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Tiptoeing Though a  Minefield

"Good" is the operative word in the mortgage market these days. Anything else may simply not be good enough.

Wishful borrowers with good income, good credit and a good-sized down payment can obtain a good interest rate and so take advantage of the sizable decline in home prices in many markets.

A real estate sign is posted in front of this four bedroom home in Los Altos, Calif., Wednesday, Jan. 19, 2005, that is being offered for $1,995,000. More homes priced at over a million dollars sold last year in California than in the two previous years combined, a real estate analyst says. (AP Photo/Paul Sakuma)
Paul Sakuma
A real estate sign is posted in front of this four bedroom home in Los Altos, Calif., Wednesday, Jan. 19, 2005, that is being offered for $1,995,000. More homes priced at over a million dollars sold last year in California than in the two previous years combined, a real estate analyst says. (AP Photo/Paul Sakuma)

But for may other potential borrowers, the subprime meltdown and resulting credit crunch has made the once wide open mortgage market a veritable minefield, and it is resonating through all corners of the housing industry.

“The banks have priced in the risk and [interest] rates have gone up,” says Melissa Cohn, president and founder of Manhattan Mortgage Company.

“Those who are not as financially solid are terrified,” adds Mary Jo, senior VP at Barak Realty in New York City, who otherwise describes the Manhattan housing market as healthy.

“There are fewer credit options in today’s marketplace for a borrower,” says Steve O’Connor, SVP for government affairs at the Mortgage Bankers Association.

For these industry players – as well as countless borrowers and sellers – there’s reason for hope. On March 6, the federal government took the last step in effecting significantly higher borrowing levels for so-called jumbo loans, when the Dept. of Housing and Urban Development set new borrowing limits.

Given that and with the traditional spring real estate season just weeks away, here’s a map for those eyeing a way through the potentially explosive market.

Market Mayhem

Analysts, realtors and mortgage professors are all quick to say the market has changed dramatically in the wake of the subprime meltdown and the subsequent credit crunch, affecting both the products available and the pool of customers.

“The fact that many subprime mortgage lenders are out of business means a source of mortgage financing for people who have less than perfect credit has been eliminated,” says Mary Trupo, public issues director at the National Association of Realtors. “So there is an added burden for first time buyers.”

Lenders are clearly cutting some programs and raising standards for others.

“If you’ve got bad credit or a high debt-to-income ratio, it’s either more costly or not available at all,” adds Mike Larsen, an interest rate and real estate analyst with Florida-based Weiss Research.

No-documentation loans are virtually a thing of the past. Borrowers are also having to put down more in the form of a down payment.

“You can’t get 100 percent financing anymore,"“ complains Cohn of Manhattan Mortgage. “It is really hard to get 95 percent.”

Jo notes that in the Manhattan condo market, where it used to take five days to go to contract, it is now taking 15-20 days. Interested buyers are finding it wise – if not essential – to get a property appraisal and a loan commitment before entering into a sales contract.

Interest Rates – Then And Now

The big surprise for many mortgage shoppers these days is that interest rates don’t reflect the aggressive easing of the Federal Reserve.

“The Fed is cutting rates when inflation is clearly not dead and buried,” says analyst Larsen.

That means lenders are pricing in the possibility of higher interest rates down the road. Banks are enjoying lower short-term borrowing costs and using higher-than-usual interest rate spreads to repair balance sheets damaged by the free-wheeling lending days and subsequent spike in foreclosures.

Thirty-year and 15-year fixed rates – though still historically low -- are about the same as they were a year ago. (Adjustable rate mortgages are between 4-tenths and half a point lower than in March 2007.

Some buyers may already feel like they missed the chance for a bargain.

Mortgage rates fell early this year then rose again and are now higher now than they were in late January, when the Fed slashed the federal funds rate 1.25 percent.

On January 24, a 30-year fixed rate mortgage carried an average rate of 5.69 percent. By Feb 28, the rate was up to 6.24 percent. (A fifteen-year fixed mortgage saw a similar boost, hitting 5.72 percent in late February).

Even though interest rates remain historically low, many consumers expect them to be lower – and that’s created a little sticker shock.

The rate on 30-years flirted with 5.00 percent in June 2003, when the federal funds rate was 1 percent and the Fed was very concerned about the possibility of deflation. The recent high was 6.86 percent in June of 2006, around the peak of the housing boom.

“Rates are a lot higher than they have been and than they should be,” says Cohn.

The Price Is Right

On the positive side, affordability is up.

Sales of existing homes fell 12.8 percent in 2007, while the median price dropped 1.2 percent, to just under 219,000. Homebuilders are slashing prices and offering buyer incentives for new homes.

The National Association of Realtors affordability index – launched in 1982 -- edged up from an average of 106.21 in 2006 to 111.8 in 2007. It is expected to jump to 129 this year.

"That’s a real improvement,” says NAR’s Walter Molony

The index – a broad gauge which factors in median home prices, median family income, and an average effective interest rate based on a bucket of land and points – spiked to more than 130 in January when rates were at their lowest.

O’Connor of the mortgage trade group admits that it has helped in some markets but adds that the affordability equation is “all relative to income.” In the past, he says, “You used to be able to expand your purchasing power” by using less conventional types of loans, higher loan-to- value ratios and smaller down payments, allowing people to enter the market.

“You need a reasonable relationship between income growth and home prices,” says O’Connor.

For many that means higher down payments and/or lower loan-to-value ratios, which prices them out of some markets and properties.

Even those with high incomes and good credit are being forced to put down larger down payments.

Products -- Then And Now

Many of those mortgage products O’Connor is referring to – no documentation, Alt-As, interest only, and of course, subprime -- are no longer available or subject to significantly tighter lending standards.

A year ago or so, says O’Connor, that group accounted for 40 percent of the market. Now it has “effectively evaporated,”

Jo, the Manhattan real estate agent, says she hasn’t dealt with a customer seeking a no-documentation loan all year.

“I had no-docs everywhere last year,” she says. “Now, I think they are scared.”

Plain vanilla is back in fashion.

“If you’re a mortgage shopper today, it makes all the sense in the world to go with the fixed rate loan,” says Mike Larsen, am interest rate and real estate analyst with Weiss Research. “ARMs have their place for savvy borrowers in the right circumstances,”

Jo says more buyers are doing 30-year fixed than before and most are shying away from ARMS. “They’re terrified that rates are going to go sky high. “

The Big Enchilada

In an economy where million dollar homes are no longer palatial estates and are now the stuff of many a suburban street, the jumbo loan – also known as a non-conforming loan – is at the fulcrum of many a local real estate market.

Right now, any loan with a value over $417,000 falls into the jumbo category. Add a down payment of 20 percent or 25-percent -- hardly the norm of old -- and you have house with a value of around $500,000. Seen many of them advertised lately?

That’s the current conundrum for many buyers and sellers. After two decades of price gains, even with the recent slide in prices, many transactions require a jumbo loan.

In California, for example, one third of existing mortgages are a jumbo, according to the NAR. Other high-priced markets have similar ratios.

“In the jumbo space, you almost have to put a lager down payment than before," says O’Connor.

What’s more, the premium has gone up. Jumbo loans are now between 1 percent and 1 ¼ percent higher that conforming ones, says Maloney. Prior to the credit crunch the spread was typically 25--50 basis points, depending on the size, the borrower and the market.

For these reasons and others, the new ceiling for jumbos, backed by Fannie Mae and Freddie Mac, will soon rise to about $729,500. (The exact level will vary from market to market based on the median sales price of metropolitan areas as defined by the Department of Housing and Urban Development.)

That change should provide “a little short in the arm,” says Cohn, many of whose clients are in the relatively high-priced New York City market and its suburbs.

The higher borrowing limit will not only facilitate more transactions but is also expected to shave a quarter percent or more off the price of a loan. On the lender side, it should also improve liquidity, partly because a related legislative measure raised the amount of loan money backed by federal insurance.

Another big part of the impact may be on a less concrete level; industry players hope it will improve confidence about the market.

“A lot of people are looking for stability and trying to time the market,” says Maloney.

Of course, even that may take some time.

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