Can You Believe the Mortgage Rates You see in the Paper (or on the Internet)? Why Advertised Mortgage Rates are "Never Right" – Factors Affecting Mortgage Pricing – Part 2
13th June 2009
(This is an update of a previous blog post)
The one question I am asked more frequently than any other is, What is your rate? This is a great question because you obviously want the lowest rate, but it’s a question that is impossible to answer. First of all, the rate will depend on what type of loan you are getting, whether you want to pay extra money in points and fees to get the best rate (which is what happens with the low rates you see in ads). Even if you were comparing apples to apples and making sure the loans are priced the same way, you can’t compare mortgage rates without without taking into account all the factors in your personal situation which go into pricing a loan. When
a lender takes on a new mortgage their goal is to minimize their risk and make sure that they are getting paid for the risks they are accepting. Some loan characteristics increase the chance that the borrower will default on their loan, costing the lender money. Over the last year Fannie Mae and Freddie Mac, the buyers of most conventional loans, have instituted a whole new series of price hits called LLPAs or loan level price adjustments, based on situations they consider more risky. This means that loans that fit into these situations will cost more than other loans. These price hits can be paid as extra fees at closing, or by increasing the rate on the loan.
Here are some of the things that factor into the price of a loan, and how I price out my Illinois Mortgage Rates:
Credit scores – Fico scores are a measure of how likely a borrower is to pay back the loan. It used to be that if you qualified for a conventional loan (a loan that was eligible for purchase by Fannie Mae or Freddie Mac) your pricing would be the same whether your score was in the low 600s or the high 800s. If you didn’t meet these guidelines you could still get a mortgage at a higher rate, but these were considered Alt-A or sub prime loans. Now you will need a score above 780 to get the best interest rate and if your score is below 680 the price hits will be substantial (if your score is below 680 you may be better off with an FHA loan). In order to quote an accurate mortgage interest rate, we need to know your Fico score first. This makes it all the more crucial to review your credit and work on any problems before you are ready to apply for a loan.
Loan type – Even when comparing 30 year fixed rate loans, there are a whole variety of programs available, each to meet specific needs. The pricing changes based on the loan type. Conventional loans (Fannie and Freddie) are good up to $417,000 for a single family home. If your loan is above that you would most likely look at a Jumbo loan. Jumbo mortgages are not able to be sold to Fannie Mae and Freddie Mac and they are priced much higher. If you qualify best for an FHA loan, the pricing would be different.
LTV and CLTV – This means the Loan to Value and the Combined Loan to Value, or how much is the mortgage compared to the value of your home, and how much if you include any other mortgages on that home. This is another way of stating how much equity you have in your home – the higher the equity, the lower the loan to value. And the less equity you have, the higher the risk is to the lender. This is tied in with your credit score, and if you are buying with a lower down payment, this could make a big difference in your rate. Are you buying with a second mortgage added on? In the past this has been a great way to buy with less money down and avoid mortgage insurance. It is harder to do in many cases now, and you may pay more on your first mortgage if you have a second loan attached.
Loan purpose – Are you buying a home or refinancing? If you are refinancing your home and taking cash out, it would cost you more if your loan to value is greater than 70% (less than 30% equity). A purchase or a rate term refinance would be priced the same.
Occupancy – Is this your primary residence, a second home or an investment property? You get the best rates and fees for your primary residence. Second home loans are often the same, but in some cases they can be slightly higher. Investment property is looked at as a riskier type of loan and investors are more likely to walk away from a bad investment, than home owners are on their homes. So there are higher rates and fees when you buy non-owner occupied or investment homes.
Type of property – Mortgages for single family homes are are priced better than loans for two, three or four unit homes. In one of the biggest changes, you will pay more if you buy a condo with less than a 25% down payment. (Here is more information on Chicago condo loans)
Loan amount – On conventional loans, pricing is usually better for larger loans. It costs the same to process and close a small loan as it does for a larger mortgage. Because of this the pricing improves on loans over $200,000. On the other side, loans under $100,000 have increased fees, and the fees go higher as the loan price drops.
Property location – There are some areas in the city of Chicago and in the Chicago suburbs that are considered target areas. These neighborhoods are targeted for redevelopment and banks are encouraged to lend in these areas – more than encouraged, they have to have to lend a certain amount in low income areas or they could face big problems with the federal government. Because of this pricing in these areas is better. The original idea here was to offer more homes for low and moderate income borrowers. Often the areas marked for redevelopment are the hot areas where prices are rising. Make sure your loan officer checks to see if you are in a CRA or targeted area.
Buying out of state the pricing can be different, too. I specialize Illinois Mortgages, but also close loans in most states. The wholesale lenders have different rates for each state.
Length of the rate lock – You will get better pricing for a 15 day rate lock than if you locked your rate in for 60 days. The longer the rate is locked in for, the greater the risk to the lender, so they pass the cost of hedging the loan on to you.
Escrows – Mortgages are usually priced so that the end lender will hold your escrows for taxes and insurance, collect 1/12th of the payment from you every month and pay the bills when they come due. Many borrowers want to pay these bills themselves and earn the interest on their money until the bills come due. You can do this if you meet certain guidelines, but it will cost you. Most lenders charge a quarter point fee if you waive your escrows. On a $300,000 loan this is an extra cost of $750.
Pre-payment penalty – If you know you aren’t going to be moving or refinancing for a while, you can sometimes get a lower rate by agreeing to pay a pre-payment penalty. This will lower your costs, but it also handcuffs you into staying in the mortgage. If you end up moving or refinancing before the time expires, it could cost you a lot.
These are some of the things that factor into the rate and cost of a mortgage. Even bigger though is how the loan fits your needs and what you qualify for best. It doesn’t make any sense to shop the rate on a conventional mortgage if you can only qualify for FHA. Also, make sure you look at the bigger picture, not only the interest rate but the costs of the loan and how the financing works for your personal situation.
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ve based on how traders read the state of the economy and the possibility of inflation in the future. Inflation brings down a bond’s yield, so any hint of inflation is going to decrease the value of a mortgage bond, meaning interest rates will go up. On the other hand, when the economy is slowing down this means that the yield is safe, so more investors buy in and mortgage rates go down. That is how it works in normal times. But these aren’t normal times.
bonds, you name it, this week was a bloodbath. When the $700 trillion dollar economic bailout bill failed to gain the markets confidence and get the credit markets moving, Treasury secretary Paulson and Fed Chairman Bernanke pulled out some more tricks from their bag and did everything but drop money from the sky. The Fed doubled their auction capacity from $450 billion to $900 billion, opened their lending window to commercial paper and dropped the discount rate by .5% in conjunction with a consortium of global national banks. And none of it made a bit of difference. The commercial paper market, banks lending to other banks, remained frozen, and stock markets around the world went back in time about 5 years to the values they were at in 2003. The stock markets now about 40% off its peak, the Dow was at about 14,000 a year ago and closed just above 8,451 today (after being below 8,000 in the morning).
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week in an unprecedented move, the government was putting together a bailout of the entire banking system. Ever since the credit crunch kicked in over a year ago, the economy has been crippled by a lack of credit. All this goes back to the banks and brokerage company’s exposure to bad mortgage loans. While the real estate market was hot, they loaded up on loans that seemed risky at the time, and down right stupid in hindsight. It was a herd mentality that said risk didn’t matter as long as home prices continued to rise. When the bubble popped, the market for these securities disappeared overnight. Pools of theses riskier mortgages (Sub prime and Alt A loans) which used to sell for a premium, were suddenly so toxic that investors wouldn’t touch them at any price. The economy runs by money constantly changing hands. All these loans were like a game of hot potato or musical chairs. You were safe as long as the music was playing and the money and loans were being passed along to the next in line. But when the music stopped, these financial companies were stuck with billions of dollars of loans that they couldn’t sell. Their balance sheets overloaded with debt, they had trouble borrowing and cut back on who they would lend to. With less credit available, the economy has contracted and the real estate market has continued to fall, cutting the value on their collateral causing the entire market to cycle lower to the point this week where the system almost collapsed. Now the government is stepping in with a plan to buy out all the non-performing loans at a deep discount, as a way to bring liquidity back and get the banks to start lending again. 
So here are my questions: 
talked about bailout of the two mortgage giants. This action has been anticipated for a while as both the Fed and Treasury Secretary Paulson announced a month ago that they were ready to stand behind and guarantee any losses. Announcing the guarantees calmed the markets at first, but further losses have now forced the Government’s hand. The new plan means that the Federal Government is not just standing behind Fannie and Freddie, but propping them up completely. They now have virtually unlimited access to capital. This plan will dilute common shares of stock in the companies to the point they are near worthless. Preferred shares (owned mostly by big banks) will still be viable, but a new treasury class of preferred stock (owned by the Treasury) will be issued. This new stock will have first dibs on any profits the company makes, and the stock holders won’t see any dividends until all the money lent from the treasury has been paid back.
huge portfolios of mortgages they haven’t been able to sell. Fannie and Freddie have pulled back and are only taking on the most risk free loans. With the US Government behind it, this will give investors the confidence that if they buy a mortgage bond, they won’t be left holding the bag if Fannie and Freddie go down.
in full rally mode now, which means 
Mortgage bonds improved most of this week, but after the worse than expected employment numbers bonds actually ended the day worse than where they started. Still, it was a major rally for the week, and some profit taking by traders is expected. Technical indicators show that we may have some more room to run. One unknown is how low oil prices will go. Some analysts doubt that they will go below $100 per gallon. If they do OPEC could shut off the spigot and reduce supply to keep prices high. That may be harder to enforce than it has in the past, and with the economy slowing they may need to cut back a lot to keep the price propped up. What this all means is that if you are in the market to buy a new home, you may have better rates in your future, and if you’ve been thinking about refinancing but weren’t able to get it done when the rates were lower, you may be about to get a second chance. Either way, if you need help, give me a call.
steps back and other weeks it is exactly the reverse. In other words 
that that is not the case. The economic downturn we have been seeing is now spreading world wide. Another suggestion that rates should be going down.
Stearns. If left to fail on its own, it was feared that this would set off a panic that could shake our financial system to its core. Since then we’ve been told that the worst was over, and even though the housing market was still a mess, our economic foundations were strong. This week the bullet we missed with Bear Stearns is looking like a pea from a pea shooter, and we have a nuclear missile headed our way (Where is Superman when we need him?) The stock of Fannie Mae and Freddie Mac, the two pillars of our mortgage finance system, dived this week as the loss of liquidity pushed these giants toward insolvency. Both stocks lost about 45% of their value this week and are down about 90% in the last year. With the stock prices this low there is no way they can raise the cash they need to continue operating in the markets. If the worst comes to pass, this means 2 possibilities: a bailout where the government funds the organizations, or a receivership or complete government takeover. 
Everyone agrees that Fannie Mae and Freddie Mac are too big to fail. If it gets to that point the government will surely step in and do what is necessary to keep the mortgage market going. But the question then becomes how would they do this? The debt is so huge (even backed by the homes supporting all those mortgages) that it would be equal to almost ½ our current national debt. After the panic first started, Fed officials, Treasury Secretary Paulson and statements from both Fannie and Freddie assured everyone that there was no crisis. But a panic is a panic. The market calmed down a little Friday afternoon, but this will come back as an issue. Maybe this coming week, maybe later. We are still in a severe credit crunch this fear only tightens it another notch. What it means for consumers is that conventional mortgages are likely to continue their trend of becoming harder to qualify for and more expensive for those who can qualify. On the good side, there is almost no chance that the Fed will hike rates any time soon. 
Much of the inflation is due to the high demand for commodities in developing countries overseas. India and China have been booming and they are growing a huge middle class. This brings a desire to increase their standard of living, which means more cars on the road and an improved diet, so food and fuel prices go up. This trend will be with us for a while, but there are signs pointing to a slowdown in Asia, and if there is this will reduce inflation by itself. The other thing that makes me think this will come down on its own is the trading activity. I have a friend who is a trader at the Chicago Mercantile Exchange where he trades contracts for cattle futures. Futures contracts are traditionally used as a hedging device. So if McDonalds wants to lock in the price of their hamburgers 9 months from now, they buy contracts on the exchange and they know what their costs will be going forward. This exchange has traditionally been used by farmers and food producers to take some of the ups and downs out of the market and measure their risk. So who are the big buyers of cattle futures today? They’re not food producers; they are financial companies, some of the same big players who created the bubble in the mortgage market. They are buying futures in all the commodities from grains to oil. The reasoning is sound. Prices are going up, so they need to buy the futures and take advantage of the rising prices. Only their buying divorces the price from any fundamentals of supply and demand. Food and fuel prices are in a bubble now, and at some point this bubble will pop and prices will go down. The question is when, and it could get much worse before it gets better.
October of this year is eligible, and with payouts of up to $600 per individual and $300 for each child under 17, this should cover several tanks of gas. What are you planning to do with your check? The idea behind the checks is the hope that if everyone goes out and buys something, this will kick the economy back in gear. There are of course, a few problems with this theory. First of all, not everyone is going to buy something. If you are feeling the economic pinch, you might rest easier putting this money in your savings account or paying off your credit cards. And those who do their civic duty and go out shopping are likely to buy foreign goods which will give a more limited kick. But if the checks make people feel more confident about their own finances, then the plan will have done its job. I think it will take more than this to prime the pump.
or client who put an offer on a pre-foreclosed property (a short sale – this is where the lender would have to agree to let the buyer buy for less than the full amount of the mortgage so they don’t have to go to the expense of foreclosing the property) 3 months ago. He’s still waiting for an answer. I called the number on the sign and was referred to a web site. The web site offers several tours in an “air conditioned bus” stopping at a variety of pre-foreclosed and bank owned properties. A Realtor is giving the tour and you will be able to make offers on the homes if you choose. The bus isn’t free, though. A ticket for one tour cost about $100, another tour of luxury homes was priced at over $300. But lunch is included. It is a sad fact of life that foreclosures are on the rise, even in the nicest areas. But if you are looking to invest, you don’t have to take a bus. If you are looking for investment property and need the name of a Realtor who can help you, let me know and I’ll direct you to an expert who can offer personalized service.