|Forecast Item||HSH.com expectation||Discussion|
|Mortgage rates||30 FRM peak 5.50%||Mortgage rate outlook|
|Federal funds||2 increases to 3%||The Fed/Monetary Policy|
|Mortgage regulations||Changing... looser?||Mortgage Regulations|
|Fannie/Freddie reform||See you in '20... maybe||Fannie/Freddie/FHFA|
|Underwater mortgages||25% or more reduction||Underwater conclusion?|
|Home equity / Cash-out refi||More... and some||Refinancing & home equity|
|HECM / Reverse Mortgages||A rebound after a soft year||HECM/Reverse Mortgages|
|Home Prices||3.5%-4% national gain||Home price forecast|
|Existing Home Sales||Slightly lower, 5.2 - 5.4 million||Existing home sales|
|New Home Sales||Up slightly to ~650,000||New home sales|
|Additional thoughts||3 random additional thoughts||A few odds and ends|
Mortgage rate outlook
While it was expected that mortgage rates would move up in 2018, they generally moved more than was expected, running a trough-to-peak of almost one full percentage point. In a way, that's good news for 2019, as it means that they likely won't have a whole lot of potential upside. That said, we appear poised to start 2019 with the lowest fixed mortgage rates in several months, thanks to troubles that range from slowing growth in major developed economies, a messy Brexit process, sliding oil prices and rumblings from the Fed that seem to suggest that we are nearing a terminal for interest rate increases.
For 2019, the prospects for higher interest rates still remain greater than those for any meaningful declines. The U.S. economy is strong and has good momentum; recent slowing in other economies may only be a soft patch. Just as our own Fed did several years ago, the European Central Bank is set to begin the process of ending QE-style supports for the Eurozone; to the extent that their QE was still providing economic support for the common-market zone there may be a diminishment in economic output there for a time. However, the ECB will be reinvesting inbound proceeds from bond they hold into new purchases for an indeterminate time period, just as our own Fed did, and has also pledged not to consider raising short-term interest rates until late in 2019. As such, the support from low interest rates and bond recycling will continue even if outright bond-buying will not.
Inflation has only recently arrived at the Fed's desired speed limit of a 2 annual increase in "core" Personal Consumption Expenditures. Slower growth overseas and a serious decline in oil prices seem as though it might be hard to hold this 2% level at times in the next year, but the transient effects of lower oil costs will likely peel away as the year progresses, again allowing inflation and interest rates to firm up. Still, a lack of sustained inflation pressure will make it difficult for interest rates to rise.
If mortgage rates had closed the year at their 2018 highs, we might have expected further increases of perhaps a half percentage point or so. However, the recent dip for rates expands the space for interest-rate movements a bit. Odds favor that we'll see a similar pattern of movement for fixed rate mortgages in 2019 as we did in 2018 -- a run up over a period of weeks, mostly level for a time, then another run up. We think that the average conforming 30-year FRM as tracked by Freddie Mac won't get much past 5.5% for the year, and probably will spend the majority of it well below this peak. At times of elevated FRMs, ARMs may get a little more play; we think that the average offered rate for conforming 5/1 ARM could make it to about 4.5% at some point, probably after the last Fed hike for the year.
You can track and shop for mortgage rates here.
The Fed / Monetary Policy
Much speculation about what the Fed will do and when they will do it will fill the financial headlines in 2019. The Fed has essentially abandoned giving the market any kind of "forward guidance" about its intentions for policy; in addition, Chairman Powell now conducts press conferences at the close of every FOMC meeting, so all meetings are now technically considered to be "in play" in that a change to short-term interest rates may come at any of the eight scheduled get-togethers. This is a bit of a change for this Fed cycle; up to now, the Fed has changed interest rates only when it has released new economic projections each quarter.
The Fed's "balance sheet" -- portfolio holdings of Treasury bonds, mortgage bonds and mortgage-backed securities -- is now in full runoff mode. So far, about $129 billion in MBS holdings has been trimmed, and about $212 billion in Treasury bonds have been retired. Both outstanding balances are at about a 4.5 year lows and will continue to slowly diminish, so far with only muted effect on financial markets. The Fed engineered the process to hopefully disrupt things as little as possible, and so far, so good, but the slow pace of decline may mean somewhat less future capacity to use QE-type programs should the economy require new support to offset a downturn in economic activity.
In the meanwhile, the Fed is in the process of getting other policy tools back to a "normal" position. Opinions as to what the "neutral" level for the federal funds rate is (R-star, in the Fed's parlance) and vary widely within the Fed and among investors, with opinions converging somewhere around the 3 percent mark. As we write this, the federal funds rate is presently set in a target range of 2.25% to 2.5%, with the most recent increase taking place in December. This suggests that there may be perhaps two more increases to the key policy rate yet to come in 2019. The question is "when?".
For our part, at the outset of '18 we thought we'd see only 3 increases in the fed funds rate; four occurred. For 2019, we think that we'll only see two increases, with one in the first half of the year, probably in March. This would likely conclude a familiar cadence of making moves at meetings accompanied by new economic projections and would push the funds rate to a range of 2.5% to 2.75%, certainly a level close to or even at the "neutral" rate.
The Fed would then likely feel comfortable with a pause for a time; we think this means that they would skip making a change at the June meeting, then make a final 2019 change after a meeting that does not include new economic projections (helping to break the market's habit of expecting such quasi-scheduled moves). This change might come the late July/early August or November meetings, with the two 2019 moves pushing the range to 2.75% to 3%. A move beyond this "neutral" level isn't out of the question, but with more programmatic increases complete, the Fed will be fully "data dependent" and may or may not need to push higher into 2020.
For more about the Fed's actions, see our regular updates on Fed policy changes, updated after each Fed meeting.
In 2019, the Consumer Finance Protection Bureau now has its third leader, as Kathy Kraninger replaced interim head Mick Mulvaney. It seems likely that she will continue the softer approach to regulating the financial services industries initiated by Mr. Mulvaney, and she has pledged that privacy and data security with regards to the information collected by the Bureau are her chief priorities.
As he exited the building, Mr. Mulvaney made a few final changes with regard to product innovation by financial companies. He floated a proposal to make it easier for companies to obtain a regulatory OK for trying new things (called a "no-action letter") as long as the company provides certain information to the bureau and complies with a series of rules. Part of the proposal is said to contain a "product sandbox", encouraging companies to create and test new products and services under safe harbor provisions from the bureau itself. This would allow certain companies under certain circumstances to innovate without fear of a CFPB enforcement action. Such things include, for example, the use of alternative data sets to assess the creditworthiness of borrowers who lack traditional inputs or credit scores.
One thing that bears watching, though, is how much flexibility will be allowed. With housing sales soft and refinance activity weak, it may be that mortgage underwriting standards will continue to loosen, perhaps passing a lower bound that a more stringent regulator might prefer. The Office of Comptroller of the Currency recently raised a regulatory eyebrow about an increase in lending to riskier borrowers by banks, including allowing for higher back-end debt-to-income thresholds and higher acceptable loan-to-value ratios, noting that "Much of this easing is in direct response to competition from nonbank lenders." Non-bank mortgage lenders are regulated by the CFPB, so riskier lending needs to get at least a tacit OK by them in order to happen.
We don't expect to see much by way of specific changes to mortgages or mortgage enforcement from the CFBP in 2019. After years of wrangling and spending billions of dollars to become compliant with a wide series of new regulations and pay fines assessed from boom- and crisis-era problems, it seems more likely that the mortgage industry would simply prefer to see no changes. The basic rules governing mortgages, including the Qualified Mortgage and Abilty-to-Repay standards as well as disclosure requirements and timing are all unlikely to change much.
One item some consumers may notice is that getting a mortgage may not require an appraisal. A recent proposal could exempt loans below $400,000 (formerly $250,000) from requiring an appraisal to be performed on the property being financed. It will not affect loans sold to Fannie Mae and Freddie Mae, who were already exempt from the requirement and who almost-always require appraisals for their transactions. The change is estimated to apply to perhaps 200,000 or so mortgages but probably applies more to rural areas (where finding appraisers is difficult and "comps" are few and far between) but it may end up being applied to a wider audience. The change isn't intended to allow for feckless lending, though, as transactions that qualified for the exemption would still need to pass an evaluation consistent with safe and sound banking practices, including an estimate of the value of the property.
It looks as though we'll see a new head of the Federal Housing Finance Agency at some point in 2019. Mel Watt's term comes to a close in a few weeks, and the President's nominee is Mark Calabria, the current chief economist for Vice President Pence. Dr. Calabria has a long history working in and around housing policy, having served as deputy assistant secretary for regulatory affairs at the U.S. Department of Housing and Urban Development under G.W. Bush, as a member of the senior professional staff of the Senate Committee on Banking, Housing, and Urban Affairs, as well as positions at Harvard’s Joint Center for Housing Studies, the National Association of Home Builders and the National Association of Realtors.
In his present post, he has called for an end to the conservatorship of Fannie Mae and Freddie Mac, possibly by a "recap and release" arrangement, where the GSEs are allowed to rebuild capital levels and then are eventually turned back into private companies. However, it's by no means clear that this is an avenue that will be explored anytime soon, and there have been any number of competing proposals as to how best to reform the existing housing finance system. Tremendous complexities and politics have confounded reform efforts for many, many years, but the conservatorship has now run 10 years and must eventually be resolved.
That said, and aside from the GSEs massive footprint in mortgages, the system mostly works as is and is providing the Treasury with billions of dollars every quarter. The risk in the current arrangement is that the housing market again weakens and Fannie and Freddie have no capital of their own to absorb losses and must again start to draw on a credit line from taxpayers. The makes allowing for at least some capital retention to be a worthwhile idea. Fully reforming housing finance or even shrinking the GSE's influence is difficult; for example, the FHFA has no authority to begin to trim ever-increasing conforming loan limits (something we called for years ago) which would allow for a larger share of private lending to occur. That said, the new head could take actions such as reducing or eliminating purchases of second homes, reeling in purchases of multi-family projects or raising guarantee fees, in turn lifting rates for conforming loans and making private offers relatively more competitive.
Frankly, we're skeptical that any substantive change will happen to Fannie or Freddie that will greatly affect consumers in 2019. Even if plans for change do manage to get put in place, serious change takes time, and 2020 is an election year (and therefore, politically, no time to be messing with the housing market). One scheduled change for next year worth observing may be the way investors treat the new single securities to be issued by the GSEs starting in June. The Common Securitization Platform will produce combined MBS that will replace separate and rather disparate MBS produced individually by Fannie and Freddie. Although it sounds simple, it has been years in the works, and as we've learned before, any change in the long-standing MBS market does come with a risk of disruption.
We track important changes to regulations, regulators and the GSEs in our weekly MarketTrends newsletter.
We've been hoping to eliminate this specific section of the Outlook for the last several years, but it would seem that the "negative equity" situation remains a bit of an intractable problem. By our own analysis, home prices in 73 of the nation's top 100 metro areas have now regained or surpassed last decade's "boom-era" price peaks, meaning at least some homeowners in 27 metro areas still haven't seen home prices return the prices they paid for them years ago. Certainly, the numbers here have been improving steadily, rising from 50 metros in the third quarter of 2016, to 66 in 3Q17 to a current 73 in the third quarter of 2018. The ranks of the recovered include several "poster children" from the crisis, including such metros as Phoenix-Mesa-Scottsdale AZ and Tampa-St.Petersburg FL among others.
From what we can reckon, the remaining borrowers who are underwater are either concentrated in select markets or coalesce around very narrow original purchase dates, usually just a couple of quarters surrounding the peak of boom-era pricing in a given market. For example, a borrower who purchased a property in the Albuquerque, NM metro area before the third quarter of 2006 or after the fourth quarter of 2007 should be in the black in terms of the price of their home relative to what they paid for it; only those within this 5-quarter window remain in the red, and that by less than 2%.
Still, the problem continues to affect a fair number of people. Attom Data Solutions reported that in the third quarter of 2018 more than 4.9 million U.S. properties were seriously underwater — where the combined estimated balance of loans secured by the property was at least 25 percent higher than the property’s estimated market value, representing 8.8 percent of all U.S. properties with a mortgage.
If you're still one of the unlucky homeowners whose property is still underwater, you can learn when you'll be back to a positive equity stake again with our KnowEquity Underwater Mortgage Calculator.
Although we expect home price gains to slow overall, we still think that there will be 10 to 12 more metro areas that will hit "fully recovered", where all home values are above the prices their owners paid for them by the time 2019 closes. It bears noting that most previous price peaks (80 metros) were hit in 2006 or 2007, so recovery for many places has been a long time coming... and for others, may still be a long time yet.
Interested in the metros with the strongest and weakest home price recoveries or just want check a market's performance over a given time period?
Home Equity / Cash-out refinancing
Home values rising strongly over a number of years has accomplished several things, including pricing some potential homebuyers out of the market. However, that which penalizes homebuyers has benefited homeowners, as home equity is at or remains near all-time highs. Black Knight (a data and analytics firm) reported that homeowner's "tappable" equity is currently nearly $6 trillion dollars, and TransUnion (a credit reporting firm) noted earlier this year that home equity lending is set to soar in 2019. We generally agree that originations of HELOCs are likely to rise solidly in 2019 but don't think that there will be a boom; while equity can still be used for any purpose, interest on a second lien is no longer tax deductible unless it is used to buy or substantially improve an owner-occupied home. Although still-rising interest rates may be a bit of a deterrent to some potential borrowers, home equity borrowing is still among the most accessible and least costly debt available.
Substantial equity positions can also argue for cash-out refinancings, which have been on the rise despite an less-favorable interest-rate climate. To be sure, it doesn't seem likely that a borrower with a 2016-vintage 30-year fixed rate mortgage at 3.5% will want to trade it for a new, higher-balance loan at perhaps 5%, but these borrowers probably have little available equity to borrow anyway, given common cash-out LTV caps of perhaps 85%, if not lower. Arguably, there are certainly potentially many folks with older, never-refinanced mortgages with rates not all that far from current levels (2011 vintage and earlier) who now have very deep equity positions, thanks to routine amortization and property price appreciation.
A late 2018 article in the Wall Street Journal described cash-out refinancings as "having reached a record", but this was in terms of the percentage of refinancing being done for cash-out purposes (about 80% of refinances). Traditional rate-and-term refinance activity has all but been dead for nearly all of 2018, so it's little surprise that the share of refinancing for cash-out purposes has grown. To be sure, there is no massive "equity extract" happening; cash-out refinance balances totaled an about estimated $15 billion per quarter during 2018. During the equity-draw boom times there were several years where the quarterly totals ran 3-5 times as much in terms of dollars.
That said, there are reasons to expect continued activity here. Despite higher mortgage rates, the primary driver is pretty simple: There are very few opportunities for people to meaningfully recast their debt obligations over a long term at a fixed rate, and a cash-out refinance offer a chance to pay off much higher interest debt and stretch payments out over a 30-year term. This action can considerably change a homeowner's cash-flow dynamic and ease budgetary stresses (if not necessarily enjoying either tax advantages or achieving actual interest savings over time). For our part, we think that if there is any refinance activity to be seen in 2019, it will be cash-out refinances for home improvement and debt consolidation.
Learn about mortgage refinancing and see calculators and tools
Strong equity positions should help support a robust environment for Home Equity Conversion Mortgages (HECMs) or proprietary reverse mortgages, but that wasn't the case in 2018, when changes to the FHA's HECM program trimmed originations.
Citing losses to the Mortgage Insurance Fund, the FHA continues to focus on curtailing potential abuses of the program, requiring multiple appraisals in some cases, and of late, some concerns have been voices about the potential for occupancy fraud, where the original borrower on the HECM isn't occupying the property. FHA Commissioner Brian Montgomery has essentially committed to keeping existing Principal Limiting Factors (PLF) in place for 2019.
According to HUD, 55,332 HECMs were originated in FHA's fiscal year 2017; for 2018, that number dropped by more than 13% to 49,359. 2018 changes to the program included new loan-limit factors, increases in fees when equity draws of greater than 60 occurred in the first year and other changes designed to limit the FHA's exposure and promote responsible, sustainable use of equity. For 2019, these HECM changes will have been in place for a time and have likely been digested by the markets, and conditions for potential HECM borrowers remain favorable, so we think we'll see a rebound in HECM lending for 2019, perhaps enough to take back rather a bit of the 2018 decline. Call it perhaps 54,000 new HECMs for the year.
Changes to the HECM program have prompted private firms to again start to offer proprietary reverse mortgages. These are often available in "jumbo" amounts (loan amounts available above FHA limits) and have different and sometimes more flexible underwriting requirements. These aren't include in the forecast estimates above, so there will likely be some number of additional equity-extract originations, most likely in the highest-cost markets.
Strong demand for homes amid limited supply has pushed home prices strongly higher for years, but the dynamics are changing. Higher mortgage rates have served to at least temporarily cool demand for housing, and we have begun to see increases in the number of homes for sale (if tailing a bit of late, probably due to seasonal effects). More inventory and rather fewer buyers -- home sales are about 5% below year-ago levels as we write this in mid-December -- have flattened home price gains from increases commonly in the 5+% range early in 2018 to those in the lower 4% and upper 3% range of late.
With existing home sales likely to still be experiencing headwinds in 2019 -- still-high prices, limited but improving inventory, firm mortgage rates -- we think that gains in existing home prices will likely run in a 3.5% to perhaps 4% range for the year as a whole.
New home prices are often considerably more elastic, and therefore erratic and harder to predict. Rising materials costs and difficulty securing skilled labor argue for increases; a months-long decline in demand suggests that at least some builders will look to clear some inventory by trimming sale prices at times. The median price of a new home sold in 2018 posted month-to-month declines in 7 of the 10 months reported to date; we'd be surprised if there was much traction for prices of new homes at all in 2019, which will probably rise less than the inflation rate.
You can reckon what's happened to the value of your home since you've owned it using our MyHPI tool.
Existing home sales
It seems to us that an uneven year for existing home sales is coming up. In general, the fundamentals that support home purchases remain solid, with continued economic growth and rising incomes among them. However, the problems of high prices, limited inventory in the strongest markets and affordability challenges that have plagued the market in recent years won't simply vanish, but there are reasons to think they might improve.
As 2018 comes to a close, there are a growing number of anecdotal reports that suggest that homes in certain markets are starting to sell at discounts from asking prices, a means of combating flagging demand from buyers. Of course, some of these areas have seen exponential price growth in the last few years, so it's not as though sellers are bailing out of homes at a loss; rather, they are simply accepting less of a markup from what they paid then they might have gotten at a different point in time. In general, this is the expected effect of higher mortgage rates permeating the market; incomes at a given level can only support so much mortgage, and higher interest rates mean that some buyers must step out of the market unless home prices ease enough to re-align with incomes.
Even as some of the recently strongest markets may fall back to earth, we expect home prices overall to rise more modestly than they have in recent years. This is partly due to higher rates everywhere, but also due to available for-sale inventory levels continuing to edge higher. Somewhat more supply and still modest demand will tend to have a damping effect on price increases.
It will be another month or two before we know the final existing home sales tally for 2018, but the current annualized run rate for sales is 5.38 million. With higher mortgage rates expected at some point in the coming year and prices still firming a bit, we think it will be hard for sales to improve much for the year as a whole. We do think that conditions should be pretty favorable in the early portion of the year, setting the stage for a solid spring housing season, but that the pattern will look much like this year -- a burst of sales for a couple of months followed by a string of general diminishment. For the year, we think existing home sales should end up in the 5.2 million to 5.4 million (annualized) range.
New home sales
Late in a long economic expansion, sales of new homes have not really gained all that much traction. We would have expected to see greater levels of sales by now, especially given very tight inventories of existing homes, but that has not been the case. From where 2018 seems to be closing (November and December sales yet to come), sales of new homes have been tailing off for months; some of this is likely seasonal in nature, builders are experiencing other headwinds, including an inability to add supply in the strongest markets, skilled labor shortages and rising input prices.
Slowing sales for months has meant a bit of a buildup in supply, which has been steadily rising since May. Optimal levels are typically around six months supply at the current rate of sale; presently, there are 7.4 months available (336,000 actual built-and-ready-for-sale units, an expansion high). As noted above, builders do have some leeway when it comes to lowering prices to clear inventory (unlike existing homes, where a mortgage repayment and transaction costs can create a bare-minimum price level).
We do think there will be a rebound in sales of new homes from existing levels, probably starting early in 2019. As with existing homes, headwinds that are tempering sales won't suddenly disappear, and expected higher interest rates may curtail demand for more-expensive new homes to a degree. One potentially bright-spot caveat is that the National Association of Realtors noted that an increasing number of existing home owners believe that it is a good time to sell, possibly helping to re-start the moribund trade-up market. Leaving an existing home with a substantial equity position can be turned into a larger down payment toward more-expensive new construction, keeping the new home's mortgage relatively affordable. If this phenomena starts to form, some additional support for new home sales may result.
Overall, we don't think the picture for sales of new homes is appreciably different that what we saw this year, so we expect to see 640,000 to perhaps 660,000 units sold by the time 2019 comes to a close.
Yield curve inversion
Will the yield curve invert, and does it signal an impending recession? The answers are "it's likely to" and "probably not immediately". We've already seen a partial inversion in the closing weeks of 2018, where 5-year Treasuries returned less than did 2-year versions, but not yet a "classic" inversion, where 10-year Treasuries yield less than the Fed-sensitive 2-year version. However, the gap between those two has become quite narrow, with long rates more reactive to growth (slowing) and inflation (softening), while the 2-year note is likely to be kicked higher from Fed moves in late 2018 and expected ones to come in 2019. As such, we will probably see an inversion at some point.
One thing to consider is that longer-term rates are still being strongly tethered by ultra-low yields in other developed economies. Investors across the globe prize the safety of U.S.-backed debt, and if it comes with a solid yield, too, there's a lot to like. This is especially true when you consider that similar bonds in Japan yield nothing, German Bunds of comparable maturity just 0.25% and even U.K. Gilts bring less than half of what Treasuries yield. As long as this is the case, and as long as inflation remains contained, money will likely continue to flow here, and this demand for U.S. debt will continue to help anchor longer term interest rates.
It has been noted that an inverted yield curve has predated every recession since 1975. Usually, the inversion has been from the Fed lifting rates to a point that kills both inflation and growth, and a recession ensues. That doesn't seem likely to be the case in the near term; the current expectation is that short-term rates may only rise mildly from here, and gradually (see above). Certainly, at some point, the Fed may go too far, but the working outlook suggests a better than average chance that the Fed won't overshoot anytime soon. Unfortunately, this can only be seen in hindsight, so we'll know more about how it all works out come 2020.
So much has been changing with regards to trade and tariffs in 2018, but there's a good possibility we'll see more of this next year. Any disruption from NAFTA's replacement (USMCA) seems to be minimal, but the ongoing arguments with China could impact both markets and economic growth in 2019. Right now, there seems a bit of detente between the two largest economies, but these are happening in the space of delays or temporary moratoria and so may flare up again before long. In general, ongoing trade skirmishes would be bad for economic growth, and as concerns about them wax and wane interest rates will pressed to rise and fall.
With the House switching over to Democratic control it seems unlikely much will get accomplished, but there probably will be some bipartisan support for infrastructure spending. Other than that, a fractious political climate will persist and major initiatives on taxes, spending or regulation probably don't happen, at least not through the legislative process.
As is our custom, we'll review all these things and assess how our expectations are coming along (or not!) in July in our mid-year update.
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