Increasing borrowing costs will lower house prices
Borrowing costs are likely to increase in 2012 for a variety of loans. The lower conforming limit will push many borrowers to either the FHA or the jumbo market where borrowing costs are higher. The FHA may also raise its borrowing costs again to cover the inevitable losses from the ongoing decline in home prices. Further, the new rules on conforming mortgages will push up costs on loans which do not conform.
The result of higher borrowing costs will be greater pressure on home prices. If borrowing costs go up, affordability declines, and it’s only affordability which will put a floor beneath home prices.
By JEFF COLLINS / THE ORANGE COUNTY REGISTER — December 16, 2011
Cameron Findlay is the chief economist at LendingTree.com, working out of the Charlotte firm’s Irvine office. responsible for risk management, hedge strategy and analytics. He is the firm’s principal representative in Washington, D.C., involved in mortgage industry reform. We asked him for his take on the mortgage market these days …
Us: What’s going on with the current mortgage market?
Cameron: There is a battle ensuing between Fannie Mae and Freddie Mac vs. the Federal Housing Administration in terms of market share.
Just take loan limits as an example. For Fannie and Freddie loans, the local loan limit is set at $625,500. For FHA loans, those limits are actually $729,750.
The translation for high-cost regions like Orange County, the government is committed to reducing the number of Fannie and Freddie loans, and the volume we expect will be diverted to FHA as consumers look to secure higher loan limit loans. In short, there is confusion for both lenders and borrowers which inhibits the loan origination process and increases cost.
The reduction in Fannie and Freddie loan limits from $729,750 to $625,500 on Oct. 1 was particularly significant because 28 percent of the homes impacted nationally are located right here in California.
I don’t believe this is competition or confusion. The government wants to pull back from its subsidies to stop from losing even more money, by leaving the option open to use FHA financing, they can provide some support for the more expensive homes, but at a higher borrowing cost. This should encourage private lending in the jumbo loan market to enter this space.
FHA loans with their insurance premium of 1.15% is more expensive than a competing jumbo loan. Of course, the jumbo loan will require 20% down and the FHA loan only requires 3.5% down, so many will chose FHA loans anyway because they won’t have another choice.
Whatever choice the borrower makes, it will carry a higher cost which will reduce the size of the available mortgage. Smaller mortgages make for lower prices.
Us: What’s the outlook for mortgages in 2012?
Cameron: Qualification will continue to play a central role in the first half of the year when regulators are expected to release the definition of a “Qualified Residential Mortgage.”
The cost of borrowing may rise as much as 1.25 percent for those who do not qualify for a QRM. Clearly this would be detrimental to existing home prices and reduce the market’s ability to clear existing inventory.
That is only half true. It is detrimental to existing home prices, but it doesn’t reduce the market’s ability to clear the inventory. Lower prices will do that.
Being an election year, there may not be much new policy agreed to. We expect policies already in place to be central to election results. This may drive government intervention to further stimulate improvement or at least stability in housing.
I agree that legislation in an election year is not likely, particularly since the two parties can’t agree on much. But given the perceived need in Washington to support home prices, something may emerge from Washington which further distorts the market.
Us: UCLA forecast that these historically low rates will last two more years? Do you agree? How long do you think they’ll last?
Cameron: Mortgage rates have bottomed out despite additional monetary easing from the Federal Reserve. Any additional efforts by the Fed to stimulate mortgage rates lower will have only a marginal improvement on increasing the number of borrowers who are eligible for a loan or refinance.
We expect low rates to prevail for less than 24 months, by which time it is expected regulatory influence will begin to push rates higher. The increased transparency any private label investment in mortgages would require implicates a risk premium that will be passed onto borrowers.
That’s a reasonable assessment. Over the next 18 to 24 months, interest rates will likely remain low. Just when it looks like prices have found a bottom, higher interest rates will reduce affordability and stop any meaningful appreciation.
People say that mortgages were too easy to get in the boom, and now they’re too hard. Has the pendulum swung too far?
The pendulum for qualification was previously built on the concept of creative and unstable loan. Existing loan types today are primarily Fannie, Freddie or FHA-qualified loan types, meaning lenders are very cautious about qualifying a borrower.
For sustainable, long-term growth, you need a solid foundation. Today, the market, in collaboration with government oversight, is still clearing the rubble and defining that foundation.
In other words, no, the standards are not too tight.
Standards are finally reasonable again. Only if lenders get stupid, take on excessive risk, or innovate again will we see stupid loan standards and possibly another bubble.
The concern we have expressed is the constant market shock of changing rules will result in adverse market condition premiums that will be passed onto borrowers in the form of higher rates.
Us: How long will this tight-money climate last?
Cameron: The “tight-money climate” will remain in place until private label investment deems mortgages are a risk-worthy investment, which cannot happen as long as the government is buying all of the supply at a market premium to synthetically suppress mortgage rates.
Exactly. The entire mortgage market today is government backed. Private lenders are unwilling to loan at the interest rates backed by government loan guarantees, so we have a completely artificial government-backed interest rate sustaining current pricing.
The government is fully aware that consumption (which is about 70 percent of GDP) is driven by confidence, and without support for housing initiatives, this will risk reducing growth targets not only for mortgages but the broader economy.
Clearly, underlying this issue is the labor market. Jobs creation will be central to any improvement. Focus will need to be on both the cyclical unemployment rate and the structural unemployment concerns that takes into account the skills loss that results in lower-paying jobs and reduced income.
Job creation and household formation are essential to the recovery of the housing market. We need qualified borrowers taking on plain-vanilla debt to absorb the homes being vacated by toxic mortgage holders.
Us: Who’s getting these historically low interest rates, the rich, or cash-strapped homeowners who need them the most?
Cameron: Qualification has mainly been restricted by loan to value or FICO score constraints vs. a focus on debt to income, or higher-income households. Access to credit is being restricted by the loss of equity and home devaluation over the past five years.
The recent Home Affordable Refinance Program 2.0 program was designed specifically to focus on high loan-to-value borrowers. Although it is expected to help, it will still only assist less than 10 percent of the market.
He didn’t answer the question about who benefits, so I will. The primary beneficiaries of the low interest rates are prudent borrowers who were able to refinance, and new buyers purchasing in areas like Las Vegas where prices are well below rental parity.
The people who have not benefited from the low rates are the buyers who paid much more than rental parity to take advantage of the low rates. Those knife catchers have watched the values continue to decline despite the bargain rate they got.
The other group that has not benefited are the deeply underwater who did not strategically default because they got a loan modification or took advantage of the new GSE program allowing deeply underwater borrowers to refinance. This group believes they’ve been helped, but they have merely extended their pain.
The bottom line is that increased borrowing cost is going to continue to put pressure on home prices. With the additional inventory coming next year from B of A and other lenders, I expect prices to continue to decline.