MID-YEAR UPDATE: HSH.com's 2014 Outlook: Nine factors for '14
Each year, HSH.com details the important factors most likely to influence the mortgage and real estate markets in the coming year. While it seems we have made our way out of the turbulent times that have bounced the market around for the last few years, there is still plenty of uncertainty ahead. Here are nine factors which will affect the markets in 2014:
1. Mortgage rates: Expect 5 percent for fixed-rate mortgages
MID-YEAR UPDATE: So far, mortgage rates have been on a gentle downward slide for the first half of the year, pressed there largely by external forces, but also by a negative U.S. growth rate to start the year. If we are going to see 5 percent handles for fixed-rate mortgages in 2014, we’ll need to see some significant change in the stance of the market in the last half of the year. This would need to show in the form of accelerating economic growth coupled with rising inflation and a growing likelihood of a sooner-than-expected hike in short-term rates by the Fed. There is still time for this outlook to come to pass, but it is becoming increasingly unlikely… and that’s a good thing for homebuyers.
If everything goes as planned (always a long shot; see the 2013 Outlook), there will be good news and bad news for mortgage shoppers in 2014.
JANUARY 2014: The good news is that mortgage rates will remain historically favorable; as we've noted at times, if you leave out the Fed-induced record lows of the past year or so, the previous record low, set in more "normal" market conditions, was a bottom of 5.24 percent set in June 2003. The bad news is that fixed mortgage rates are more likely to tend toward the higher rather than lower end of the scale in 2014.
Several factors will conspire to firm fixed rate mortgages somewhat in 2014:
Obviously, the first is the Federal Reserve slipping out of the direct-mortgage-support-market business, which should firm mortgage rates somewhat. As the Fed does this, the more typical market-moving forces of economic growth and inflation will become the drivers of rates, and there are some reasons to believe that economic growth will be reliably stronger in 2014 than it was in 2013, which would add to the firmness in mortgage rates. Inflation is not a concern at present but is never far from the minds of investors, and a growing economy may see some thoughts turned that way.
Adjustable-rate mortgages (ARMs) are a different story, though. Even with Quantitative Easing tapering and completion likely at some point in 2014, the Fed will take pains to continue to remind the markets that short-term interest rates will remain exceptionally low for the foreseeable future. These are the rates which govern and influence ARM pricing, and while these rates will of course move up and downward through the year, the already considerable gap between fixed and ARM rates may widen, making these mortgage products even more attractive for certain borrowers.
Mortgage-rate forecasting is a tricky business, even over the short term, let alone a whole year. That said, we're always willing to give it a shot, even if the range for rates is necessarily wide:
- Conforming 30-year fixed-rate mortgages (and jumbos, too, if the below item comes to pass): It's reasonable to expect 4.375 percent to 5.625 percent borders in place for 2014
- 5/1 Hybrid ARMs: Call it a 2.875 percent to 3.875 percent range
As a side note, and since the Guarantee Fees that Fannie and Freddie charge to lenders to protect them from loss will be rising again in 2014, it is likely that we may begin to see fixed-rate jumbos priced below their conforming counterparts on a more regular basis at times during 2014. While this "inversion" existed at times in 2013, it was not a market-wide phenomenon, but rather limited to certain lenders. More expensive conforming loans and spirited competition for jumbo buyers may promote this inversion on a more widespread basis.
2. Real estate: Markets and prices stabilizing
MID-YEAR UPDATE: The original summary of the real estate market seems to be on track at midyear. Sales of existing homes in December 2013 were running at a 4.87 million annual rate; this dipped to about a 4.59 million rate but has again been moving upward, landing at a present (May) 4.89 million annualized level. Meanwhile, the National Association of Realtors noted that inventory levels have moved up from a thin 4.6 months in December to a closer-to-normal 5.6 months in May, and price gains – running at a 9.1 percent year-over-year clip in December – have cooled to just a 5.1 percent rate of gain in both April and May. Sales of new homes have been more erratic, but have also moved upward in recent months and the latest report puts them at better than six-year highs. Prices here have been back and forth, and inventories have been closer to normal, too, excepting the unexpected drawdown of stockpiles in May. The housing market continues to grind toward recovery.
JANUARY 2014: One of the hallmarks of 2013 was the return of a competitive real estate market. Demand was driven by low mortgage rates and low home prices, a firmer job market and perhaps a sense of opportunism by investors. However, that demand was not really met by supply, driving up home prices; at the same time, mortgage rates rose, driving up costs.
Outsized gains in home prices in 2013 were no doubt sparked by record or near-record low mortgage rates. Those have left the market, probably never to return. In their place are roughly multi-year highs for rates, making it less likely that the run of double-digit increases in home values can continue in 2014. Although there's no reason to expect mortgage rates to perpetually march higher in 2014, it is reasonable to expect that they will be somewhat higher than 2013, especially if the economy continues to find traction.
At other times when home prices have risen so quickly as to outstrip incomes, and often at times when mortgage rates have risen, we have seen the emergence of so-called “affordability” products designed to give borrowers greater leverage so that they can afford these pricier homes. Such products have allowed for low or no down payment, interest-only payments, high debt-to-income ratios and other constructs. These allowed potential buyers to further leverage their incomes or their assets; in turn, this helped allow prices to continue to rise as it helps to put more potential borrowers in the market, or allowed those in the market to stretch their budgets further.
With the new QM regulation in place for 2014, a re-emergence of these products is unlikely to happen. QM doesn’t specifically ban things such as interest-only payments, but these products won’t qualify for protection against borrower lawsuits, so it’s less likely that lenders will be lining up to make these kinds of loans available. Should fixed-rate mortgages continue to firm in 2014, perhaps the only “alternative” mortgage product available to allow some budget-stretching will come in the form of ARMs; those will have lower rates, allowing for more leverage by borrowers, but will still be subject to the same stiff underwriting standards as are fixed rates.
In the absence of new “affordability” products, and in light of rising fixed rates (and a general distaste for ARMs, no matter how valuable they can be), it is not likely that home prices can continue to rise at the pace of 2013. Both home price and interest rates can only rise together for so long until affordability is impacted, and without the additional leverage afforded by alternative products, each leg up means fewer potential buyers can participate.
Two other factors which are affecting home prices are in play, too:
- Tight supplies of both existing and new homes have engendered higher prices; however, those higher prices may begin to lure some sellers back into the market as they will have recovered a portion (perhaps most or even all) of the equity lost in the downturn.
- As such, inventories of available homes may rise, helping to temper price increases, and that's without necessarily considering properties coming on the market from lender's books.
Overall, we expect the recovery in housing markets to persist in 2014, but in a context of flattening gains for home prices, higher inventory levels and firm mortgage rates and underwriting standards.
3. Fed taper: Stimulus is going, going... gone
MID-YEAR UPDATE: The Fed’s QE program – which was purchasing Treasuries and MBS at a full $85 billion per month when we first wrote this outlook at the start of 2014 – has been pared down to just $35 billion, and continues to be trimmed by $10 billion at each Fed meeting. At the present pace, the program will be concluded at the October 28-29 meeting. With a huge decline in loan originations in 2013 through 2014, there have been fewer MBS for the Fed to buy (as noted above), so even with reduced buying the Fed’s influence is still being felt in the market. Meanwhile, private investors have discovered some appetite for these high-quality offers (and always have one for Treasuries) so mortgage and other interest rates have been little affected by the Fed’s diminishing influence.
JANUARY 2014: As we write this the Fed has begun the process of tapering purchases of Treasuries and MBS. Now started, it is a certainty that they will continue the process in 2014 and may completely halt QE purchases altogether by mid-year. Of course, the economy will need to perform well (which is never a certainty) but an economy growing even modestly does not require the kind of emergency-level (and extraordinary) support the Fed has provided.
The QE program has currently been reduced to a $75 billion per month run rate, with reductions in purchases of both Treasuries (-$5 billion) and MBS (-$5 billion). If the economy cooperates, other steps could accompany the first four Fed meetings in 2014 (Jan. 28-29; March 18-19, April 29-30, June 17-18) in reductions of equal size. However, the process could be a little more protracted than that, perhaps running through September (two additional meetings).
One reason for the Fed to step out of MBS purchases is plain to see: The number of mortgage originations -- and hence, the number of purchasable MBS -- has been dwindling, what with the slump in refinancing which began in mid-2013. At one point, the Fed was "only" buying perhaps 1/3 of new GSE MBS production (or less), but as recently as November, the Fed's purchases of MBS represented more than half of the market. The Fed wants to reduce its influence; however, their fixed-dollar commitment to buy these assets (rather than simply some flexible percentage of the market) means that as loan volume slips the Fed's share grows. Although the Fed may leave this space, there should be an appetite for these high-quality securities, just as there was when volumes were higher, so the impact on rates should be limited.
It's also clear that the Fed's buys are having less influence, too. After running up by 120 basis point from 2013 lows in May, fixed mortgage rates have struggled to decline much in spite of the Fed's influence, and remain about a full percentage point above bottom.
4. Fannie, Freddie reform: Nope. Well, maybe. Or sort of.
MID-YEAR UPDATE: Although a reform bill pushed by Senators Tim Johnson and Mike Crapo got some serious consideration earlier this year, the realities of reforming the GSEs in an election year has at the very least been put on the back burner for the remainder of 2014. So far, the Johnson/Crapo bill has made it further along in consideration than any other idea, but with Fannie and Freddie technically solvent and kicking billions into government coffers, it may be that we never get to a place of reform.
Mel Watt, the new head of the FHFA, has made it pretty clear that he is interested in operating Fannie and Freddie to the concept of the conservatorship, namely running them for as long as they exists and leaving any reform up to Congress. His first action upon taking office was to delay indefinitely the slated increases in both Guarantee Fees and Loan Level Pricing Adjustments (LLPAs), so mortgage costs have not increased to borrowers, at least for the moment. There is some whispering that these LLPAs may actually be reduced or modified at some point this year.
JANUARY 2014: Through record profits and a mandatory commitment to send all of them to the Treasury, Fannie Mae and Freddie Mac have "repaid" all of the $187.5 billion dollars they "borrowed" to be kept afloat as the housing and financial crisis unfolded.
However, as the firms are not technically allowed to pay off the debts, they cannot free themselves from the shackles of conservatorship and return to the markets unfettered and free. Instead, they remain wards of the state, at least until Congress makes a decision as to how exactly to reform or eliminate them. Given the dysfunction in Congress, this seems unlikely in 2014, but that doesn't mean that there won't be any changes, such as a new director to the Federal Housing Finance Agency, the overseer of Fannie and Freddie.
FHFA head Ed DeMarco has done an excellent job in promoting the solvency of Fannie and Freddie, and even has made good progress in creating a common securitization platform, a key step toward either consolidating the GSEs into a single entity (or perhaps a precursor of a new entity yet to be designed). Will that happen in 2014? Probably not.
The explanation is a bit roundabout, but record profits at Fannie and Freddie have come from stronger values for loans with tight underwriting standards and declining losses on legacy holdings. With the $187 billion bailout "repaid," the GSEs are now kicking in billions of dollars to the Treasury each quarter. These are dollars that the Congress would like to have to spend, and full-blown reform might disturb this free flow of spendable cash. Given the FHA’s shaky fiscal situation, perhaps those funds should be earmarked to support the flagging FHA insurance pool, instead.
In 2014 we will see a new head of the FHFA, perhaps one less committed to full-blown reform of the GSEs and the concept of protecting the taxpayer from loss. It could very well be that Mr. Watt may convince Congress to allow the enterprises to commit some (or all) of these funds toward affordable housing goals, toward principal reductions for still-underwater borrowers, expanded HARP refinance offers or other such measures. None would likely be possible if reform of the enterprises was imminent.
From where we stand, we prefer to see any profits used to lower the considerable "risk premiums" now added into each and every mortgage price. These come in the form of "adverse market delivery fees" (only remaining in four markets after April 1), "loan level price adjustments” (LLPA) and "guarantee fees," all of which are passed onto the consumer.
LLPAs are slated to increase, and fairly sharply, for many borrowers in April 2014. Reductions in these add-ons would help to make loans somewhat more affordable for all comers, not just some.
5.Regulations: Revenge of Dodd-Frank
MID-YEAR UPDATE: We’re about six months into the era of the new rules and documentation, and so far, it’s been pretty smooth sailing. Worries that the implementation of the new regulations and documentation would constrict credit or slow down the process of getting loans through have not come to pass, and the market seems to be managing these items comfortably. That said, it would appear that we won’t see a minimum down payment requirement as part of the QM definition, but regulators still haven’t agreed on this. If they do, there will probably be trigger provisions to review or adapt the regulation at regular intervals if risks appear to be rising.
JANUARY 2014: ATR. QM. QRM. CFPB. FHFA. GFE? TIL? HUD-1? IYIYI! Consumers who haven't been paying attention to all things mortgage over the last couple of years (and most don’t until they are close to starting a transaction) will find some new acronyms to learn in 2014 and some changes to the game.
The new "Ability to Repay" (ATR) rule, which puts the onus upon lenders to make sure you can cover your monthly mortgage payments by considering all of your incomes and outgoes, kicks in Jan. 14, 2014. Expect somewhat more scrutiny to occur under the microscope of mortgage lending, as lenders will likely be quite exacting under the new rules (not that they aren't already).
This is all falling under new definitions of what constitutes a Qualified Mortgage (QM) or a Qualified Residential Mortgage (QRM). Aside from meeting ATR rules, QM and QRM have other characteristics that lenders must adhere to (including a 43 percent Debt to Income [DTI] cap). Under QM/QRM, if a loan meets all of the provisions, lenders will have some shelter against future lawsuits from borrowers. If not, or if it can be proven that the lender failed to properly assess/enforce the ATR rule, it becomes easier for consumer to sue them (and for investors to push failed loans back to them), something no lender wants to happen.
Non-QM/QRM loans will also require securitizers to hold back a 5 percent position (risk retention), essentially in cash holdings. That will no doubt make industry participants wary, and arguably, non-compliant mortgages more costly and scarce.
As lenders become more accustomed to the new rules, the process may smooth out somewhat, but getting a mortgage will likely be an even less comfortable arrangement in at least the early part of 2014.
While the new acronyms above join the mortgage lexicon, two are arguably leaving, including the GFE (Good Faith Estimate of Closing Costs), which is being replaced by a new "Loan Estimate" form, while the old Truth-in-Lending (TIL) form disappears, too, having been incorporated into the new upfront document. On the other end of the mortgage process, a new "Closing Disclosure" form will supplant the venerable HUD-1 closing statement.
6. Growing the audience: Return of "near prime"?
MID-YEAR UPDATE: Several players have re-entered or expanded their operations in the subprime space in 2014. The New York Times even had a June 28 article in the business section entitled “In Home Loans, Subprime Fades as a Dirty Word.” While not yet mainstream by any means, this is a natural progression of the market at work: Plenty of borrowers looking for money, lenders looking to find underserved, profitable markets, regulators warily eyeing these riskier loans and plenty of politicians hoping that private capital will return to the mortgage market, lessening the mortgage market’s still-huge dependence on government backing to function.
The new subprime loans aren’t easy to come by, require very deep equity stakes and carry interest rates of perhaps double or even triple what the “prime” marketed can obtain – but access to money at all is the primary consideration here, with the price of that access a secondary concern.
JANUARY 2014: We've come through a period of time where borrowers have needed fairly pristine credentials to get access to the mortgage market, or at least access to the best possible mortgage rates. However, that's a finite pool of potential borrowers, and a lot of them were homeowners. With refinancing falling back to more typical levels, there will be a lot of hungry mortgage lenders and investors scouring the market for business.
With an eye toward the QM/QRM rules (and the disturbance they will no doubt cause in at least the early part of 2014), we think there is a good chance that some lenders will venture out into some untapped territory to find new borrowers as the year progresses. We know that in 2013 a couple of "wildcatters" began to again offer subprime mortgages under certain (and still rigid) conditions, but there is an audience for mortgages that won't meet the QM/QRM definitions. These include folks with high-debt loads, those who need (or desire) interest-only payments, those with temporary black marks on their credit due to job losses, seasonal income streams and others. Provided that serving this audience doesn't become the start of a new "race to the bottom," it would represent another step in getting private money back into the mortgage market in 2014.
7. Lawsuits: Are we done yet?
MID-YEAR UPDATE: “Are we done yet?” Nope, and probably not even close. BofA may be hit with a new lawsuit over MBS which could carry up to a $12 billion price tag; smaller banks such as SunTrust just settled for close to $1 billion, the FHA is suing Wells Fargo, Ocwen (a larger servicer) was slapped with levies, Citibank may face a lawsuit over mortgage activity, and the list goes on and on. At some point all this will come to a close, but it may be years yet.
It bears noting that fines, fees, levies and settlements could total $100 billion or more, a truly astounding number. If paid directly to homeowners, this could have paid off 500,000 mortgages of $200,000; could have cured the average first mortgage underwater position of $52,000 (Corelogic; 1Q2014 data) for nearly two million mortgage holders – about one third of all currently underwater homeowners. These vast sums of money may be changing hands, but the likelihood of meaningful amounts making its way to actual homeowners remains slim.
JANUARY 2014: If we hope to see the "private" mortgage market grow in 2014 to expand opportunities for more borrowers, we'll need to see a diminishment in the number of lawsuits being filed by various "aggrieved groups."
In 2013, we saw tens of billions of dollars extracted from banks and other entities as compensation for actual or perceived wrongdoings during the boom years. Prior years included mass settlements for mortgage servicing wrongs and shoddy foreclosure practices, but the reality is that many (if not most) of those funds never reach the actual injured party -- homeowners and former homeowners. These lawsuits were supposed to provide compensation to folks who lost their homes or were otherwise treated badly by an ill-managed process, but many states used these windfalls not to help homeowners, but to plug holes in budgets or for other needs.
Every billion extracted from a bank needs to come from somewhere or someone. Those someones are shareholders and especially depositors and account holders who pay higher and more varied fees for services and such. The "fear of future loss" due to these things necessarily sees lenders keeping standards tight, since lenders need to make higher profits on the loans they do make to help offset the cost of payments. While it is certainly right and proper to compensate an injured party, the reality is that this really isn't what's happening, and all we may be doing at this point is driving up costs and limiting access to credit.
8. Loan modifications: First "step" to kick in for some
MID-YEAR UPDATE: You heard it here first… and almost nowhere else. The process of interest rate increases for some borrowers did get a little play, especially after the Special Investigator for the Troubled Asset Relief Program (SIGTARP) issued a report in January noting that about 90 percent of the 900,000 borrowers with HAMP modifications would see rate increase from 2014 to about 2021. For borrowers whose rates were moved down to the lowest allowable levels, their first increase from a 2 percent to a 3 percent rate will happen before the year is out, and lots of others will move from 3 percent to 4 percent, and 4 percent to 5 percent (most of these step-ups in rates will cap in the low-to-mid 5 percent range). The SIGTARP report notes that when the process completes, the median increase in monthly payment will be $200, but some extreme cases could see a payment jump by up to $1,724 per month.
The process is just underway, so expect to see more headlines on the topic as we go… and get ready for the concept of re-modifying modified mortgages at some point, especially if the economy founders.
JANUARY 2014: Looking back, 2009 was a long time ago in the mortgage world. In the midst of the crisis of loan failures came the Home Affordable Modification Program (HAMP), but it was beset by mass confusion on both the part of servicers and frantic homeowners looking for help.
Most important at the time was getting homeowners into "sustainable homeownership," promoted by making changes to loan terms, all with a goal of getting a borrower's mortgage debt-to-income ratio down to 31 percent of their monthly gross income. Lenders were encouraged to use methods such as interest rate breaks and lengthening loan terms out to 40 years to achieve this goal. (Interestingly, the new QM rules do not allow Fannie and Freddie to purchase loans with terms longer than 30 years.)
HAMP regulations called for a standard modification "waterfall," where the first rule of order to promote affordability called for a reduction in the interest rate to whatever would produce a 31 percent ratio. For some borrowers, this could have resulted in an interest rate as low as 2 percent. However, given the nature of these modifications, there could be an issue beginning in 2014 for some of the 587,000 homeowners who received a modification in 2009.
If the borrower’s modified interest rate was lowered below a market “reference rate” (called the “Interest Rate Cap” in the standard waterfall guidelines issued in 2009), the modified loan would allow for a step up in interest rate of as much as a full percentage point beginning five years after the date of the modification.
This market reference rate is the average interest rate for 30-year fixed-rate mortgages as reported by Freddie Mac in its weekly Primary Mortgage Market Survey (PMMS), rounded to the nearest one-eighth of one percent, which was reported as of the date the modification agreement was prepared.
In 2009, the rounded to nearest one-eighth PMMS rate ranged from a low of 4.75 percent to a high of 5.625 percent.
It's a fair bet that at least some frantic borrowers in dire fiscal straits missed these clauses about future interest rate changes, and also the one that allows for a continuing 1 percent step upward in the rate each year after that until the loan reaches the "reference rate" in place at the time of their loan mod. As such, some homeowners are going to find an unpleasant surprise in their mailbox at some point in 2014 in the form of a notice that details a rise in mortgage costs. For some, it could be the “gift” that keeps on giving, too... a borrower with loan reduced to a 2 percent rate in 2009 could see a one percent rise in interest rate in 2014, 2015, 2016, 2017 and possibly 2018, too.
9. Wondering about refinancing activity? Don’t bother.
MID-YEAR UPDATE: Refinance activity was in decline when we rote the 2014 Outlook in December, and it’s safe to say that it’s a non-factor in the market despite falling mortgage rates for much of the first half of the year. Refinance activity, as reported by the Mortgage Bankers Association of America, is presently running at levels last seen in late 2008 – when interest rates were in the low-to-mid 5 percent range. Since it’s an election year, it’s not out of the realm of possibility that we could see the HARP program opened up to try to include even more borrowers, but that might be the only way refinance activity gets a kick.
JANUARY 2014: Unless we get some form of HARP 3.0, refinance activity will remain very low. With mortgage rates already off rock bottom and many borrowers already having braved the mortgage refinancing gantlet, there is virtually no rate-and-term refinance audience left, excepting folks trading old higher-rate long-term mortgages for new shorter-term (and lower rate ones) if they can.
Tight underwriting standards that require deep equity positions mean another year of no-cash-out refinance activity to speak of, either. However, with the Fed committed to keeping short-term interest rate low throughout the year, we might see some additional fixed-rate-to-ARM refinancing, as this may be the only avenue to find interest rate relief.
A 25-year expert observer of the mortgage and consumer debt markets, Keith Gumbinger has been cited in thousands of articles covering a wide range of consumer finance and economic topics in outlets ranging from the Wall Street Journal to the Bottom Line newsletters. He has been a featured guest on national broadcasts for CNN, CNBC, ABC, CBS and NBC television networks and has been heard on NPR and other national and local radio programs. Keith is the primary researcher and writer for HSH.com's MarketTrends newsletter and has authored or co-authored a number of consumer guides on mortgages, home equity, refinancing and more.
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