There has been a ton of attention paid to the recent legislation that passed as part of President Bush's Economic Stimulus Plan. Especially by people in the mortgage industry. And people with mortgages. Rightly so - the mortgage market has been in a funk since last August, especially for people with "Jumbo" loans. You have a Jumbo loan if you started out owing more than 417k.
Rates on Jumbo loans spiked back in August, as the secondary market essentially shut down. The value of bundled mortgage investments on Wall Street exchanges was called into question after defaults within these bundles started to run at higher levels, causing the bond investments they fed into to underperform. Why did this happen? Because home values started to drop, and homeowners with mortgage balances larger than the value of their homes went into voluntary default. Others had loans with adjusting rates that caused the payments to jump - and they went into semi-involuntary default. I say "semi", because I think they'd have found a way to pay the bill if the equity in their homes was still there. It was all related. Values coming down, rates going up, payments coming in late, payments not coming in...
if you were looking for a place to invest money, would you buy a bond in which the underlying debt represented somebody's mortgage, and their motivation to pay back the mortgage was deteriorating as fast as their home equity? Neither did Wall Street. The market shut down, became illiquid, and CNBC began the era of "Liquidity Crisis" and "Credit Crunch" headlines. Banks were stuck holding their latest batch of mortgages, and had no willingness to lend new money. They communicated this by jacking rates up about 1.5-2% over a few days.
Since then, we've seen some liquidity come back, and the market has made a few attempts to recover. But nothing has really lasted. Every time a "new shoe drops", the market freaks out and sticks its head back in the ground. Bear Stearns? Forget it. This bubble burst is a big meal for the markets to digest, and its going to take a while...
But in the non Jumbo market - also known as "conforming" - the market has been much more fluid. Thats because conforming loans have an implied government backing, and they "conform" to the standardization rules set by Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac).
So when Bush's Stimulus Package passed, it was seemingly great news that the new conforming loan limits would be set based on a revised county-by-county valuation model. For areas with higher than average cost, this would represent big changes, and help close the gap between average home costs in above-average cost areas. The maximum new limit reaches as high as $729,750. Big change!
At first, many assumed that people with loans between 417k and 729k - who were facing jumbo rates - were going to be able to refinance down to rates 1-1.5% lower. A few steps needed to happen between the legislators, regulatory bodies, and banking institutions before these new rules would take shape. This was a stimulus package, right? A bail-out for consumers who had been recently swindled into bad loans and were facing losing their home, right? The news has been full of these stories.
But a big wet blanket has been thrown on this whole idea - little bit by bit. You see, the banks have started taking the new loans with conforming rules. Except the conforming rules for these arent the same. For example, there's a price premium on the rates, and for a refinance, you have to have 25% equity... !!! I don't know many borrowers with 25% equity who are really having a problem. They don't allow foreclosure, even if their rates are a little high. They'll find money from family, or sell the home, or something. So in other words, this whole thing was pointless.
But really, what was the point? Well it seems that the "bail-out" was more for the banks than the consumer. The banks are now able to go back and sell all of this stagnant mortgage debt they issued, now backed retroactively by the FNMA/FHLMC guarantees. They get to liquidate, loosen things up, start breathing again. Its kind of like getting an insurance policy after you get in a car wreck - and getting to cash it in!
So thats where we are. The banks are clearly showing that they do not want to take new loans in on the temporary Stimulus Act model. They want to liquidate their books. But that may not be such a bad thing if you are a consumer. Because as they restore their balance sheets, they'll grow more confident to loan new money out. And they'll lower rates to attract new business. That may cause the pricing premiums to narrow, and eventually this should make new loans more attractive. But the stimulus act is only applicable until the end of the year. So how long is this going to take? There is no data on thes new conforming loans for performance or prepayment - the statistics that give investors an ability to guage their risk. It doesnt feel like anybody wants to take unknown risk on any type of investment in this climate. Might be a lot of us trying to squeeze through the door before it shuts on Jan 1. Maybe it will never happen...
So now what? Even though this whole thing looks like a bit of an empty promise, there are some other pieces of the Stimulus Act that may allow some people to still get 95% refinances up to that 729k level and at about a 6% interest rate. We are still watching the details unfold, but if you know more or stay updated, email me and ask to be included on new announcements.
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