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HSH.com’s yearly outlook: 10 items for 2016

2015 Outlook

At the start of each year, HSH.com details the important factors we think are most likely to influence the mortgage and real estate markets in the coming year. Halfway through the year we take a look back at our outlook and provide a mid-year update:

No. 1: Mortgage rates will be mostly firmer in 2016

Although the overall trend for mortgage rates is expected to be an upward one for the year as a whole, periods of volatility could see rates drop or limit the uptrend from time to time. Any drops will likely be driven by forces outside of the U.S., but any stumbles in our economy could foster some declines, too.

Overall, mortgage rates are expected to be firmer, here’s why:

  1. The Federal Reserve will continue a campaign of raising short-term interest rates, slowly lifting all mortgage rates, but affecting initial interest rates for ARMs in a more pronounced manner.
  2. Inflation should not be a significant concern, but continuing growth here and perhaps less deflationary drag from energy prices will also allow fixed rates to float upward somewhat.

Rate predictions: From late-2015 through the end of 2016, we anticipate conforming 30-year fixed-rate mortgages to peak at 4.625 percent. This would be comparable with peak 2014 levels, but would mean fixed mortgage rates would be as much as a half percentage point above 2015 highs.

Depending on how aggressive (or not) the Fed begins to move short-term rates as the year progresses, adjustable rate mortgages (ARMs) may or may not move as much, but common 5/1 ARMs might see a peak of 3.625 percent or so.

In conclusion: As we wend along, what the Fed has to say about the path for future policy will determine the steepness of any grade for mortgage rates, but the current expectation is a mild, protracted process for normalizing rates. Absent any significant new global issues, we expect all mortgage rates to be mostly firmer in 2016, especially later in the year.

No. 2: The Fed will raise rates multiple times in 2016

Speaking of the Federal Reserve, it's an open secret that the Fed will continue to raise short-term interest rates in 2016. What's not clear is how many times they will lift the federal funds rate, or by how much at any given interval.

Related content: HSH.com on the latest move by the Federal Reserve

How many times will the Fed move? Futures markets and the Fed's own forecasts suggest three or perhaps four increases in the federal funds rate by the time 2016 comes to a close.

With the first change having taken place in December 2015, it seems likely that the Fed will want to wait a while to assess market reactions to the December change, and so will probably give March's meeting a pass in terms of making any changes. If the economy continues on its present pace, it seems likely that changes will come in July, September and December, which would leave the federal funds rate close to 1 percent at the end of 2016, with corresponding effects on the prime rate.

The Fed may no longer be an active buyer of MBS and Treasuries at some point: After the Fed stopped outright buys of Mortgage-Backed Securities (MBS) and Treasuries back in 2014, it began a “reinvestment” program of using inbound proceeds from maturing instruments to purchase more of the same, keeping its balance sheet level and long-term rates lower than they would otherwise be. While this process has been running, the Fed often noted that they would likely terminate this program once the first change to the federal funds rate took place.

In September, having been briefed by the Fed’s staff, the FOMC discussed leaving the program in place even while raising short term rates, with the presentation noting that there would likely be little economic  effect in doing so “until certain levels of the federal funds rate, such as 1 percent or 2 percent, were reached.” No decision to continue or discontinue at any point was reached, and this reinvestment plan wasn’t discussed at all at the October meeting.

This makes December’s decision to continue the process for a while longer a bit unsurprising, but there is a bit of a vague commitment in terms of how long this will continue. When it raised rates in December, the Fed said “it anticipates doing so until normalization of the level of the federal funds rate is well under way.” 

This could be sometime in 2016. If it happens in the coming year, it would be the first time since late 2008 that the Fed would no longer be an active buyer of Treasury Securities and MBS, removing a reliable and regular buyer from the market. In turn, there would be more supply of these instruments for the market to absorb, and it's not clear if there will be sufficient demand from the market for these instruments, so this may bump up longer-term rates to some degree.

It’s a complicated time for the Fed: The process of lifting short-term interest rates will be more complicated for the Fed than in the past, for while the Fed expects to use the federal funds rate as a policy tool and indicator, it will also need to utilize other tools to manage the flow of funds into the economy, including paying banks interest on excess reserves (IOER) and through the use of an overnight bond repo facility (ON RRP), where the central bank swaps bonds for cash. The Fed has been testing these tools for some time, but it's not exactly clear how they will work collectively in the free and open market. With these new tools being employed, it's likely that markets will be more volatile at times, at least until all parties become comfortable with the new policy tools.

In conclusion: Regardless, interest rates will remain well below "normal" throughout next year.

No. 3: There will still be opportunities to refinance in 2016

Traditional rate-and-term refinancing is largely the cause of refinance booms, and a rising interest rate climate damps this considerably. With rates as low as they have been for such an extended period of time, even a small lift in rates is sufficient to quell refinance activity to a real degree.

That said, there will still be opportunities for homeowners to refinance in 2016.

More cash-out refis: With increasing home equity, we may start to again see some more cash-out refinancing taking place for purposes of debt consolidation or home improvement, as first mortgage rates will offer the lowest possible interest rates and the longest payment terms in the market.

Extending the loan’s term: The re-extension of terms might also play a role in refinancing, too. Here are two examples why:

  1. A loan originated back in 2010 for $200,000 at 4.5 percent could be refinanced in 2016 with the combination of a lower loan balance (about $180,000) and a reset of the remaining term to a new 30 years, driving down the monthly payment by $100 per month.
  2. “Term extension refinances” might also benefit homeowners who refinanced to shorter terms over the last few years but now find themselves needing greater budgetary relief. A 20-year, $200,000 mortgage at 4 percent taken in June of 2012 and refinanced to a new 30-year term at a 4.5 percent rate in June 2016, for example, would see a payment decrease of about 25 percent -- over $300 per month.

ARM refinancing: For the relatively few borrowers with outstanding ARMs, some may consider refinancing to get away from the Fed's protracted process of lifting rates, but that will remain a tough sell. Most ARMs adjusting today feature rates in the low threes, and even if the Fed raises rates a full percent over the next year, that only would push a then-adjusting rate into the low fours. ARM holders today face a bit of a Hobson's choice – preemptively refinance and pay more today to eliminate the risk of potentially paying more at some point tomorrow.  In either situation, a homeowner with an ARM is likely to pay more – it’s just a matter of when, and how much.

In conclusion: While traditional rate-and-term refinances are expected to dwindle in 2016 due to higher mortgage rates, other opportunities, such as cash-out, term extension and product-changing refinances should grow.   

No. 4: Home equity borrowing will continue to increase

Borrowing of home equity will continue on an upward path in 2016.

The Federal Reserve recently estimated that equity in the nation's housing stock has roughly doubled to $12 trillion dollars since home prices bottomed in 2011. Homeowners are taking advantage of this, and tapped about $45 billion of equity in the first half of 2015. That's way up from 2014 levels (a 45 percent gain, according to Inside Mortgage Finance), but still only a fraction of the boom years for equity use (which also included "piggyback" second mortgages in the tally).

Both banks and borrowers remain cautious: Burned in the real estate downturn with sometimes unrecoverable losses and negative equity situations, both lenders and borrowers remain cautious in offering and using home equity.

Bank balance sheets are healthier, but most lenders continue to adhere to very traditional underwriting guidelines, requiring solid credit scores, low debt loads, full appraisals and limiting the loan-to-value ratio to 80 percent in most cases. That said, low interest rates and tax deductibility of interest make a compelling case for consumers interested in using these products to re-cast balance sheets, make home improvements, fund educations and more.

HELOC resets in 2016: In 2016, we will be in the middle of the peak group of years for existing Home Equity Lines of Credit (HELOCs ) to reset from interest-only payments to fully-amortizing ones. So far, resetting HELOCs have caused no crisis, and lenders have been strongly encouraged by regulators to work with borrowers who may be struggling with the change in monthly costs. Banks with sizable legacy portfolios of home equity holdings will probably continue to be reluctant participants in the market, at least for a while longer yet.

Also from the lending side of things, changes in regulations (TRID and others) for closed-end credit in 2015 have made traditional lump-sum home equity loans less desirable, and some have stopped offering them, focusing instead on line-of-credit offerings. HELOCs are considered an open-ended form of credit and are subject to different rules.

As such, for borrowers interested in a fixed-rate product, many (but not all) lenders will allow a borrower to originate a HELOC, borrow funds, then trigger a "fixed rate option," locking in an interest rate and ascribing a fixed repayment term to this debt. As it is paid down, it replenishes the line of credit. Rates and terms for fixed-rate portions are often comparable to what a fixed-rate, lump-sum second lien would have been, so it works out for all parties.

As far as debt consolidation goes, there's a kind of interest rate arbitrage to be had paying off double-digit interest on credit cards with low single-digit rates for home equity lines; whether it’s a good idea to trade unsecured debt for that secured by your home is a discussion for another day.

In conclusion: With home prices expected to still be rising, more homeowners will get the chance to use some of the equity in their homes.  Equity usage remains low compared to the boom years of the mid-2000's, so there remains plenty of upside for growth, and it wouldn't be a surprise to see another sizable double digit increase for 2016.

No. 5: Home prices

It's always hard to get a clear picture of what's happening with home prices. The different available reports (CoreLogic, Case-Shiller, etc.) all seem to measure different things, and they don't really tell you about the value of a given piece of real estate or even a given market, since they can only measure homes which actually sold in a given period.

The problem is that the mix of homes sold in one month is obviously different then the next, and this depends upon what homes come up for sale in the market and other unpredictable factors, so these can be both erratic and provide false signals. That's not a quibble with the analytics themselves, but only to say that it’s hard to know what's happening with any precision.

Existing-home prices: Prices of existing homes haven't been falling, but year-over-year percentage gains have become more muted over the past couple of years. Back in 2013, we often saw double-digit gains; in 2014, we saw a downshift to mid-to-low single digits, but 2015 saw prices perk back up again, averaging a 6.3-percent increase over the first 10 months of the year.

In what is expected to a firmer (if not firming) interest rate climate, this price increase is probably unsustainable. Low mortgage rates allow for prices to rise, as the carry cost of the mortgage remains relatively constant -- that is, a borrower's monthly payment for a $200,000 loan at 4 percent is virtually the same as one for $188,000 at 4.5 percent -- but this means a borrower can afford a home priced about 6 percent less.

Affordability could decline: The combination of higher mortgage costs and larger loan amounts means potential borrowers need higher incomes to qualify; with wage growth still soft, this may make affordability an issue for more marginal borrowers, requiring the accumulation of a larger down payment and more. To the degree that higher costs lessen demand for houses, sellers may not be able to command gains as large as they have over the last couple of years.

In conclusion: With an expectation of a smaller increase in existing home sales in 2016 and the possibility of more inventory coming on line as we go, we think that existing-home prices will probably hold perhaps a 5 percent increase on average for 2016. Although a smaller gain, this will be sufficient to continue to cure the underwater/negative equity situation for more homeowners, albeit at perhaps a slower pace than in recent years. As it always has, it remains a fact that home prices cannot forever outstrip incomes and general inflation, as affordability becomes impinged.

No. 6: Existing home sales down but still up

Housing markets solidified nicely in 2015 and are poised to have another solid year in 2016. When final 2015 data becomes available, we reckon that existing home sales tracked by the National Association of Realtors will have risen by just under 7 percent in 2015 as compared to 2014.

As many headwinds from the last recession remain, it will probably be hard to replicate 2015's percentage gains in 2016. Unlike at other times in the recovery, steadily rising home prices won't likely have falling mortgage rates to offset them, crimping affordability to a degree (a situation more pronounced in some regions than others). As well, sales can only rise if there is enough inventory to meet demand, and inventories of homes for sales have been running at less than optimal levels for the entirety of the recovery.

Demand will still exist: That said, key supports for continued (if lesser) gains are in place. The ongoing improvement in jobs over the last few years is serving to create demand, and the continued paring of debts and improvement in credit strength of potential borrowers continues to get folks in better alignment with modern underwriting standards.

In addition, expansion of the credit box should improve eligibility for at least some additional borrowers. With mortgage rule-making proscribed under Dodd-Frank largely complete, lenders may again be able to turn their efforts to reaching new audiences. This could mean better and cheaper borrowing opportunities for self-employed borrowers, those who are carrying high amounts of debt and other niches.

In conclusion: We might see a 5 percent gain in existing home sales in 2016 over 2015 levels.

No. 7: New home sales to rise

Unlike existing homes, sales of new homes still have plenty of upside to approach normal levels. The current run rate of about 500,000 annualized sales is perhaps less than half what is considered to be a normal level of sales, but builders continue to express caution, building few homes on spec and keeping inventories lean.

In conclusion: This seems likely to continue in 2016, but it would be reasonable to expect perhaps a 10 percent (or slightly more) gain in new-home sales for 2016. 

No. 8: More buyers to see credit?

As time has wended its way since the days of the market meltdown, mortgage opportunities have been hard to come by for borrowers who don't align well with today's firm underwriting standards.

We've seen some gradual changes over the last couple of years:

  • The re-introduction of 3-percent-down mortgages backed by Fannie Mae and Freddie Mac
  • The lowering of FHA mortgage insurance costs
  • Some lenders reducing so-called "overlays" which restrict access for low-credit score buyers and refinancers

We should see more of this kind of thing in 2016, but aside from further reductions in overlays, more pronounced changes may come in the expansion of the non-qualified (non-QM) mortgage sector.

Time to grow the non-QM audience? So far during the recovery and expansion, non-QM lending has been mostly limited to top-shelf borrowers seeking jumbo mortgages, but there a number of audiences who might benefit from loans with interest-only payments, loans with alternative or limited documentation or being able to borrow with high debt-to-income ratios or less-than-perfect credit.

With plenty of new regulations in place from Dodd-Frank and the CFPB, any expansion here is likely to come from outside of traditional banks, but it will more than likely continue to be more of a toe-in-the-water than a jump-headfirst-into-the-pool affair. Expanded offers may come fromREIT-connected firms, or from credit unions lending their own funds, and we may start to see some non-QM mortgage-backed securities start to be put together, which would help to liquefy the market, just as the re-start of jumbo mortgage-backed securities helped the market a few years back.

Opening the credit box to a greater degree is likely to occur in other ways, too. As with last year, there is some pressure building to see reductions in risk-based pricing factors employed by Fannie and Freddie, including items such as the quarter-percentage-point "Adverse Market" fee which has been in place since the early days of the crisis (and applies to all mortgages backed by Fannie or Freddie), and possible reductions in so-called Guarantee Fees (costs incorporated into the rate of a mortgage sold to Fannie or Freddie).

In conclusion: Access to mortgage credit should continue to improve, and may become less costly, too.

No. 9: HAMP and HARP: Last call

HAMP: Important components of the housing recovery are slated to sunset in 2016. The Home Affordable Modification Program (HAMP), a federally-engineered program for borrowers who were having trouble holding onto their homes, will stop accepting borrowers at the end of 2016. When announced, the HAMP had lofty goals of helping millions of borrowers but fell rather short of those goals. Still, for those who engaged the program, it allowed them to keep homes which otherwise would have been lost to foreclosure.

As housing and job markets improved over the last few years, as with the bulk of newly-initiated modifications behind us, the number of new HAMP mods continues to dwindle. As such, it seems likely that the program won’t be extended per se.

 The program of course had its critics, and based upon how many of these modifications  were structured, we may yet have an "echo crisis" for borrowers whose interest rates will gradually rise up to what were prevailing market conditions when the modification took place. Whether those 4 percent to 5.5 percent final rates will prove troublesome for some homeowners remains to be seen, and with sizable percentage of modifications re-defaulting, it wouldn’t surprise us to see new or more emphasis on re-modifications for these continually-troubled homeowners.

In conclusion: All in all, there is little doubt that the program provided important, if not always permanent, breathing room for troubled homeowners, but the benefit to most has run its course.

HARP: The Home Affordable Refinance Program (HARP) is an unqualified success, though. After stumbling out of the gate due to both confusion and restriction, the twice-expanded program hit its stride when LTV caps were lifted and income- and appraisal-documentation requirements were shelved. A virtual no-cost, no doc, no-PMI refinance for a borrower whose home was worth far less than the face value of the mortgage provided not only substantial payment relief but also was a key factor in curing what was expected to be a growing "walk away" problem.

Like HAMP above, the heyday of HARP is fading behind us. In this case, the number of borrowers that haven’t yet refinanced continues to dwindle, and there are relatively few seriously underwater borrowers (for whom the program was designed) taking advantage. Of late, the vast majority of HARP refinances – more than three quarters of them – are loans to people between 80 percent and 105 percent LTV. Many of these people would likely be able to manage a traditional refinance. 

Also, should interest rates firm as expected in 2016, there will be fewer people in general looking to refinance as the differential between existing and new interest rates shrinks.

In conclusion: Having provided a valuable, successful support for many American homeowners, the HARP program will retire at the end of 2016.

No. 10: Debt Forgiveness Act - again

Time is running out for Congress to again extend the Debt Forgiveness Act of 2007 -- or at least to do so with a minimum of stress and paperwork for homeowners.

Currently, any short-sale or principal reduction received by a homeowner in 2015 will soon be treated as regular taxable income, with the amount of tax due based upon the homeowner's tax bracket and the amount forgiven.

This could be an easy fix. It's understandable why the Congress doesn't want to make this a permanent feature of the tax code, but it would be an easy fix to make it apply only to homes being sold that were originally purchased during the last decade's "boom years," the same kind of time-test that defines the HAMP program. Having a time definition in place from the date of the home sale (say, pre-2009) would solve the tax liability issue for a given homeowner, even if the value of their home doesn’t recover for many years yet to come.

The underwater/principal forgiveness, modification/short sale problem is likely to persist for a while longer yet, too, as RealtyTrac estimates that at the end of the third quarter of 2015, some 12.7 percent of all properties with a mortgage – almost 7 million homes -- are still seriously underwater (defined as a situation where the mortgage amount is 25 percent higher than the current value of the property).  That said, the number of homes with this issue may be less, as CoreLogic estimates that only about 8.1 percent (about 4.1 million) of homes with a mortgage were still underwater by the end of September 2015, and falling.  Choose your measurement, but the reality is that there are millions still affected by this problem.

Things likely to get messy. Congress can certainly change these tax rules at any time, but waiting until filings for the 2015 tax year expire on April 15, 2016 -- or even to late January, when people begin receiving their W-2s and 1099s and start to file for the year -- would make a mess of things. For one, folks subject to the levy on this "income" would need to send it in when they file, or request extensions; should Congress subsequently make this retroactive, those "overpayments" of tax liability would probably take additional filings and months to sort out and return the funds. Even needing to come up with this cash in the first place might imperil already strapped homeowners.

Limiting for-sale inventory. It's also very possible that the lack of a law in place is serving to keep at least some folks trapped in homes they would rather sell. With the taxman's axe hanging over their head, homeowners wanting to sell can price their home no less than what they owe on the mortgage (or a difference between selling price and amount owed of what they can reasonably cover out of pocket). This would tend to keep these lower priced homes off the market and make it especially hard for first-time homebuyers to get a shot at them.

Limiting modifications. Finally, it's also likely that this is a deterrent to a homeowner accepting a principal reduction in a loan modification situation, since the "savings" from a lower balance (and other changes) won't be quite as beneficial if it comes with a huge tax bite. It's also silly to tax these transactions; there is no tax incurred for a modification which utilizes a reduction in interest charges, which can produce thousands of dollars of benefits.

In conclusion: Odds are good that this extension will get pushed though, but at what time is uncertain. Sooner is better than later, and the Act should be extended through 2016 and perhaps even 2017; better yet, add in a time component to homes eligible for the extension and solve the issue once and for all.

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