April 1, 2008

The Markets Have It All Wrong-Again!

Just because these are "markets" does not mean that they are right all the time. Obviously, when the markets priced subprime mortgages very close to the price of prime mortgages, they were wrong. We can remember twenty years ago when those with bad credit paid 18% or more for their loans. During the real estate boom, those with bad credit were paying as little as 1.0% more than those with good credit. Imagine lending to someone with a poor credit history at 6.0%. Well, we all know what happened. Apparently the markets did not correctly assess the risk. So now what do they have wrong?

The markets have priced the high default rates into mortgages, increasing the spreads between Treasuries and mortgage instruments. The problem with that? New mortgages are being originated under completely different guidelines. Larger downpayments are being required. And better credit standards are in place. In other words, with the lower home values of today and the tighter lending restrictions, the mortgages that are being originated today have a much lower risk of default. But the markets are pricing these loans as if they are being originated during the boom period of two years ago. The markets have it wrong. We predict that when default rates for new mortgages originated today are measured sometime in the future and they are performing better, the spread between real interest rates will narrow. Therefore, mortgages will get cheaper. This is especially true of jumbo mortgages and adjustable rate mortgages which are really being priced high by the markets. How long will that take? Well, that is one question we can't answer.

The Markets. Fixed rates were mixed in the past week as adjustables rose due to pressures in the secondary markets. Freddie Mac announced that for the week ending March 27, 30-year fixed rates averaged 5.85% down from 5.87% the week before. The average for 15-year fixed rose to 5.34%, but had fallen more steeply than 30-year fixed the week before. The average for one-year adjustables increased to 5.24% and five-year adjustables rose to 5.67%. A year ago 30-year fixed rates were at 6.16%. "Long-term rates were mixed, but relatively unchanged in the past week as the latest economic indicators came in much as expected," said Frank Nothaft, Freddie Mac vice president and chief economist. "For instance, the index of leading indicators continued to fall for the fifth straight month while consumer confidence reached a 5-year low. On the housing front, house prices keep declining across the nation. The S&P/Case-Shiller Home Price Index was the most recent to document the drop in prices, reporting a decline of 2.3 percent from December to January in its 10-City Composite Index and a cumulative decline of 11.4 percent from January a year ago. Lower prices improve affordability and the National Association of Realtors reported that its home affordability index was at the highest level in nearly five years, contributing to a pickup in existing home sales in February."

Current Indices For Adjustable Rate Mortgages
Updated March 28, 2008

Before a home owner curses the troubled housing market, he or she should take solace in the U.S. tax code, which makes buying a home a good deal for almost everyone. Here's why: Interest deductions, including in some cases mortgage insurance premiums, reduce home owners' tax liability by reducing income. The deduction includes interest paid on both a first and a second home. Interest on home equity loans is also deductible - whether the borrower uses the money to remodel the kitchen or to take a vacation to Disney World. Profits from selling a house are potentially a huge windfall. When a home owner sells a primary residence, any profit on the sale of the property is tax free up to $250,000 for single home owners and $500,000 for married home owners filing. Any profit above that is nearly always a long-term capital gain taxed at 15 percent - less if the seller's tax rate is less than 20 percent. Home owners can itemize. That opens up opportunities to deduct a host of other items that wouldn't be deductible if the taxpayer took the standard deduction. Source: The Boston Globe

If a house doesn't sell, owners should consider renting - and hiring a real estate professional to manage the property, experts say. Renting out a house rather than leaving it vacant is almost always a better option, says Eileen Landau, an associate with Realty Executives in Naperville, Ill. She tells her clients to plan to rent the property for several years, get some income and "get on with your lives." Some are afraid they'll lose a tax-free sale. But sellers only have to live in a home for two of the last five years to claim the capital-gains exclusion, so even if that is an issue, sellers have three years to rent, Landau adds. Once a home is rented, any fix-up costs are tax deductible, points out Rob Massey of Rentals.com. An empty house is hard to insure and it's a target for vandals. "A vacant house goes downhill fast," says Karen Rhodes, an associate with Happy Home Realty in Chattanooga, Tenn. Source: United Feature Syndicate