The Stimulus Bill & Increased Conforming Loan Limits

There is an element of the Stimulus Bill that will temporarily raise the conforming loan limits from $417,000 up to $729,950. Why "up to" and not just "to" almost $730,000? FHA (the Federal Housing Authority) will base the new limit by location. It will be based on 125% of the median home price with a maximum of $729,950.

The idea is that the traditionally lower conforming interest rates combined with higher limits (through the end of 2008) will help stimulate the economy. Those of us in the real estate world have all been excited by this proposal -- a nice jump to our slowed industry.

The primary question I'm hearing from my clients is "When?" When will buyers & home refinancers benefit from the increased limits? Good question.

Here's the deal: FHA had 30 days from when Bush signed the bill into law to set the limits. They say they'll have the new limits out the first week of March. Then what? Then Fannie Mae & Freddie Mac (the GSEs -- Government Sponsored Enterprises) will make their adjustments. Once they make their adjustments to not only the limits, but likely to the guidelines for borrowers things will trickle down to the big banks (BofA, WaMu, Wells, etc.). I've heard another 2 months at most, but no one really knows. We're all hoping for sooner (fingers crossed).

More things that no one really knows: what's really going to happen. It's highly likely that here in the Bay Area we'll get the maximum new conforming loan amount (that $729,950), but will the interest rates for loans at $400,00 be the same as those at $550,000? $700,000?

Fannie Mae is pretty fair in how they charge borrowers for added risk. You want to state your income and not have it verified? Okay, but we're going to charge you a slightly higher rate for it. You want a loan and your credit's not so hot? Well, okay, you still fall in the "okay" zone so we'll lend to you, but we're going to have to charge you a higher rate. Basically, if you represent a larger risk as a borrower, you can still get the money, but it'll cost you.

So, going back to the higher limits. Doesn't a $700,000 loan represent a higher risk than a $400,000 one? There's more to lose, right? Does it not stand to reason that if you want a loan that benefits from the increased limits that you may be charged a little more? But again, who knows how, or if, that will be accounted for.

I would love to see our high cost area get a small break for home owners and home buyers. It's about a 1% difference in rate, which can make a big difference. Don't think we're going back to the days of less cost equals more house (like with interest only and pick-a-pay loans). The banks are going to stay tight on qualifications and down payments for the time being.

My point is this: Don't base your actions on the idea that the increased conforming loan limits will be your saving grace. The fact is that no one knows exactly what is going to happen. I've heard a lot of talk going around. I've heard mortgage brokers (not with my company, of course) telling people that as soon as the Stimulus Bill is passed they'll be able to get a $700,000 loan for under 5%. Now that's just not true...it could end up being factual, but at this point don't believe it as fact. Do your research and ultimately make the decision that's best for you & your situation today and tomorrow. And if you need information specific to your situation, leave a comment & we'll talk.

Basic Bond Info

Rates and prices move in inverse fashion with bonds. If you buy a bond for $100, and it pays you a fixed payment of $5, the yield is 5%. If you have to pay $200 for it (the price doubles), suddenly you're only earning 2.5% (the rate goes down). Conversely, if you pay $50 to earn $5 (price dropped), you earn 10% (rate increased). Simple.

The image to the above is the 10-year Treasury Note over the past year (end of February 2007 to today).

When the Fed cuts rates

This has to be one of the questions I get asked the most by clients and Realtors alike:

What happens to mortgage rates (and why) when the Fed lowers their rates?

The short answer is mortgage rates tend to go up after the Fed announces a rate cut. "But that doesn't make sense -- shouldn't mortgage rates go down if Fed rates are cut?"

It's widely known when the Fed will meet to discuss rates; analysts across the board give opinions about what the Fed will do -- raise or lower rates and by how much they think they'll move. These opinions are out in the general financial markets weeks before the Fed actually meets. And the analysts are good at what they do -- they may not be spot on, but they're usually pretty close.

Because we "know" a couple weeks ahead of time what we think the Fed is going to do, the market generally prices in that opinion before the actual announcement is made. Once the rates are adjusted by the Fed (or unadjusted, for that matter) the market shifts again.

For example, say the Fed is meeting in two weeks and it's expected they they will lower rates by .5%. In the two weeks leading up to the announcement the financial markets "price in" the coming rate cut. The markets may decline slightly, bring mortgage rates down with them. Then the Fed meets. Say the analysts were right on track and the Fed drops rates by .5%; the markets had already accounted for that cut and so they remain relatively unchanged after the announcement, with potential for a slight increase. The market is happy since they correctly predicted what the Fed was going to do and the market rallies and goes up -- mortgage rates go up too.

Now, say the analysts were a little off the mark. The Fed still reduces rates, but by only .25%; the market has already pre-priced in a .5% decrease in rates -- whoops, too much decline. The economy isn't in a place where it needs a whole .5% cut; the market is happy that the economy's doing better than predicted and it goes up, mortgage rates go up too.

Okay, so what if the market predicted .5% and the Fed lowers rates by .75%? Now the economy needed a bit more of a boost than the .5% would give. The market priced in .5% cut weeks ago, but now things look worse on a macro-economic scale. The market may decline, mortgages rates should drop too.

What happened in January? The Fed was scheduled to meet (and expected to reduced rates) on the 30th. Martin Luther King, Jr.'s birthday (observed) fell on Monday, January 21st. The US markets were closed for the holiday. Before the markets opened on Tuesday, the Fed held an unscheduled meeting and reduced rates by .75%. This unexpected, unscheduled reduction a week before the scheduled meeting was to take place shocked the market to a 300 point decline. Mortgage rates fell. Wednesday morning things looked about the same -- market declines all over the place were holding strong. Then there was a shift; the market turned around. By Wednesday afternoon the market had gained 600 points -- 180 degree turn around! Mortgage rates jumped right back to where they were the previous week. And we still had to hear what the Fed would do in their scheduled meeting the following week (they dropped the Fed rates again, this time by .5% and the mortgage rates rose slightly and then dropped slightly ultimately having no meaningful effect).

The rates that the Fed raises & lowers is not any rate that you or I would see on any of our bank statements. "Fed Funds" is the rate that banks can borrow money from each other to keep their reserve amounts in line. The "Discount Rate" is the interest rate at which an eligible financial institution may borrow funds directly from the Federal Reserve when their reserves dip below the reserve requirement. The Discount Rate is considered the last resort for banks, which usually borrow from each other. The Federal Reserve can change either, but they can't change mortgage rates. The Fed's job is to control inflation while maintaining moderate growth. Their job is not to support the stock or bond market.

That's the long and the short of it. So if you're looking to lock in a rate for your mortgage, you're usually better off getting something in place before the Fed makes any announcements -- I can always renegotiate your rate with a different investor should rates fall later :)

Real Estate Cycle Overview/Outlook

While I can't take credit for writing this, I thought it was interesting & insightful enough to present....

If one looks back on previous economic cycles, typically housing recessions have been followed by big booms in the industry which have usually persisted for at least two to three years. Is this the same? Many experts think not, since the forces driving the current downturn are much different from those in the past. Before the 1980s, pent-up demand moved housing. The Federal Reserve would tighten, to keep inflation in check, which increased the cost of mortgages. There was no "secondary market" for mortgages, and many homebuyers put off buying homes because they were unwilling to pay the higher mortgage rates or because they were unable to get loans. During the economy-wide recession that usually ensued, interest rates fell, and this "pent-up demand" boosted home buying. What about now? Although higher rates helped the housing downturn, but many potential borrowers who would like to buy homes cannot obtain the credit. We are now faced with a huge potential supply of housing, as foreclosures mount and many move back to renting instead of owning.

-from my corporate Director of Capital Markets

Beer Tax Logic

I received this in an email and thought it was a decent explanation of the tax system from the perspective of drinking buddies...

Suppose that every day, ten men go out for beer and the bill for all ten comes to $100. If they paid their bill the way we pay our taxes, it would go something like this:

The first four men (the poorest) would pay nothing. The fifth would pay $1. The sixth would pay $3. The seventh would pay $7. The eighth would pay $12. The ninth would pay $18. The tenth man (the richest) would pay $59.

So, that's what they decided to do.

The ten men drank in the bar every day and seemed quite happy with the arrangement, until one day, the owner threw them a curve. 'Since you are all such good customers,' he said, 'I'm going to reduce the cost of your daily beers by $20. Drinks for the ten now cost just $80.'
The group still wanted to pay their bill the way we pay our taxes so the first four men were unaffected.

They would still drink for free. But what about the other six men - the paying customers? How could they divide the $20 windfall so that everyone would get his 'fair share?' They realized that $20 divided by six is $3.33. But if they subtracted that from everybody's share, then the fifth man and the sixth man would each end up being paid to drink his beer.

So, the bar owner suggested that it would be fair to reduce each man's bill by roughly the same amount, and he proceeded to work out the amounts each should pay.

And so:

The fifth man, like the first four, now paid nothing (100% savings). The sixth now paid $2 instead of $3 (33%savings). The seventh now pay $5 instead of $7 (28%savings). The eighth now paid $9 instead of $12 (25% savings). The ninth now paid $14 instead of $18 (22% savings). The tenth now paid $49 instead of $59 (16% savings).

Each of the six was better off than before and the first four continued to drink for free, but once outside the restaurant, the men began to compare their savings. "I only got a dollar out of the $20," declared the sixth man. He pointed to the tenth man, "but he got $10!" "Yeah, that's right," exclaimed the fifth man. "I only saved a dollar, too. It's unfair that he got TEN times more than I!"

"That's true!!" shouted the seventh man. "Why should he get $10 back when I got only two? The wealthy get all the breaks!"

"Wait a minute," yelled the first four men in unison. "We didn't get anything at all. The system exploits the poor!"

The nine men surrounded the tenth and beat him up.

The next night the tenth man didn't show up for drinks, so the nine sat down and had beers without him. But when it came time to pay the bill, they discovered something very important....they didn't have enough money between all of them for even half of the bill!

And that, boys and girls, journalists and college professors, is how our tax system works.

The people who pay the highest taxes get the most benefit from a tax reduction. Tax them too much, attack them for being wealthy, and they just may not show up anymore. In fact, they might start drinking overseas where the atmosphere is somewhat friendlier.

-from a University of Georgia Economics Professor

Conforming - Jumbo Spread

The difference in rates between a conforming loan amount ($417,000 today) and a jumbo loan (anything over $417,000) has historically been .25%-.5%; since August 2007 it's been hovering around 1% or more.

With the conforming limits about to be raised to just under $730,000 in high cost areas, the question becomes what will happen to the spread between the now higher conforming limit and the now larger jumbo loans.

It is widely hoped that spreads will narrow, but many analysts feel that the change in conforming limits will actually have a negative impact on loan amounts above $730,000, due to the perceived higher risk.

This means that the high end homeowner or home buyer whose home is in the $915,000+ range could end up paying a premium in interest rate to own a premium home.

Quick Notes

• The next meeting for the government to discuss Fed Funds (rates) is March 18th. Currently, Wells Fargo expects the Fed to cut rates by another half point (50 basis points)
• On Thursday, February 14th Mr. Bernanke, the Chairman of the Federal Reserve will give his semi-annual testimony on the status of the economy. Market particiants will watch his words closely.