Post by jeffolie on Aug 8, 2007 13:39:55 GMT -6
Higher Rates, Elimination of Products, Spell Home Price Decline
Published at August 8, 2007
Wells Fargo recently raised rates on its jumbo mortgage products from approximately 6.875% to 8%. A jumbo mortgage is one that falls outside of the Fannie Mae/Freddie Mac conforming loan limits (above $417,000 for here in CA). This represents a massive change to the cost of borrowing money. From our friends at the L.A. Land blog (quoting CNN Money):
Wells Fargo, one of the nation’s biggest mortgage lenders, raised the interest rates on it 30-year, fixed-rate, non-conforming (AKA jumbo) loan to 8 percent last week, up from 6.875 percent. Other lenders followed suit and more are likely to join them. … The rate jump means the monthly bill for a $600,000 mortgage would hit $4,403, compared to $3,942 previously, an increase of $461. Jumbos are loans of more than $417,000.
What does that do to qualifying for this mortgage? Well let’s take a look at the qualifying ratios used to approve someone for this loan. Wells requires the back end debt ratio to be at 45% to qualify for this program.
The back end debt ratio compares your major recurring monthly expenses to your gross monthly income. For example if you are getting a new home loan your back end ratio will include your new housing payment, car payments, student or other loan payments, credit card payments, etc. divided by your monthly income. That number must be 45% or less to qualify for the loan.
If we assume 8% of monthly income is used for recurring expenses, at 6.875% a borrower or a family could carry a $600,000 mortgage making $10,750 per month. A hefty salary to be sure, but one that is in reach for many double-income families in California. At 8% the payment becomes $4,403. Now assuming the same 8% expense the borrowers would need to be making almost $12,000 per month to afford the same home. This is a 7.8% increase in monthly income.
That’s asking for a healthy raise at the office.
A family needs to be making over $144,000 per year to afford a $600,000 mortgage. This would limit these mortgages to only the top 15-20% of all Californians (UCLA study, PDF).
Now take the following recent changes in to consideration as well::
Elimination of high loan-to-value stated income products
Elimination of high combined loan-to-value of stated income piggyback loans
Elimination of high loan-to-value loans to alt-a and subprime credit borrowers
Toss that in with the pay raise needed to get the same loan and you can quickly see that the pool of potential borrowers for these jumbo loans is being sliced down to the quick.
It’s simple economics after that.
With fewer qualified borrowers sales will stagnate at prices that fall far-outside the conforming loan limits. Buying will be contained to the very qualified few; and they will be picky. Excess supply will push down prices to a level where more people can afford them - naturally this points us to loan sizes under conforming limits. Loan sizes at conforming limits will only support prices up to those amounts.
Will this be what pushes housing off the precipice?
If people can only afford homes priced at conforming loan limits and more and more homeowners are forced out of their homes due to exploding mortgage payments the excess supply will only begin to move at levels that stimulate buying activity - which will clearly reside under conforming loan limits. If this scenario plays out we’ll be looking at massive 30%-plus price declines to bring supply in-line with demand. Perhaps more.
Is the above scenario likely?
While it is probable I believe real losses will be mitigated to one degree or another for the following reasons:
There is major pressure on Fannie and Freddie to increase loan limits and expand underwriting - both moves would alleviate some of this price pressure.
Banks will continue to innovate - there is still a ton of global liquidity and it has to go somewhere. If banks can figure out a way to make the risk a) attractive to investors and b) affordable to homeowners those product innovations will soften the blow.
Federal/state bailout - While I’m not for one, it seems likely that the government will do something. Even if it is just Hillary Clinton’s waiving of prepayment penalties; something will be done through the government to mitigate some of (not all!) the losses ahead for the market.
However, with ARM resets rolling in to a credit desert it is easy to see how those caught up in the exuberance of the housing market will be stuck with no option but to take a loss. The question is how big a loss can they afford to take, and how many homes will be returned back to the bank in the process?
How do you think the repricing of risk will affect the California (and other high-priced) home market?
blownmortgage.com/2007/08/08/higher-rates-elimination-of-products-spell-home-price-decline/
Published at August 8, 2007
Wells Fargo recently raised rates on its jumbo mortgage products from approximately 6.875% to 8%. A jumbo mortgage is one that falls outside of the Fannie Mae/Freddie Mac conforming loan limits (above $417,000 for here in CA). This represents a massive change to the cost of borrowing money. From our friends at the L.A. Land blog (quoting CNN Money):
Wells Fargo, one of the nation’s biggest mortgage lenders, raised the interest rates on it 30-year, fixed-rate, non-conforming (AKA jumbo) loan to 8 percent last week, up from 6.875 percent. Other lenders followed suit and more are likely to join them. … The rate jump means the monthly bill for a $600,000 mortgage would hit $4,403, compared to $3,942 previously, an increase of $461. Jumbos are loans of more than $417,000.
What does that do to qualifying for this mortgage? Well let’s take a look at the qualifying ratios used to approve someone for this loan. Wells requires the back end debt ratio to be at 45% to qualify for this program.
The back end debt ratio compares your major recurring monthly expenses to your gross monthly income. For example if you are getting a new home loan your back end ratio will include your new housing payment, car payments, student or other loan payments, credit card payments, etc. divided by your monthly income. That number must be 45% or less to qualify for the loan.
If we assume 8% of monthly income is used for recurring expenses, at 6.875% a borrower or a family could carry a $600,000 mortgage making $10,750 per month. A hefty salary to be sure, but one that is in reach for many double-income families in California. At 8% the payment becomes $4,403. Now assuming the same 8% expense the borrowers would need to be making almost $12,000 per month to afford the same home. This is a 7.8% increase in monthly income.
That’s asking for a healthy raise at the office.
A family needs to be making over $144,000 per year to afford a $600,000 mortgage. This would limit these mortgages to only the top 15-20% of all Californians (UCLA study, PDF).
Now take the following recent changes in to consideration as well::
Elimination of high loan-to-value stated income products
Elimination of high combined loan-to-value of stated income piggyback loans
Elimination of high loan-to-value loans to alt-a and subprime credit borrowers
Toss that in with the pay raise needed to get the same loan and you can quickly see that the pool of potential borrowers for these jumbo loans is being sliced down to the quick.
It’s simple economics after that.
With fewer qualified borrowers sales will stagnate at prices that fall far-outside the conforming loan limits. Buying will be contained to the very qualified few; and they will be picky. Excess supply will push down prices to a level where more people can afford them - naturally this points us to loan sizes under conforming limits. Loan sizes at conforming limits will only support prices up to those amounts.
Will this be what pushes housing off the precipice?
If people can only afford homes priced at conforming loan limits and more and more homeowners are forced out of their homes due to exploding mortgage payments the excess supply will only begin to move at levels that stimulate buying activity - which will clearly reside under conforming loan limits. If this scenario plays out we’ll be looking at massive 30%-plus price declines to bring supply in-line with demand. Perhaps more.
Is the above scenario likely?
While it is probable I believe real losses will be mitigated to one degree or another for the following reasons:
There is major pressure on Fannie and Freddie to increase loan limits and expand underwriting - both moves would alleviate some of this price pressure.
Banks will continue to innovate - there is still a ton of global liquidity and it has to go somewhere. If banks can figure out a way to make the risk a) attractive to investors and b) affordable to homeowners those product innovations will soften the blow.
Federal/state bailout - While I’m not for one, it seems likely that the government will do something. Even if it is just Hillary Clinton’s waiving of prepayment penalties; something will be done through the government to mitigate some of (not all!) the losses ahead for the market.
However, with ARM resets rolling in to a credit desert it is easy to see how those caught up in the exuberance of the housing market will be stuck with no option but to take a loss. The question is how big a loss can they afford to take, and how many homes will be returned back to the bank in the process?
How do you think the repricing of risk will affect the California (and other high-priced) home market?
blownmortgage.com/2007/08/08/higher-rates-elimination-of-products-spell-home-price-decline/