TRAVERSING THE CURRENT JUMBO LOAN MARKET

Is it possible to get great Jumbo loan rates in today’s market? The answer - absolutely! The strategies I use in this market place, on how to best negotiate and buy property*, give the Jumbo borrower some very positive opportunities.

The current definition of a Jumbo loan is an amount borrowed larger than $417,000. However if the loan amount is between $417,100 and $523,750 (many counties in eastern MA -- your counties maximum loan limit maybe higher or lower), then this is considered a Conforming Jumbo until January 1, 2009. The Housing and Economic Recovery Act of 2008 that was signed into law will increase the conforming limit ($417,000) to 115% of an area’s median sales price. I expect that for most counties inside the RT 128 belt of Massachusetts the definition of Jumbo loans will be those loans greater than $481,850 beginning in the New Year.

Most Jumbo loans are not on the edge to the conforming market, a few thousand dollars over the limit. Many families find they need or want a mortgage much greater than the current limit. Typically a Jumbo borrower is able to put twenty percent or more down on the purchase, typically from the sale of their current residence. If this describes your circumstance read on.

So what are the best Jumbo loan products available and why? The fact is the thirty-year fixed rate market has become very expensive for Jumbo financing, especially for a loan amount over $650,000. Therefore I have found that the intermediate portfolio adjustable rate mortgage (ARM) loans work best. These are the five and seven year fixed loans that adjust after the initial fixed period. My first reason to use these products is because the spread in rates between the 30-year fixed rate and the 5/1 or 7/1 ARM have widen sharply. The second reason is that private (non-governmental) 30- year fixed money has all but evaporated from our market; this leaves only the portfolio lenders. The third reason I recommend these loans is the current housing market slump will not last forever. As the housing market recovers there will be ample fixed rate mortgage money to replace this loan if needed; see the chart on the next page from the Office of Federal Housing Enterprise Oversight. This is a national chart created by the forecasters’ that the entire real estate industry trusts, because they predicted the downturn and saw the bubble in 2005 and 2006 – this is the organization that got it right! You will be hard pressed to pick the absolute bottom of this market. By the time the bottom is recognized the recovery will already be six months to twelve months into its cycle.

Other considerations for using portfolio intermediate fixed ARM is the Yield Curve. I would much rather stay on the short term end of the interest rate market than the long term. The traditional yield curve is plotted on an X and Y chart where X equal interest rate and Y equals term. Historically one should find that as the term of the debt repayment lengthens the corresponding rate is higher. So a one-year term Note would have a lower interest rate than a thirty- year term Note. However one indication that a recession is forthcoming is when the Yield Curve will become inverted; in this case short term interest rates are actually higher than long term interest rates. This has happened several times in the last two decades; I blame most of it on the Federal Reserve policies and unfortunately those cannot be expounded in the scope of this paper.

Bottom line best overall cost of financing today’s Jumbo loan is with the use of 5/1 or 7/1 ARM. The housing market will recover. Sanity will eventually return to the mortgage marketplace where entrepreneurial lenders will develop and be able to sell Jumbo fixed rate loans as competitively priced as the conforming market. Don’t let the irrational fear of an ARM trick you out of purchasing in this housing market. You will lose more by not acting.














*I have strategies on how best to negotiate and buy property in this market. I am building teams of realtors and other professionals to implement and utilize these strategies so that both the buyer and sell win in every transaction. Call or email me today to learn more on how you can implement these strategies to win in this market.

Not All Adjustable Rate Mortgages are Toxic

I have been receiving a of lot calls from past clients inquiring whether or not if now is the time to refinance. Many inquires concern an adjustable rate mortgage that has been fixed for the past five years and now is set to adjust. There is a misconception that all adjustable rate mortgages (ARMs) adjust to a much higher interest rate. This is not necessarily the case. There are many Intermediate fixed term ARMS that have very favorable terms at adjustment. The fact is all ARMs are not alike. The Press will headline Subprime ARMs that were given to borrowers a few years ago with credit, income and asset issues. These Subprime ARMs do contain new terms at adjustment that will insure the adjustment interest rate will be higher than the initial NOTE rate. The fact is not all ARMs are subprime there are Prime or “A” paper ARMs as well. There is a large spread between these two types of ARMs and if you have an ARM you need to understand what the terms of your loan are before making a decision to refinance.

Definition of an ARM

An ARM allows the lender the ability at a future date to adjust the interest rate and payment terms of a mortgage loan to the market based on two factors. The first factor is a published and market accepted interest rate Index; the index also has to be outside the control of the lien holder. The mortgage industry has accepted several Indexes to tie its various mortgage loan products. Here is a list of the most common residential mortgage indexes:

• CMT –These indexes are the weekly or monthly average yields on U.S. Treasury securities adjusted to constant maturities.
• MTA -- The Monthly Treasury Average, also known as 12-Month Moving Average Treasury index (MAT) is a relatively new ARM index. This index is the 12 month average the monthly average yields of U.S. Treasury securities adjusted to a constant maturity of one year. It is calculated by averaging the previous 12 monthly values of the 1-Year CMT.
• LIBOR -- London Inter Bank Offering Rate is an average of the interest rate on dollar-denominated deposits, also known as Eurodollars, traded between banks in London. The Eurodollar market is a major component of the International financial market. LIBOR is quoted as a one month, six month, and one year index.
• PRIME -- The Prime Rate is the interest rate charged by banks for short-term loans to their most creditworthy customers whose credit standing is so high that little risk to the lender is involved. This index is directly affected by the Federal Reserve interest rate policy. This index is widely used for Home Equity Lines of Credit and Second Mortgage loans.
  

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The index will raise or fall depending on the general credit market and each month a snapshot of the index is taken and used by mortgage lenders to determine a given loan’s interest rate. All the above indexes are an indication of the short term interest rate environment – debt that is repaid within a one year time frame or shorter. There are longer term indexes but for our discussion most residential mortgage ARMs are based on one of the above Indexes.

The second factor to an ARM is the Margin. This is the fixed percentage that will be added to the Index at adjustment to determine the new interest rate. Margins vary widely between Subprime and “A” paper loans for example:

On a Subprime loan the margin might equal the start rate / initial interest of the Note taken at closing. If the interest rate was initially 7% for the first three years of the loan the margin might also equal 7%. Therefore the interest rate will always be at least 7%, but only if the corresponding index were to go to zero. That would mean a zero interest rate environment, not likely, so this borrower will be looking at an increase at adjustment. An “A” paper loan will typically carry a margin less than 3% and has no relation to the starting Note rate. Therefore at adjustment the “A” paper loan could very well adjust lower depending on the current interest rate environment. The two components to all ARMS are the index, this will change over time, and the Margin a fixed percentage added to the index to determine the new interest rate.

In addition to the two elementary components Index and Margin there are two other concepts that need to be understood by the borrower. These are the interest rate caps and adjustment term. Interest rate caps are contractual and defined in the mortgage Note at closing. These caps will contain or keep interest rates from adjusting above or below a defined level. For example the interest rate caps might be expressed as 5/2/5. This means that the interest rate cannot adjust more than 5% at the fist adjustment, no more than 2% at each subsequent adjustment and never adjust more than 5% over the loan’s lifetime. 5/2/5 are typical caps on “A” paper 5, 7 and 10 year fixed ARMs, but you might also see 2/2/6. How it works is if the index used for the mortgage raises enough so that the new interest is above 5% the initial start rate, then the lender will be able to adjust the new rate to that level. This way the lender is able to receive interest comparable to the current market interest rates. Further if the loan were to adjust the full 5% at the first adjustment it could never be higher than this amount for the life of loan. The second cap, in this case 2%, comes into play when index has increased or decreased less than the 5% during the initial fixed term. Therefore the loan would adjust to the new interest rate index plus margin for the new fixed period of time. At each subsequent adjustment the interest rate can only increase a maximum of 2% until and if it reaches the maximum of 5%. The period of time the loan’s interest rate is fixed once more at each subsequent adjustment is the adjustment term. This is generally based on the index chosen for the mortgage product. For example if the lender uses the CMT or 1-Year LIBOR index, then the loan will adjust annually after the initial fixed term of the Note. If a 6-month LIBOR is used, then the loan will adjust every six months. If the MTA is used, then the loan will adjust monthly for the remaining term of the loan and so on.

Examples:

An “A” paper mortgage ARM; initial interest rate 4.75% for the first five years, then adjusting each twelve month period thereafter for the balance of the twenty five year term; most ARMS are based on a 30 year Amortization. The Margin is 2.75% and the index used is the 1 year LIBOR with 5/2/5 caps. If this loan was closed in October of 2003 the October 1-Year LIBOR index was 1.5625%. I want to bring to your attention the fully index rate (Margin plus Index) at the initial closing. In 2003 the fully indexed rate was 4.375% rounded to the nearest eighth (1.5625% plus 2.75%). As you can see the initial Note rate was .375% higher than the index plus the margin. In October of 2008 this loan will adjust based on the terms of the Note. However the lien holder cannot wait till the October’s index is published to adjust the interest rate. Therefore the terms of Note will generally allow for 45 days prior to adjustment the then index will be used and a notice of the new interest rate will be sent to the borrower. In our case that would mean before August 15th 2008 the August 1-year LIBOR index will be used to by the lender. The 2008 August 1 Year LIBOR index is 3.244%. Therefore in this example the new interest rate will be 6.00% rounded to the nearest eighth (3.244% plus 2.75%) and a letter explaining this change would be mailed to the borrower. That is a 1.25% increase and is much lower than current fixed ate interest rates that stand around 6.75%.

Let’s use the same example but change two of the components. Lowering the margin to 2.25% and switching the Index to the 1 Year CMT. The October CMT was 1.25% plus our margin would have equaled the fully indexed rate of 3.50%. In this case the initial Note rate was 1.25% higher than the initial fully index rate. Fast forward five years the August CMT is 2.12% plus our margin will equal a new interest rate of 4.375% (2.12% plus 2.25%)—that would be a .375% decline in rate. In this example you can see the difference in which index is used as well as the margin. There can be a significant difference between ARMs depending on the initial structure.

One caveat, the CMT was used widely a few years ago but today most ARMs are based on the 1-Year LIBOR.

If we consider the caps in both cases the first adjustment cap would not come into play because the index did not raise enough for the adjustment to climb 5% above the initial start rate of 4.75%. The Note’ index with 2.75 Margin would have to climb to 7% and the Note’s index with the 2.25 Margin would have to have climbed to 7.5%. Historically over the past 18 years the CMT highest point was 7.78% in August 1990 and went to 7.14% in December of 1994. The 1 Year LIBOR has been .25% to 1% higher in any corresponding month than the CMT.

This doesn’t mean the CMT is superior to the 1 Year LIBOR it just means you need to understand the terms of your mortgage Note and how these affect the interest adjustment.

In my examples there are clear differences between Subprime and “A’ paper ARMs. The fact is Subprime ARMs might be considered toxic; this set of borrowers has been excluded from being able to refinance these ARMs because of the illiquidity of the current mortgage market. For many Subprime borrowers the only way to refinance is with an FHA insured mortgage or asking the current lien holder to restructure the terms of the mortgage note. However the “A” paper borrower should not confuse their situation with that of a Subprime borrower nor ignore the benefits of intermediate fixed ARMs. In fact if one is purchasing a home today and needs a Jumbo loan (a loan amount above $523,750 – jumbo conforming limit for most counties inside the 128 belt of Massachusetts), then your only choice may be a five or seven year fixed ARM. Many of the available Jumbo ARMs have favorable terms and should be considered as part of the mortgage planning process.

If you are considering refinancing, have your Note reviewed by a mortgage planning professional. This will help you understand where the loan might adjust so that you can make a comparison to the current interest rate environment; you might be pleasantly surprised. As part of my planning process for my clients we perform an annual review and an ongoing review with a mortgage under management process. To learn more on whether you should refinance contact me and I will perform a review of your current mortgage and make recommendations based on your future goals as well as interest rates.

What’s Your Rate?

This is the first question I get when someone learns what I do for a living. As a mortgage planning professional I cringe at this question. I have never liked the fact that my industry has conditioned the general borrowing public to ask this question when they inquire about a mortgage. To ask it in the current market, the unsuspecting applicant is asking for trouble.

Since the implosion of many mortgage lenders and the private sector shirking the mortgage market since last summer, there have been many very important changes to how a loan is quoted. The headlines are scary. There are fewer loan programs left and credit scoring rules the mortgage industry. The major mortgage funding markets that exist at the moment are FANNIE MAE, FREDDIE MAC and GANNIE MAE. Within this market lurk many caveats to be understood by the consumer prior to getting a solid interest rate quote. No longer is it possible to pick up the phone and get a reliable quote unless you are able to access the lenders guidelines for what are known as risk based pricing adjustments and loan level price adjustments.

The government backed mortgages currently have the lowest interest rates on 30 year fixed rate loans. If your loan amount is above the government current limits, then you must rely on the private sector to fund your loan. In that case the lowest cost loan products are intermediate Adjustable Rate Mortgages with initial fixed terms of 5 or 7 years. To qualify for these loans however you must have high FICO scores, a sizeable down payment or equity along with adequate income to qualify. For this article I am putting the true Jumbo loan aside and will focus on the Government market.

The fact is the majority of homes purchased and refinanced fall into the category of the government loan arena. Finding out what the payment is within this arena is tricky and really cannot be accomplished without having your lender having reviewed:

1. Credit report and scores


2. Income documentation


3. Asset documentation


4. Appraisal of the property

There is no way around the fact that all four of the above will determine the terms of your new loan – you cannot guess at these in today’s market.

Why? Because of risk based pricing adjustments and loan level price adjustments. These terms are the reality and are set in stone. To stave off losses both FANNIE and FREDDIE have created a systems that compensates for the greater risk. FHA currently has adopted a similar risk avoidance system that is a little softer than FANNIE and FREDDIE. I will explain the impact on an interest rate quote in the world of FANNIE over two scenarios later in the article. FHA is up in the air as to whether the risk based pricing will continue or not. The Housing and Economic Recovery Act was signed into law on August 1st, 2008 (That was Bill H.R.3221). It will become effective on October 1, 2008 and it eliminates risked based pricing on FHA loans. However on its heal Bill H. R. 6694 authorizes risk-based insurance premiums for FHA mortgages. This is a perfect example of constant change in the mortgage lending industry.

LOAN LIMITS:

FANNIE MAE / FREDDIE MAC – Make up the conforming mortgage loan market that define the single family (1 unit and Condo) loan limit as $417,000; except in Alaska, Hawaii, Guam and the U.S. Virgin Islands, which are 50 percent higher than the limits for the rest of the country

FANNIE MAE / FREDDIE MAC (Stimulus Package) –if the loan amount is above $417,000, then it is a Stimulus or so called “JUMBO conforming” (only through December 31, 2008) – the loan limit varies by county go to: https://entp.hud.gov/idapp/html/hicostlook.cfm to find your counties maximum loan amount.

GANNIE MAE – Is the agency that insures FHA and VA loans with the full faith and of the Federal Government. FHA currently follows conforming loan limit guidelines including up to the stimulus package loan limits. The VA insurance program gives an eligible Veteran a certificate that is worth 25% of the loan amount up to $417,000 conforming limit on single family home. Therefore up to $417,000 loan amount no down payment is required. However a Veteran that qualifies can have a loan up to $1,000,000 putting a 25% down payment on the excess balance over the $417,000 of the purchase price – these are called Super Jumbo VA loans.

FANNIE Adjustments:

You are shopping around for a mortgage loan and look on the internet for current rates. You find there is a lot of variation between the lenders advertising. How can you get an accurate read on an interest rate? Let me tell you that you can’t - you need to find a professional you trust and apply for the loan. Here is why.

Example one:

$500,000 purchase price and you have 10% to put down that leaves you with a $450,000 loan amount request. This means you will have a Jumbo conforming loan with private mortgage insurance. Since it is conforming jumbo your rate is already affected higher than if the loan amount was $417,000 by about .25%. Now consider FICO score - you need a 700 to get a loan. If you don’t have this score you will need to put 20% down. This used to be accomplished with a second mortgage to make up the additional 10% needed. Good luck finding one in today’s market. So you find the second mortgage you will still have an additional .75 to 1.50 points added to the price which will increase your rate by a .25% to .375% over the Jumbo .25% already added. Another pitfall is if the property falls into a declining market county, then there may be an additional 5% down payment requirement.

Example two:

You want to refinance out of your adjustable rate loan into a fixed rate. You think your home’s fair value is $500,000 and you owe $400,000. Let’s assume 30 year fixed interest rates are advertised at 6.5%. Now you need to be aware that that rate assumes a minimum FICO score of 720; if your score falls below this level there can be anywhere between a .50 point to 2.50 point price adjustment. How this translates to rate is .50 point will equate to .125% higher rate, a 1.50 point adjustment will be .375% higher in rate and 2.5 point adjustment will be .625% in rate. So you could be looking at a 7.125% instead of the advertised 6.50%. We haven’t considered the appraisal - if that comes in lower than $500,000 you are going to need private mortgage insurance if available with your given credit score. Again watch out if you are in a declining market county another 5% cut in your loan.
There are many examples of why it is impossible to get a rate quote over the phone. The two examples above is just a sample. If you are seeking a mortgage use a professional and give them all your information and apply for the loan. Let the professional handle the job of finding you the best possible loan for your current situation and heed their advice. If you are worried about making a mistake in choosing the mortgage professional here are some tips you can follow before you meet with anyone:

1. Get a copy of your credit report and learn about Credit Scores – there is an entire section of my web site dedicated to this topic at http://www.prmibev.com -- request your free annual credit report at https://www.annualcreditreport.com/cra/index.jsp


2. Gather your documentation together – income documents (W-2 and Tax Returns last two years) know how much money you make in gross income


3. If you are refinancing look up your property online at http://zillow.com or some other valuation web portal – no this is not an appraisal but it will give you a quick indication of the value -- also check Assessment value of your home on your real estate tax bill or online – most of the time Zillow has this information updated.


4. If you are purchasing get a basic idea of the price of properties you are most interested in – go to some open houses and do some research. Target an area to learn how quickly properties are selling.

A good mortgage professional will have the tools to further educate you on mortgage options and also help you structure how to make an offer on the property with your real estate agent. In this market the sellers are very concerned about the sale falling through because of financing problems. Believe me if you are positioned with a realistic loan approval and understand how you want to structure your purchase agreement you will be in the best possible position to close on the home; but you need a team of professionals on your side to put this together – including a mortgage professional and real estate agent. If you need to refinance because of an adjustment in your current ARM, then get a realistic valuation of your home and get that credit report. You won’t be able to affect the value of your home but you could improve your credit score prior to applying for the refinance. Remember whether you are buying or refinancing the more you understand the current lending environment the better.