Bulls & Blogs

On January 20th, FHA announced changes in its residential loan programs designed primarily to prevent the insolvency of the FHA insurance fund. The fund insures lenders against loss when FHA loans go bad. More than 14.4% of FHA loans were delinquent (payments more than 30 days late) at the end of the third quarter 2009, and another 3.3% were in the foreclosure process. In its most recent audit, FHA reported that its capital reserves had fallen below the congressionally-mandated two-percent of its loan portfolio, and some industry experts are concerned that the fund eventually will require a bailout from the Treasury.

The changes designed to head this off include:

- An increase in the upfront mortgage insurance fee (UFMIP) paid by borrowers at closing from 1.75% to 2.25% of the loan amount;

- An increase in the minimum down payment for borrowers with credit scores below 580 from 3.5% to 10%; and

- A decrease in the maximum amount a property seller is allowed to contribute to the buyer's closing costs (seller concessions) from 6% to 3%.

The changes could have been worse. Most buyers add the UFMIP to their loan balances rather than pay it at closing, so the UFMIP increase is unlikely to discourage buyers. Very few lenders currently approve loans for borrowers with credit scores below 580, so the higher down payment standard will affect few potential buyers. Besides, a credit report can have a few hickeys, and the score still can exceed 580.

The most significant change is the decrease in the maximum seller concessions. The change makes FHA's guidelines consistent with conventional loan guidelines. It is said the change was aimed at arresting the practice of sellers increasing their sales prices to absorb buyers' closing costs.

FHA left the monthly mortgage insurance premium rate as it is - for now. FHA indicated it would like to increase the rate, but this requires congressional approval. An increase in this rate will reduce the number of qualified buyers because a higher premium raises the buyers' debt ratio, which, of course, is one of the primary loan qualifying factors.

In November, Congress passed an extension and expansion of the homebuyer tax credit. If you're considering purchasing a home, read the details carefully. This program could put as much as $8,000 in your pocket.

The tax credit is available to both first-time homebuyers (haven't owned a primary residence in the last 3 years) and so-called "long-time" homebuyers (have lived in the same home for at least 5 consecutive years in the past 8 years). Importantly, a buyer is eligible for the tax credit if he/she uses a co-signer, even if the co-signer is ineligible. (In other words, a parent can co-sign for a child.)

The credit is 10% of the home's purchase price up to a maximum of $8,000 for first-time homebuyers and $6,500 for long-time homebuyers. The purchase contract must be dated on or before 4/30/10, and the transaction must close on or before 6/30/10. (A special provision extends the date an year for active military personnel.)

The buyer must purchase the home as his/her primary residence, and the maximum purchase price is $800,000. Multi-unit (2 to 4-unit) properties are eligible as are condos, manufactured homes, and new construction.

Income limits apply: $125,000 for single and $225,000 for married. (The credit is available up to $145,000 and $245,000 at a reduced amount.)

Important restrictions include:
- Buyer must be 18 years or older;
- Buyer cannot purchase the home from a close relative;
- Buyer cannot be a non-resident alien; and
- Buyer cannot purchase the home from a decedent.

The IRS has some okay information in its Web site. You have to poke around a bit. I found the "questions and answers section" particularly helpful.

Getting a loan to purchase residential investment property has become more difficult. The discussion below summarizes some of the options that still remain.

Conventional financing - If you currently own fewer than 4 residential properties, conventional financing (Fannie Mae or Freddie Mac) is still available to you. However, maximum leverage is 80% (20% down), and you have to put at least 25% down to get a decent rate. While underwriting guidelines state you can qualify with a credit score of 620, you need at least 680 to get anything approaching a good rate. A score of 740 or above will get you a nominal rate of about 6.5% on a 30y fixed rate loan. Expect to pay a higher rate for duplexes, triplexes, and 4-plexes.

The 4-property limit makes it difficult to acquire multiple properties with conventional financing. (As an aside, I heard a rumor about a month ago that one or both of Fannie and Freddie are considering easing this restriction, but I have heard nothing to corroborate this rumor.) Thus, it is important to look at alternatives that are available in this tight credit market.

Local Banks - Local banks picked up some of slack in financing investment properties last year, but I'm hearing more and more from my banker friends that they have stopped. Many of the banks are scared to make real estate loans right now because of potentially falling home prices and increased foreclosures. I also understand regulators are putting pressure on them to stop lending on real estate, especially "speculative" real estate. If you can find a local bank willing to lend on investment property (when I say local, I'm suggesting smaller banks, banks with maybe only a couple branches - not the Bank of America down the street), count on no better than 75% loan-to-value and very strict underwriting rules. They will want to see liquidity - "cash in the bank" (not necessarily their banks). The idea is that these "reserves" will cover you if you're unable to keep the property rented or you have unforeseen expenses.

Rehab and Hard Money Lenders - This is private money and generally expensive money. Expect to pay 3 to 8 points and 10% to 18% interest. These are short term loans. The lender expects you to flip or refinance the property in a short period of time, usually a year or less. That begs the question why would anyone use these lenders? Well, they specialize in helping investors pick up foreclosure properties, especially ones that require some rehab work. Most of these lenders will lend based on the ARV (after repair value) of the property, and many will lend up to 100% of the acquisition and rehab costs. Most restrict the loan-to-value to around 65% (maybe a little higher) of the ARV. So, if you agree to purchase a property for $50k, and the property needs $25k in rehab, you could conceivably purchase the property with little money out-of-pocket if the ARV was around $125k. (But, remember, the lender orders the appraisal.)

That all makes it sound easier than it is. Liquidity is a HUGE issue for rehab lenders. They generally want you to have money in the bank sufficient to cover at least half the rehab costs plus 3 to 6 months of interest payments plus the closing costs (points plus other fees). This is even if the ARV is sufficient to absorb these costs into the loan. They don't want to foreclose on the property, so they want to make sure you have enough cash to cover everything, foreseen and unforeseen. Other personal financial factors are not as significant. A credit score of at least 640 will grant you consideration, but higher scores and higher incomes improve your chances.

One final comment on rehab and hard money lenders: In the last couple months, I have noticed several of them have stopped funding residential properties. I don't know why, but I suspect it stems from concern about real estate prices.

Seller Financing - Sometimes, the property seller will agree to take a lien against the property rather than cash at closing. This is more likely if the seller currently has no lien against the property or if the seller is having a hard time selling the property. There are no rules for seller financing. The financing terms are whatever you and the seller negotiate into the contract.

I hear from my realtors friends that there are some real bargain properties out there. These are the financing options available to you. While they are quite restrictive, I have talked to many investors who are making them work to their advantage.

As a closing comment, I want to mention that some investors are choosing to move their 401k money into real estate. This requires a special lender with an appetite for this sort of thing. Fortunately, a few such lenders do exist. I will save the details for another blog.

If you're in the market for a new home or thinking about refinancing, I have one question for you: What are you waiting for? I'm talking to those of you who are waiting for interest rates to get better. Interest rates are at historic lows, and sitting on the fence may cost you money.

Okay, I'm a mortgage professional, so I admit I have a vested interest in you making a decision. However, if you're really going to purchase a home or refinance, it matters not to me whether you act now or act later. (I would like to do business with you either way.) However, it should matter to you. Acting now may save you money.

Buying

Let's suppose you're thinking about buying a home. The home's price is $200,000, and you're prepared to put down $10,000 towards the purchase. Today's 30-year conforming rate is 4.75%, which equates to a $991 mortgage payment. If you're paying $1300 in rent each month, your "housing" payment would be $309 dollars less if you buy now.

You may have heard that the Federal government is considering incentives that might drop rates to 4.5%. Does it make sense for you to wait?

Consider this. Any program the government offers is probably 3 to 6 months out. (Let's use 6 months as we're talking government time.) If you buy now, in 6 months, you will have saved $1854 on your housing payment. Yes, if you wait for that 4.5% rate, you can lower your monthly payment by another $30, but:

- If you find a home you like that's priced right, is it worth the risk losing it?

- What if rates don't drop?

- How long will it take to recoup that $1854 you could have saved?

You are correct to point out that I haven't considered property taxes and insurance, which will reduce your savings. But I also didn't consider the tax benefits of owning. On balance, if you buy now and live in the home for 7 years, I calculate you will save over $27,000 by buying over renting. (Please check with you tax professional about the tax benefits of home ownership.)

Refinancing

Suppose you're already a homeowner, and you're thinking about refinancing. Should you refinance today or gamble 6 months for that 4.5% rate?

Let's say your loan balance is $200,000 with an interest rate of 6.25% - a pretty good rate last year. If you refinance today, your monthly mortgage payment would drop from $1231 to $1043 - a $188 savings each month. If you wait for 4.5%, your monthly payment would be $1013. Here's the question:

In 6 months, you will have saved $1128 if you refinance today. If you wait 6 months to get that 4.5% rate (and remember, there's no guarantee rates will drop), it will take 38 months - more than 3 years - before you recoup that $1128. (I'm assuming you have sufficient equity in your home to refinance.) Which makes more sense to you?

Of course, these are only examples, and in both cases I'm assuming you qualify for the loan. The point I want to make is that waiting involves risk AND cost. Rates are really low today. While they may get lower, they also may get higher. If you're ready to act now and decide to wait, you're not only risking today's really low rate, but you're also giving up guaranteed savings.

(You can run your own examples using the calculators on our Web site, www.LoneStarLending.com. Just click the "Calculate Payment" button in the left margin.)

If you're addicted to cable news as I am, you can't help but worry about the credit crisis gripping the world. I keep wondering how and when it's going to affect me personally. Currently, I'm not seeking credit, but what if I was? I hear the stories about car dealerships unable to make auto loans, home equity lines being cut off, and credit card limits being cut back. But you'll notice I didn't mention mortgages. That's because mortgage credit is the one segment of the financial market that remains relatively healthy. That was not a typo. Yes, you still can get a mortgage.

That may sound like an outrageous statement given what you're hearing on the news. This credit crisis began because of bad mortgages. The Wall Street boys sliced, diced, packaged, and collateralized those bad mortgages and went belly-up. Fannie Mae and Freddie Mac overindulged on those bad mortgages and were nationalized. How can the words "mortgage" and "healthy" appear in the same sentence?

Well, it's because of the Federal government's involvement that it can. Back in the good ol' days (before 2007), Fannie and Freddie represented only part, albeit a large part, of the secondary mortgage market. (The secondary market is where loans are packaged and sold to investors. In effect, it makes money available for more mortgages.) Wall Street also had a large share, and the government had a rather small share through FHA, VA, and USDA guaranteed/insured loans.

Fast forward to this year. Investors lost interest in mortgage investments, which put Wall Street out of the business. That meant a large part of the secondary market was gone (but this part was dominated by the exotic and sub-prime loan programs that were falling out of favor.) Loan originations plunged, in part because of the disappearance of these programs but also because mortgage insurance companies dramatically tightened the terms of loans they were willing to insure. Confidence in Fannie and Freddie started to wane, and investors began to question the strength of their guarantees. Both began to report capitalization problems, and questions arose about whether they would be able to continue buying new mortgages.

In steps the Federal government. First, it's rather small share of the mortgage market started to balloon. The FHA loan became the program of choice for those with marginal credit. FHA loans represented almost 30% of the total mortgage market in July, up from less than 6% just three years ago. (FHA's share is probably larger than it should be. Folks with good credit and down payment money get better terms with non-FHA loan programs, but they're being steered to FHA.)

Second, the government nationalized Fannie and Freddie. Suddenly, that implicit backing from the Federal Treasury became explicit, and the risk associated with their bonds disappeared. (In fact, the day after the nationalization, mortgage rates dropped by more than half a point.) Not only that, but the government made capital injections into both companies and promised further injections going forward. The government's goal was to insure that both companies had plenty of cash to buy mortgages.

The net effect is that virtually the entire mortgage market is controlled by the Federal government, and the government is determined to do what it can to prevent further deterioration in housing.

Lenders are making mortgages, and you probably can qualify.

So if you're considering a home purchase, what should you do? I suggest you consider these facts.

a. Housing prices are down - some even say affordable. There are even some bargains out there.

b. Mortgage rates are low. The question is will they remain low. Once this crisis ends, rates most likely will rise, especially after the government divests itself of Fannie and Freddie.

Can you qualify?

Did you ever hear the radio ad that said "Got a job, get a car?" Well, there's some truth to that right now in the mortgage market. While easy credit is gone, if you have a steady job, decent credit, and a little savings, you should qualify. But what are decent credit and a little savings? If you have avoided bankruptcy, foreclosure, and repossession for the last few years, you probably have decent credit. The FHA and Fannie/Freddie loan programs require 3% down payment, but VA and USDA loan programs still require no down payment.

Finally, how might the economic rescue bill affect housing? Should you wait?

I am confident the government will modify many of the mortgages it purchases through the rescue bill due to political pressure. In the short term, this may put slight downward pressure on home prices because mortgage investors will be forced to acknowledge lower property values to participate in loan modifications. (Their alternative is foreclosure, which can be time consuming and expensive, and I suspect that same political pressure will block or lengthen foreclosure proceedings.) Loan modifications mean fewer foreclosures. Foreclosures tend to drive home prices down. Fewer foreclosures means more stable prices and should help the market find its floor more quickly. I would argue that if you find the home you want, and it's priced right, now is the time to buy.