All posts tagged mortgage

In my last post, I hinted at using QE2 to your advantage by investing in companies that benefit from a steepening yield curve. But I didn’t have time to get in to specifics. Which is what I’ll do right now, seeing that I have a couple of hours to spare at the Fort Lauderdale airport.

The Federal Reserve let the market know that it plans to keep short term interest rates at extremely low rates for the next few quarters (if not longer). Companies that can borrow short term, can do so at very low rates. So long as you have AA-rated collateral, you can borrow money at about 0.30% on a 30 day basis. If you plan to borrow for a longer term, you just need to keep “rolling” your loan every 30 days or so.

So if you can invest in a AA-rated bond that pays say 3% or 4% and borrow money at 0.30%, you’re going to profit from the spread. Do such bonds exist?

They do – they’re called Agency RMBS and they’re just large pools of single-family residential mortgages that are bundled together in to large multi-million dollar securities and guaranteed against default by a government sponsored agency such as Freddie Mac or Fannie Mae. They also yield about 3.75% or higher.

So you can borrow money at 0.30% and invest it at 3.75% and you’re guaranteed against loss of principle by a government agency! Sounds too good to be true? Well it gets better!

Companies that use this business model to make money are set up as REITs and pay out a hefty dividend to shareholders. Companies like Annaly Capital Management (NLY),  Hatteras Financial Corp (HTS), Cypress Sharpridge Investments (CYS) are mortgage REITs that are set up to do exactly this. And they all pay approximately 15% in dividends.

An RMBS is basically a bond and all bonds have 3 types of risk:

  1. Credit Risk
  2. Prepayment Risk
  3. Interest Risk

Companies which invest in Agency MBS don’t suffer from credit risk. If the borrower of the mortgage defaults, the government-sponsored agency just buys it back and you get your money back. There is no fear of loss of principle!

Prepayment risk is when the borrower pays off the loan early and returns your principle back to you. This usually happens in environments when interest rates are dropping and borrowers can refinance their mortgages at a lower rate. If you get your money back early, you need to reinvest the money, typically at a lower rate. Given that mortgage rates are so low and refinancing is much more difficult than it used to be, the risk of prepayment is limited. There are some always some prepayments though which occur as regular amortization of the loan. Some companies will calculate how much of their portfolio and try to enter forward contracts to purchase more RBMS and thus mitigate the prepayment risk. CYS is one company that does this.

The third and major risk is interest rate risk. As the cost of borrowing increases, the spread between borrowing and invests decreases. Your profit margins drop and are no longer able to make the kind of returns you’re used to. Again some companies hedge against this event, and incur some cost in doing so. But hedging maintains long-term predictability of cash flows and may be worth the drop in potential yield. Again CYS does this and it’s net spread after hedging is 2.55%. It also uses 7.5:1 leverage to maintain a $4.5 billion portfolio against $600 million equity position. When you earn a 2.55% spread and can leverage up 7.5%, that’s a whopping 19% yield! CYS has about a 17% dividend yield.

Disclosure: I bought a 33% position in CYS on Friday and am going to be buying more under $13.50.

Suzie Orman is a famous financial planner who appears regularly on TV and is a prolific writer. I’m not a big fan, mostly because her ideas are too simplistic for me although they must appeal to a lot of people who have no knowledge of financial information.

But now and then she has a good nugget of information. Check out this short clip about paying off your home mortgage as soon as possible.

The only counter argument I can think of is inflation.

If you bought your house in 1980 for $50,000 and never paid off the mortgage (that wouldn’t be possible unless you refinanced the home loan along the way), the value of $50,000 today is a lot lower than it used to be 30 years ago.

But on the flip side, the mortgage interest tax deduction on $50,000 is rather small too. So maybe you should send in that extra $100 every month!

One resource I strongly recommend is How to Save Thousands of Dollars on Your Home Mortgage. You can buy the book used on Amazon for under $2.00 – possibly the best 2 bucks you’ll ever spend!

You must have read the recent post about the New York Times economics reporter who is facing foreclosure himself. Edmund Andrews covered the US economy and Alan Greenspan for over six years, but despite his financial accumen still got suckered into a loan he couldn’t really afford. He hasn’t made a mortgage payment in 8 months and is wondering when the bank is going to throw him out of his house. Instead of making his payments, he has been busy spending money on a beach rental, clothes, gifts and other necessary expenses. At some point, I think foreclosure is inevitable.

But could he have avoided foreclosure?

I think so. Let’s review some of the financial mistakes he made. The real ones, not the excessive spending that set in once he stopped making house payments!

1. He divorced his wife of 21 years

This is always grounds for economic disaster. No matter who you are, the longer you stay married, the more it’s going to hurt you financially.  If you are going to divorce, do it like Tom Cruise and get out before the magic 10 year mark or before you have kids.

2. He paid almost 2/3rds his net income in child support

Ouch! Paying $4,000 in alimony and child support when your net income is $6,777 is a lot. Effectively, his take home income is $33,000 per year or about $16/hour. I think most people on that wage move back home to their parents basements.

3. He bought a house he couldn’t afford

If there’s one major recipe for disaster, it’s buying a $500,000 house when you’re only taking home $16/hour.  He really should have known better. But then again, he outsourced the analysis of his finances to his mortgage broker instead of doing it himself.  He was set up to fail from the beginning. I’m sure his broker knew in the back of his mind there was a chance Ed would face foreclosure at some point. But Ed really should have bought a cheap house instead.

4. Not spending enough time understanding the most expensive purchase of your life

A home mortgage is the most complex financial transaction you’ll probably ever undertake. So it’s easy to blow it off or let some one else do the heavy lifting for you. However, the mortgage broker doesn’t necessarily have your best interest at heart. They get paid on commission for every loan they close and are directly incentivized to get you into the largest, most outrageously expensive home loan possible. There is a tremendous conflict of interest and you should not let them dictate what you should do. Many people claim that a home loan is just too difficult too understand. True, but only if you don’t take the time to understand it.

I strongly recommend Randy Johnson’s stellar book How to Save Thousands of Dollars on Your Home Mortgage. If you don’t know what Yield Spread Premium (YSP) or Paid Out of Closing (POC) means on a HUD-1 you definitely should read this book. If you own a home and don’t know a HUD-1 is then get your spouse to smack you and then go buy the book! I promise you’ll save thousands of dollars on your mortgage.

Just in case, you missed that last paragraph, BUY THAT $12 BOOK ABOUT SAVING THOUSANDS OF DOLLARS ON YOUR HOME MORTGAGE. You should buy it before you buy a house, before you even think of buying house, maybe before you even graduate from college. If you’ve already read it, you should buy a dozen copies of the book and gift it all your friends, co-workers, in-laws, cousins, nieces and nephews for Christmas. Unless you hate them.

The best way to prevent foreclosure from happening to you is to buy a house you can afford with a mortgage that is the cheapest over the life of the loan. That may mean paying extra points to buy down your interest rate, which means the cheapest loan is not necessarily the loan with the lowest closing costs. Learning about your finances, and how mortgages actually work is probably the best way to save money in the long run.

With mortgage rates at historic lows, you might think first time buyers will be falling over themselves to buy entry level homes. In California, condos count as entry level homes.  But starting April 1st, Fannie Mae and Freddie Mac have just changed their guidelines for mortgages when it comes to condos.

It may now cost borrowers between 3 and 5% more to finance a condo versus a single family home!

Fannie Mae now has a mandatory fee of 3/4th of a percentage point on all condominium loans, no matter how high the applicant’s credit score. For a once-popular interest-only condo loan with a 20% down payment and a borrower credit score of 690, Fannie imposes the following ratcheted sequence of add-ons:

  • 0.25% as an “adverse market” fee
  • 1.5% for the below-optimal credit score
  • 0.75% for the interest-only payment feature
  • 0.75% fee since the property is a condo

The total comes to 3.25% extra, which can be paid upfront or rolled into the loan. Additionally, condo units with a high percentage of investors or commercial tenants may now be impossible to finance.

Companies like Wells Fargo have also lowered the threshold for total debt-to-income ratios from 45% to 41%.  Their minimum FICO for a conventional loan without 20% is now 720, up from 620!

On top of this, getting an appraisal is now more expensive.  It used to cost about $275-$325. Nowadays, its in the range of $400-$450, with no guarantee that it will come close to where you think it will.

Another issue to be aware of when purchasing a condominium or a townhome is the reserves held by the Home Owners Association. If they don’t have enough reserves, you may be assessed for repairs.  One of my friends was assessed $15,000 for renovating the exterior of the unit. Not a small sum of money!

This is sure to negatively impact the prices of condos, which will put further downward pressure on certain housing markets. There’s nothing like more affordable housing!

Mortgage rates have hit record lows. You can get a 30 year fixed-rate mortgage for 4.85%. The 15 year is at 4.58%. I don’t think mortgages have ever been this cheap. According to Frank Nothaft, Freddie Mac chief economist, “The Federal Reserve’s announcement that it intends to purchase Treasury securities over the next six months caused bond yields to drop and mortgage rates followed.”

Meanwhile, home sales are up for the 2nd month in a row. Some people think this is a sign of a stabilizing of the housing market and higher prices are likely to follow.

So are home prices really bottoming out? Some of the things to consider are

  • Foreclosures made up a significant portion of all home sales.
  • Prices are still dropping.
  • There is significant inventory overhang in many markets
  • Banks haven’t listed a lot of foreclosed properties for sale yet, mainly to prevent this supply from further depressing prices
  • A large number of ARMs are adjusting next year. This might cause the whole cycle to repeat and prices to fall further.
  • It’s becoming more difficult to qualify for a home loan and the days of 100% or 105% financing are gone.

And if you think higher home prices are on the horizon, check out these real estate prices.

A few days ago, Ben Bernanke said that mortgage lenders should reduce the principle amount on loans to home owners to prevent major defaults. While this is quite a bizzare thing to say, at some level it makes sense. Rather than foreclosure on a house and sell it for 50 cents on the dollar, the lender might as well knock off 30% of the principle and keep collecting interest on the remaining 70%.

However, in principle I feel its the worst thing to do. Speculators who buy “investments” they can’t afford do not deserve to be saved and neither do the banks that lent them money – they both deserve to be punished. That is actually what recessions accomplish. They shake out the excesses of past booms and clear the way for fresh blood to have their chance at creating wealth. Remember what happened in Japan, where it is common for loss-making companies to be propped up by banks and the government? Their recession last for 15 years and it’s still not clear whether there are fully out of it or not.

Before I get flamed for being un-American by actively supporting a recession, let me clarify my position. There has been a world-wide asset bubble. The natural order of things is to let the bubble burst quickly so the next boom can start again. I resent a slow deflating of this bubble that Bernanke is engineering through his “soft landing”, which is nothing more than inflating the pricing of everything else (except wages). It will only serve to extend this down-cycle and will eventually result in the Federal Reserve losing its credibility and ability to manipulate the economy.

As if in deference to Ben Bernanke’s wishes, a CountryWide (CFC) rep called me today asking if I wanted to refinance my property since I had a 5 year ARM. I was surprized to hear that I had a 5 year ARM, since it was supposed to be a 10 year ARM! The rep explained that it was in fact a 10 year loan with a 5 year ARM, which I think was completely false since the rep sounded like a telemarketer rather than a loan officer. Anyway, he said I should refinance and suggested that I go for a 30 year fixed at the same rate as my 5 year ARM. When I said I wasn’t interested, he suggested that I find out whether I qualify for the Loan Modification Program.

A Loan Modification Program is where the bank extends the length of the term on the loan. So instead of the rate adjusting in 5 years, they can extend it out for another 5 or 10 years. So basically its like a no-doc refinance, only you don’t have to pay for it! This is a much better option than a no-cost refinance, which has a cost, but it’s actually rolled into the mortgage so you don’t pay for it upfront. Instead you pay for it over 30 years, which is usually a terrible financial decision. Even worse, you accept a higher interest rate and in exchange the bank picks up the cost of the refinance. That means you end up paying thousands of dollars more on your principle to save a few thousand dollars. Unless you’re planning to move in 2 years, that’s a really big, but common, blunder.

Considering that I don’t currently have any W-2 income, it should be easy to qualify for the Mortgage Modification Program. Since all my income flows through my corporation, and I don’t need to draw a salary, I’m technically unemployed. (I know what you’re all thinking but no, I don’t qualify for unemployment assistance). Even though I am gainfully unemployed, I still qualify for the modification program!

Don’t know if I’ll take them up on their offer though. I think things could get a lot more interesting over the next few years.

A few of my friends who own homes got into the habit of getting interest-only loans and refinancing them every year. Apparently there was some math that “made it cheaper” to refinance every year. Starting every year with a new loan didn’t seem like a good investment but I’d never really understood the math. Of course, with the drop in home values, LTV ratios decreasing and the drying up of liquidity, this fad has disappeared, but I always wondered how the math worked. I was too lazy to actually do it since I knew intuitively that it must be wrong.

Fortunately ace mortgage broker, Randy Johnson, send me an email with the math.

many homeowners will never burn their mortgages because they make poor choices, like continually refinancing into 30-year mortgages.

Assume that a homeowner started out with a $100,000 loan at 6.5% and that he has been in his home for 5 years. He refinances the existing balance to a new loan at 5.5%. If he is like most Americans, he looks just at how much he saves per month. He gets modest interest savings, $14,265, less if you deduct the costs, which I will ignore. But in choosing to make the new lower payment, he goes out to the lousy end of the amortization curve again. He actually adds 10 months to the total time payments are made, a total of 370 months. That’s why it never gets paid off.

It is much smarter to make the old payment he was paying. He afforded it for five years and he can keep affording it. This converts his interest saving into principal reductions. It shortens the remaining repayment time from 300 to 249 months and doubles his interest savings compared with the first option. Now he saves $32,377.

The most valuable opportunity, however, is to get a 15 year loan which also carries a lower interest rate, 5% today. The payment is about equal to the original payment plus $100. That reduces the remaining payback time to 180 months. The interest during this 15 year period drops by over 60% from what it would have been had no refinance taken place.

To summarize

Interest due in remaining 25 yrs without refinance $96,009

Interest if refinance and make lower payment $81,743

Interest if keep payment the same $63,632

Interest if move to a 15 year loan $39,690

The cost of refinancing is usually never zero. Even if you don’t pay for it, its somehow baked into the loan.

I strongly recommend Randy Johnson’s stellar book How to Save Thousands of Dollars on Your Home Mortgage. If you don’t know what Yield Spread Premium (YSP) or Paid Out of Closing (POC) means on a HUD-1 you definitely should read this book. If you own a home and don’t know a HUD-1 is then get your spouse to smack you and then go buy the book! I promise you’ll save thousands of dollars on your mortgage.

I was listening to the radio yesterday and I was listening to an investment show. The announcer was talking about mortgages and I heard him mention a NINJA loan.

It stands for “No Income No Job or Asset” verification! If that isn’t a liar loan I don’t know what is. You basically show up at the bank(or mortgage broker’s office) and say I have a job and assets to qualify for this loan to buy a house but I don’t want to show you anything. Just take my word for it!

Talk about easy money and excess liquidity! No wonder there has been such a boom in the real estate prices in some parts of the country. I wouldn’t be surprised if these loans end in tears for someone people.

Seems like there’s a lot of easy money chasing global investments. The Swiss and Japanese carry trades (where borrowers could borrow money under 2% in these currencies and invest them in something else, say a US T bill yielding 5%, and pocket the difference) has created a lot of excess liquidity that is chasing investments all over the place.

Some people think that asset prices have now become a function of liquidity and are no longer a fucntion of value.

I wouldn’t be surprized if the subprime meltdown caused coastal property prices to drop 40-50% from the peaks.

I’m on a lot of mailing lists, which usually get sold and result in my getting a ton of spam. Most of it is effectively filtered out, but sometimes “relevant spam” filters through. Here’s an interesting example from a mortgage company.

Did you know that one or more rate changes per day is normal? Most people do not know that. Rate quotes can easily change when you call back later that same day. In the lending business, a rate change can also include a change in the point cost for the same rate. In other words, a rate can be no points in the morning, then later that day cost ¼ point. That is a rate change to lenders. Did you also know that regular fixed mortgage rates are not directly affected by what the Fed chairman Ben Bernanke does?

Mortgage rates change primarily based on:
1) the perception of inflation,
2) times of uncertainty and
3) the movement of money in and out of the stock market–that’s it.

When a piece of news shows weakness or uncertainty in the economy, that helps rates fall. The opposite is also true. A drop in the unemployment rate, a rise in durable goods orders, a rise in the consumer confidence index–rates go up.

These influencing factors can present themselves all the time, many without warning, affecting mortgage rates instantly. There is no “delay”. It doesn’t take time to “filter down” like some people think. Reading the paper for quotes doesn’t really work because the information is old by the time you read it. Radio, TV and billboards are not the answer because the details are always missing. They just want to get you on the phone. Competitive lenders can deliver nearly identical rates to each other. Most borrowers don’t ask the right questions and focus only on the interest rate. A professional will always be competitive and deliver what is promised.

To really know about your mortgage I strongly recommend How to Save Thousands of Dollars on Your Home Mortgage. My dog-eared copy is currently vacationing in Egypt with a friend. Its not difficult to understand and is a great resource.