Purchase Applications, Investors, and ARMS – Signs of a changing housing market

The last six months seen some incredible housing activity.  In Orange County, the housing market exploded with some segments of the market increasing 20% in value, bidding wars for homes, and a high percentage of cash sales.  Then in May there were indications that the Federal Reserve might scale back it’s Quantitative Easing (money creation) program.   This cause mortgage rates to increase and then skyrocket in June.  Simultaneously, home values increased due to low supply and the previously ultra low rates.   These two factors should change the housing market dynamic, and I was looking for some indicators of this change.  Some news articles this week gave some cues on these early indicators.  So let’s examine the number of purchase loans, types of loans, and the behavior of investors; these are all indicators relating to purchasing.  At this point close sales are misleading, since they show the housing before changes in home values and mortgage rates.  One of the first indicators have been refinances and purchase applications during the week when mortgage rates skyrocketed in the fast pace since 1987.

Loan applications decline as mortgage interest rates skyrocket

By Brena Swanson June 26, 2013 • 6:01am

Mortgage applications fell 3% last week as mortgage rates rose on fears of less Fed intervention in the mortgage-bond market.

The average contract interest rate for a 30-year, fixed-rate mortgage with a conforming loan balance shot up to 4.46% from 4.17% a week earlier: the highest it’s been since August 2011, the Mortgage Bankers Association reported.

For the same week ending June 21, refinance applications dipped 5% even as purchase applications edged up by 2%.

The shift in the nation’s refi activity accompanied a sharp rise in mortgage rates.

“Interest rates moved up sharply following the Federal Reserve press conference last Wednesday where it was indicated that the Fed could begin tapering their asset purchases later this year,” said Mike Fratantoni, MBA’s vice president of research and economics.

Since then, rates have shifted in an upwardly direction.

On the other hand, refinancing activity continued to fall, with refis representing only 67% of all mortgage applications.

Applications overall moved inverse to rates in this week’s report, with mortgage rates rising across the board.

Hitting its highest level since March 2012, the 30-year, FRM jumbo increased to 4.52% from 4.23% a week earlier.

Additionally, the average 30-year, FRM backed by the FHA climbed to 4.20% from 3.85%.

The 15-year, FRM also rose to 3.55% from 3.30%, while the 5/1 ARM grew to 3.06%, it’s highest level since October of 2011

Now, this report is telling.  As mortgage rates increased, so did purchase applicants.  This is logical, since borrowers believe that mortgage rates will further increase and they will want to lock the ultra low rates.  However, refinances’ decrease means it’s a sign that most people have refinanced and that part of the market share will shrink in the future.  This probably means there will be a very strong dip in purchase applications in the coming week if mortgage rates maintain their current levels.  The long term implication of refinances means that existing homes will no longer be able to lower the cost of financing.  The lowering of these housing costs have help households deal with lower wages and higher costs of living.  That ability will no longer be there.

Now, let’s look composition of the recent purchase loans.  Fix Rate mortgages have been the most popular since we have had these historically low rates.  Why not lock in your rate for 30 years, it makes the most financial sense?

Rising Mortgage Rates Cause ‘Rush to ARMs’

By: Diana Olick | CNBC Real Estate Reporter

After hovering around record lows for the past few years, mortgage rates are rising dramatically. That has consumers not only shopping more but also considering adjustable rate mortgages, which offer lower rates and lower monthly payments.

These ARMs, many requiring interest payments only, were popular during the latest housing boom but quickly fell out of favor when safer, fixed-rate loan rates fell to record lows. ARMs accounted for 36 percent of mortgages in 2006 but just 4.5 percent today, according to Lender Processing Services.

The shift to ARMs is not visible on a grand scale yet, but it is beginning.

The average contract rate on the 30-year fixed rate rose to 4.46 percent from 4.17 percent, the Mortgage Bankers Association said Wednesday. At the beginning of May, rates were as low as 3.5 percent. Concern that the Federal Reserve will begin to pull back on its purchases of mortgage-backed bonds, which pushed rates so low in the first place, caused the most recent spike.

“Mortgage rates increased by the most in a single week since 2011, and refinance application volume dropped to its lowest level in almost two years. However, applications for conventional purchase loans picked up by more than 3 percent over the week,” the MBA’s Michael Fratantoni said.

Mortgage applications to purchase a home are rising for two reasons: Buyer demand is increasing, and those buyers are afraid rates will go up dramatically, so they want to lock in fast…

…The combination of sharply higher home prices and rising rates is squeezing buyers who are already facing tighter underwriting standards. In order to qualify for loans, they must fit into strict debt-to-income calculations, and those calculations change with every increase in mortgage rates.

“I think you’re seeing much more intense shopping where people are comparing rates between lenders, but also looking at different less conventional products,” said Glenn Kelman, CEO of Redfin. “They’re getting teaser rates, they’re buying it down, they’re trying different things to try to get back to the rate they saw last week.”

Some buyers are also being forced into adjustable rate loans in order to save deals that may have blown up in the past few weeks due to the rise in rates.

“Funny, people are rushing into higher-risk loans to save deals as rates spike. What happens in five years when their rate starts adjusting upward 2 percent per year? They blow up!” said Mark Hanson, a California-based mortgage and housing analyst.

Interesting enough there is an increase in purchase applications AND increase in Adjustable Rate Mortgages (ARM).  This means that some buyers are hitting their affordability ceiling in the location and the type house they want.  There has been a 16% increase in mortgage rates and using a with a ARM for the purchase loan lowers the monthly compared to a fixed rate loan.  Now these ARMs are structured different from early bubble ARMs, however what to these borrower when their loan adjusts 5 years in the future?  Most likely mortgage rates will be lower and their payment will adjust upward.  The increase of these products might indicate that Orange County is reaching peak pricing.

Also, new mortgage rules going into affect on January 10, 2014, however they will probably be adopted by lenders before this actual date.  They might impact the use of ARM’s.  Look at his spinet from this article.

To meet general QM requirements loans must be fully amortizing, or have a set pay-off timeline; have a term of 30 years or less; and have borrower fees less than 3 percent of the total loan amounts.

Under nearly all circumstances “balloon loans,” or loans that must be paid off or refinanced before the loan term ends, do not meet QM requirements.

Does this mean that ARM’s mortgage will no longer be considered Qualified Mortgages?  I don’t know, it could also impact what buyers could afford in November when Lenders start to implement the new mortgage rules.

Investors have been big part of the housing market ever since the bubble much higher than historical levels.  Over the course of the last five years it has progressed from small investors to institutional investors, to semi-institutional investors with less knowledge following the pack.  What has been the  behavior of investors in recent weeks.

Changing market leaves investors cautious on housing

By Christina Mlynski June 26, 2013 • 11:23am

As mortgage rates and home prices soar, investors are growing more weary and beginning to back away from the housing market.

This segment of the homebuying market is somewhat risk-adverse due to fears over home price appreciation, the potential for lower affordability levels and uncertainty as to whether there will be a sudden pullback in investor buying, Bank of America Merrill Lynch’s said in a report.

Investors have played an important role in stabilizing the market, particularly in hardest hit areas. As a result, they have been able to arbitrage between a market with excess supply of owner-occupied properties and a market with an undersupply of rentals.

However, investor demand is waning as the pipeline of distressed properties shrinks and affordability declines….

…In contrast, there is a smaller gap between home price appreciation for investors versus the overall aggregate in Las Vegas, Los Angeles and Miami, which is due to a greater share of investor buying in these markets and therefore these transactions “overwhelm the aggregate composite,” BofAML analysts stated.

Overall, investor participation should start to decline given the drop in affordability and shrinking share of distressed home…
If investors are pulling back then demand for homes should decrease.  In addition, it seems like the Los Angeles market has a larger percentage of investor purchases then the rest of the country and therefore might even experience a greater pull back than other markets.
It’s still really difficult to tell exactly where the housing is trending.  It’s going to take 60 to 90 days to see what happens with these contracts that have been started these last few weeks.  In addition mixed signals from the Federal Reserve is introducing a high level of violently into the market place.  It’s going to be an interesting summer.