Rates Are Up? Not Really....

Over the last four weeks, there has been a major move in mortgage rates – up almost 1%. After a move like this, the market generally finds and settles into a trading range. That trading range is usually within a 1/4% range. I do not think the market has yet found that range, but I think it is close. For planning purposes, it is important to know and accept – regardless of our view on the matter - that bond traders presently have a bias towards higher long term interest rates.

The Fed and the Treasury are in a pickle, and it’s a sour one. Housing sales are critical to economic recovery. Low mortgage rates stimulate housing sales. Their ability to maintain low rates has been materially impacted by their need to finance huge federal deficits, with no end in sight. The growing supply of treasury bonds is putting considerable pressure on the long end of the yield curve. Their plan to support the market with the purchase of mortgage backed securities has been trumped by a rapid rise in treasury bond rates – especially the 10 year and 30 year bonds. Yesterday, China announced it is moving some of its reserves to the IMF and out of US Treasuries. It seems that some of our international benefactors are starting to question the safety of U.S. Treasury bonds – due to the huge supply and our fiscal deficits. Look for a lot of talk and “jawboning” on both of these subjects. They are the topic du jour and pose great danger to the economic recovery.

Sound scary? A little I guess. I offer it only as information and to assist with planning. Certainly, refinance activity will subside – already has. But there is still plenty of purchase activity and rates are still low. 4 ½% a month ago sounds great. But housing prices were still falling. Buying a house at 4 ½% is not quite so attractive when combined with the prospects of a drop in the value of the house you buy. Today, it seems housing prices are stabilizing. I think 5 ½% with a stable or increasing house value is better than 4 ½% wt a falling value. One can still buy a home for less than replacement cost. If you are a first time home buyer, you can get an $8Ktax credit as a bonus. Pretty sweet!

Non-Sequiturs

The spread between the 10 year constant maturity Treasury and average conventional mortgage rates has narrowed from about 2.6% at the end of January to about 1.95% last week. That compares with a spread in April, 2008 of about 2.2% and about 1.5% in April 2007. The Treasury's plan to buy mortgage backed securities has precipitated some narrowing of the spread – which helps lower consumer mortgage rates. But the spread has not yet returned to the levels that existed before the financial crisis began.

Today, 30 year fixed conventional mortgage financing is available at approximately 4.75% plus a 1% origination fee.

In the last sixty days, 30 year fixed financing for jumbo loans (greater than $417K) has begun to return. Some lenders are quoting 30 year fixed rate jumbo financing in the high 5's with a 1% origination fee. Jumbo adjustable rate financing with the rate fixed for the first five years is plentiful - with the first five year's rate in the high 4's and low 5's.

In the fall of 2008, Fannie Mae and Freddie Mac tightened their mortgage qualification guidelines for investment property purchases and refinances. Their guidelines were changed to limit the number of financed properties owned by the borrower to five. Effective May 1, they have raised that limit back to ten properties. The qualifying and down payment requirements have been tightened for those borrowers who own 5 to 10financed properties. Nonetheless, this affords investors the opportunity to refinance their existing properties and to acquire new properties. This should help absorb some of the foreclosure inventory.

The state and federal moratoriums on foreclosures have expired, or soon expire, in most states. The federal foreclosure assistance programs do not work for everyone. We will see a spike in foreclosures and inventory over the next 30 to 120 days.

On April 29th, the Treasury will announce it's 10 year and 30 year offerings for the May bond auctions. Bond investors are concerned about the possible needs of the Treasury, the size of the auctions and the market's ability to absorb huge supplies of new bonds. This auction could be a glimpse of things to come. The fiscal deficits are just beginning to put pressure on the bond markets. It is reasonable to believe that this could signal the bottom of this interest rate cycle. If the auctions go well, rates could drop. But it will probably be temporary. If the auctions go poorly, rates could spike.

Your Home - Shelter or Investment?

In recent postings, I have opined that it's a good time to buy a house – if you need a home and can afford to buy. My rational is that existing homes are selling below replacement cost and mortgage interest rates are at historical lows.

But is a house a good investment? Or should it matter? My Dad told me to buy a house with the primary motivation as shelter for me and my family. If it works out to be a good investment, that's even better. He also told me that a good investment is usually measured by what you buy it for, and not what you sell it for. OK, that works. If I need and can afford a house, I can now buy one cheap with a very low mortgage rate.

The things that assure the investment value of a house are exactly the same things that attract me to a house – good schools, good location, close to jobs, access to public transportation, access to good shopping, access to entertainment and cultural things, a stable local government with affordable property taxes, a price range that is affordable for the area in which I am buying (don't buy the most expensive house in the neighborhood – even if it looks like a great deal). If I stray from those values, I endanger the long term investment value of my home.

I believe the economic situation in which our country finds itself has changed the rules about real estate investing – at least for the next decade. The tremendous federal deficits will keep pressure on interest rates for the foreseeable future. The deficits and resulting financing needs will gradually erode our government's ability to impact interest rates with fiscal and monetary policy. That could create huge spikes and valleys in interest rates. It will cause banks and institutional investors to be volatile enterprises that behave with increased unpredictability. I believe that today's low, fixed rate mortgage financing offers generational opportunity to those who can afford a home.

For the next decade, I do not necessarily think that homes will be a great investment. Here's why.

If you think the federal government has problems, think about our state and local governments. I know very few that are healthy. Many state and local governments are facing large property tax increases, large income tax increases and cuts in services. If you purchase a home in one of those communities – and there are many – the value and “affordability” of your home will be impacted.

There is a large segment of our population that is unemployed, under-employed or nervous about their job stability. Do you see anything on the horizon that might cause that to get a lot better? I don't. If I'm right, that will inhibit home purchases and will probably keep home prices low, albeit stable, for the next five to ten years.

Interest rates will go up. When they do, that is likely to inhibit home sales. Hopefully, the rise in interest rates will be accompanied by economic improvement and consumer confidence. But it is more likely that it will be primarily due to huge federal financing needs.

Many think that the federal deficit will lead to inflation. In times of inflation, those who own tangible, scarce commodities usually win. Although it has lost its appeal, gold is the most common example of a scarce commodity. Real estate is also recognized as a good hedge against inflation. The current inventory of unsold homes seems to conflict with the notion of scarcity. That is probably a short term condition. But I believe it is only short term in those communities where there is or will be scarcity of housing. A fabulous home on 50 acres that is 75 miles from downtown is scarce. But the demand for such a property is limited and inconsistent. The supply of small homes on an 80X100 lot in a great school district that is 2 miles from downtown is limited and demand is fairly consistent. Many of us cannot afford the home close to downtown. But there are many communities that exhibit, or will exhibit in the future, the same characteristics.

I don't mean to sound negative. Actually, I see incredible opportunity.

If you are buying homes for investment, be disciplined and be prepared for a 10 year investment horizon. It's going to take awhile to straighten out this mess and the government is in the driver's seat. The government is unpredictable and has both social and economic agendas. The “bank problem” is not over. In fact, it is probably still in the early innings. For the foreseeable future, free market capitalism rules have been “trumped.” If you accept that and plan accordingly, you will be the smartest guy in the room. You will likely do very well on your investment.

If you need a home for shelter and can afford to buy one, this is a very good time to do so. But be careful, do your homework and be smart. Buy your home as shelter for you and your family. Keep some cushion in your cash reserves. Do your homework and don't stray from the basics of real estate investing. What the heck - plan on staying in the house for 20 years.

Blooms on The Rose

“I compare you to a kiss from a rose on the gray, the more I get of you, the stranger it feels, and now that your rose is in bloom, a light hits the gloom on the gray” – Seal

Mustard seeds, blooms on the rose, chutes of green, the end of the Depression, the bottom of the market, St. Patty’s Day bear rally, return of a bull market, historically low mortgage rates, record high foreclosure rates, foreclosure relief, $1.4 trillion dollar federal deficits, 8.5% unemployment rate, at least 650,000 jobs lost each of the last three months, a strong dollar, mark to market relaxed, bank bailouts, federal debt at 80% of GDP, $ 1 trillion of IMF support for under developed countries, Madonna denied adoption rights (just slipped that one in to see if you’re paying attention).

Omigosh – talk about information overload! I watch the financial news far too much. It reminds me of a herd of cows following a feed truck with a leak in the truck bed. The cows want the feed. The truck driver is wandering through the field looking for a dry spot to park. The cows and the truck wander aimlessly through field, and it’s pouring down rain.

The financial markets are behaving much the same way. They seem to wander. Everyone is tired of the “gloom on the gray” and wants to acclaim the bloom on the rose. We have two or three weeks when bad news produces good results, and two or three weeks when bad news produces bad results. We are all looking for some sign of recovery, or some positive results from all of the money that our government is throwing at this problem. And the bad news just keeps pouring down.

Are there any blooms, or any buds on the vine? There are a few.

Mortgage rates are at incredibly low levels – in the mid 4’s. Given the outrageous financing needs that our government faces, I just do not see how they sustain these low levels. If you have not yet refinanced, hurry. If you need and can afford to buy a house, now is the time.

There are some indications that houses are beginning to sell. Realtors and mortgage companies are reporting increased activity. Prices are still below replacement cost in most areas of the country. The housing affordability index is at an all time high. New construction has been at a slow pace for almost a year. Foreclosures are still pervasive, but are showing some sign of stabilizing. As supply and demand stabilizes, home prices will go up. I believe there is little doubt that mortgage rates will go up – within the next year. If you need or want to buy or refinance your house, the bloom is on the rose.

Say what you will about the plan. It’s not perfect. But we finally have a plan. Banks are actually starting to see some operating profits. The government’s toxic asset plan and relaxation of mark to market rules will diminish the huge loan losses. Banks will soon begin to report decent quarterly operating profits – perhaps even this quarter. Once the banks sustain that profitability for a few quarters, we will see private capital start to come back into the banks. That will further the process of improving credit availability. It’s not a bloom, but there’s a bud on the vine for the banks and the availability of credit.

The notion of a world economy is disconcerting. It’s also a reality. Our country’s deficit is too large for us to be arrogant and protectionist. Let’s face it. We’re in better shape than most of them. But we badly need the rest of the world’s money to finance our bad habits and expensive mistakes. We also need to sell them our goods and services. I read where Rosetta Stone Co. will soon complete a $100 mm IPO. It’s time to brush up on your Arabic and Chinese. The recent G20 meeting signaled a new era of international cooperation for the economic good of all countries. That is a change of recent world status for our country, and a bloom on the rose.

There remains a “gloom on the gray” that bothers us all – job loss and unemployment. I think everyone would like to believe that the monthly job loss numbers have stabilized at the lowest levels we will see. But no one seems ready to say they will return to normal numbers. That’s the most positive way that one can think of such gloomy numbers. Unemployment stands at 8.5%. It is hard to imagine that it will not reach 10%.

The last issue is “the gray” itself. That is inflation and federal deficits. We are entering a gray zone in which we have never before been. Everyone likes to compare this to the great depression of the 1930’s. I don’t see it. Government and its institutions, the demographics and education of world population, the nature of industry and the point from which we are coming are all too different. Only time will tell. Our vigilance against run away inflation is the easy part. What to do is the problem. The speed and immensity of the fiscal stimulus could produce equally fast and immense inflation. If the Fed raises short term rates to fight inflation (and the yield curve flattens), they will harm the already weakened bank and financial sector. If we have to increase intermediate and long term rates to attract money to finance our federal debt, this could slow economic growth. This is the gray zone. A lot of smart and well educated guys are trying to figure this out. My guess is that we will just have to watch and be fast and graceful on our feet – something at which our government has never been good. Is it just me, or is the new group in Washington better dancers?

Transparency and Credit Card Limits

I've had a credit card from one of the “big five” banks for about 20 years, and usually pay the balance due monthly. Recently, I've been charging some unusually high business expenses and I let the balance accumulate for a couple of months. About two weeks ago, they sent me a letter congratulating me on the increase of my credit balance to something like $60,000. There was an “oh by the way” in the same letter. They are increasing my interest rate from 9.99% to 13.99%. This is a bank which is now almost 40% owned by our federal government. I guess their generosity is a result of their new found capital and market for credit card backed securities that they can now sell to the Treasury Department. Makes perfect sense, huh?

Today, the Treasury Department announced its plan for removing toxic assets from the balance sheets of banks. Here's a simplistic summary of how it works. A bank has some toxic assets it wants or needs to to sell. For the most part, these are loans and securities backed by low grade residential and commercial mortgages. The bank puts them up for auction. Private investment funds can bid on and buy the assets. If the private investment fund puts up ½ of the needed capital, the Treasury department will put up the other ½. And then FDIC will agree to guarantee loans, secured by these assets and provided by banks or other lenders, up to 6 times the aggregate capital of this public/private investment fund that is formed.

On March 2nd, the Chairman of FDIC announced that, unless FDIC insurance premiums charged to banks are materially increased, the FDIC insurance fund will become insolvent during 2009. FDIC is a division of the Treasury Department.

OK, let's get this straight. I put up $10mm and the Treasury Department puts up $10mm. That gives us $20mm and we go buy some toxic assets from a bank. We borrow another $120mm from a bank (6 times $20mm), and that loan is guaranteed by the FDIC. So we buy $140mm of assets. The FDIC, which guarantees the $120mm loan, is owned by the Treasury Department. The Treasury Department owns ½ of the fund to which the loan is made. The FDIC says it is going broke. But they'll be fine because they are going to raise the insurance assessments to the healthy banks. Not only do they guarantee the loan to the bank who makes the loan, they also insure the deposits of that bank. But they are part of the Treasury Department and there's no way the Treasury will let the FDIC The stock market rallies because it likes the plan. Or perhaps just likes the fact that there is a plan. Is this transparency? It's clear as mud to me – sorry.

Then there's Fannie Mae and Freddie Mac. The government just keeps buying securities issued by these two companies. These two companies keep issuing securities backed by their guarantees. But they are both broke – by their own admission. Their guarantees are only as good as the implied support and guarantee of the U.S. Treasury. In other words, the U.S. Treasury is the implied guarantor of several trillion dollars of mortgage backed securities issued by these agencies

There's also the federal deficit of $1 trillion, or whatever it is today. That means the government is spending more than it is taking in. And that does not count a lot of these loans and securities that they are guaranteeing either directly or through government owned or controlled entities. The government will issue debt to pay for all of that. And that's just for this year. The current administration estimates we will run deficits for another four years.

I am sure you have heard of the Lehman failure that occurred back in the fall of 2008. That's the one that the Treasury “let fail” because there were no buyers. Its failure was closely followed by the Bear Stearns purchase and ”save” by JP Morgan Chase, supported heavily by Treasury guarantees and loans. Lehman was put into bankruptcy. But Lehman still owns two banks whose deposits are insured by the FDIC. About a week ago, the bankruptcy court allowed the bankrupt Lehman to inject $430mm of new capital into these banks to “keep the regulators from seizing them.” First of all,where did a bankrupt company get $430 million? Secondly, is Lehman FSB – one of the banks - eligible for TARP funds, or will it be eligible? Lehman now says they are going to auction off these two banks as part of the bankruptcy liquidation. Lehman FSB has assets of about $6.5 billion and is the bank in which Lehman did most of its mortgage originations. Did Lehman fail? Yes, the holding company failed. But the bank subsidiaries did not fail. With all of the hoopla about this, does it not seem like these are relevant facts? There is just something that does not make sense about all of that.

My points are these:

> There is nothing remarkably transparent about all of this. It's a convoluted web.

> When the Treasury guarantees debt, that's just like borrowing money. The Treasury has guaranteed, and continues to guarantee, huge sums of loans and securities. In the eyes of lenders to our country, that counts against our government's credit limit. If all of those guarantees were counted, our government debt is at historical highs, and growing.

> Remember my credit card? When we need it the most, or the lenders think we do, they will raise the interest rate, cut back the limit they will loan us or both. Debt issued by our government is being purchased, at an increasing rate, by foreign investors. The American dream is not their dream. It's just a matter of time.

It's a time for positive attitude and optimism. I'm trying. The stock market is showing some life. Existing housing sales are up. Say what you want about it. But there's a plan in place. We've got a President that's out working hard and selling America. Maybe things are starting to loosen up a bit. At this stage of the race, I'm not saying we have much of a choice. We have to ride this horse. But when things start getting better, we must keep focus on these fundamental issues and resolve them. There is a natural tendency to ride the wave of optimism. Our credit card has reached its limit. We must maintain the discipline and goal to pay it off - or expand our knowledge of foreign languages. One in particular comes to mind.

Mortgage Rates - Going Up or Down?

The Treasury Department recently announced its intent to buy up to $600 million of mortgage backed securities. Their initiative is aimed at lowering mortgage rates, which they hope will stimulate the malaise in housing and the economy. By purchasing the mortgage backed bonds, their hope is that the spread between mortgages rates and the 10 year Treasury bond will narrow.

After the announcement, mortgage rates fell. On November 20th, the national average rate was 6.04%. Last Thursday, it was 5.53%. It is likely to be even lower when the new data is released today.

But, the yield on the 10 year treasury has fallen more than 30 year mortgage rates. On November 20th, the 10 year Treasury yield was 3.38%. It has fallen to 2.68%. Therefore, the spread between mortgage rates and the 10 year Treasury has widened to a huge 2.8%.

This does not necessarily mean that the Treasury action failed to narrow the spread – which was their intent. Certainly, mortgage rates fell. But, in this case, it was due to the fall in market interest rates and not the narrowing of the spread. This tells us that the market does not believe that 10 year Treasury yields should be so low, and that they are likely to increase. As they do, it is likely that they will rise faster than mortgage rates. And the spread will narrow.

The media reports the Treasury’s goal to lower mortgage rates to the mid-4’s. Will they be successful? Not unless the spread narrows. It is difficult to believe that 10 year Treasury rates could drop much lower than their present level. It is more likely that they will go up. It is however reasonable to believe that the spread between mortgage rates and the Treasury yield could narrow. At times during the last year –before the crisis- it has been as low as 1.4%. If that same spread existed today, mortgage rates would be at about 4.1%.

In the near term, it is not likely that the spread will narrow to 1.4%. But it is possible that it could narrow to around 2%. And if 10 year Treasury yields stay in the high 2%’s, 30 mortgage rates could fall into the mid to high 4%’s.

Mortgage rates are not likely to hold for long at these low levels. The massive amounts of federal financing necessary to support all of the bailouts will inevitably put upward pressure on interest rates. And as the economy begins to recover – if the bailouts work, there will also be upward pressure on rates.

During the next 60 to 90 days, we could see 30 year mortgage rates in the 4%’s. Once we reach the summer of 2009, mortgage rates will probably be back well into the 5%’s, and perhaps in the high 5%’s or low 6%’s.

What does this mean for you? If you would like to refinance, start watching rates and get ready to pull the trigger. If you are thinking about buying a house and want these lower rates as a buying incentive, the next 90 days could offer good opportunity. Rates are low and prices are depressed.

Changes to the FHA Down Payment and Maximum Loan Requirements

The Housing and Economic Recovery Act of 2008 revised the National Housing Act and the down payment requirements for FHA loans to:

1) Require that the mortgagor “shall have paid, in cash or its equivalent…an amount equal to not less than 3.5 percent of the appraised value of the property….”;

2) Eliminate the variable loan-to-value limits that were based on the combination of the property value and the average closing costs of the State where the property is located (also known as “down payment simplification”); and

3) Limit the total FHA-insured first mortgage to 100 percent of the appraised value, and require the inclusion of the upfront mortgage insurance premium (UFMIP) within that limit.

The revised down payment requirement takes effect with all new FHA case number assignments (new applications) on or after January 1, 2009.

Closing costs may not be used to help meet the minimum 3.5% down payment requirement. Closing costs are not considered in the mortgage amount/down payment calculation for purchase money mortgages.

For purchase money mortgages, the maximum LTV is 96.5 percent, i.e., the reciprocal of the 3.5 percent down payment requirement. The examples that follow will use 96.5 percent and apply it to the lesser of the appraiser’s estimate of value or the adjusted sales price. The examples do not include UFMIP or closing costs to be paid by the borrower.

When combined with the FHA first mortgage, government subordinate liens are not limited to 100 percent. When a unit of government or an instrumentality of one is offering down payment and/or closing costs assistance in the form of secondary financing, the CLTV can exceed 100 percent of the appraised value.

The maximum mortgage is calculated by applying 96.5 percent to the lesser of either a) the appraiser’s estimate of value or b) the contract price for the property minus any required adjustments.

Example 1

Sales Price: $218,000 Appraiser’s Estimate of Value: $220,000 Maximum Mortgage: $218,000 x 96.5% = $210,370 Down payment: $218,000 – 210,370 = $7630 The maximum mortgage shown does not include any upfront mortgage insurance premium, and the example does not consider any closing costs that must be paid by the borrower.

Sellers are still permitted to provide financing concessions up to 6 percent of the sales price. Amounts exceeding six percent must be subtracted from the sales price (or value, if less) before applying the down payment percentage multiplier. Other inducements to purchase must also be subtracted from the sales price or value, as appropriate, in calculating the maximum mortgage amount/down payment. In such cases, the actual down payment is increased by the amount of the inducement.

Example 2

Sales Price: $218,000 Appraiser’s Estimate of Value: $220,000 Gift Card worth $3000 Adjustment to Sales Price: $218,000 - $3000 Maximum Mortgage: $215,000 x 96.5% = $207,475 Down payment Calculation: $218,000 - $207,475 = $10,525

The calculation of the maximum mortgage requires that the gift card value, which was provided by the builder at closing, be subtracted from the sales price and, thus, the 96.5 percent applied to $215,000 rather than $218,000. The down payment, of course, is calculated by subtracting the mortgage amount from the actual contract sales price.

Refinances, including FHASecure refinances, are not subject to the 3.5 percent down payment requirement since there is no “down payment” on a refinance. The LTV will be calculated, as it has been, by dividing the loan amount prior to adding the UFMIP by the appraiser’s estimate of value. However, the loan amount, including the UFMIP, may not exceed 100 percent of the appraiser’s estimate of value for all new case number assignments made on or after January 1, 2009; this will result in various refinancing products including rate-and-term, FHASecure (including refinances of both non-delinquent and delinquent mortgages), streamlined refinances, and cash-out refinances having possibly different LTVs before adding the upfront mortgage insurance premium.

Example 3

Appraiser’s Estimate of Value: $220,000 UFMIP of 1.5% Maximum Mortgage before adding UFMIP = $216,749 Maximum Mortgage w/UFMIP = $216,749 + $3251 = $220,000 LTV before UFMIP: $216,749/$220,000 = 98.52%

This example assumes that the borrower’s payment of the existing first lien, closing costs, amount to establish a new escrow account, discount points, etc., yield an amount before adding the UFMIP of at least $216,749. Any shortfall would require payment in cash. If less is needed to extinguish the existing mortgage and pay associated transaction costs, a lower amount is required before adding the UFMIP. (The amount of mortgage before adding the UFMIP can be determined by adding the insurance premium percentage, in this example 1.5%, to 100% and then dividing that result into the appraiser’s estimate of value ($220,000/1.015 = $216,749 (rounded up).

In most locations, the maximum FHA loan amount for a single family home is $271,050. There are provisions for higher loan amounts in high cost areas of the country.

FHA loans are good options if 1) the loan amount is equal to or less than $271,o50 2) the borrower makes less than a 5% down payment 3) the seller of the property is paying more than 3% of the sales price in sales concessions or costs that would otherwise be paid by the borrower and/or 4) the borrower has deferred student loans with monthly payments that cause their debt to income ratio to rise above about 43%. If the borrower is making a 10% or greater down payment, conventional financing is usually more favorable.

Short Sales and Loan Mods

Many homeowners are having trouble making their mortgage payments. They have three options – sell the home, let the home go into foreclosure or attempt to get some help from their mortgage lender.

Clearly, foreclosure is the least desirable option. It is definitely not in the best interests of either the lender or the homeowner.

If the homeowner is still employed but has had an income interruption or a drop in their income, they probably would like to retain their home. They may need their lender’s help to reduce the ongoing monthly payment. Or they may be able to start making current payments, but not past due payments that have accrued. They may need for their lender to defer those past due payments, or add them to the balance of the loan. If their lender agrees to any of those things, that is called a loan mod (slang for loan modification) or forbearance agreement.

If the homeowner has no foreseeable ability or desire to make mortgage payments, they may choose to simply sell the house. If the house is worth less than they owe and they do not have the cash assets to pay the difference between what they owe and the proceeds from the home sale, they have a problem. Responsible homeowners will contact their mortgage lender and ask if they will accept a mortgage payoff for the net proceeds from the home sale, rather than the full amount due. If the lender allows this, it is called a short sale.

A derivation of the short sale can be accomplished through refinance of the mortgage. If the value of your house has dropped below what you owe and you can find a lender who will refinance your loan based on the lower value, you can approach your existing lender and request a discounted loan payoff. If they are anxious to get mortgages off their books that have inadequate collateral, they might accept a short payoff. One of the recent housing stimulus bills created a program that allows FHA insurance for loans that are refinanced into a new loan based on a payoff discount from the existing lender. That is an example of this strategy.

I have spoken to many frustrated homeowners about this. For loan modifications and short sales, there is no standard that lenders must follow. Each lender can make their own decision based on the financial consequences to them. When a lender modifies a loan, they must record a financial loss related to the restructure of the loan. They will compare that loss to the amount they might lose if they foreclose on the home and sell the property. They will also assess the financial condition and prospects of the borrower to keep their end of the bargain – just as if they were making them a new loan. The loan modification terms to which they agree, if any, are primarily based on that assessment.

When a lender approves a short sale, they will compare the loss they will take – the difference between the full payoff and the amount they will receive from the short sale – to the amount they will receive if they foreclose on the home and sell the property. They also assess the amount of cash assets that the homeowner might have available to pay or participate in the loss. Their willingness to accept the short sale is primarily based on that assessment.

That is the cold, hard financial reality of the situation. However, lenders have social responsibilities and self-interests to preserve home ownership and home values. Due to the recent support that many lenders are receiving from the government bailout, that responsibility is strongly implied, if not mandated, by the terms of the bailout. For those reasons, there is presently a strong lender bias for approval of loan modifications and short sales. And many lenders have announced programs to help struggling homeowners.

A great deal of the frustration that I hear relates to the practical administration of the approval process for short sales and loan mods. This is a new phenomenon for most lenders. Their systems and past experience for handling large volumes of such requests did not exist twelve months ago. Lenders are also getting volumes of request from homeowners who are current on their mortgage, but are asking for help because their financial situation has deteriorated or will soon deteriorate. How does the lender fairly assess who needs help and who is trying to take advantage of the circumstances? All of these things often make lender reaction times, the clarity of their responses and the consistency of their responses less than perfect.

I have a friend who has his loan with a large national lender. A couple of years ago, he financed his home purchase with a fixed rate loan at about 11%. He paid a higher rate because his credit was spotty and he could not document his income. His house is worth more than he owes on his mortgage. But he is in the real estate business and his income has decreased. He is struggling to make payments, but has continued to make them on time. He feels he can continue to make the payments if his lender will lower his interest and payment rate. He is uncertain of his ability to make them at their present level. His lender recently announced a financial hardship plan to help their struggling mortgage customers. He called them for assistance. They told him that they do not presently have a program to help him because their financial hardship program is only for borrowers with adjustable rate mortgages who are facing large interest rate and payment adjustments, or for borrowers who are delinquent. He is neither, but he needs help. His lender will not help. Will he continue to “struggle through” and avoid foreclosure? I don’t know.

I have another friend who has been trying to buy a home from a homeowner who is requesting short sale approval from their lender. After waiting three weeks to hear from the lender, they simply bought another house. I don’t know what happened to the homeowner, but one can presume the home will now go into foreclosure.

Those are two very real examples of how complicated and frustrating this whole mess is. With all of that said, there is hope and there is movement. Lenders are gradually developing systems, initiatives and policies to help struggling homeowners stay in their homes. And they are coming to terms with the nuances of the situation. Thousands of mortgages have already been modified. And many short sales have been approved.

If you are a struggling homeowner and need a loan modification or short sale approval, don’t give up. Here are a few tips.

> Be patient. It will likely take at least two weeks for a response, and more likely four weeks. Plan accordingly.

> Document your situation and your request in writing. Get the name of a specific person or department to whom you can send the request. Don't just leave a message or mail something to a P.O. Box.

> If you are financially struggling, provide the lender with third party evidence of that – pay stubs, bank statements, tax returns, the tax assessed value of your home. Remember that you are asking them to help you, and it will require that they lose money. Build a good case for why they should do that. For instance, you might document that your house is worth “x” they will only get 80% of “x” if they foreclose and helping you out will only cost them “y.”

> Try to stay away from emotional statements and dwell on the facts. You must differentiate yourself from the thousands of request they are receiving. Be straightforward and back up all of your statements with written evidence and/or facts.

> If the person with whom you are dealing is not responsive, politely ask for the name of their supervisor and escalate the request.

> Be persistent.

> Ask questions and seek advice from professionals that you know - Realtors, attorneys, bankers, mortgage professionals.

> Look on the Internet for government agencies or consumer credit counseling agencies that will help or counsel you without charge.

> There are really only a few practical ways that the lender can help you - lower your payment by extending the term of the loan, lower the interest rate which results in a lower monthly payment or accept a discounted payoff amount through either a short sale or payoff from a refinance. In very extreme cases, they might agree to forgive part of the mortgage balance and lower your payment accordingly. But most lenders will consider the discounted payoff or balance forgiveness only as last options. To win that battle, you will need to build a very good case of financial hardship and evidence that their losses will be less than their alternatives.

In closing, be persistent and don't give up. If you have a valid and documentable hardship, there is a very good chance you can get help.

Are We Bailed Out Yet

Last week, the government announced that the unemployment rate had grown to 6.5%. That is the highest rate since March of 1994.

In March of 1994, the average conventional mortgage rate was 7.80%. That rate was 1.32% above the 10 year Treasury rate. The Dow Jones was trading at about 4000. The seasonally adjusted gross domestic product (GDP) was about $7,030 billion. The national debt was about 65% of gross domestic product. Existing home sales in March of 1994 were 4.06 million.

Last week, the average conventional mortgage rate was 6.20%. That rate was 2.45% above the 10 year Treasury rate. The Dow Jones closed at 8943. The seasonally adjusted GDP was about $14,429 billion. The national debt is at about 69% of GDP, and at its highest rate since 1955. And that does not count the implied debt assumed in the Fannie/Freddie nationalization. Existing home sales in September, 2008 were 5.18 million.

What might all of this mean?

Continued expansion of the national debt will keep upward pressure on U.S. Treasury rates and mortgage rates. The spread between mortgage and treasury rates has some room to contract, which could soften any upward rate pressure. However, the nationalization of Fannie Mae and Freddie Mac, and direct government investment in our nation’s financial institutions, has created untested conditions for the spread between mortgages and treasuries. Due to the implicit government support, one would think that both actions would cause mortgages rates to trade closer to treasuries. So far there has been some compression, but the spreads are still in a historically high range.

The combination of relatively low interest rates and softening home prices has produced an attractive buyers market, and a housing affordability index that is hovering at three year highs. The rate of increase in housing inventory shows signs of stabilizing at near normal levels.

Americans are still buying homes. If you need and can afford a home, it is a very good time to consider the current market conditions.

Curves and Spreads

The events of the last year have precipitated two interesting scenarios.

The first is called the treasury yield curve. In normal times, short term interest rates are lower than long term rates. That’s because investors require a rate premium to lock their money in for a longer period of time. If one plots the time period (1 month, 6 months, 1 year, etc.) on the “x” axis of a graph, and the corresponding treasury security rate on the “y” axis of the same graph, the result is the yield curve.

A normal yield curve is upward sloping. On average, the normal slope is considered to be about 3% from the shortest to the longest term rates.

From 1927 to 2006, there were only 8 years when the average weekly yield curve status was inverted for the year: 1927, 1928, 1929, 1966, 1969, 1980, and 1981.

Most of those inverted years were associated with tough economic times. It is generally held that a prolonged inverted yield curve produces a subsequent recession.

Now here’s some interesting data about the yield curve over the last 12 months. For this purpose, I’ll look at it for treasury notes and bonds with maturities from 6 months to 10 years. One year ago, that yield curve was relatively flat at .39%. Six months ago it had steepened to 2.13%. On the last day of October 2008, it had steepened even further to 3.07%.

The steepening of the yield curve is the likely result of intentional loosening of the money supply by the Federal Reserve, lowering of the target rate for federal funds and lowering the discount rate charged to banks for borrowing from the Federal Reserve. A steep, positive yield curve is usually good for the economy. When created by significant government intervention such as we have recently seen, it can also be inflationary and lead to higher long term interest rates. The Federal Reserve has “pulled out the stops” to heal the economy, and must be vigilant in their control of inflation. In recent years, the Federal Reserve has precipitated higher short term interest rates to control inflationary pressure. And that causes the slope of the yield curve to flatten out.

The second phenomenon is the spread between mortgage rates and the comparable treasury security. Mortgages trade at a spread to the treasury security with comparable term.

As noted in a previous posting, thirty year mortgages have an average life about 10 years. Therefore, they are usually related to the ten year Treasury bond. In October of 2007, mortgages averaged about 1.85% above the 10 year Treasury. Six months ago, that had widened to about 2.25%. At the end of October, it had widened even more to near 2.5%.

That means that homeowners are paying relatively more for mortgage financing than they had to pay only one year ago. The 10 year treasury rate has dropped almost .5%. The thirty year mortgage rate is about the same as it was a year ago.

As a result of the Treasury Department takeover of Fannie and Freddie, securities issued by those two entities have the implicit guarantee of the government. Why then should Fannie and Freddie mortgage backed securities, and the underlying mortgages, trade at such a wide spread to Treasury securities?

It is likely that the spreads between the two will narrow as uncertainty diminishes. And that will be good for mortgage rates. Uncertainty has caused mortgage security investors to demand a higher spread versus Treasury securities. That spread will probably narrow as confidence improves. Even if Treasury rates go up a bit, the mortgage rate that we pay could remain the same. If rates go down at the same time the spread narrows, the resulting mortgage rate drop could become even more favorable.

It’s a good time to buy a home. Rates are attractive and housing prices are depressed. The steep yield curve is likely to precipitate economic recovery. Once housing inventory is absorbed – and it will be – we will see housing prices again increase.