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   ARTICLE   |   From Scotsman Guide Residential Edition   |   February 2014

Tapering Expectations for 2014

New regulations and Fed policies will shape mortgage-business trends this year

Will the Federal Reserve taper off its quantitative-easing (QE) policy that has bolstered home values and kept mortgage interest rates low? Will new regulations brought by the Dodd-Frank Wall Street Reform and Consumer Protection Act dry up the credit for smaller borrowers and make it tougher for smaller lenders to compete? Are expectations for a robust housing market too optimistic? These issues could help, or hinder, the economy in general, and the housing market in particular, and mortgage originators and brokers should pay attention to them through the rest of this year.

Regulatory environment

New regulations that came into effect this past January could reduce loan options for smaller borrowers and harm smaller lenders, while steering more business to big banks. With the recent implementation of the qualified mortgage (QM) guidelines, lenders must analyze a prospective borrower’s ability to make the monthly mortgage on time and repay the loan.

Dodd-Frank brought two big changes. Beginning this past January, banks and mortgage companies were to be prohibited from approving residential mortgage loan requests for any borrower with debt-to-income ratios higher than 43 percent. Banks also were to limit the cumulative originating mortgage fees to no more than 3 percent of the total loan amount. The new 3 percent cap rate for combined banking fees, such as loan fees, title and appraisal, could reduce smaller loan options for borrowers. Many banks may be reluctant to offer smaller, $100,000 loans as they are confined by the cap to charge less fees.

QM policies also could restrict the smaller community banks’ lending options. Traditionally, community banks offered more flexible underwriting guidelines for property and business owners in their neighborhoods. Although community banks might worry about future litigation for refusing to lend to qualified buyers, they could be even more concerned about offering loans to less-than-perfect borrowers.

Another consequence of tighter regulations is that the big banks, such as Bank of America, JPMorgan Chase and Wells Fargo & Co., may pick up a bigger share of the residential lending business. That’s partly because big banks can handle substantial lawsuits over violations of QM policies linked to the Consumer Financial Protection Bureau (CFPB) and Dodd-Frank.

With even more challenging QM regulations, the top five financial institutions may fund a higher percentage of residential loans nationwide. With less competition from small to midsized banks, the big banks might be able to charge higher rates and fees. Consumers tend to be hurt when the access to capital is tightened.

Seller financing

Dodd-Frank created new rules for seller financing, potentially making it harder for seller lenders that want to carry a first mortgage or offer creative wraparound mortgages to prospective buyers, such as contracts for deed or all-inclusive deeds of trust.

Seller lenders can no longer offer a residential mortgage loan without first making a reasonable and good-faith determination that the customer has the ability to repay the loan. The seller also has to meet the following guidelines before offering terms:

  1. The seller did not build the home.
  2. The loan must be fully amortizing. Balloon payments are prohibited.
  3. The loan must have a fixed interest rate for five years.
  4. The loan also must meet other guidelines established by the Federal Reserve Board.

Seller lenders are exempt under Dodd-Frank if they sell less than three properties each year.

Sadly, the Dodd-Frank regulations of 2010, 2013 and 2014 have restricted options to buy and sell residential properties with either conventional or nonconventional forms of financing offered by banks and sellers. The boom-and-bust housing cycle over the past 100 years has followed the same pattern. In upswings, buyers have easy access to credit, while in downswings they do not. The vast majority of home-buyers need financing options to purchase their homes.

This past year, the Federal Housing Administration’s (FHA) loan fees increased a few times, with the FHA citing high default rates in mortgage loans nationwide as a reason. FHA loan losses were so significant that FHA sought a $1.7 billion government bailout this past October to stay afloat. Government-backed or insured loans, such as those from FHA, the U.S. Department of Veteran Affairs, the U.S. Department of Agriculture, Freddie Mac, and Fannie Mae, made up as much as 97 percent of all funded residential mortgage loans in recent years. Higher FHA fees and rates may reduce the availability of capital for potential borrowers.

Quantitative easing

The Fed’s QE strategies bolstered home values in the past two years. After seemingly creating money out of thin air, the Fed and its affiliated financial institutions and investment groups were able to purchase trillions of dollars of stocks, bonds and mortgages.

The Fed has been the primary buyer of stocks, bonds and mortgages for several years now. The Fed’s desire to purchase more U.S. Treasuries drove down the 10-Year Treasury Yields. This paralleled declining 30-year, fixed mortgage rates. QE polices had a net positive effect on the stock market, moving the Dow Jones Industrial Average higher than 15,000 points this past May.

Home prices increased by double digits in some areas. In some of the “bubble state” regions, such as California, Nevada and Arizona, home prices shot up 20 percent to 35 percent in less than a year. This came about because of record, or near-record, low mortgage rates, an artificially suppressed home-listing inventory, and an increasing number of all-cash buyers. This group included individuals, hedge funds, investment companies and foreign investors. These buyers accounted for as much a 50 percent of all homebuyers in some regions.

When Fed Chairman Ben Bernanke said several times this past year that the Fed could curtail QE policies to reduce the cash infusion, stock prices began to fall and mortgage rates increased. QE policies are a double-edged sword. If the Fed doesn’t purchase more stocks, bonds and mortgages in the secondary market, then asset prices may decline rapidly. Yet, hyperinflation may continue to worsen as the dollar’s purchasing power falls as a result of QE policies.

Is asset deflation or hyperinflation worse for America? It all depends upon one’s perspective and personal financial situation. Investors who own stocks and real estate may love QE policies because these financial strategies are improving their net worth in the short term. Others may not appreciate that the price of gasoline, food and other consumer goods has increased rapidly in recent years because of a weakening dollar.

Market sentiment

Can home prices continue to increase by double digits through 2015 to stay on pace with the rate in the past two years in many regions? Is another boom cycle even desirable?

The home-price swings since 2001 have been extreme. In some years, home prices increased 20 percent to 30 percent or more. In other years, in 2008 for example, prices dropped between 30 percent to 40 percent in Southern California and other regions. These price fluctuations have been quite stressful for many Americans.

Mortgage brokers and originators may hope for more stability in the financial and real estate markets instead of the extreme boom-and-bust cycles over the past decade. If the economy strengthens with improving employment, less government spending, and better access to capital sources and investment options, then we soon may see a more stable U.S. economy once again.

Although it may be wise to taper optimism about the economy this year, mortgage professionals shouldn’t be overly pessimistic. Investment opportunities are readily available in both boom and bust times, so all must keep their eyes and ears open for the best potential deals in their regions. 


 
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