Mortgage rate outlook
It goes without saying that interest rates didn't act as expected in 2016, unexpectedly holding near record lows for a good portion of the year. That said, mortgage rates are ending 2016 a little above where they began it, and this actually did conform to most forecasts, including ours. However, the reasons they were lower than expected -- and then suddenly higher -- both were largely due to planned events (Brexit and U.S. elections) that had unexpected outcomes.
But they were also lower than expected as a result of a third consecutive year where the economy started the year in a soft patch. Whether these have been due to an actual economic stumble or measurement issue isn't clear, but does bring the question as to whether or not we'll see this pattern repeated in 2017. As well, as the 2016 year-starting slowdown came after the Federal Reserve made its first change to interest rates in almost 10 years, it bears pondering how much effect a lift in interest rates contributed to that initial slowness.
We wonder about this as it appears at least possible that we could have a repeat of this situation to start 2017, meaning that rates might settle a little from present levels for a time. Ultimately, though, and with the new Trump administration's fiscal policy expected to promote somewhat more growth, somewhat higher mortgage rates are more likely for the year than not.
How far will they go? With an overall pattern that is most likely to be "firm to firming" in place for much of the year, we think that conforming 30-year fixed rates probably make it into the 4.625 percent to 4.75 percent range at some point during 2017 as a peak, but probably spending most of the time below the 4.5 percent level. Of course, expected upward pressure is predicated on lots of things going economically well, not just here but abroad, too. This is a happenstance that has been a bad bet in recent years, and may be again in '17, too.
Any measured or ongoing firmness in fixed rate mortgages may give life again to ARMs. Portfolio lending is alive, largely thanks to jumbos, but a firmer rate environment could see lenders more aggressively positioning ARMs to attract shoppers who are looking for lower rates and more flexibility in underwriting than fixed rates can typically offer.
So far, mortgage rates have confounded us again. Conforming 30-year fixed-rate mortgages did flare as high as 4.30 percent in mid-March, but a soft economic start to the year, zero follow through on fiscal policy and tax matters by the Trump administration and a bit of a fade in inflation pressure have all served to pull rates back down. This has occurred despite two increases in short-term rates (and the promise of more yet) from the Federal Reserve and a new plan to stop recycling inbound proceed from old bonds into new. Certainly, it's possible we'll yet see our expected 2017 peaks, but at the moment, it seems like conforming 30-year fixed mortgage rates might not make it much higher then 4.4 percent to 4.5 percent this year.
You can shop for mortgage rates here.
Is 2017 the year the Fed finally accelerates increases in short-term rates? Probably. We think that 2 and possibly even 3 increases in the federal funds rate are likely to come during the year, which would be a doubling or even tripling of the snail's pace of 2015 and 2016. Since the Fed moved in December 2016 as expected, odds favor that the next increase will probably not come for as long as 6 months, as the Fed will want time to assess how the economy is progressing.
If the first quarter does not show the kind of slowdown we've seen in the last three years, this would raise the odds for a March move... which would in turn probably put a September 2017 move on the table. This would leave room for a late-year third increase if the job market, growth and inflation are still performing or making progress toward levels the Fed feels are optimal. The Fed's own expected long-run rate for the federal funds is about 3 percent or so by 2020, and in order to get there at what at a measured pace, the Fed will need to lift rates 2-3 times per year in 2017, 2018 and 2019 to close in on that mark.
Making policy changes later in the year could become dicey, though. Fed Chair Janet Yellen's term is up in early February 2018; Vice Chair Fischer's expires in June 2018. It is not clear whether President Trump would ask Ms. Yellen to stay on, as he has been critical of Fed policies at times. Of course, it's also not clear if Ms. Yellen even wants to stay on after 2018, but she has indicated that she will at least complete her existing term.
We've not had much by way of a "Fed watch" since the days when Alan Greenspan was on his way out and ultimately Ben Bernanke was on his way in, and if a change is to be made to the Fed's helm, we'll probably start hearing rumblings about viable candidates come late summer or early fall.
Two increases in the federal funds rate are already in place, and there is expectation that the Fed will pull the trigger on a third increase yet in 2017. But when? For a time, it looked as though the Fed would likely move in perhaps June and September and start to pare their massive balance sheet come December. Instead, the central bank lifted short-term rates in March and June and released a plan to start to trim their holdings of Treasury and mortgage-related bonds "relatively soon", which markets have interpreted to mean possibly September. A recent lessening in inflation has led some to speculate that if the balance-sheet reduction starts in September that the next move in the fed funds rate will come in December. As such, our expectation for as many as three lifts in the federal funds rate seems to still be on track.
You can see our regular updates on Fed policy changes here.
Dodd-Frank & CFPB
Enacted in July 2010, and with many provisions not even completed yet, it seems likely that we'll start to see some changes in the sweeping Dodd-Frank financial reform laws enacted in the wake of the Great Recession.
It's really hard to reckon how much change will make it through the political process in 2017, but there are certain aspects which seem most likely to be addressed. Given that its structure was decreed unconstitutional in October, it would seem likely that the structure of the Consumer Financial Protection Bureau will be revisited, with changes most likely occurring in the management structure being changed from a since director to a board. As well, changes will likely come in the way the agency is funded, from one of being directly underwritten by the Federal Reserve subject to budget appropriations by Congress. However, the function of the Bureau and its mission to help protect consumers should remain intact.
As far as regulation relief goes, there are some rumblings in the markets about simplifying the Volker rule, which disallows banks from making speculative investments and trades with their own portfolios, and even ruminations about reinstating some form of the Glass-Steagall act, which separated commercial (consumer) and investment banking functions. We'll see if those bubble up to the surface come 2017, but maybe not.
Regulatory relief for smaller banks is likely to come, though, with changes in the tier structure that triggers certain regulatory oversight. Currently, the $50 billion dollar threshold has caused all manner of compliance headaches and needless costs for smaller institutions that were little more than victims of the financial crisis. Higher thresholds (or even outright exemptions for smaller and community banks) should theoretically see more banking freedom turn into more lending and higher profitability, promoting marginal additional economic growth.
To us, mortgage securitization also seems like an area that might be ripe for change, too. Since the early days of the financial crisis, Wall Street has pulled back strongly from mortgage markets, pinching liquidity and access to credit to all but the best (read: GSE or FHA eligible) borrowers. Since Dodd-Frank's start in 2010, there have been only a handful of private-label securitizations of mortgages, almost all jumbos, and many were comprised of older, seasoned loans. Before the subprime madness took hold, there were robust private-label markets for all manner of good quality (even private-label conforming) loans, often put together from new originations, improving access to credit for more homeowners and homebuyers. As we think that change here will help markets, we hope it gets a little attention in 2017.
Dodd-Frank and CFPB reform are rumbling beneath the surface, and it's still likely we'll see at least some changes before '17 is through. The Treasury released a working outline of recommendations for changing financial market regulations in June, and a range of revisions are proposed. To us, it appears that Dodd-Frank's rules won't be thrown out wholesale, but there will be considerable tweaks in the regulatory framework. That said, at this stage it's impossible to know what will eventually come of the reform efforts, as these recommendations must yet survive the political and industry gauntlet before they can become law. Stay tuned.
Although housing market reform didn't get much discussion during the election, it also seems likely that we'll finally see changes in the government's role in housing finance. After more than eight years, there is a good chance that the conservatorship of Fannie and Freddie will finally come to a close.
Steven Mnuchin, president-elect Donald Trump’s nominee to be U.S. Treasury Secretary, has gone on record stating that Fannie Mae and Freddie Mac should leave government control, and he expects that the incoming administration “will get it done reasonably fast.”
As such, it seems possible to us that the entities will be again be privatized in some form. Leaving out the thorny discussion of what happens to shareholders from the entities' prior lives, there are some considerations. Re-privatizing in some form will require the firms to both hold sufficient capital as to be in a better position to manage risk, and there also needs to be some mechanism in place for the entities to be able to purchase some form of "catastrophic risk insurance" from somewhere (probably the government). This is especially the case if there is a desire to retain the 30-year fixed-rate mortgage as a viable option for consumers.
Neither of these are insurmountable issues, though. Fannie and Freddie are producing considerable profits at the moment that could be used to recapitalize themselves; rather then giving all these funds to the Treasury, the entities could be allowed to use some or all of them to recapitalize over time, continuing in a conservatorship "wind-down" phase until a given capital level is achieved. Fannie and Freddie are also still in portfolio "runoff" mode and are mandated to have not more than $250 billion in their retained portfolio of loans by the end of 2018, so at least one aspect of their risk is diminishing as time wends forward.
However, and in order to ensure a more robust private mortgage market, we'll probably need to see several concurrent changes. Certainly, private securitization reform (as noted above) would be a start, but there will also need to be a reduction in the GSE's influence in order to open more space for the private market to participate. This could take a number of forms, including changes to the GSE (and FHA's) loan purchase limits. For example, with jumbo mortgage markets again alive and competitive, the ability of the GSEs to back "jumbo conforming" mortgages might come to a close, allowing the private markets to serve these wealthier borrowers. Other changes might be considered, too, such as reducing in stages the current absolute conforming limit of $424,100, or even pegging the conforming limit to a factor above the median home price in an area (i.e. 1.5 times the median price). This would tend to open up the market for private interests.
If Fannie and Freddie are extricated from convervatorship, or perhaps regardless, we will probably see at some point a new head of the GSE's regulator, the FHFA. Mel Watt, the current director, has done a decent job overseeing the companies in their current form, but hasn't looked to change the GSEs, instead managing them in their "zombie" state and looking to Congress to undertake comprehensive housing reform.
So far, it's "same old, same old", but the clock does seem to be ticking, as the GSEs continue to wind down their holdings and capital levels continue to shrink toward zero. There are plenty of proposals floating about to reform the enterprises, but nothing seems imminent. FHFA head Mel Watt continues to prod Congress for comprehensive housing policy reform and GSE reform, and has all but said he won't make changes without their direction.
Paul Muolo at Inside Mortgage Finance recently wrote "Almost 60 percent of mortgage professionals want Fannie Mae and Freddie Mac preserved with their existing operations remaining intact, according to poll results compiled by Inside Mortgage Finance and IMFnews."
Given the range of items bouncing around Congress -- repealing the ACA, tax and regulatory reform and more -- it's starting to look like it's another "wait until next year!" situation for changing Fannie and Freddie. Meanwhile, profits keep rolling in to the Treasury.
We've all seen the headline that national home prices have returned to their pre-crisis peak. It's too bad that most folks don't own a "national" home, but rather a home in a local market which may or may not have yet recovered (you can see the recovered and lagging markets or look up a market's home price recovery for a given time period.)
However, even if not all areas have yet fully recovered, we may be coming to the end of the underwater crisis for the vast majority of borrowers. Being underwater -- a happenstance where the amount of the mortgage is greater than the value of the home -- impacted millions of homeowners in the recession and recovery.
By our reckoning of home price trends, homeowners that bought prior to 2004 or purchased homes after 2009 should currently find themselves with home values at about where they started - for some, truly a decade of lost appreciation, but at least no longer a loss of value. Of course, folks with the wherewithal to buy homes when values were at their low points have largely done well since then.
According to the FHFA's Home Price index data, about 80 of the 100 largest metropolitan areas saw home prices peak in 2006-2007; most hit their troughs in 2011-2012. By the same measure, about 50 of that 100 are currently at new price peaks (some by just a bit, others by quite a lot). A home's current value is just one component of being underwater, though. The outstanding mortgage balance is the other.
However, steady recovery in home prices over time coupled with the amortization of mortgage balances means that these "equity holes" become closer to being filled as time wends along. In November 2016, ATTOM Data Solutions reckons that the problem is about one-third as large as it was at its worst back in 2012.
In areas where home prices have recovered to original levels for many homeowners, the regular paydown of mortgage principal has restored solid equity stakes for many as well. For example, a homeowner with a mortgage taken in January 2005 would have paid down the outstanding balance by about 24 percent already, and with the home price returned to starting levels, this homeowner would have a 76 percent LTV loan. For a January 2009 loan, that equity stake would be about 14 percent at present.
Given present home price trends and another year of amortization, we reckon that probably 66 percent of all markets will see prices at of above "boom-era" peaks by the end of 2017. Even in markets that haven't fully recovered values at the aggregate, it is likely that there will only be pockets of borrowers who bought at absolute boom-era peaks who might remain underwater once remaining loan balances are considered.
Two quarters' worth of fresh HPI data have come since we wrote this particular Outlook passage, and the number of markets that have returned to former "boom era" price peaks has grown to 60. Of the remaining 40, more than a third are within reasonable distance (~10 percent) of recovering in the next year or two. More importantly, this simple comparison doesn't show that the vast majority of homeowners now have positive equity stakes, with only those who bought in not-yet-recovered markets at or near previous peak levels remaining without equity. ATTOM Realty solutions pegs the number of "seriously underwater" propeties at about 5.5 million in the first quarter of 2017, down from about 6.7 million in the first quarter of 2016 (and fully half the level of 1Q13), so the issue continues to correct itself as we go. According to Congress.gov, "S.122 - Mortgage Debt Tax Relief Act" has seen no movement since 01/12/2017, when it was "Read twice and referred to the Committee on Finance."
When will your property no longer be underwater? Find out with HSH's KnowEquity Underwater Mortgage Calculator
All this said, there will still be some homeowners who will remain in situations where a short-sale is in the offing in 2017. What's not know is whether Congress will again extend the Debt Relief Act of 2007, which doesn't treat mortgage debt forgiven by a lender in a short-sale process as taxable income. The Act currently only covers transactions though 2016, and it's not clear if or when it will be extended again. At this point, it should probably simply be made a permanent part of the tax code.
Home Equity / Cash-out refinancing
The flipside of rising home prices and falling mortgage balances over time is that equity available to homeowners is rising. Couple this with vastly improved lender books over the last few years and the desire of banks to make new, profitable loans, we are probably on the cusp of an equity borrowing boom such as we've not seen in since the go-go times of the last decade.
To be fair, we're not talking about the overall size of the home equity lending market, but rather the pace of growth in lending. At its peak, and including piggyback first-mortgage originations, home equity lending ran at about a $350 billion per year pace. Presently, it might be running at about half that level, but has been rising for 17 consecutive quarters through the second quarter of 2016, according to a recent release ATTOM Data solutions.
Growth in equity borrowing will likely accelerate as a result of the rise in first mortgage interest rates. Although rates for HELOCs and HELoans remain above those for first mortgages, high levels of refinancing in recent years have seen millions of equity-rich homeowners refinance with rates in the mid-to-upper 3s, and refinancing to take cash out of a property will mean exposing all that mortgage debt to a higher interest rate, rather than just a small portion of it being at a higher rate.
At the same time, rates for HELOCs and HELoans will be rising a bit, too. Most HELOCs are keyed off the Prime Rate, which usually tracks changes in the federal funds rate in lockstep. As such, if the Federal Reserve does lift rates multiple times in the 2016-2017 period, costs for these borrowers will rise a little bit, too. As has been the case since the early days of the recovery, some lenders are competing for this business to a greater degree than others, so shopping around in your local market is crucial to getting a great deal.
Of course, rising rates may also be a problem for those with existing lines of credit. According to the Office of the Comptroller of the Currency, 2017 should be peak year for last decade's interest-only HELOCs to reset to fully-amortizing payments. This reset phenomenon was supposed to cause all manner of havoc for lenders and borrowers, but so far has been a non-event, thanks to an improving economy, stronger equity positions among borrowers and proactive lenders.
Cash-out refinancing had been enjoying a bit of renaissance over the last few years, but higher first-mortgage interest rates may cool this to some degree. In the second quarter of 2016 (latest available data) Freddie Mac estimated that $13.3 billion in cash was pulled from properties, the most since the third quarter of 2009. Of course, mortgage rates in the second quarter closed in on record lows, making increases in loan balances as a result of the cash draw more palatable for borrowers as they served to temper monthly payment increases. Still, these may make sense for some borrowers, so choices need to evaluated carefully when looking to extract equity from one's home.
It would appear that the borrowing of home equity by various means is continuing apace. Moody's noted that borrowing of home equity has reached the highest levels since 2008, even if that time period saw equity extraction being curtailed swiftly. According to ATTOM Realty Solutions, home equity borrowing tailed off a bit in the first quarter of 2017, slipping 5 percent to $46.0 billion. Still, that's an annual run rate of $164B, and rising equity positions seem likely to entice homeowners to draw funds for a range of purposes.
That is, unless ultra-low first mortgage rates entice them to do a traditional cash-out refinance. With the Fed lifting rates three times in the last 7 months, the Prime Rate (on which most HELOCs are based) is now running about 30 basis points above the average rate for a conforming 30-year FRM, and that's without a typical 1-2 percent margin added on top.
Freddie Mac reported that about 49 percent of all refinances in the first quarter were for cash-out purposes, but the amount of money being drawn in such transactions was still small at about $14 billion for the period. Given rising equity stakes and low rates, cash-out refinances and more traditional equity access can be expected to continue to grow as the year progresses.
It's a fact that home price increases continue to outstrip income growth. However, it's also a fact that home price gains have cooled and settled over the past few years, with average annual median existing home price increases falling from double digits as recently as March 2014 to a current annual run rate of about 5.75 percent.
An improving economy over the last few years has seen more borrowers become better aligned with mortgage underwriting standards; meanwhile, low mortgage rates have been a steady drumbeat, driving demand into the market. That demand mostly hasn't been met with supply, and this has largely been the cause for sizable ongoing price gains.
Supplies of available homes may loosen a bit in 2017. More homeowners are in equity-positive positions now than in the last few years, and so in a better position to sell without incurring financial stress. As well, some homeowners who might have considered a "renovate and stay" choice may look at higher home equity rates and decide that "find a more suitable home" may be a better option for their needs.
Demand factors will still be in place in 2017, but the firming of mortgage rates and the possibility of more supply becoming available seems likely to trim price growth to a degree. We think that price increases for existing homes will still be rising, but probably at a pace closer to an annual 5 percent rate than not.
Solid demand amid tight supplies of available existing homes continue to drive prices higher, but the trend seems to be settling a little of late. The National Association of Realtors reported that median home prices were some 5.8 percent higher in May 2017 than May 2016, but that's actually the coolest the year-over-year comparison so far this year. The Case-Shiller national home price measure revealed a 5.5 percent rise for the three month period ending in April, down from 5.5 percent in the three-month period ending in March. So far, our forecast seems to be on pace, or at least close.
Existing home sales
Even though we believe that somewhat more supply of homes will become available for shoppers in 2017, it is still more likely that they will remain rather below the 6 months of supply which is considered optimal. According to data from the National Association of Realtors, we've not seen that "normal" level in more than 4 years, and even with some stock coming on line, we probably won't see it in 2017, either. In October, a supply of just 4.3 months of stock was available, so we have a long way to climb to get back to 5 months, let alone 6. Tight supplies will remain, limiting any upside for existing home sales.
With somewhat firmer rates expected to be in place, there could be a slight lessening in demand as the year progresses, but we expect that existing home sales should be able to hold a 5.4 to 5.6 million (annualized) rate of sale for the year, a level essentially on par with this year's pace.
After an upward surge, mortgage rates retreated as the traditional spring homebuying season kicked in, fueling demand a bit more. Inventory levels for existing homes have loosened a bit; when we wrote this in December, there was about 4.3 months of supply available (October data); this figure shrank as low as 3.6 months by December, but has generally trended upward since then, rising back to a still-very-tight 4.2 months by May. This lack of supply is throttling sales as we expected; so far this year, sales of existing homes are running at a 5.61 million (annualized) rate, and with traditionally slower sales portions of the year yet ahead, it seems as though our forecast remains on track.
New home sales
We expect to see mostly steady gains in sales of new homes in 2017, if at a gain of about half that seen over the last two years. Very favorable conditions for builders have persisted for a good while, but the challenges of construction and sales probably don't get any better in the coming year. A lack of buildable land in the strongest markets and skilled labor shortages in construction are issues that won't go away quickly, if at all, even as demand for new homes likely remains pretty constant despite an expected climate of firmer mortgage rates.
After the last credit-crunch recession back in the early 1990s (a time of much less severe conditions than we recently endured) more than 15 years passed between the nadir for sales than began the period and the most recent peak for new home sales in 2005.
In current times, the most recent low-water mark for sales was seen back in February 2011, so the recovery here so far is only about six years old. In that time, sales have risen by more than 100 percent (from a low of 270,000 (annualized) units sold to the present 563,000 units.
By comparison, the January 1991 low was 401,000 units, and if we look forward by about six years from that date... we see that sales then had just about the same percentage gains over that six-year period, climbing by a little more than 100 percent over that time.
As such, sales of new homes seem to be recovering on pace, even if that pace is rather lackluster. From a long-range perspective, and leaving out the most recent boom and bust cycle, it would seem that annual sales in the mid-800,000 range is ultimately where we'll end up... but it's going to take a while yet to get us there. This year should see some continued gains in this area, where we expect to see a 5 to 6 percent rise in sales of new homes, which will probably tally around 590,000 for the year.
Although still only modest by historical standards, sales of new homes are gradually firming. Three of the first five months have seen annualized sales of new homes top the 600,000 mark; there was only one other foray over this level since early 2008, and that occurred in July of 2016. So far, sales of new homes are running a little above our expectations, averaging 612,000 (annualized) for the first five months of the year as a whole. Of late, though, there has been a three month decline in housing starts, with both single and multifamily stars falling below even comparable 2016 levels. With prices here also rising, the combination of fewer homes available at higher prices brings into question whether new home sales will be able to hold these levels for the entire year. Presently, odds favor that our forecast will bear out.
One final item for 2017 is that the Home Affordable Refinance Program will continue until September, when it is expected to be replaced by a new permanent program to help troubled borrowers refinance. That is, however, provided that the current construct of Fannie Mae/Freddie Mac/the FHFA all continue along as they are at the moment... not really a certain thing at this moment. We might suggest that if you are HARP-eligible or will be soon that you might take advantage of the old program while it still exists, as there is no guarantee that the next program will come.
As we do each year, we'll take a look back at all of these items to check on their progress (or lack thereof) in our July mid-year update. We invite you to check back to see if our expectations and prognostications are working out.
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