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Nickelless
Administrator
USA
5580 Posts |
 Posted - 01/09/2009 : 07:43:07
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Current stresses in the home loan market have changed the ground rules for borrowers in many ways. A recent column focused on the confused state of affairs in the market for jumbos (loans larger than $417,000). Jumbos are priced higher than smaller loans even when they can be purchased by Fannie Mae and Freddie Mac -- and much higher when they can't.
This article reports on the results of an online shopping exploration I did on December 12. I priced conforming loans of $400,000 that can be purchased by Fannie and Freddie and $800,000 (jumbo) loans that cannot. Within each size class, I looked at 15- and 30-year fixed-rate mortgages, as well as 5/1 adjustable-rate mortgages (ARMs in which the rate is fixed for a period of five years). Prices were obtained from sources including the four largest depository institutions in the market: Bank of America, Citicorp, Chase, and Wells Fargo.
To assure comparability, I posed as a prime borrower purchasing a single-family house in California with a large down payment, while fully documenting my income and assets. What I learned probably holds for non-prime transactions as well.
Price Diversity: The differences in prices quoted by different lenders were extremely large. On the popular 30-year conforming fixed-rate mortgage (FRM), on which spreads usually are the smallest, the highest quote was more than 1 percent above the lowest quote. On ARMs, the spreads were even larger. On a 5/1 jumbo ARM, one lender quoted 8.125 percent plus $9,800 in points, while another quoted 5.75 percent with zero points.
Bottom Line: Borrowers can save a ton of money by shopping loan providers.
Conforming ARMs: One striking fact about the current market is that conforming ARMs cost more than 30-year FRMs, something I cannot remember ever having seen before. The rate difference between the 30-year FRM and the 5/1 ARM, holding points constant, was almost 1 percent. Furthermore, 3/1 and 7/1 ARMs were both priced higher than the 5/1s. On the other hand, all the lenders -- with the exception of one -- offering jumbo loans priced ARMs below the 30-year FRM, which is the usual pattern.
Bottom Line: There is no reason for a borrower to select a conforming ARM, but on jumbos, ARMs continue to enjoy a significant rate advantage.
15-Year FRMs: The 15-year FRM has always been my preferred instrument for borrowers who could afford the payment, because it carried a significantly lower rate than the comparable 30, and it amortized much more rapidly. On jumbo loans, the 30-15 spread remains very attractive at about 5/8 percent, but on conforming loans, it has dwindled to about half of that.
Bottom Line: There is no reason to avoid 15-year FRMs, but on conforming loans the advantage is not what it was.
Interest-Only Version of the 30-Year FRM: Until recently, the 30-year FRM that allows interest-only (IO) payments for the first 10 years was very popular. Borrowers could avoid making payments to principal for 10 years. To get the IO option, borrowers typically paid a rate premium of about 1/8 percent.
In an environment of declining home prices, investors don't like loans that build no equity for 10 years, and they have raised the premium to 1.4-2 percent.
To illustrate, one lender priced a standard 30-year FRM for $400,000 at 5.75 percent and the IO version of the same mortgage at 7.25 percent. This means that the borrower was offered a choice between paying a) $2,354 a month, of which $1,917 is interest and $437 is principal, and b) $2,416 a month, all of which is interest. This pricing eliminates the only benefit borrowers receive from an IO, which is the lower payment.
Bottom Line: Borrowers should avoid the IO option on the 30-year FRM. On ARMs, however, the rate premium to get an IO option is still reasonable.
Paying Points to Reduce the Interest Rate: Stressed markets do offer one significant bargain: buying down the interest rate by paying points. In 2005 it cost about 1.5 points to buy down the rate by .25 percent on a 30-year FRM. In early 2007 it cost about 1.125 points. Today the price is down to about half a point.
In part, the lowered price is due to the shorter average life of loans, which increases the value to investors of collecting points upfront. In addition, lower rates carry lower payments, which reduce the likelihood of default. In a stressed market, this carries a lot of weight.
Borrowers viewing a rate buy-down as an investment can earn a very high return. For example, one lender on December 12 offered a rate reduction of .5 percent for 1.119 additional points. Using calculator 11c on my Web site, I determined that this investment in points would yield 28 percent over five years and 32 percent over 30 years.
Bottom Line: Buying down the interest rate is a very good investment.
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Mortgage Shopping in a Stressed Market
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