No it’s not déjà vu, or Groundhog Day. Guaranteed Rate has launched yet another 1% down payment mortgage in the span of about a month.
However, their new “Double Match” loan program is quite a bit different than their previously announced 1% down mortgage that relied on a grant from the City of Chicago and Chicago Infrastructure Trust (CIT).
Guaranteed Rate Double Match Mortgage Available Nationwide
This is yet another 1% down home loan
That relies upon a 2% grant from the mortgage lender
The result is a 97% LTV mortgage (3% down)
That fits the agency guidelines of Fannie Mae and Freddie Mac
For one, the Double Match program is available to home buyers nationwide, not just in the city of Chicago.
One thing that is the same is the down payment requirement, which is set at a low, low 1%. That’s right, you just need 1% of the purchase price to get into the home.
It’s a 97% LTV mortgage, meaning it qualifies for backing from Fannie Mae and Freddie Mac, but you only have to come up with 1% of the total 3% down payment.
The other 2% is a “completely forgivable” grant that doesn’t need to be paid back, even if the buyer moves or refinances their mortgage. They claim this is unlike other down payment assistance programs.
I asked Guaranteed Rate for specifics regarding the grant and was told the following via their communications department:
Guaranteed Rate is providing the grant
There is no waiting period to get it
And no penalty if borrowers sell or refinance
This seems to mirror a similar loan program recently launched by United Wholesale Mortgage via the broker channel that gifts 2% of the home purchase price.
It also seems to be a trend in the mortgage world – despite max LTVs capping out at 97%, many lenders are getting creative to stretch it to an effective 99% LTV, which clearly isn’t far from the days of zero down financing.
[Check your local credit union for 100% LTV mortgages.]
Double Match Mortgage Guidelines
The biggie here is a minimum 680 FICO score
Which is significantly higher than the 620 score required
For the 3% down loan program offered by Fannie and Freddie
The maximum loan amount is also set at the conforming limit
And while property types can vary, it must be owner-occupied and likely a single unit
As mentioned, the loan program appears to run on the back of the Fannie or Freddie loan programs, such as the Home Possible Advantage.
However, there are some lender overlays specific to Guaranteed Rate, such as a minimum FICO score requirement of 680, which is significantly higher than the 620 required by Fannie/Freddie.
Of course, 99% LTV presents more risk to lenders, so requiring a good credit score (not great or excellent by any means) is probably a prudent measure.
The maximum loan amount is also set at the conforming limit of $453,100, and there are income limits depending on where the subject property is located.
Allowable property types include single-family homes, condos, and townhomes, and all must be owner-occupied. I’m assuming they all must be one-unit as well.
The Double Match program can also work in conjunction with a Mortgage Credit Certificate if you want to save even more money on mortgage interest.
Speaking of mortgage interest, I have no idea what the mortgage rates are like on this program, or if mortgage insurance is paid separately or built into the rate. My assumption is that rates will be higher than 97% LTV mortgages to account for risk.
If you’re interested, reach out to Guaranteed Rate to get more details. They originate mortgages in all 50 states and have local offices all over the place.
For the record, Guaranteed Rate is now the eight largest retail mortgage lender in the country.
Have you ever thought about doing a cash-out refinance on your home for investment?
A lot of people have.
I received exactly this question from a reader.
Reader Question
Hi Jeff,
Thanks for your videos and educational websites!
I know you are very busy and this may a simple answer so thank you if can take the time to answer!
Would you ever consider approving someone to taking a cash-out refi on the equity in their house to invest?
I have been approved for a VA 100% LTV cash-out refi at 4% and would give me 100k to play with.
With average ROI on peer to peer, Betterment, Fundrise, and S&P 500 index funds being 6-8%, it seems like this type of leveraging would work. However, this is my primary residence and there is an obvious risk. I could also use the 100k to help buy another property here in Las Vegas, using some of the 100k for a down and rent out the property.
BTW, I would be debt free other than the mortgage, have 50k available from a 401k loan if needed for an emergency, but with no savings. I have been told this is crazy, but some articles on leveraging seem otherwise as mortgages at low rates are good at fighting inflation, so I guess I am not sure how crazy this really is.
I would greatly appreciate a response and maybe an article or video covering this topic as I am sure there are others out there who may have the same questions.
My Thoughts
But rather than answering the question directly, I’m going to present the pros and cons of the strategy.
At the end, I’ll give my opinion.
The Pros of a Cash-Out Refinance on Your Home For Investment Purposes
The reader reports he’s been told the idea is crazy.
But it’s not without a few definite advantages.
Locking in a Very Low-Interest Rate
The 4% interest rate is certainly attractive.
It will be very difficult for the reader to borrow money at such a low rate from virtually any other source. And with rate inching up, he may be locking into the best rates for a very long time.
Even better, a home mortgage is very stable debt. He can lock in both the rate and the monthly payment for the length of the loan – presumably 30 years. A $100,000 loan at 4% would produce a payment of just $477 per month. That’s little more than a car payment. And it would give him access to $100,000 investment capital.
As long as he has both the income and job stability needed to carry the payment, the loan itself will be fairly low risk.
So far, so good!
The Leverage Factor
Let’s use an S&P 500 index fund as an example here.
The average annual rate of return on the index has been right around 10%.
Now that’s not the return year in, year out. But it is the average based on nearly 100 years.
If the reader can borrow $100,000 at 4%, and invest it and an average rate of return of 10%, he’ll have a net annual return of 6%.
(Actually, the spread is better than that, because as the loan amortizes, the interest being paid on it disappears.)
If the reader invests $100,000 in an S&P 500 index fund averaging 10% per year for the next 30 years, he’ll have $1,744,937.That gives the reader a better than 17 to 1 return on his borrowed investment.
If everything goes as planned, he’ll be a millionaire using the cash-out equity strategy.
That’s hard to argue against.
Rising Investment, Declining Debt
This adds an entire dimension to the strategy. Not only can the reader invest his way into millionaire status by doing a cash-out refinance for investment purposes, but at the end of 30 years, his mortgage is paid in full, and he’s once again in a debt-free home.
Not only does his investment grow to over $1 million, but over the 30 year term of the mortgage, the loan self-amortizes down to zero.
What could possibly go wrong?
That’s what we’re going to talk about next.
The Cons of a Cash-out Refinance on Your Home
This is where the prospect of doing a cash-out refinance on your home for investment purposes gets interesting.
Or more to the point, where it gets downright risky.
There are several risk factors the strategy creates.
Closing Costs and the VA Funding Fee
One of the major disadvantages with taking a new first mortgage are the closing costs involved.
Whenever you do a refinance, you’ll typically pay anywhere from 2% to 4% of the loan amount in closing costs.
This will include:
origination fees
application fee
attorney fee
appraisal
title search
title insurance
mortgage taxes
and about a dozen other expenses.
If the reader were to do a refinance for $100,000, he would only receive between $96,000 and $98,000 in cash.
Then there’s the VA Funding Fee.
This is a mortgage insurance premium charged on most VA loans at the time of closing. It’s usually added on top of the new loan amount.
The VA funding fee is between 2.15% to 3.30% of the new mortgage amount.
Were the reader to take a $100,000 mortgage, and the VA funding fee set at 2.5%, he’d owe $102,500.
Now… let’s combine the effects of both the closing costs in the VA funding fee. Let’s assume the closing costs are 3%.
The borrower will receive a net of $97,000 in cash. But he will owe $102,500. That is, he will pay $102,500 for the privilege of borrowing $97,000. That’s $5,500, which is nearly 5.7% of the cash proceeds!
Even if the reader gets a very low-interest rate on the new mortgage, he’s still paid a steep price for the loan.
From an investment standpoint, he’s starting out with a nearly 6% loss on his money!
I can’t recommend taking a guaranteed loss – upfront – for the purpose of pursuing uncertain returns.
It means you’re in a losing position from the very beginning.
The Interest on the Mortgage May No Longer be Tax Deductible
The Tax Cuts and Jobs Act was passed in December 2017, and applies to all activity from January 1, 2018, forward.
There are some changes in the tax law which were not favorable to real estate lending.
Under the previous tax law, a homeowner could deduct the interest paid on a mortgage of up to $1 million, if that money was used to build, acquire or renovate the home. They can also deduct interest on up to $100,000 of cash-out proceeds used for purposes unrelated to the home.
That could include paying off high interest credit card debts, paying for a child’s college education, investing, or even buying a new car.
But it looks like that’s changed under the new tax law.
Borrowing up $100,000 for purposes unrelated to your home, and deducting the interest looks to have been specifically eliminated by the new law.
It’s now widely assumed that cash-out equity on a new first mortgage is also no longer deductible.
Now the law is still brand-new and subject to both interpretation and even revision. But that’s where it stands right now.
There may be an even bigger obstacle that makes the cash-out interest deduction meaningless, anyway.
Under the new tax law, the standard deduction increases to $12,000 (from $6,350 under the previous law) for single taxpayers, and to $24,000 (up from $12,700 under the previous law) for married couples filing jointly. (Don’t get too excited – personal exemptions are eliminated, and combined with the standard deduction to create a higher limit.)
The long and short of it is with the higher standard deduction levels, it’s much less likely mortgage interest will be deductible anyway. Especially on the loan amount as low as $100,000, and no more than $4,000 in interest paid.
Using the Funds to Invest in Robo-advisors, the S&P 500 or Peer-to-Peer Investments (P2P)
The reader is correct that these investments have been providing steady returns, well in excess of the 4% he’ll be paying on a cash-out refinance.
In theory at least, if he can borrow at 4%, and invest at say, 10%, it’s a no-brainer. He’ll be getting a 6% annual return for doing virtually nothing. It sounds absolutely perfect.
But as the saying goes, if it looks too good to be true, it probably is.
I often recommend all of these investments, but not when debt is used to acquire them.
That changes the whole game.
Whenever you’re thinking about investing, you always must consider the risks involved.
The last nine years have somewhat distorted the traditional view of risk.
For example, the stock market has been up nine years in a row, without so much as a correction of greater than 10%. It’s easy to see why people might think the returns are automatic.
But they’re not.
Yes, it may have been, for the past nine years. But if you look back further, that certainly hasn’t been the case.
The market has gone up and down, and while it’s true that you come out ahead as long as you hold out for the long term, the debt situation changes the picture.
Matching a Certain Liability with Uncertain Investment Returns
Since he’ll be investing in the market with 100% borrowed funds, any losses will be magnified.
Something on the order of a 50% crash in stock prices, like what happened during the Dot.com Bust and the Financial Meltdown, could see the reader lose $50,000 in a similar crash.
But he’ll still owe $100,000 on his home.
This is where human emotion comes into the picture. Since he’s playing with borrowed money, there’s a good chance he’ll panic-sell his investments after taking that kind of loss.
If he does, his loss becomes permanent – and so does his debt.
The same will be true if he invests with a robo-advisor, or in P2P loans.
Robo-advisor returns are every bit as tied to the stock market as an S&P 500 index fund is. And P2P loan investments are not risk-free.
In fact, since most P2P investing and lending has taken place only since the Financial Meltdown, it’s not certain how they’ll perform should a similar crisis take place.
None of this is nearly as much a problem with straight-up investing based on saved capital.
But if your investment capital is coming from debt – especially 100% – it can’t be ignored.
It doesn’t make sense to match a certain liability with uncertain investment gains.
Using the Funds to Buy Investment Property in Las Vegas
In a lot of ways, this looks like the most risky investment play offered by the reader.
On the surface, it sounds almost logical – the reader will be borrowing against real estate, to buy more real estate. That seems to make a lot of sense.
But if we dig a little deeper, the Las Vegas market in particular was one of the worst hit in the last recession.
Peak-to-trough, property values fell on the order of 50%, between 2008 in 2012. Las Vegas was often referred to as the “foreclosure capital of America”.
I’m not implying the Las Vegas market is doomed to see this outcome again.
But the chart below from Zillow.com shows a potentially scary development:
The upside down U formation of the chart shows that current property values have once again reached peak levels.
That brings the question – which we cannot answer – what’s different this time? If prices collapsed after the last peak, there’s no guarantee it can’t happen again.
Once again, I’m not predicting that outcome.
But if you’re planning to invest in the Las Vegas market with 100% debt, it can’t be ignored either. In the last market crash, property values didn’t just decline – a lot of properties became downright unsalable at any price.
The nightmare scenario here would be a repeat of the 2009-2012 downturn, with the reader losing 100% of his investment. At the same time, he’ll still have the 100% loan on his home. Which at that point, might be more than the house is worth, creating a double jeopardy trap.
Once again, the idea sounds good in theory, and certainly makes sense against the recent run-up in prices.
But the “doomsday scenario” has to be considered, especially when you’re investing with that much leverage.
Putting Your Home at Risk
While I generally recommend against using debt for investment purposes, I have an even bigger problem when the source of the debt is the family homestead.
Borrowing money for investment purposes is always risky.
But when your home is the collateral for the loan, the risk is double. You not only have the risk that the investments you’re making may go sour, but also that you’ll put your home at risk in a losing venture.
Let’s say he invests the full $100,000. But due to leverage, the net value of that investment has declined to $25,000 in five years. That’s bad enough. But he’ll still owe $100,000 on his home.
And since it’s a 100% loan, his home is 100% at risk. The investment strategy didn’t pan out, but he’s still stuck with the liability.
It’ll be a double whammy if the money is used for the purchase of an investment property in your home market.
For example, should the Las Vegas market take a hit similar to what it did during the Financial Meltdown, he’ll not only lose equity in the investment property, but also in his home.
He could end up in a situation where he has negative equity in both the investment property and his home. That’s not just a bad investment – that’s a certified nightmare!
It could even lead him into bankruptcy court, or foreclosures on two properties – the primary residence and the investment property. The reader’s credit would pretty much be toast for the next 10 years.
Right now, he has zero risk on his home.
But if he does the 100% cash out, he’ll convert that zero risk to 100% risk. Given that the house is needed as a place to live, this is not a risk worth taking.
Final Thoughs
Can you tell that I don’t have a warm, fuzzy feeling about the strategy? I think you figure it out by the greater emphasis on Cons than on Pros where I come down on this question.
I think it’s an excellent idea in theory, but there’s just too much that can go wrong with it.
There are three other factors that lead me to believe this is probably not a good idea:
1. The Lack of Other Savings
The reader reports that he has “…50k available from a 401k loan if needed for emergency, but with no savings.”For me, that’s an instant red flag. Kudos to him for having no other debt, but the absence of savings – other than what he can borrow against his 401(k) plan – is setting off alarm bells.
To take on this kind of high risk investment scheme without a source of ready cash, exaggerates all of the risks.
Sure, he may be able to take a loan against his 401(k), but that creates yet another liability.
That that will need to be repaid, and it will become a lien against his only remaining unencumbered asset (the 401k).
If he has to borrow money to stay liquid during a crisis, it’s just a question of time before the strategy collapses.
2. The Reader’s Risk Tolerance
We have no idea what the reader’s risk tolerance is.
That’s important, especially when you’re constructing a complex investment strategy.
While it might seem the very fact he’s contemplating this is an indication he has a high risk tolerance, we can’t be certain. He’s basing his projections on optimistic outcomes – that the investments he makes with the borrowed money will produce positive returns.
What we don’t know, and what I ask the reader to consider, is how he would handle a big reversal.
For example, if he goes ahead with the loan, invests the money, and finds himself down 20% or 30% within the first couple of years, will he be able to sleep at night? Or will he instead contemplate an early exit strategy, that will leave him in a permanent weakened financial state?
These are real risks that investors face in the real world. At times, you will lose money. And how you react to that outcome can determine the success or failure of the strategy.
This is definitely a high risk/high reward plan. Unless he has the risk tolerance to handle it, it’s best not to even start.
On the flip side, just because you have the risk tolerance, doesn’t guarantee success.
3. Buying at a Market Peak
I don’t know who said it, but when asked where the market would go, his response was “The market will go up. And the market will go down”.
That’s a fact, and one that every investor has to accept.
This isn’t about market timing strategies, but about recognizing reality.
Here’s the problem: both the financial markets and real estate have been moving up steadily for the past nine years (but maybe a little bit less for real estate).
Sooner or later, all markets reverse. These markets will too.
I’m worried that the reader might be borrowing money to leverage investing at what could turn out to be the absolute worst time.
Ironically, a borrow-to-invest strategy is a lot less risky after market crashes.
But at that point, everyone’s too scared, and no one wants to do it. It’s only at market peaks, when people believe there’s no risk in the investment markets, that they think seriously about things like 100% home loans for investments.
In the end, the reader’s strategy could be a very good idea, but with very bad timing.
Worst Case Scenario: The Reader Loses His Home in Foreclosure
This is the one that seals the deal against for me. Doing a cash out refinance on your home for investment is definitely a high-risk strategy.
Heads you’re a millionaire, tails you’re homeless.
That’s not just risk, it’s serious risk. We don’t know if the reader also has a family.
I couldn’t recommend anyone with a family putting themselves in that position, even if the payoff were that high.
Based on the facts supplied by the reader, we’re looking at 100+% leverage – the 100% loan on his house, then additional (401k) debt if he runs into cash flow problems. That’s the kind of debt that will either make you rich, or lead you to the poor house.
Given that the reader has a debt-free home, no non-housing debt, and we can guess at least $100,000 in his 401(k), he’s in a pretty solid situation right now. Taking a 100% loan against his house, and relying on a 401(k) loan for emergencies, could change that situation in no more than a year or two.
This is a guest post from CJ at WiseMoneyMatters.com. This post represents CJ’s viewpoints, which are not necessarily my viewpoints. (Although I, too, hope to pay off my mortgage early.)
Note: This is embarrassing. I don’t think I’ve ever had a post with an error like this slip by me before. I apologize. I’ve removed the offending section, not out of any attempt at revisionism, but out of interest in accuracy. Please let me know if the piece is still mathematically unsound. (And a sincere “thank you” to those who caught the error!)
The other day, I was telling my wife’s grandmother that we had sold our house. We are downsizing in order to eliminate our mortgage more quickly. It looks like we will have our mortgage completely paid off in three to five years, depending on when kids enter the scene. She gave me a speech about how our house is one of the only tax deductions we have, and how most accountants recommend you keep a mortgage payment for that reason.
I think this logic is misguided. Let me show you why.
The Standard Deduction
The 2009 standard deduction for married couples will be $11,400. That means in order to gain any benefit from tax deductions, your interest paid must exceed this number. In other words, you would have to pay $950 per month in mortgage interest (not principal) in order to see any tax benefit from your mortgage payment.
If you had a mortgage on a $200,000 house at 6.25%, you would be barely exceeding the standard deduction for the first few years, assuming the deduction never increases (which it usually does). After that, you would be better off taking the standard deduction assuming you receive no other deductions.
So, in reality, such a tax deduction would only be helpful in house purchases in which your mortgage is $200,000 or more. Anything else and it’s almost pointless.
J.D.’s note: As I usually do with articles like this, I asked my accountant for feedback. His response was: “This article seems accurate, but the author makes the assumption that an individual will only have mortgage interest to deduct when comparing to the standard deduction. Other items that are deductible include state income taxes, property taxes, and charitable donations.”
He also added: “You should not look at the tax savings as the reason to purchase a home. It is only one component, and a minor one at that.” Basically, he agrees with CJ.
A Poor Trade
If you do itemize deductions, you’re still paying more in interest than you’ll save on taxes. This is the second thing that people overlook.
If you are paying over $11,400 in interest, that does not mean that you are paying $11,400 less in taxes. It means that $11,400 of your income is not counted as taxable income.
Let’s say you’re in the 25% tax bracket. If you pay $20,000 in mortgage interest, it will save you $5,000 in taxes. $20,000 of your income does not count towards taxes. Effectively, you are paying $15,000 to get your tax deduction. This is not the most financially sound advice I’ve ever heard. If you take such advice, I’ve got a really good deal. I will pay you $33 in exchange for $100. That’s the same type of financial advice as someone telling you that keeping a mortgage is a good thing for tax reasons.
The Risk Factor
The final benefit to paying off your mortgage is that it reduces financial risk to yourself.
Keeping a mortgage payment (and especially a high mortgage payment) is risky. In the unfortunate circumstance that you lose your primary source of income, your largest “asset” can quickly turn into your largest liability. This is a big reason why so many people are facing foreclosure these days. They got into a mortgage payment they couldn’t afford (or could barely afford) and all of a sudden when a small hiccup comes up in life, they are living on the street. Emergency funds are important to help offset these risks, but to truly eliminate the risk, you should pay off your mortgage.
I’ve heard of people who took out mortgages on their homes during the housing bubble so that they could invest the money in stocks. They argued that you get the tax benefit and stocks appreciate quicker than a house. As we can see now, this is an unwise financial decision. Sure, you could make lots of money. You could also make lots of money by winning the lottery, but that doesn’t make it a wise retirement plan.
When it comes down to it, I would rather have the safety of knowing that if the economy crashed and I had to work at McDonald’s for the rest of my life, I could still survive just fine with my current lifestyle.
Final Thoughts
While I know there are a lot of variables and other tax deductions I didn’t cover here, I think it’s safe to say that the old notion that keeping a mortgage simply for its tax benefits is not the best advice you can get. When it comes down to it, get the financial advice of a professional regarding your individual situation but don’t simply take their word for it. Have them show you the numbers before you start throwing your money away. I’d argue that even if the numbers are close, the risk factor puts paying off the mortgage in a slightly better position than not.
I’d love to hear some comments or scenarios where keeping a mortgage is better than taking the standard deduction.
Americans’ bank accounts are under siege. Whether it’s a trip to the supermarket or a night out for dinner and a movie, the cost of just about everything seems to be on the rise.
So homebuyers are doing something about it. Frustrated by high home prices and rising mortgage interest rates, they’re increasingly seeking out more affordable places to live—like Lafayette, IN.
The Lafayette metropolitan area was named the top up-and-coming real estate market this spring, according to the quarterly Wall Street Journal/Realtor.com® Emerging Housing Markets Index. The top 20 markets are generally smaller cities offering cheap homes for sale, low costs of living, and strong job markets. The index highlights real estate markets that economists believe will be strong this year.
“We are continuing to see this shift in demand for less expensive markets, many of which are in Midwestern markets,” says Hannah Jones, an economic data analyst at Realtor.com. “They didn’t see the same kind of price growth that larger cities did during the [COVID-19] pandemic, so they maintained affordability.”
Not a single one of these real estate markets was in the West, the region with the highest home prices.
The index identified the top markets for both buyers and investors out of the 300 largest metropolitan areas. It looks at metros with strong housing demand based on page views of local listings, the number of homes for sale, property taxes, and median days homes sit on the market before a sale. It also factors in metros with robust economies, lots of well-paying jobs, a good quality of life, and desirable amenities such as lots of small businesses and reasonable commutes to work. (Metros include the main city and surrounding towns, suburbs, and smaller urban areas.)
The median home list price in the Lafayette metro was $289,000—about a third less than the national median of $424,000 in March, according to the most recent Realtor.com data.
The manufacturing hub of Lafayette, named after American Revolutionary War hero Marquis de Lafayette, is located about an hour northwest of Indianapolis and two hours southeast of Chicago. Big-name employers include Caterpillar, Subaru, and Wabash National Corp., which produces refrigerated truck trailers. It’s also home to Purdue University.
“Homes in Lafayette are significantly more affordable, and it has a strong economy,” says Jones.
Just two of the top 20 emerging markets—Manchester, NH, which has been consistently ranked as one of the nation’s hottest markets, and Knoxville, TN—had price tags above the national median. And just one market, Columbus, OH, the state capital and home to Ohio State University, had a population of more than 1 million.
“These are some of the only markets where locals and first-time buyers can afford to buy a home based on local salaries,” says Jones.
Top 20 emerging real estate markets in spring 2023
Lafayette, IN ($289,000 median home list price)
Bloomington, IL ($339,000)
Elkhart, IN ($275,000)
Lebanon, PA ($372,000)
Fort Wayne, IN ($339,000)
Topeka, KS ($249,000)
Sioux City, IA ($305,000)
Omaha, NE ($345,000)
Springfield, IL ($144,000)
Manchester, NH ($550,000)
Janesville, WI ($331,000)
Columbus, OH ($375,000)
La Crosse, WI ($334,000)
Johnson City, TN ($413,00)
Springfield, OH ($172,000)
Hickory, NC ($349,000)
Burlington, NC ($368,000)
Columbia, MO ($367,000)
Waterloo, IA ($263,000)
Knoxville, TN ($470,000)
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Watch: The Best Cities in the U.S. for Home Sellers Right Now
Kate Wood, home expert at NerdWallet, noted that it’s not a tremendous surprise. “Mortgage interest rates rose in March, so it makes sense that fewer buyers signed contracts,” she said. “Affordability is already a major challenge due to higher home prices, and every time interest rates increase, the situation gets harder for buyers.” The trade … [Read more…]
Does this sound disturbingly familiar? Skyrocketing home prices have very suddenly leveled off. Recession fears are swirling. The number of home sales has dropped. Is it 2006—the year that saw the ramp-up to America’s housing crash two years later—all over again?
Just like in the mid-2000s, experts are adamant that the correction in the housing market is simply that: a correction and not a catastrophe. Many news reports from early 2006, which often downplayed the risk of a severe housing crash, seem like they could be written about what’s happening today.
But back then, the pundits were wrong. We all know that a housing bubble burst, ushering in the Great Recession and taking down the global economy with it. Hindsight is 20/20.
So is the housing market in for a repeat performance? Or is this just some temporary pain for both buyers and sellers?
“Parallels can be drawn because of how quickly home prices have risen over the past few years,” says Yelena Maleyev, an economist at KPMG. “But that’s where the comparisons would end.”
Housing experts are quick to point out that the foundation of today’s housing market is stronger than it was in the mid-2000s. This time the downturn is due to higher mortgage interest rates, which rose rapidly from below 3% in 2021 to the high 6% range.
Today’s buyers have monthly mortgage payments that are basically double what they were just before the COVID-19 pandemic began. So many aren’t buying, or they’re unable to bid up prices like they did over the past few years.
But the most important difference between then and now is there are many more buyers than there are homes available this time around. The acute housing shortage will likely keep prices from falling off a cliff.
During the Great Recession, there were plenty of available homes—and no one to purchase them—so prices dropped about 26% over five years for existing homes. Today, buyers are still willing to bid over the asking price for move-in ready homes in desirable neighborhoods despite the financial challenges they face.
In addition, mortgages made over the past few years are much safer than those made nearly 20 years ago when lenders joke that their dogs could have gotten loans. The worst of the subprime mortgages that got homeowners in trouble when their payments suddenly doubled—or even tripled—have largely been eradicated. Borrowers have been thoroughly vetted, and only the strongest have been approved. And today’s homeowners are generally sitting on record amounts of equity.
“There are a lot of similarities that we should not ignore just because this time is different. … We do have some of our fundamentals that are out of whack,” says Ali Wolf, chief economist of the building consultancy Zonda. “But I don’t think it’s going to be a crash because the undersupply of homes is so different.”
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Watch: The Best Cities in the U.S. for Home Sellers Right Now
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Will home prices crash?
The question on the minds of homebuyers, sellers, and homeowners is what is going to happen with home prices.
They’ve already come down from their peaks last summer, which is typical. But they’ve also dipped a bit in some of the markets that got the most heated during the pandemic.
That’s reflected in the new-construction data from John Burns Real Estate Consulting. The price of newly built homes in Phoenix fell 15% year over year in March, according to the data. (The price includes incentives and concessions.)
In Boise, ID, another pandemic destination, prices were down 14% year over year for newly constructed homes. Prices dropped 10% in San Antonio, TX, just outside of Austin.
“It’s substantial,” says Devyn Bachman, senior vice president of research and operations at John Burns.
These places where prices rose the most or were extremely expensive to begin with might be the most vulnerable to larger price corrections, says Lisa Sturtevant, chief economist of Bright MLS. That includes the priciest parts of many housing markets, such as the downtowns of large cities.
Even with the affordability challenges, more than half of the sellers in the mid-Atlantic region received multiple offers in March, according to Sturtevant. About a third of all of the home sales went for more than the list price.
And home prices could continue to rise in the more affordable markets, such as in the Midwest. Homes in the lower price tiers could also see prices go up. Demand is so high for those more affordable properties that the competition often results in higher prices.
“We should expect some price corrections, not a price crash in these places where prices ran up the fastest,” says Sturtevant. “Everything seems to be slowing down a little bit … but everything still seems very competitive.”
The shortage of homes for sale is also keeping prices high. Builders have slowed down construction as their pool of buyers has dried up. And homeowners who would have listed their homes have been reluctant to do so thanks to the high mortgage rates. Most sellers are also buyers, many of whom will need to get a new mortgage at today’s rates. That means significantly higher monthly payments.
“Are there enough homes on the market for sale today? No,” says Matthew Gardner, chief economist at Windermere Real Estate. The Seattle-based brokerage covers much of the Western U.S. “Who is going to sell their home when they’re comfortably sitting on mortgage rates that are around 3%?”
Could higher mortgage rates deliver a death blow to the housing market?
Low mortgage rates were the fuel that caused the housing market to catch fire during the pandemic. Low rates meant buyers had more purchasing power—and could afford to bid higher than they otherwise would have. But when they rose, and buyers could no longer afford to buy, the housing correction commenced.
If the U.S. Federal Reserve keeps raising its rates to combat high inflation, mortgage rates are likely to keep climbing. That could scare off and price out additional buyers and put pressure on home prices to come down.
But many real estate professionals don’t anticipate mortgage rates to zoom up. They largely expect them to stay about where they are now—in the mid-6% range—at least through this spring.
Important to note: Historically, a 6% mortgage rate is relatively low. It’s a lot better than the peak of about 18.6% in September 1981, according to Freddie Mac data. The problem is home prices are high and memories of rates below 3% are fresh in the minds of many recent homebuyers and sellers. For every percentage point rise in rates, buyers can afford a whole lot less house.
Even though higher rates have led to a correction in the market, there are still buyers around the country queueing up at open houses.
“People have figured out how to make these mortgage rates work. They’re just looking for something to buy,” says Sturtevant.
Could there be another wave of foreclosures?
Foreclosures have been ticking up as pandemic-era moratoriums aimed at preventing homeowners from losing their properties have expired. But another tidal wave of foreclosures, like what happened during the 2000s, isn’t likely.
In the 2000s, “we had a huge amount of people using adjustable-rate mortgages with remarkably low interest rates. And there were also people who quite frankly should not have gotten a mortgage,” says Gardner, of Windermere. But when mortgage rates rose, “people found their mortgage payments doubling overnight and they had next to no equity. So what did they do? They walked away.”’
About 40% of homeowners currently own their homes outright without a mortgage, according to KPMG’s Maleyev. Many homeowners have record amounts of equity in their properties thanks to the rising prices over the past few years. So if they were having trouble making their mortgage payments, they choose to sell their homes instead—and often walk away with a profit. And most homeowners who have mortgages have 30-year fixed-rate loans, which don’t balloon in size over time.
There were more adjustable-rate mortgages in the early 2000s. So when mortgage rates ticked up and borrowers’ payments ballooned, “it didn’t take very much to burst that housing bubble,” says Maleyev.
Now, many real estate experts believe the nation is headed right into a recession—or will it be a near miss? A downturn with steep job losses would likely result in unemployed homeowners losing their abodes.
It would also discourage many folks, even those who remain employed, from purchasing property. Buying a home is typically the largest transaction that most people will ever make. And many people won’t feel comfortable doing so if they’re worried about the stability of their jobs.
“We will likely see some effects on the housing market going forward,” says Bachman, of John Burns. “Any time you lose jobs, there’s less demand for housing, for sale and for rent.”
But few expect another downturn would cut as deep as the Great Recession—or last nearly as long. Once the Fed gets inflation under control, it’s expected to cut rates to combat any turbulence in the economy. That will likely lead to lower mortgage rates, giving the housing market a boost. Many economists believe the housing market will begin recovering as early as next year, if not the year after that.
“It’s not the calm before the storm,” says Gardner. “This was just an important reset in the housing market.”
While there are a number of factors that determine what mortgage interest rate you’ll qualify for, assuming you can indeed qualify for a mortgage, perhaps the most important one is credit score.
Why? Well, for one, a credit score can make or break you entirely. If your score isn’t at a certain level, you may be barred from home loan financing, regardless of your stellar income, awesome job, and astronomical asset situation.
Credit Score Can Make or Break Any Borrower
It doesn’t matter how rich you are
Or how large your down payment is
Without a solid credit history
You’ll still pay the price or get flat out denied
In other words, even if you have $1 million in the bank and a six-figure salary, a low credit score can completely bar you from certain popular home loan programs.
For example, you need a minimum FICO score of 580 to get an FHA loan with just 3.5% down, and a minimum 620 score to get a loan backed by Fannie Mae or Freddie Mac.
These three entities account for the overwhelming majority of mortgages originated today, so if your score is below those thresholds, you severely narrow your options.
Even if you are able to obtain mortgage financing, you may be limited as far as what you can get your hands on.
In other words, your max loan-to-value ratio may be reduced if your credit score is below average, and you may only qualify for a conforming mortgage versus a jumbo loan.
And even then, you’ll probably be stuck with a mortgage rate that is well above the market average, which surely isn’t good news.
[How to get a mortgage with a low credit score.]
Now let’s take a look at an example of what you might pay for a 30-year fixed-rate mortgage based on credit score, all other things being equal.
How Things Look with a Good Credit Score
Loan amount: $300,000 Credit score: 760 Mortgage rate: 4.25% Monthly mortgage payment: $1475.82 Total interest paid over loan term: $231,295.20
How Things Look with a Mediocre Credit Score
Loan amount: $300,000 Credit score: 650 Mortgage rate: 5.00% Monthly mortgage payment: $1610.46 Total interest paid over loan term: $279,765.60
As you can see, your mortgage payment could be an extra $100 each month if you happen to have a mediocre credit score. Not even a bad credit score, just mediocre folks.
On top of that, you’ll pay an additional $50,000 or so in interest over the life of the loan term, all because you didn’t stay on top of your credit score. Or check it before applying for a mortgage. Oops…
[What mortgage rate can I expect?]
This is why it’s imperative to check your scores and manage your credit wisely before you begin shopping for a mortgage.
Many other mortgage pricing factors may be out of your hands, such as down payment and property type, as they can’t really be manipulated.
But there’s no excuse for a poor credit score. If it’s not in good shape, it’s nobody’s fault but your own.
How to Ensure Your Credit Score Is Tip Top
Pay every bill on time, every month
Keep outstanding credit card and loan balances low
Avoid applying for new credit cards and other loans
Several months before applying for a mortgage
If you plan on applying for a mortgage anytime in the near future, your first step would be to avoid applying for any new credit, as doing so can lower your score. I have proven this myself.
Along with that, it’s advisable to keep existing credit card balances low, and even pay them down some, assuming it won’t affect the assets you have set aside for the mortgage.
Finally, be sure to make all payments on time, each and every month. Doing so will ensure your credit score remains in good health. It’s not really that complicated, it just takes discipline.
And as a rule of thumb, it’s also wise to pull your credit report several months before you apply for a mortgage to ensure your credit scores are where they should be. If they aren’t, it’ll take time to whip them into shape!
Read more: What credit score is needed for a mortgage?
While there are some specific steps pertinent to those using their VA loan benefits, the overall process is similar for all homebuyers.
The good news? It’s not complicated.
The VA home program has allowed millions of veterans, active-duty service members and surviving spouses to purchase or refinance homes. If all of those fellow military members managed it, so can you.
Check your VA home buying eligibility. (May 1st, 2023)
VA Home Loan Program Offers Valuable Benefits
VA loans are backed by the U.S. Department of Veterans Affairs and offer considerable benefits for eligible borrowers. Some of the most valuable aspects of the VA home loan benefit include:
Low or zero down payment
Competitively low mortgage interest rates
No private mortgage insurance (PMI)
12 Steps To Buy a Home With a VA Loan
1. Work out what you can afford
The first step toward your home purchase is determining what you can afford to spend. This involves taking a close look at your household budget.
Once you know where your money is going each month, you’ll have a sense of your potential buying power and the monthly mortgage payment amount you can handle. Keep in mind that homeowners have extra expenses including property taxes, homeowner’s insurance and home repairs.
Creating a budget isn’t a requirement for loan qualification, but it makes you a more informed consumer.
2. Get pre-approved
Getting pre-approved gives you “serious buyer” status in the eyes of sellers and real estate agents. It means you’ve talked to a mortgage lender who has run your finances.
Getting pre-approved includes establishing your eligibility for a VA loan, checking your credit, confirming your income, and working out how big a mortgage you can afford.
Once completed, the lender sends you a letter confirming your loan amount. This means sellers and agents take you way more seriously. And, gives you an advantage when negotiating the price, especially when up against other potential buyers who aren’t approved.
Don’t get confused between pre-approval and pre-qualification. Pre-qualification is better than nothing, but it only means the lender asked you a few questions and relied on your answers (with zero verification) to estimate how much you can borrow. It’s less credible than pre-approval.
VA Loan Eligibility Requirements & Your Certificate of Eligibility (COE)
Your mortgage lender can help you request your Certificate of Eligibility (COE), a document that establishes your VA loan eligibility. Your COE includes information about your military service (confirming you meet the VA’s service requirements), along with the amount of your VA loan entitlement and your VA funding fee.
3. Shop for lenders
You may think all VA loans are the same. While these loans are government-backed, your loan will be issued by a private lender. Some lenders offer great deals and others less great — or flat-out bad.
You should shop around between lenders to find the very best deal for you. But, it’s not just us saying that.
Last year, the Consumer Financial Protection Bureau (CFPB) wrote:
Mortgage interest rates and loan terms can vary considerably across lenders. Despite this fact, many homebuyers do not comparison shop for their mortgages. In recent studies, more than 30 percent of borrowers reported not comparison shopping for their mortgage, and more than 75 percent of borrowers reported applying for a mortgage with only one lender. Previous Bureau research suggests that failing to comparison shop for a mortgage costs the average homebuyer approximately $300 per year and many thousands of dollars over the life of the loan.”
Lenders are required to send you a loan estimate detailing everything you need to know about the mortgage you’re being offered. The CFPB has an exceptionally helpful guide about how to read these — and how to compare them.
Read more: Questions To Ask Before Picking A Lender.
4. Find a reputable buyer’s real estate agent
Usually, as a buyer, retaining a real estate agent costs you nothing. This is because sellers generally pay the buyer’s real estate agent’s commissions. Not every buyer has an agent, but it’s a good idea. Your real estate agent can be one of your greatest assets throughout the transaction. (Just don’t use the same one the seller is using. Their first duty is to the seller.)
A good real estate agent helps you with the following:
Finding your dream home
Negotiating the best possible purchase deal
Completing the buying paperwork
Guiding you throughout each step of the transaction
Troubleshooting any issues
5. Find your home
This is the fun part: picking out your new home.
Depending on your local real estate market, it may take time to find the right property.
Think ahead about your future needs as well as your existing ones. Choose a home that meets your requirements for many years to come if possible and realistic.
Don’t be tempted by a quick-fix purchase with the expectation that you can move again in a few years. Buying and selling a home is expensive and the real estate market unpredictable — you don’t want to do it more often than you absolutely have to.
6. Make an offer
This is the moment when a good real estate agent proves most valuable. So listen to their advice.
It’s a real estate agent’s job to get you the best deal and they should have the knowledge and expertise to achieve that. So leave the negotiations up to them. Of course, your real estate agent should talk through tactics with you. Basically, how to pitch an offer that won’t alienate the owner but will have you paying the smallest amount possible.
Your real estate agent will also advise you on any “contingencies” that should be included in your offer. These are items that allow you to walk away at no cost if certain eventualities arise like an inspection contingency (if the home inspection uncovers unexpected issues) or a finance contingency (in case your mortgage loan has problems). There may be others as well.
7. Pay earnest money
You’ll typically be expected to pay earnest money when your offer is accepted. Your agent can negotiate the amount, but expect to pay between 1 to 5 percent of the purchase price.
As its name implies, earnest money indicates to the seller that you’re a serious (aka earnest) buyer. This isn’t lost money, though. You’ll get it back either as a deduction from your closing costs, or if your closing costs are covered by a third party, you’ll be refunded the amount.
8. Get a home inspection
Home inspections aren’t required to purchase a home, but they’re highly recommended — especially if you’re buying an older home. A home inspection gives you a top-down evaluation of the home and property, including the roof and home exterior, and shouldn’t be confused with a VA home appraisal.
Typically, you can back out of your offer and receive your earnest money back as long as there is an “inspection contingency” written into the purchase contract.
The VA home appraisal is required for a VA home loan and is arranged by your VA lender. It evaluates the property according to the VA’s minimum property requirements (MPRs) and is intended to protect you from purchasing a property that isn’t safe, sound, and sanitary; it also establishes a fair value of the property.
Read more: VA Appraisal & Home Inspection Checklist
9. Update your lender documentation
Every document used to approve your loan must be the most recent. Ultimately, your lender will ask for what it needs, but you can avoid delays by having it all ready in advance. Gather copies of your personal documents, including your latest pay stubs and bank statements.
You’ll also send a copy of the signed purchase contract to your lender. This allows your lender to order the VA appraisal and update your loan application with the address for your next home.
At this point, you may be asked to sign mortgage disclosure documents. These are sent to you by your lender and lay out the terms of your loan in detail — terms may have changed now that a specific home was found and purchase price agreed upon.
Read more: VA Mortgage Loan Document Checklist
10. Meet your lender’s underwriting conditions
Once it has all the required documentation, your lender submits your application to its underwriting department. This is the final step to officially approve your mortgage loan. It’s not uncommon for underwriters to request more information — called conditions — at this stage. Usually, additional documentation is all that is needed.
After the underwriter gives final loan approval, your lender sends your final loan documents to an escrow company.
11. Sign the final paperwork
You’ll likely go to the escrow agent’s office to sign all the final paperwork. Review all the documents carefully. Compare your most recent loan estimate with the closing disclosure. (Closing disclosures provide a final breakdown of all your loan’s details, including “projected monthly payments, and how much you will pay in fees and other costs to get your mortgage (closing costs),” according to the CFPB.)
If there are discrepancies between your closing disclosure and your last loan estimate, your lender must justify them. While some costs can increase at closing, others legally can’t. Call your lender immediately if something doesn’t look right.
If you need to pay any closing costs, you’ll pay those at this time too. Bring a cashier’s check or other certified funds to the escrow office when you sign your documents; your escrow company provides the total amount needed.
12. Monitor the status of your loan
Unfortunately, your loan is not complete when you sign the documents. Your lender could take up to a week or more to finalize your loan and transfer the money. Once the lender funds the loan, the seller and all other parties are paid. (The final step: when the transaction is recorded in your jurisdiction’s official records.)
You might think now’s the time to relax. You can, soon. But, not quite yet.
Few home buyers realize that lenders routinely carry out a second (or third) credit check before closing. If your credit score has taken a hit, your lender could cancel your loan — or increase your mortgage rate. That means no late payments and no new credit cards until the loan process is complete.
Buy a home one step at a time
If you’re just getting started, then consider the VA loan program. VA loans can save you a lot of money and make your homeownership dreams come true.
VA loans typically come with lower interest rates than most other mortgages. The ICE Origination Insight Report shows they’re consistently lower than FHA and conventional loan interest rates. VA home loans also require zero money down and no continuing private mortgage insurance.
See if you’re eligible for a VA home loan (May 1st, 2023)
With mortgage rates nearly double what they were in 2021, homebuyers are getting hit with a double whammy.
Higher interest rates have increased home-financing costs. At the same time, homeowners are hesitant to move and give up their low mortgage rate, which contributes to the housing inventory shortages keeping home prices high.
One potential solution is assumable mortgages, where the buyer takes over the seller’s existing loan and keeps its interest rate and repayment terms. Approximately 85% of properties have loans with a mortgage interest rate below 5%, according to Redfin. This represents a potential for significant savings for buyers and could make it easier for owners to sell their homes — but assumable mortgages also come with some catches. Let’s take a look at how they work and when this home-financing strategy could make sense for you.
How do assumable mortgages work?
With an assumable mortgage, the buyer takes over the seller’s mortgage and keeps its interest rate, remaining payment schedule and loan balance. When rates are increasing, assuming an older mortgage loan can be a great way to secure a mortgage rate that’s far below what you could qualify for if you applied for a new home loan.
To assume a loan, the buyer must meet the lender’s qualification standards. This process is essentially the same as applying for a standard mortgage — the lender reviews the buyer’s credit history, debt-to-income ratio (DTI) and other financial information. Because an appraisal of the home isn’t typically required, the application process usually moves quicker than normal and can be less expensive in terms of fees.
However, you have other factors to consider before building your homeownership dreams around assuming a mortgage with a 3% interest rate. For one, most mortgages aren’t assumable. Typically, only government-backed loans are assumable and the majority of mortgage loans are conventional. During the past three years, government-backed loans have only accounted for roughly 18% to 26% of residential loan applications, according to the Mortgage Bankers Association’s Weekly Applications Survey.
If you want to assume a mortgage, the seller needs to have one of the following types of mortgages:
Pros and cons of assuming a mortgage
Assuming an existing mortgage means balancing the benefits with the tradeoffs. On one hand, assuming a mortgage can be a cost-effective way to finance a home purchase. But It can also significantly increase your down payment.
Pros
A potentially lower mortgage rate
Can have lower fees
Easier to find a buyer (when you’re ready to sell)
For a buyer, the advantages of an assumable mortgage are obvious, especially when rates are rising. And if the loan has lower upfront fees, it’s an even better deal for the buyer.
Sellers with an assumable loan carrying a favorable interest rate may attract a larger pool of potential bidders. It’s like having an extra bedroom, says Ted Tozer, a nonresident fellow at the Urban Institute’s Housing Finance Policy Center. “It’s something that differentiates you from the marketplace.” And to get a hold of that cheaper mortgage loan, buyers may make higher offers on the property.
Cons
May need a second mortgage with its own upfront fees
May require a bigger down payment
Aside from the fact that most home loans aren’t assumable, there’s another big reason why assumable loans aren’t more popular — the down payment.
Government-backed loans usually have smaller down payment requirements. VA loans and USDA don’t require any down payment and you can get an FHA loan for as little as 3.5% down. But you’ll need to make a much larger down payment — at least 15 %, according to Tozer — when assuming one of these loans.
The reason is, an assumable loan rarely covers the full purchase price of the house. That means the buyer needs to come up with the difference. Part of the price difference could be covered by a second mortgage, but second mortgages are riskier for lenders (because if you default, the first mortgage gets paid before the second). So a second mortgage will typically only cover up to 85% of the value of the home. That means the buyer will have to pay the rest out of pocket.
An easy way to think of it is, when you combine the assumable loan, second mortgage and down payment, they need to equal the home’s purchase price. For example, if you assumed a $200,000 mortgage on a home that sold for $350,000 and then took out a second mortgage of $97,500, you would need to pay a down payment of $52,500 (350,000 – 200,000 – 97,500 = 52,000) to seal the deal.
Another factor to pay attention to is the cost of a second mortgage. These types of loans typically have higher interest rates than the first home loan that’s attached to a property and have additional upfront closing costs. So you’ll want to make sure the closing costs, monthly payment and mortgage rate on a second loan don’t outweigh the potential savings from assuming an existing mortgage. Also, it’s more difficult to qualify for a second mortgage because the lender assumes more risk than they would with a first mortgage.
How to find the best deal regardless of what mortgage you go with
It’s always important to shop around for a mortgage and compare offers from multiple lenders. That’s true whether you’re assuming a loan and shopping for a second mortgage or getting a brand new home loan.
When it comes to home loans, there’s a tradeoff between mortgage rates and fees. You may be able to get a lower interest rate if you pay higher fees and vice versa. Pay close attention to both and consider the best fit for your goals and budget. One way to potentially save on upfront costs is to compare quotes with lenders that don’t charge origination fees, like PenFed Credit Union or Ally Bank (although other fees apply).
Ally Bank Mortgage
Annual Percentage Rate (APR)
Apply online for personalized rates; fixed-rate and adjustable-rate mortgages included
Types of loans
Conventional loans, HomeReady loan and Jumbo loans
Terms
15 – 30 years
Credit needed
Minimum down payment
3% if moving forward with a HomeReady loan
Terms apply.
PenFed Credit Union Mortgage
Annual Percentage Rate (APR)
Apply online for personalized rates; fixed-rate and adjustable-rate mortgages included
Types of loans
Conventional loan, VA loan, FHA loan, Jumbo loan and adjustable-rate mortgage (ARM)
Terms
Not disclosed
Credit needed
Minimum down payment
3.5% if moving forward with an FHA loan
Keep in mind, not all lenders offer second mortgages. So if you’re looking for a second home loan to supplement an assumed mortgage, you may have to search more than you expected. But comparing a large number of lenders has other benefits as well because each one offers different types of mortgage loans.
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Bottom line
Mortgage loans backed by the government, like VA loans or FHA loans are usually assumable. When interest rates are rising, assuming an existing mortgage loan can allow buyers to secure lower-cost financing.
However, the buyer may need to secure a second mortgage on the property and make a larger down payment to close the deal. These extra upfront costs may not be in your homebuying budget, especially if you’re a first-time buyer relying on a low- or no-down-payment loan.
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Editorial Note: Opinions, analyses, reviews or recommendations expressed in this article are those of the Select editorial staff’s alone, and have not been reviewed, approved or otherwise endorsed by any third party.
I saw the news about the new FHFA lending fee structure for Freddie Mac and Fannie Mae and thought, as usual, things were being blown out of proportion. Then I saw the table for the new fees and I could not believe how they have made it more expensive for high-down-payment borrowers than low-down-payment borrowers. I don’t mean the fees decreased for low down payment mortgages and are closer, but still lower than high down payment mortgages. The total LLPA fees are lower across the board for those who put 5% down or less than those who put 20 percent down.
What are FHFA and LLPA Fees?
LLPA stands for loan level pricing adjustment. They are fees that were put in place after the 2008 crash to help Freddie and Fannie Mae stay solvent during another downturn. The Fees are applied on most conventional mortgages and were set high for low down payment and low credit borrowers because those borrowers are more likely to default. If the fees are higher the banks will typically raise the interest rate on those loans. In the past, people with high credit and high down payments paid lower fees and had lower interest rates.
FHFA is the Federal Housing Finance Administration. FHFA announced that they changed the fee structure in April and has received a ton of backsplash after many sources claimed mortgages for high credit and high down payment borrowers would be more expensive than mortgages for low credit and low down payment borrowers. This is not exactly true in all cases, but it is true that the interest rate will be higher for some people with higher credit and higher down payments than those with lower credit and down payments.
Why did FHFA change the fee structure?
FHFA said:
“It had been many years since a comprehensive review of the Enterprises’ pricing framework was conducted. FHFA launched such a review in 2021. The objectives were to maintain support for purchase borrowers limited by income or wealth, ensure a level playing field for large and small lenders, foster capital accumulation at the Enterprises, and achieve commercially viable returns on capital over time.”
There have been other articles that have claimed race inequality was part of the reasons for the change, but the just of it is, they wanted to make it cheaper for low-income and low-credit score borrowers to buy houses.
FHFA officials have justified this move by saying:
“An FHFA official told The Post the agency was “tasked with ensuring [Fannie and Freddie] fulfill their role in any market condition,” adding that shifts in long-term mortgage rates are a far bigger factor in determining finance conditions in the US housing market.
The latest recalibration to the pricing framework that FHFA announced in January 2023 is minimal, by comparison, and maintains market stability,” the FHFA official said in a statement.”
This is from a New York Post article: https://nypost.com/2023/04/16/how-the-us-is-subsidizing-high-risk-homebuyers-at-the-cost-of-those-with-good-credit/
What they said was that interest rates went up a ton, so you shouldn’t worry about what we are doing. Worry about interest rates instead.
How much more will good credit buyers pay for a mortgage?
While some buyers getting a mortgage will pay less than before, overall the fees will be higher now. The people paying the highest fees will be those with high down payments and low credit. That’s right. I said high down payments. Some high down payment borrowers with good credit will now pay a .2 to .3% higher interest rate than they paid before. In fact, those high down payment borrowers are paying higher fees than those putting less money down! While high credit, low down payment borrowers, may be paying lower fees than before.
On a $400,000 mortgage, a borrower with good credit putting 20% down may pay $40 more a month because of the higher rates. That is not a huge amount but it is tough to bear with interest rates already 2 to 3 times higher than 18 months ago.
How much less will bad credit buyers pay for a mortgage?
Those with lower credit and a high down payment will be paying less than before, but those with low credit and a low down payment get the biggest discount. Some of the worst buyers will now get a .4% discount on their interest rate compared to what they are paying now. Those low-credit borrowers won’t be paying less than high-credit, high-down-payment borrowers, but the gap shrunk significantly.
For someone with a 620 credit score and 5% down or less, they will now save about $80 to $100 off their mortgage payment thanks to the interest rate decrease.
All buyers will now pay more LLPA fees for 20% down vs 5% down or less
The crazy part of these changes is that across the board for good credit or bad credit, all buyers will be paying less LLPA fees for having a lower down payment (unless they put more than 25% down). Someone with an 800 credit score will pay three times the fees when putting 20% down versus putting 5% down or less. Even someone with a 620 credit score will pay less LLPA fees when putting less than 5% down verse 20% down.
Below is the table showing the new fees:
This is from: https://singlefamily.fanniemae.com/media/9391/display
The left side of the table shows the credit scores and the top shows the loan-to-value ratio (the higher the number the less money people are putting down). There are also many other factors that will impact these fees like debt-to-income ratios, type of property, refinance vs new purchase, etc. The video below goes over the changes in detail.
Were the FHFA LLPA fees always structured to reward low-down payments?
I am always skeptical of headlines and crazy stories like this. Many of you probably think it has always been this way, but the old fees were structured much differently. You can see them below:
This chart is from 2020 and can be found at: https://www.freeandclear.com/guides/mortgage-topics/loan-level-price-adjustments.html
As you can see, the fees were higher for low down payments and lower for high down payments. The fees were also higher for lower credit and low down payments. I think common sense tells us this is what the chart should look like.
Do high down payment borrowers really pay more?
FHFA said in a statement that while the fees from FHFA for high down payments are higher than the low down payments, that does not mean those high down payment borrowers will pay more. If you put less than 20% down on a mortgage you most likely will be paying mortgage insurance which would be higher than the LLPA fees. So those who put more than 20% down, will still most likely pay fewer fees. Those who put 15% or 10% down, will still have mortgage insurance and have higher fees and mortgage insurance than those putting 5% or less down.
What the spokesman for FHFA did not mention is that you can often get mortgage insurance removed after a couple of years on conventional mortgages. After the mortgage insurance is removed, many buyers who put less down would be paying a lower rate without mortgage insurance than those who put 20% down.
What is one of the craziest scenarios with LLPA fees?
The Mortgage Interest Rate Is now lower for someone with a 680 credit score putting 3% down than for someone with a 730 credit score putting 15% down. If you look at the chart from FHFA, a person with a 730 credit score putting 15% down would have a 1.25% LLPA fee, and the person with a 680 credit score with 3% down would pay a 1.125% fee. Both of those buyers would pay mortgage insurance.
Conclusion
I could not believe the numbers when I saw them on the LLPA fee table. The media was not overblowing what had happened, in fact, I think they missed how bad it was. These guidelines do not apply to FHA, VA, or USDA but for Freddie Mac and Fannie Mae. Most people with good credit and debt-to-income ratios will be using Fanie Mae and Freddie Mac and are being punished for putting more money down.