Fed Meeting Minutes Expose Rising Interest Rate Risk

Minutes of the April/May Federal Open Market Committee (FOMC) recently released may have a significant impact on mortgage rates going forward.  One significant development from the meeting suggests that the present quantitative easing (QE)  program may be modified in the near future.  The current QE program involves the Fed purchasing $85 billion per month in mortgage backed securities (MBS) and Treasury bonds. The Fed’s goal with QE is keeping long-term interest rates, including mortgage rates, low. Considerations mentioned in favor of slowing the current QE program include concerns over “buoyant” financial markets as evidence of a developing economic “bubble”. FOMC members in favor of continuing the current easing program cited fears of economic deflation resulting from cutbacks in QE.

Fed Chief Calls Current Bond Buying Program “Overheated”

In related news, Fed chairman Ben Bernanke, in testimony before Congress, characterized the current QE program as “overheating the economy,” but he also stated that slowing economic growth is a worse alternative than continuing the current QE program. Chairman Bernanke noted that QE is supporting financial markets and the economy and indicated that it is not time to reduce the Fed’s support. Diverse opinions within the FOMC added to the impasse over QE, as one member advocated for immediate tapering of the QE program, while another proposed expanding QE purchases. The FOMC noted a number of challenges including the national unemployment rate of 7.60 percent at the end of March, that private sector hiring plans were “subdued,” and that jobless claims had trended up during the inter-meeting period.  Among numerous economic positive statistics cited, the Fed noted that consumer spending improved and was driven by higher automotive sales and a drop in fuel prices. The FOMC minutes reflect that some members had concerns about the ability of consumer spending to hold without notable improvement in hiring and business investment. Businesses contacts of FOMC members were reluctant to plan additional hiring and investing in their businesses based on reports of decreased manufacturing and lower international demand for products.

Good News Revealed About Low Future Inflation Expectations

The Fed predicted modest inflation over the medium term, and expected inflation to remain subdued until 2015. The Fed will maintain its benchmarks for adjusting the Federal Funds Rate and QE based on the national unemployment rate reaching 6.50 percent and the inflation rate reaching 2.00 percent. The FOMC characterized the improving housing market as responsible for economic improvements for related businesses, but also acknowledged that increasing demand for housing was being caused by low inventories of available homes rather than buyer enthusiasm alone. Improving home prices and easier consumer credit terms were viewed as contributing to improvement in overall economic conditions. These factors increase household cash flow and provide consumers with more discretionary income for spending. While the FOMC members did not agree on how or if to revise their current QE policy, it seems likely that the next meeting will bring increased scrutiny of QE and its impact on current economic conditions.

Quick Look At What CA Real Estate Investors Are Up To

Recognizing that real estate investors have played a key role in the state’s housing market recovery, the California Association of Realtors® (C.A.R.) recently surveyed its members about their interactions with investor customers and have developed a profile of investors and their behavior.

Two-third of investors are following a long term strategy in investing, buying and holding property although three-quarters of intend to hold the property for less than six years.   About one-quarter (26 percent) of inventors buy property in order to flip it.  Most investors, about 75 percent, are what C.A.R. termed small mom-and-pop type, owning between one and ten investment properties.  Fifteen percent own one property, 46 percent own two to five, and 14 percent own six to 10.  Owners manage more than two-thirds of the properties rather than hire a professional manager.

Single-family homes represent 78 percent of the investor purchases, 14 percent were multi-family properties and 7 percent were other investor types.  Bulk-sold properties made up only 1 percent of sales.

Investors spent a median of $272,000 on their properties and 67 percent of transactions were all cash.  Eight out of ten buyers made repairs to the property at a median cost of $10,000 or 4 percent of the median sales price.  The more expensive the property the less the investor spent on repairs with an average of 4.2 percent of the median price spent on properties priced below $250,000 compared to 3.4 percent where the properties cost more than $500,000.  Fifty-nine percent of investors found their property on a multiple listing service and 27 percent were foreign investors.  China, India, and Mexico were the most common countries of origin for foreign investors.

Among the reasons investors cited for buying or selling include profit potential (cited by 34 percent), good price (26 percent), low interest rates (10 percent), personal (6 percent), and location (4 percent).  The median rate of return on investment was 14 percent. 

SoCal Homesales Highest In 7 Years

Home sales in Southern California hit a seven year high in April spurred by pent up consumer demand and high levels of investor activity.  Prices rose along with sales to a 58 month high. DataQuick, in a report released on Tuesday, said a total of 21,415 houses and condos sold in the southern counties of Los Angeles, San Diego, Ventura, Riverside, Orange, and San Bernardino, an increase of 4.1 percent from March and 9.5 percent from April 2012. DataQuick said some of the month -over-month increase could be seasonal as March to April prices have risen an average of 1 percent every year since it began tracking them in 1988.   April sales have averaged 24,291 over the years with a low of 15,303 units in 1995 and a peak of 37,905 units in 2004.

The median price paid for all new and resale houses and condos in the region was $357,000, up 3.3 percent from March and 23.1 percent from the median of $290,000 in April 2012.  This was the highest median price since June 2008 when it was $360,000.  DataQuick said the dramatic price increase was reflective of home price appreciation, a simultaneous plunge in foreclosure resales, and a surge in mid and up-market home sales as buyers sought to move up.

John Walsh, DataQuick president said that this is a market that is still rebalancing.  “Sales of deeply discounted properties in affordable neighborhoods are way down. Activity in middle and high-end communities is on its way up. Now it’s catch-up time, with a healthier economy spurring more demand and rising prices tempting more people to put their homes up for sale. The median sales price has risen on a year-over-year basis for 13 consecutive months, and those gains have been double-digit since last August, the report says. Some of the region’s most affordable housing markets, where prices were beaten down the most during the foreclosure crisis, posted some of the largest price gains. In April, the lowest-cost third of the region’s housing stock saw a 20.7 percent year-over-year gain in the median price paid per square foot for resale houses. The annual gain was 18.5 percent for the middle third of the market and 15.2 percent for the top third.

Is This Housing Recovery For Real?

There is a lot of concern as home prices continue to climb and housing construction trucks along that the housing recovery is too good to be true.  There are three main concerns. The first is that the gain on demand owes to investors and international buyers, which could mean its temporary. The second is that the Fed’s QE3 is creating another housing bubble. And the third is that the home building industry is not prepared for a gain in construction (which explains the fall in sentiment).

A report by Bank of America/Merrill Lynch suggests that the first concern is overblown. Primary home buyers still make up the largest share of the market although the tight credit conditions have resulted in a larger share of all-cash purchases. Over 20% of buyers who are relocating and 60% of second home purchases have been all cash. In the markets that took the biggest dive (Las Vegas, Phoenix, Atlanta, Florida), investors (major and minor) have played a key role in spurring the housing recovery and have made up a disproportionate share of sales by buying properties in bulk. They’ve soaked up much of the “excess” inventory and stabilized the market, prompting primary buyers to return, and certainly international buyers are important in places like San Francisco, Manhattan, and Miami. Investor concentration held at 22% over the last three years while international buyers made up 2%, holding true to the past 3 year average.

Regarding the Fed’s third round of Quantitative Easing (QE3), yes, mortgage rates are being held artificially low – but is it really creating a bubble? I don’t necessarily agree with the experts who say that the term “bubble” is used to describe an asset priced above a level determined by economic fundamentals, and real estate is not there yet. They say many markets just went through a 33% decline in prices, and has not entirely corrected yet. In fact, many are creeping back to being “stable” and home ownership percentages are somewhat steady in the mid-60% area – much closer to the historical average. The credit market has been very tight and every mortgage professional and underwriter will tell you that the quality of borrower has improved dramatically in today’s mortgage market. So yes, the experts argue, prices are rallying in many areas, but with a much more stable base than we had 10-15 years ago.

Lastly, have you visited Home Depot or Orchard Supply lately? Prices have moved higher. Even the Census Bureau gives us home improvement trends, and retail sales on building materials are up nearly 10% recently. The price of lumber and cement have increased putting construction costs at a +5.5% gain year-over-year. The good news is that there’s a positive correlation between new home sales and construction cost inflation indicating a stronger housing market and greater demand. With the forecasted price improvements and the stability in the market, there are positive signals to believe in the housing recovery.

Your Mortgage Checklist

Whether you are interested in buying a home or getting a lower interest rate on your current mortgage, the following items will be required by all lenders for a new mortgage loan.  With underwriting guidelines being more conservative than ever it is essential to provide all documentation upon the initial loan submission if you wish to acquire a new mortgage as easily and efficiently as possible.

Here is the Checklist:

Provide clear, legible copies of the following for each borrower:

1. driver’s license
2. social security card
3. most recent paystubs spanning complete 30-day pay period
4. all 2011 & 2012 W2s
5. 2011 & 2012 Federal Tax Returns (all pages, all schedules, CA Returns not needed)
6. a recent statement (all pages) for your 401K, IRA, Stocks, Funds, etc.
7. 2 months’ most recent Checking Account statements (all pages, not internet summary, primary account)

(these additional  items are required  for refinance transactions)

1. recent homeowner’s insurance bill
2. property tax statement
3. recent HOA bill  (if applicable)
4. most recent payment coupon for your 1^st mortgage
5. most recent payment coupon for your 2nd mortgage/heloc (if applicable)
6. if subordinating a 2nd mortgage/heloc we need the NOTE for that loan
7. recent statement for any account you wish to payoff through this transaction

Mortgage Guidelines When Receiving a Down Payment Gift

When you are lucky enough to be receiving a gift to supplement or fully fund your down payment there are different underwriting guidelines that Fannie Mae, Freddie Mac, FHA and VA have regarding gifts.

When a borrower is receiving a gift, Fannie Mae and Freddie Mac both require that the borrower have 5 percent of the sales price from their own funds unless the gift is large enough for a 20 percent down payment. With a gift of 20 percent of the sales price, the borrowers are not required to have any of their own funds for the purchase of their residence.  This applies to the purchase of vacation homes as well but Fannie Mae and Freddie Mac do not allow gifts when buying an investment property. The entire down payment must be from the borrowers own funds.

FHA allows for the entire down payment to be a gift. The gift can not only be for the down payment but can also cover all closing costs.  If the veteran is receiving a gift, VA has the same gift guidelines as FHA.

In order for funds to be considered a gift, there must be no expected or implied repayment of the funds to the donor by the borrower. A gift of the cash investment is acceptable if the donor is the borrower’s relative, the borrower’s employer or labor union, a close friend with a clearly defined and documented interest in the borrower, a charitable organization, a governmental agency or public entity that has a program providing home ownership assistance.

Fannie, Freddie, FHA and VA do not allow the donor to be a person or entity with an interest in the sale transaction such as the seller, builder, etc.

When a gift is being received, all loans require it to be documented with the following:

* A “Gift Letter” showing the donors name, address and phone number, the relationship between the donor and borrower, the amount and source of funds.
* A copy of the check or wire from donor’s account listed on the gift letter
* A copy of the check or wire being deposited into borrowers account.

Rates Spike Up! Concerned?

Mortgage rates continued higher to begin the week, carrying some momentum from Friday’s rapid move higher and taking new cues from a stronger-than-expected Retail Sales report this morning.   Even before that, the most significant event of the past 2 weeks continues to be the Employment Situation Report on May 3rd, which marked a turning point for bond markets and introduced a massive, negative directional bias that has yet to run its course.  The story of that bounce back was compounded last week by a speculative ramp up in FOMC-related uncertainty.  The new (old) notion is that the Fed is set to start tightening the screws on QE and even has a plan to do so!  The fact that they might have such a framework should surprise no one, but there’s some concern that the upcoming ‘Minutes’ next week could suggest that such tightening is sooner on the horizon.  The defensive move–to whatever extent its really based on such fear–is therefor easily dealt with after the Minutes release next Wednesday but may make for volatility in the meantime.  Rates were already at their worst levels in over a month last week, but today’s losses mean we’d have to go back to March 22nd to see similar rate sheets.