some of the equity in a home. That leaves fewer assets for the homeowner and their heirs.
• The vagaries of age might make such cash availability dangerous. Families should be prepared to monitor draw downs and/or expenditures if this is a risk
• Interest on reverse mortgages isn’t deductible on income tax returns until the loan is paid off in part or whole.
• Because homeowners retain title to their home, they remain responsible for taxes, insurance, fuel, maintenance, and other ho housing expenses.
• Although the proceeds are tax-free, a Reverse Mortgage may affect your eligibility for certain “need based” public benefits.

It’s A Good Day To Have Your Mortgage Adjust

When the Federal Reserve lowered the Fed Funds Rate by 0.75% yesterday, it was in response to economic weakness that mounted since its last meeting December 11, 2007.

By contrast, the mortgage markets meet every day. 

Because of this, mortgage rates had already “priced in” the weakness to which the Fed was reacting. 

This is why mortgage rates did not fall by the same 0.75% yesterday — they only fell slightly.

Two important rates that did fall, though, were the 6-month LIBOR and the 1-year constant maturity treasury (CMT). 

These are two popular interest rates used in adjustable-rate mortgages.

When an ARM adjusts, it adjusts according to a simple math formula:

(New Interest Rate) = (Index) + (Margin)

Where:

Index: A variable, usually 6-month LIBOR or the 1-year CMT.
Margin: A constant, usually ranging from 1.500% to 6.999%

So, if the indices move lower — as we saw yesterday — the adjusted interest rate on a mortgage is going be lower, too.

As an example, LIBOR fell  percentage point over the last month from 4.83% to 3.83%.  This means that mortgage rates tied to LIBOR will adjust 1 percent lower than they would have in December 2007.

For every $100,000 in a principal + interest loan, this yields $65 per month in savings.

Of course, each mortgage has unique index, margin and rate characteristics so talk to your loan officer about how your ARM operates.

The Week In Review (January 22, 2008) : What To Watch For

As promised, last week was heavy on data and on drama.  And mortgage rates continued their slide lower. 

This week, by contrast, is devoid of data and markets are already digesting the Federal Reserve’s surprise 0.750% rate cut this morning. 

Mortgage rates are falling in response, but not because of what the Fed did as much as what the Fed implied by doing it.

The Federal Reserve does not control mortgage rates, per se, but it does exert an influence.  This is because when the Federal Open Market Committee makes changes to the Fed Funds Rate, it is making a broader statement about the health of the economy.

This morning, and in advance of its 2-day meeting January 29-30, the Federal Reserve chopped the Fed Funds Rate by 75 basis points to 3.500%.  This signals to markets that the Federal Reserve is keen on engineering a soft landing for the economy.

Mortgage rates are falling for a different reason. 

The chart above is from last week and illustrates what traders thought the Fed would do to the Fed Funds Rate at its January meeting.

Note that over a two-month span, the market expectation changed.  The blue line (4.250%) represents the Fed Funds Rate prior to this morning.

Two months ago, markets overwhelmingly expected the FOMC to lower the Fed Funds Rate by 0.250% at its January get-together(as represented by the white line). 

As time passed, however, that expectation changed and mortgage rates changed, too.  This is not a correlated event, however.  Both the Fed Funds Rate and mortgage rates tend to fall during times of economic weakness.

On the right of the chart is last Friday.  At that time, market expectations for the January meeting were equally split between a 0.500% drop and a 0.750% drop (as represented by the orange and red lines, respectively).

The 0.500% drop signals weakness; the 0.750% signals dramatic weakness.

So, after the Federal Reserve’s surprise move this morning, it turns out that the Fed sees dramatic weakness.  Mortgage markets are reacting to this “news” and resetting their bets by buying more mortgage bonds.

This added demand is causing rates to fall, but not anywhere near the three-quarter percent levels by which the Fed cut the Fed Funds Rate. 

Mortgage rates are down slightly.

(Image courtesy: Federal Reserve Bank of Cleveland)

Which Leads Which Lower: Mortgage Rates Or The Fed Funds Rate?

It’s a point that’s always worth repeating:

Ben Bernanke and the Federal Reserve do not control mortgage rates

This is particularly relevant today as newspapers, television programs, and market pundits posit that the U.S. is in the midst of a recession.

The latest evidence supporting that assertion is that Retail Sales grew at its slowest pace since 2002 –  the last time the U.S. was in a recession.

Many people fear recessions, but they are natural parts of a business cycle.  As the nation’s protector of the economy, though, the Federal Reserve can weaken a recession’s impact on the economy by lowering the Fed Funds Rate. 

When the FFR is lower, businesses and consumers pay less interest on business debt and consumer debt, respectively.  This leaves more money available to spend on goods and services, thereby providing a subtle boost the economy.

This is why the Fed Funds Rate is integral to financial markets and why it gets so much attention in the press.  It’s also why some people are calling for a drastic rate cut at the Fed’s next meeting — many believe that the economy is hurting pretty badly.

It’s not a coincidence that this outlook is causing mortgage rates to fall. 

When Corporate America is struggling (or expected to struggle), investors don’t like to be over-exposed to the stock market because of its variable nature.  By contrast, the fixed returns of the bond market provides a little bit more safety. 

As demand for stocks wanes during a recession, therefore, demand for bonds can pick up.  

Mortgage rates can fall at times like this because rates are “born” from the price of mortgage bonds.  The higher the price, the lower the corresponding rate. 

So, as investors leave the stock market and buy bonds — including mortgage bonds — the increased demand raises prices and pushes mortgage rates lower.

All of this happens independent of the Federal Reserve — it’s a natural function of the stock and bond markets.

The Federal Reserve does not control mortgage rates but it does control the Fed Funds Rate.  And both tend to respond to economic weakness.

(Image courtesy: ABC News)

Mortgage Rates Are Down (But Not Everyone Is Eligible)

Overall, mortgage rates are at their lowest levels since late-2005.

Despite rates falling, however, not everyone can take advantage.

This is because mortgage lenders started to tighten the guidelines of what they will lend and to whom, also beginning in late-2005.

In other words, the chart at right doesn’t apply to all homeowners equally.

If you are new in your home, or have refinanced your mortgage within the last 24 months, make a call or send an email your loan officer to ask about today’s low-interest-rate environment.

(Source: Bankrate.com)

The Week In Review (January 07, 2008) : What To Watch For

Stock markets tanked last week behind high oil prices and weak employment data. 

Amid a sell-off that led to a 4.5% decline in the S&P 500, investors sought safety in the bond markets. 

As a result, mortgage bonds improved last week, driving some mortgage rates to their lowest levels in two years.

This week, with no economic data on tap, mortgage markets will find direction from a variety of sources.

The first is oil.  If oil prices fall this week, expect that mortgage rates will rise slightly.  Cheap oil can be fuel for an economic engine so if oil prices are lower, it could help stave off recession. 

No recession, though, means that inflation is more likely and inflation usually leads to higher mortgage rates.

The second source of direction will come from the three Fed officials scheduled to speak publicly this week. 

Talk of recession should drop mortgage rates across the board whereas talk of inflation should raise them.  Chairman Bernanke’s speech will draw the most attention; he speaks Thursday.

And lastly, mortgage rates could move this week on profit-taking from mortgage bond traders. 

Mortgage rates have fallen because there has been more demand for mortgage bonds.  More demand leads to higher prices which decreases bonds’ rate of return. 

If traders look to lock in profit, they will sell their mortgage bonds, reverse that process, and rates will rise.

(Image courtesy: The Wall Street Journal Online)

$100 Oil Could Mean More Than High Gas Prices For Americans

The price of oil briefly touched $100 per barrel yesterday, just short of the all-time inflation-adjusted high of $102.81 in April 1980.

According to economic forecasting firm Global Insight, each $10-per-barrel increase in oil prices:

1. Increases gas prices by 19 per gallon
2. Cuts consumer spending by one-third of a percent
3. Reduces employment by 100,000
4. Adds one-half percent to consumer prices

And, because oil prices have nearly doubled from the $51/barrel levels of January 2007, the above figures calculate out to:

1. $0.95 more per gallon in 2007 because of oil prices
2. 1.67% cut to consumer spending in 2007 because of oil prices
3. 500,000 lost jobs in 2007 because of oil prices
4. 2.50% increase in consumer costs in 2007 because of oil prices

In addition, oil’s run-up has ignited fears of inflation and of recession, with the possibility that both would exist at the same time.  This rare economic condition is commonly referred to as “stagflation”

Stagflation is a particularly difficult situation for the Federal Reserve because increasing the Fed Funds Rate would increase the likelihood of recession whereas lowering the Fed Funds Rate would increase the risk of inflation.

For now, mortgage rates are benefiting because less evidence of inflation could attract foreign investment in mortgage bonds.  As demand for bonds increases, mortgage rates fall.

Source
Weakened U.S. Economy May Be Facing New Test
Sudeep Reddy
The Wall Street Journal Online, January 3, 2008
http://online.wsj.com/article/SB119930367405362875.html

Why It’s Not So Bad That Unemployment Reached Its Highest Rate Since November 2005

On the first Friday of each month, the Bureau of Labor Statistics releases key data about the American workforce.

The report is officially called “Non-Farm Payrolls” but most people refer to it as the “jobs report”.

The jobs report’s influence on markets is palpable for two major reasons:

1. Consumer spending makes up two-thirds of the economy
2. When more people are working, there is more consumer spending

When consumer spending is strong, the economy expands.  This tends to be bad for mortgage rates because a growing economy is at risk for inflation. 

Inflation causes mortgage rates to rise, making home ownership more expensive.

By contrast, when consumer spending is low, the economy tends to contract.  This tends to be good for mortgage rates because — well — it’s not inflation.

So this morning’s jobs report held two key data points:

1. The Unemployment Rate reached 5.0% in November 2007
2. For all of 2007, payroll growth averaged 111,000 per month, down from 189,000 in 2006

The newspapers and television shows are saying that this news is terrible and that the U.S. is headed for recession.  That point is debatable.  What isn’t conjecture, though, is that with fewer Americans in the workforce, there is less money available to propel the economy forward.

That’s why mortgage rates should fall today — because the threat of inflation is reduced. 

Source
U.S. payrolls rose 18,000 in Dec
Glenn Somerville
Reuters.com, January 4, 2008
http://www.reuters.com/article/economicNews/idUSN0324081520080104