The Chicken and the Egg

Roger Schlesinger
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Posted: Aug 29, 2008 3:00 PM
The Chicken and the Egg

Beginning the story in chronological order, we have the chicken being played by the real estate industry and the egg by the mortgage lenders. The chicken is telling all who will listen that the industry will be in good shape as soon as the lenders begin lending in earnest again. The egg is just as adamant as the chicken when saying they will begin lending once the real estate market starts moving.

So what we have now, as Paul Harvey would say, is “The rest of the story.” Before we get into that, however, we notice that an ominous character looking much like the big bad wolf is lurking around the story, played by Fannie Mae and Freddie Mac. In as much as they are the predominant lenders today, they feel that you should be charged a “whole lot more” for no other reason than they can do it with ease. Now we have the cast, characters and scenario for a story that currently has no ending. But I am getting ahead of myself once again.

In the proverbial battle of the chicken and the egg, I am forced to go with the chicken in this case. Real estate cannot really improve and “start moving” without sufficient financing. The bulk of the financing we had was done through securitization of mortgage loans. A simplified overview: a lender would bundle a number of loans and sell them at the best yield he could find on Wall Street. Wall Street investors would get a fixed rate on their “bundled loans” and the lender would take his money and profit and start the process over again. Unfortunately there aren’t any bids for the most part on bundled mortgage loans, so that type of financing is not available at this time. This largely eliminates jumbo loans as a category for borrowers.

(See below). Fannie Mae and Freddie Mac finance conforming loans, and a small amount of jumbos known as conforming jumbos. The conforming jumbos are set to disappear at the end of the year as the stimulus bill that created them runs out on December 31.

Lenders are unwilling to make jumbos loans in great numbers because they do not have a way of selling them. The larger banks who are mortgage lenders are playing a game with their prospective borrowers: they will give you a loan but at a rate and cost you will not take unless you are desperate. They apparently do not want to be accused of being a hindrance instead of a help, so they will offer loans in the high 6% range up to the 9% range with heavy points attached. Even if you are desperate, it is much harder to qualify for a rate in the 7% range with 1.5+ points than in the low 6% range without points. These same lenders are anxious for you to consider them for conforming loans, loans up to $417,000 maximum, until they are raised to $625,500 in January. Why? Because they will still be considered as “mortgage lenders” and can sell the loans to Fannie or Freddie.

Realtors are working hard to sell houses but without jumbo loans, the houses over $700,000 aren’t moving for lack of financing. Once you get into prices in the millions, the borrowers can go after private banking money found in the major banks that cater to that clientele. Therefore the vast majority of house sales are limited to those that can be bought with loans no higher than the conforming limit. As an aside, this is another reason for the drop in the average price of a single family residence.

After the first of the year, we will see some improvement in the housing market where the conforming limit has gone to $625,500. Even though this new limit is more than $100,000 below conforming jumbos’ limit, the market will get a boost because conforming loans are better priced and offer easier qualification for most borrowers. The big mystery is whether the new conforming limit will be decided by state or broken down like the conforming jumbos to each specific county. If the limit applies statewide, it will provide the most help to the recovery of the mortgage and real estate markets. Using California as an example, more than half the state wouldn’t get the move up to $625,500 if limits are determined county-by-county, even though there are very expensive areas in many of the less affluent counties.

And now the big bad wolf(s): Fannie and Freddie. We are all familiar with the fact that the two giants in the mortgage industry are in trouble financially, and thus they are anxious to start making more money to help alleviate the problem. How can they make money? They facilitate loans for the public so they decided to charge the public more for their services. It started a year or so ago with a charge for taking cash out of your house, which would mirror what jumbo loans was doing. The borrower would have to pay a fee if the cash-out was over 75%. Then it dropped to 70% and now, depending on your credit score goes down to any cash-out transaction. No matter how good your credit score, everyone pays at 75%.

But there is quite a difference in the charge. The following is the chart at 75.1% loan to value per your FICO (credit) score:

740 credit .25% (of the loan amount as a fee) 700 .50 680 .87660 1.0 640 1.75 620 2.25 
 

740 credit

.25% (of the loan amount as a fee)

700

.50

680

.87

660

1.0

640

1.75

620

2.25

Yikes! The rationale for these hits is that cash-out makes the loan riskier, and of course they (Fannie and Freddie) wish to make more money. As expensive as they are, these fees are just the beginning. If you take any loan with a longer amortization than a 15-year, you then have FICO/LTV (credit score/loan to value) charges to your loan. You can escape with excellent credit, 720 or better, a loan-to-value under 60%, or by taking a 10- or 15-year fixed. ARMs, such as a 5- or 7-year, are still amortized over 30 years or more and subject to the charges in the following chart. I again will use just the 75.1% loan-to-value category, but you can figure that if the loan is for a smaller portion of the property’s value, the charges will be lower, and if the loan-to-value is higher, the charges will be greater.

740 credit

0% (of the loan amount as a fee)

720

.25

700

.750

680

1.00

660

1.75

640

2.25

620

2.75

If you want a 75.1% cash-out loan up to the conforming limit of $417,000 and your credit score is 670, your combined extra charges will be 2.75% (points) of the loan amount. It doesn’t simply end there; if you have units or a non-owner occupied property, there are substantially higher costs. These costs do not include any lender or broker charges. The answer: either improve the heck out of your credit or take a 10- or 15-year loan. As another incentive, the 10- or 15-year are lower in interest as well. These newer and larger charges are just now taking effect and we haven’t yet seen the reaction to them.

So, do the chicken, the egg and the big bad wolf live happily ever after? We are a nation of strong men and women who have faced many problems and overcome them. I believe this will happen again and I am already seeing some turnaround. What Fannie Mae and Freddie Mac have done with these fees is certainly no help to the recovery, but market forces in the long run will prevail and Fannie and Freddie will have to adjust as well. Because this isn’t the end of the story, more columns will follow tracking the progress of real estate/lending and Fannie Mae/Freddie Mac adventure.