The Ten Most Important Factors for 2010's Mortgage Market
1. A Changing Regulatory Environment. RESPA changes begin in January, and shopping for a mortgage should become more precise.
The Real Estate Settlement Procedures Act, which has been with us for a very long time, is finally getting an overhaul. Of particular important to consumers, new Good Faith Estimate of Closing Costs (GFE) requirements kick in. Provided within three days of a loan application, the GFE is intended to give a borrower a sense of some of the costs of obtaining a mortgage loan.
For the first time, HUD has provided a standardized form for lenders to fill out so that borrowers can easily compare loan terms. Previously, they could use any form they wanted provided it contained all the required information. However, the differences in documentation and vague terminology used made direct comparisons from lender to lender difficult, if not impossible, leading to needless borrower confusion.
Not only will the new GFE will be a standard document, but for the first time it will put some limits on how much difference there can be between the Estimate of fees and their final total (usually not revealed until closing on the required HUD-1 form). Several studies found considerable difference between the fees quoted up front and their ultimate cost, and the new requirement sets a limit of not more than a 10% differential.
It's worth noting that the costs to lenders of complying with the new regulations are considerable: software must be changed, new documents printed, originators trained. While fees will be better disclosed, expect them to be somewhat higher as a result.
Mid-year Update: The new GFE is in place, but this will be just the first of many reforms to the mortgage documentation process. We have heard some complaints that the new forms still fail to adequately reveal key information to the borrower, but we can't say we've heard any complaints from borrowers about the new docs. Time will tell whether it's more or less confusing.
As noted, more documentation changes will be forthcoming. Once the new consumer agency is created (see below) there are mandates for them to create a new, consolidated set of documents which satisfy both Truth-in-Lending (TIL) and Real Estate Settlement Procedure Act (RESPA) requirements. We'd like to wish the new bureau good luck with that. Documentation reform has been studied on a number of occasions, including an exhaustive one not more than a few years ago, but implementation rarely goes as planned.
2. A Consumer Finance Protection Agency is coming. Still in the formative stages, the CFPA will likely be the regulator for consumer-finance oriented things, from credit cards to furniture loans to mortgages. New rules, regulations, disclosure requirements and more are certain to follow. These may bring greater safeguards to the market, but may also serve to limit innovation and product choice. And, as with the new-and-improved RESPA, it may ultimately trim the availability of certain kinds of loans and drive up the cost of others. Depending upon the form it takes, investors may embrace the changes or be spooked by them, but any changes will inject uncertainty into long-understood and modeled processes. As uncertainty equals risk, and risk equals higher costs, it's hard to expect that rates would be lower as a result of rule changes.
Mid-year Update: There's been a lot of wrangling since the beginning of the year, but the coming financial markets reform law will establish a new bureau within the Federal Reserve to manage Consumer Protection. While not a separate, stand-alone agency, the new body will have sweeping powers to enact new regulations for virtually all forms of consumer credit. Auto financing though car dealers, however, won an exemption from new regulation after intense industry lobbying.
Once underway, we will probably be looking at years of regulatory uncertainty as studies are conducted and new rules are ironed out. While there is no doubt that new and better rules may serve consumers well, we must point out that even well-intentioned changes, such as those in the CARD act, can seriously limit the availability of credit and raise its costs.
3. Federal Mortgage and Housing Support Programs Will End. The Federal Reserve's program of purchasing a total of $1.25 trillion of mortgage-backed securities will come to an end on March 31. By HSH's reckoning, the Fed's involvement in the market means that conforming fixed-rate mortgages are perhaps 75 basis points (0.75%) below where they would be absent the program. This means that we expect interest rates to rise somewhat when the program expires. How much they rise will depend on whether or not private investors will want to buy these investments, and how strong that demand will be is quite unclear at this time. It's best to plan for at least some increases in interest rates as the end of the program approaches and for some period after March 31, with perhaps as much as a half-point rise to start.
Mid-year Update: The Fed's program did expire on schedule. However, in the weeks leading up to the March conclusion, we had ample opportunity to re-consider its effect on the mortgage markets. Before the Fed program expired, Fannie Mae announced that they would purchase up to $200 billion in failing loans from investors, a program which could provide additional support for mortgage rates. We noted as much in the March 8 edition of our Two-Month Forecast, in which we said that "the re-purchase of up to $200B of bad loans from investors should produce... fresh private demand for securities, which will help to offset the [loss of the] Fed's influence in the market."
Mortgage rates did rise a bit in the aftermath of the Fed's program, about a quarter percentage point. Thereafter, mortgage rates have largely declined, first slightly due to disappointing economic growth, then steeply to the euro-zone debt crisis. Of late, we have seen some residual easing as the economic recovery displays little upward momentum, keeping both inflation and any Fed policy change at bay for the foreseeable future.
4. Home-Buying Tax Incentives will expire in April. As the initial expiry of the "first-time" homebuyer credit came closer, there was a flare in homebuying activity, and of course an associated increase in the demand for mortgage credit. That seemed to give us a minor rise in mortgage rates of perhaps an eighth-percentage point, which vanished when the program ended (it has since been revived). If there is a rush to take advantage of the credit in February and March, this increase in demand may push mortgage rates up to some extent as well.
Mid-year Update: The extended tax credit offering did expire in April, but there is growing evidence that the housing market's natural ability to recover has been severely distorted by the off-again, on-again nature of the credit. A rush of deals in March -- but especially in April -- has left lenders scrambling to complete them by the June 30 deadline, and a recent attempt to extend the settlement date for transactions failed.
Rates were pretty stable in February, dipped in early March and the "demand effect" on rates expected above didn't seem to materialize, overwhelmed as it was by broader economic issues.
5. Fannie Mae and Freddie Mac will change. While no proposals have yet been released, an outline of some sort is due from the Obama administration early in 2010, perhaps sometime in the first quarter. Whatever new form the GSEs take, or whatever new entities are formed, there will probably be at least some disruption to the flow of mortgage credit at times in 2010 as investors try to become accustomed to these market changes.
Mid-year Update: Kicked down the road until at least 2011 (and possibly beyond). Even the coming Financial Reform law fails to even consider changes to Fannie and Freddie, despite the fact they continue to bleed billions of taxpayer dollars. While the GSEs continue to provide very important housing market support (and receive great political consideration in return), it bears noting that keeping them alive in their current incarnation may be preventing clear and vital evaluation of how secondary markets will need to function in the future. With no planning or even discussion until sometime next year, any serious change to secondary mortgage markets is probably years away. By then, it's not out of the realm of possibility that Fannie and Freddie may have recovered, be starting to pay back some of the funds they've consumed, and may start to again be the cash-producing and lobbying machines they once were.
6. The Economy Should Improve. As measured by Gross Domestic Product, the economy turned the corner in 2009 and should remain on the positive side of the ledger in 2010. We expect growth to be quite restrained, but any sustained improvement will probably cause at least some firmness to interest rates as the economy's appetite for credit increases.
Mid-year Update: When we wrote the above, we did not yet even have a first estimate of GDP growth for the fourth quarter of 2009, which turned out to have a 5.6% rate of growth. Unfortunately, we've downshifted a bit from there, with the estimate of first quarter GDP growth first estimated at 3.2%, then 3.0%, before landing at 2.7%. It is clear that there is little upward momentum in growth, but as noted above, we are still holding to the positive side of the ledger. Still, real and continuing improvement is being challenged by overseas troubles and corresponding austerity measures, and domestically by an inventory rebuilding cycle which needs to be replaced before long by a consumer-driven rebound. With labor markets uneasy, housing markets unsteady and consumer confidence at low levels, it may be hard for growth to gain speed very quickly, even when the expected production-to-consumer handoff occurs.
That said, inflation should be no great concern. During the downturn, we avoided outright deflation, and prices are again firming. Still, there will likely be periods where inflation concerns (rather than actual inflation) will move market interest rates upwards, as was the case in late Spring 2009. Overall, the world remains awash in excess liquidity, thanks to central bank programs enacted during the market panic and subsequent recession, and new asset bubbles are forming or have formed in various places around the globe. Removing that liquidity will be a challenge for the Federal Reserve and other central bankers, as leaving it in place for too long will risk igniting inflation beyond 2010. We expect at least some movement for short-term interest rates during the year, possibly by mid-year. It's worth noting that a Federal Funds Rate below even as "high" as 1% would still qualify as extraordinarily low.
Mid-year Update: While inflation can never be said to be truly dead, it is at least sleeping for the moment. Increases in production have led to some price increases (from very low levels) for raw materials, but price pressures at the consumer level remain quite muted, with even seasonal gasoline cost increases kept at bay by weak economic growth.
7. Lending Standards May Start to Ease. After several years of continual and often abrupt tightening, improving bank balance sheets should start to allow some loosening around the fringes of consumer and mortgage lending. What form this takes will depend upon what happens to jobs and home prices, as these considerations increase the risk of borrower default. If banks continue to rebuild their balance sheets, and if losses on existing loans become not only more clear but also more manageable, we think that certain requirements, such as the size of a pricing add-on for a credit score/loan-to-value bucket or other terms may be eased somewhat.
Mid-year Update: The last Senior Loan Officer opinion survey from the Federal Reserve found that the tightening cycle for mortgage loans seems to have come to an end, a crucial step before strict lending standards start to ease.
"Most banks reported essentially no change in their standards" noted the Fed, but since most mortgages are being sold to Fannie/Freddie or are backed by the FHA, that's not much of a surprise. However, for loans whose standards individual lenders directly control, there was improving news: "The April survey results included the first net easing of standards on home equity lines of credit since [...] January 2008."
While too soon to judge the entire year, and while noting that Fannie and Freddie have made no changes to loosen underwriting standards, there are encouraging signs. Aside from the HELOCs above, these improvements can perhaps best be seen in the pricing of private-market jumbos. In this market, and with almost no private secondary market to speak of, average rates for jumbo mortgages have more or less steadily declined and are near all-time lows. As the rust continues to fall off portfolio lending machines, and as lenders search for profitable lending opportunities where they retain full underwriting control, we will most likely see any additional easing of standards first appear in loans made to the "best of the best" borrowers and those with deep equity positions.
8. Mortgage Rates Should Remain Favorable. During 2010, the mortgage market will transition from almost-fully-government supported to one again driven by the private market to a much greater degree. As markets return to "normal", so too will mortgage rates, which should still remain in a range among to the best seen during the past 50 years. However, barring a double dip to the recession, borrowers should have no expectations that rates will remain at multi-generation lows throughout the year. An unsettled and changing marketplace won't allow for that.
Broadly, we expect interest rates to be lowest in the early part of the year, as support programs remain fully in force, with 30-year fixed-rate mortgages hanging around the 5% mark during the first quarter. After that we'll start the transitional period described above, and for planning purposes, borrowers should expect figures one-half to even a full percentage point higher than this. We do think perhaps a half-point lift is most likely, but we may flare higher than that during the Spring at times. Any rise in rates would be accompanied by a reduced demand for mortgages, which in turn would serve to somewhat temper any upward rise.
Rates for the rest of the year are likely to be more economy- and inflation-dependent. With continued economic healing expected, pressure will build for the Fed to list rates and/or begin to remove supports, and, absent any resumption of these programs, that rates will nudge closer to 6% than 5% for the final two quarters of 2010.
Mid-year Update: We presently have the lowest mortgage rates in some 54 years in the market, far better than what we (or anyone else, for that matter) expected. The Spring lift in rates never materialized due to the conditions noted above, and the late Spring/early Summer slump in housing credit demand, overseas troubles, investor appetite for MBS amid weak supply dynamics and a soft economy are all serving to keep rates low.
Even with that, the year's only half done. From where we are, we still think rates will be higher as the year comes to an end, but perhaps not higher than 5.5% to perhaps 5.625%, with 6% an unlikely target at this moment.
9. Demand for Homes Remains Stable. The firming of home sales in 2009, driven by record low rates and tax incentives, should generally continue in 2010. Presently, we have no expectation for any kind of breakout from present ranges; expiring federal supports for mortgage rates and those tax incentives, coupled with a high unemployment rate and stabilizing home prices, will make it difficult to push sales much higher than present levels. Still, there will continue to be excellent opportunities for well-situated borrowers to get great homes at reasonable prices, and financed with attractive interest rates.
Mid-year Update: Home sales have generally been higher in the first half of 2010 than the first half of 2009, but you'll need to smooth out the distortions. We are considerably above year-ago levels, but what should have been a stable-to-slightly firmer pattern has been replaced by spikes of activity in the rush to get the tax credit noted above. We are on the downside of demand at the moment, with new home sales plummeting to record lows, while existing home sales (the much larger segment of the market) holding mostly firm at last report. June's home sales numbers aren't due for weeks yet but presents conditions and the most recent trends don't seem very promising at the moment. It may be months until the formation of a sizable new pool of potential homebuyers begins to form, and as a result we are probably in for a very slow summer ahead. Of course, the outlook above is for the entire year, and we should still have overall better sales numbers in 2010 than 2009, spiky nature or not.
10. Failing Loans Will Continue to Distort The Market. Pressures from yesterday's failed loans will continue to push inventory into the marketplace. Many loans will fail for the first time (largely now from economic reasons) and there are a fair number which will fail again after unsuccessful loan modifications. A large number of PayOption ARMs will hit their five-year "recast" trigger in 2010. While lower underlying interest rates may help some borrowers survive the payment increase which will come with the change to fully-amortizing payments, many will not be able to manage the considerable leap in payments -- even if their new interest rate climbs only into the 3% range. As a result, investor and lender losses will continue to make mortgage lending a challenge, and the push to modify mortgages will continue unabated. Loan failures put more homes out into the already-crowded market, so bloated inventory levels of cheap existing homes seems likely to continue, keeping demand for new homes quite low. If inventories of unsold homes increase, the nascent stabilization of home prices in some markets could be affected.
Mid-year Update: It goes without saying that the market continues to be completely distorted by failing loans, short-sales and strategic defaults. The weak economy will see the creation of many more such situations, and these (especially short sales) will be a persistent force in the market for years to come if home prices fail to firm. Loan modification efforts continue to fall short, with a majority of "permanent" modifications failing before these loans reach their first anniversary. There is much work to do and a long way to go before homeownership and housing are healthy again, and it may be time to reconsider new options for addressing these problems.
Before long, we'll need to consider incentives -- not penalties -- for homeowners who are making payments on time but are underwater. These folks need refinancing options beyond HARP and possibly principal forgiveness in order to keep them from mailing in the keys -- you know, the kind of help to which only those borrowers who are failing have access.
For further Information, inquiries, or comment: Keith T. Gumbinger, Vice President
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