It might sound a little bittersweet, but former homeowners are now authorized to purchase the properties they lost to foreclosure at fair market value, instead of having to pay back the entire amount owed on the old mortgage.
This new rule applies to real estate owned (REO) properties held by Fannie Mae and Freddie Mac.
The Federal Housing Finance Agency (FHFA) announced the news today in a press release, with director Met Watt referring to it as a “targeted, but important policy change” intended to reduce the number of vacant homes and stabilize property values.
In other words, a larger pool of potential buyers should lead to fewer empty homes, which in turn should boost home prices and aid the ongoing housing recovery.
Previously, borrowers who lost their homes to foreclosure couldn’t repurchase them at their current value. Instead, they were forced to pay off the associated mortgage balances if they wanted the properties, something I doubt anyone actually did.
The old rule also applied to anyone who attempted to buy a foreclosed property on behalf of the previous homeowner.
Going forward, previous homeowners (or third-parties who purchase on their behalf) will be able to scoop up their old properties at their present value, as determined by Fannie and Freddie.
This policy change is limited to properties held by the pair as of November 25th, 2014.
For the record, the fair-market value policy already applied to purchasers of REO properties who did not originally own the homes.
If a former homeowner wishes to purchase their old property (or have someone buy it for them), it must be used as a principal residence. Simply put, you can’t buy your old home and rent it out.
The FHFA also noted that some property exclusions may apply and will be dealt with on a case-by-case basis.
At the moment, Fannie and Freddie hold about 121,000 REO properties in their collective inventory. It’s unclear how many former owners want to move back in.
If you’ve lost your home and want it back, you might be able to reacquire it more easily, though it should be noted that home prices have surged in recent years. So you’ll probably still pay more than you originally did, but I suppose it’s better than nothing.
However, you’ll need to be able to qualify for a mortgage again (assuming you can’t pay with cash), which can be difficult after experiencing a foreclosure.
The timeline to get a mortgage after foreclosure ranges from three to seven years for conventional loans, depending on the circumstances involved. It can be as short as one year via the FHA.
You may have heard the phrase mortgage rate lock-in effect lately.
As a quick refresher, it’s a homeowner’s unwillingness to give up an ultra-low mortgage rate for a much higher one.
Or simply the inability to give up their low rate, as qualifying for a home purchase at today’s much higher rates would be an impossibility.
Regardless, there is now a value assigned to this so-called mortgage rate lock-in effect, with Freddie Mac putting the average at about $55,000.
This means an existing homeowner needs a big incentive to sell, unless they want to forgo that value.
How Valuable Is Your Low Mortgage Rate?
Freddie Mac reported that six out of 10 borrowers now have a mortgage rate at or below 4%.
And that the mortgage rate lock-in effect is a benefit to homeowners who hold fixed-rate mortgages.
Now everyone knows a low mortgage rate can save you money, thanks to a lower monthly payment.
But it also carries value, which can ebb and flow based on prevailing market rates. Never has this been truer than the last year and change.
Simply put, mortgage rates more than doubled from their record low levels in 2021.
As a result, those who locked in low rates around that time now hold something extremely valuable.
For perspective, the 30-year fixed hit its all-time low of 2.65% in early January 2021, per Freddie Mac.
Last week, it averaged a significantly higher 6.78%, which is a more than 150% increase.
Aside from creating a world of haves and have nots, it has made moving a lot more difficult for those who need a mortgage to buy a home.
Even if you can qualify at a much higher interest rate, do you want to give up your low rate?
It’s not as if home prices have come down, so you’re simply trading your old low fixed-rate mortgage for a new one that’s much more expensive.
But how much would you “lose” if you did? Well, now we might know.
Determining the Value of Mortgage Rate Lock-In
Thanks to some daunting math, this value has now been quantified by Freddie Mac economists.
They determine the value of mortgage rate lock-in by taking the difference between the outstanding balance of the mortgage and the present value of the mortgage at prevailing market interest rates.
In their example, a “lucky homeowner” gets the opportunity to refinance their mortgage at 2.65% in January 2021.
Their $250,000 loan amount would be whittled down to about $236,379 after 29 months, with a ridiculously low principal and interest payment of $1,007.
Now supposing they wanted to sell and move elsewhere today, they’d be looking at a comparable mortgage rate closer to 7%.
Assuming a similar loan amount, the monthly P&I would jump to more than $1,500 per month.
This hypothetical example puts the value of mortgage rate lock-in at a sizable $86,136.
Put another way, they’d need a near-$90,000 reason to move, whether it was for a much better job, way of life, etc.
Otherwise, they’d need to stay put, which appears to be the most common outcome at the moment given the dearth of existing housing inventory.
Your Mortgage Rate Lock-In Value May Vary
The Freddie Mac economists noted that the average value of mortgage rate lock-in “varies considerably” thanks to region and year of origination.
For example, it’s just $32,000 in West Virginia, but a whopping $91,000 in Hawaii.
And those who took out mortgages in 2020 and 2021 have an average mortgage rate lock-in value of $77,000 and $85,000, respectively.
What’s perhaps more surprising is even those who took out a home loan in 2023 have an average mortgage rate lock-in value of $10,000.
Overall, homeowners with fixed-rate mortgages financed by Freddie Mac (30-year and 15-year fixed loans) have locked in a collective $700 billion dollars in total value.
This total is equal to about 25% of Freddie Mac’s single-family mortgage portfolio’s unpaid principal balance.
It tells you why this phenomenon is so impactful, and why there is a major lack of available for-sale inventory at the moment.
While this will dampen home sales and mortgage originations, it should help prop up home prices at a time when affordability has rarely been worse.
Freddie Mac said its official corporate forecast for the next 12 months has home prices falling by 2.9%, followed by another 1.3% annual decline.
But given current market conditions (and an early read on their data), they expect an upward revision.
In short, they foresee continued tight inventory due in no small part to this lock-in effect, which should keep sales volume down but prices up.
Read more: Will mortgage rates go down for the rest of 2023?
Think it’s hard to get a mortgage? How about a loan modification via the Treasury’s Home Affordable Modification Program (HAMP).
A new report from SIGTARP, which stands for Special Inspector General for the Troubled Asset Relief Program, the agency that oversees the program, claims about seven out of 10 troubled borrowers who applied for a HAMP loan mod got denied.
Per the official HAMP database from the Treasury, from December 2009 until April 2005, some 5.7 million homeowners facing the prospect of foreclosure applied and more than four million were denied by their loan servicers.
There’s a Good Chance You Were Denied
The denial rate is actually 72%, which is pretty startling given it’s a government program designed to help homeowners avoid foreclosure by reducing their monthly payments.
The denial rates are even worse at some of the largest banks in the nation, including Chase and Citi, which both turned down 80% or more who applied for a modification.
Chase denied about 84% of applicants, while Citi somehow said no to 87% of homeowners. Bank of America also kicked 80% of applicants to the curb.
Amazingly, Ocwen is the largest HAMP servicer in the nation despite denying 70% of all homeowners who applied.
“All cannot be right when three of the largest HAMP servicers, Citi, JPMorgan Chase and Bank of America, turn down 80% or more of homeowners’ HAMP applications, and the largest HAMP servicer, Ocwen, turns down more than 70% of homeowners for HAMP,” the report reads.
Top 10 HAMP Denial Reasons
1. Request incomplete (25%) 2. Current DTI less than 31% (18%) 3. Offer not accepted by borrower or withdrawn (13%) 4. Ineligible mortgage type (8%) 5. Default deemed not imminent (8%) 6. Property not owner-occupied (5%) 7. Excessive forbearance needed (5%) 8. Post-modification DTI too high (4%) 9. Investor guarantor not participating (4%) 10. Negative net present value (NPV) (3%) 11. Other (7%)
Even More Changes Coming to HAMP?
Now SIGTARP wants answers – specifically, they want to know if HAMP eligibility requirements are too stringent, or if mortgage servicers have wrongfully denied homeowners.
This could actually be good news for homeowners because changes may come to the program….again.
The report noted that changes were made to HAMP after large numbers of borrowers fell out of their initial trial modifications, leading Treasury to “course correct” the program.
Beginning in June 2010, servicers were required to verify income before starting a trial modification, a move that reduced fallout substantially.
Later in mid-2012, HAMP Tier 2 addressed many of the issues that caused so many denials. But it appears that servicers continue to struggle with approving applicants.
“It is time for Treasury to do a similar course correct for homeowners who have been denied entry into the program altogether, particularly where servicer misconduct contributed to the outcome.”
The report certainly points the finger at servicers, and notes that Treasury has gone far too easy on them, instead of using its full authority (such as permanently withholding TARP incentive payments) on those that fail to perform.
For the record, HAMP was extended until the end of 2016. If you’re already participating, be on the lookout for that extra $5,000 in principal balance reduction.
And also watch out for the payment increases that are now taking place for Tier 1 participants.
Foreclosures have been halted and loans have been modified, even for those underwater, but what about those pesky option arm loans?
The WSJ says government officials are looking for ways to reduce losses, as a flood of option-arm related foreclosures could dent any semblance of a housing recovery.
The so-called “toxic loans,” which allowed borrowers to defer interest up to 125 percent of the loan balance, are so far underwater that they seem destined for foreclosure.
Even with a principal write-down, a mortgage rate reduction, and extended amortization, the prospect of paying off the loans still doesn’t look all that bright. That’s a testament to just how bad these loans are.
Apparently investors believe principal reductions are the key to saving these loans, along with refinancing borrowers into more traditional FHA loans.
Loan servicers, on the other hand, believe the solution is forgiving deferred interest and converting them into interest-only loans.
Unfortunately, many of these loans already have rock-bottom mortgage payments (as low as 1%), so there isn’t much room to negotiate.
Factor in the ridiculous amount of negative equity resulting from plummeting home prices, and you’ve got a loan mod scenario that would likely fail the net present value test required to complete one under the government’s program.
But the loans represent no small minority; they account for nearly 40 percent of loans 60+ days past due in Florida and Nevada, 28 percent in California, and 20 percent of delinquent loans in Arizona.
And another million option arms are expected to reset over the next four years.
They also pose a huge risk to some of the nation’s largest banks, including Wells Fargo, who inherited a $90 billion Pick-A-Pay portfolio from Wachovia.
Of course, they say they’ve been able to modify the loans using the current government program and their own loss mitigation programs, but that seems, at best, optimistic.
Then there’s Chase, which holds nearly $40 billion in option arms, acquired from WaMu, and Bank of America, who took on Countrywide’s $23 billion pay-option arms.
The problem: how do you save something that is beyond redemption? There’s a good chance most of these loans won’t be saved, and the borrowers will face foreclosure, or perhaps a short sale.
Save more, spend smarter, and make your money go further
Personal finance and investing gurus are fond of an old Chinese proverb: “The best time to plant a tree was 20 years ago. The second best time is now.” Chances are you’ve heard it before.
It’s a profound quote, and trees are a great metaphor for growing your investment portfolio. If you water the tree daily – and have patience – you can expect to reap the rewards in due time. Whether you start investing in college or after you turn 40, the important thing is planting the seed.
The problem is, this proverb actually undersells the importance of starting as soon as possible from an investing perspective.
While a tree grows to maturity at a sustained rate and only reaches a certain height, investments actually grow larger the earlier you start. If investments are trees, then the seed you planted today may grow as tall as a mighty redwood, while the one you plant in 20 years becomes a pine. In other words, the growth potential of your portfolio is directly tied to the amount of time you give it to grow.
This is thanks to something called compound interest, where the interest your account accrues is compounded on itself. Here’s everything you need to know about compound interest – how it can help you, how it can hurt you and how to maximize its benefits.
Keep reading for a comprehensive look at compounding interest, or skip to the section you’d like to learn more about using the navigation links below.
What is Compound Interest?
There are two ways to accrue interest: simple and compound. Simple interest is when you earn interest only on the principal. So, if you have $1,000 invested at 5% interest, you’ll earn $50 every year.
Compound interest is earned on the principal and the interest in your account. Let’s look at a hypothetical example. Pretend you have $5,000 in a retirement account, earning 7% interest each year. The first year that your account is open, you earn $350 in interest, which brings your total to $5,350. The following year, interest is calculated based on that $5,350 total, not the original $5,000. You earn $374 in interest and now have a total of $5,724.
Even if you never deposit anything but the original $5,000, you’ll have $38,061.28 in 30 years. That’s a $33,061.28 profit.
Compound interest rewards people who invest over long periods of time, not necessarily those who can afford to invest the most. It’s specifically helpful for young people who start investing early.
A 25-year-old who invests $200 a month with 7% interest will have $226,705.89 in 30 years. If they wait 10 years to start investing, they’ll have to more than double their savings rate to reach the same total.
Use our compound interest calculator to see how much of a difference it can make.
Pros and Cons of Compound Interest
Compound interest is your best friend when you’re investing or saving for a long-term goal, but it’s your worst enemy if you have debt that’s not being paid off.
Here’s an example: A borrower with $30,000 in student loans defers their loans for a year while they look for a job. During that year, interest continues to accrue on those loans. Once they’re ready to resume making payments, they discover their $30,000 balance has grown to $45,000 because of compound interest.
To slow down the negative effects of compound interest, you should pay off your debt as quickly as possible. You can also refinance your loans to a lower interest rate. When you borrow money, compounding interest works against you and benefits the lenders. The interest rate a lender charges is the trade-off for taking on the risk of lending money and giving out loans. However, it makes it very important for you, the borrower, to pay off your loans on time and keep tabs on your interest rate.
If you have credit card debt, you may want to consider transferring your balance to a card with 0% APR to avoid interest while you pay off the balance. Otherwise, you’ll accrue interest that makes it more expensive for you to carry debt month to month.
Calculating Compound Interest
To calculate compound interest, you’ll need to use the formula below:
Compound Interest = Amount of Principle and Interest in Future (or Future Value) less Present Value
= [P (1 + i)n] – P
= P [(1 + i)n – 1]
P = principal, i = nominal annual interest rate in percentage, and n = number of compounding terms.
Compound Interest Investments
Some banks only calculate interest on a monthly basis, while others do it every day. More frequent compounding is better when you’re trying to maximize interest, so find out how frequently your bank calculates interest. You might have to call or poke around the fine print to determine their compounding schedule.
Next, find the highest interest rates possible while also minimizing risk. If you have a savings account with $10,000, choose a high-yield savings account. Aim for 2% interest or higher. A $5,000 savings account with 2% interest will be worth $7,459.04 in 20 years, but only worth $5,204.05 in a savings account with .2% interest. Using an investment calculator can give you a better idea of how interest will impact your return.
Compounding interest investment accounts can help both grow your money and secure your future. But it’s important to start early. And before you start investing in stocks, it’s important not to get ahead of yourself. Do your research and familiarize yourself with different investment options. Make sure you’re only investing money after you’ve topped off your emergency fund. It’s also important to ensure that you’re current on all your loan payments. Otherwise, any investment gains might be negated by snowballing debts.
If you’re saving for retirement, invest in low-fee index funds. Fees of 1% or more will drag down your profit and cut into your compound interest. Index funds will follow the market’s course and provide a solid rate of return. Avoid investing in individual stocks, as their volatility can be problematic.
Compound interest works best if you start saving as soon as possible, even if it’s just $25 a month. A 22-year-old who saves $25 a month at 7% interest for five years will have $1,795.80. When she gets a raise after those five years and can afford to put away $100 a month, she’ll have $294,213.07 when she retires at age 67. If she hadn’t started investing until after her raise, she’d only have $264,689.70.
Even though she only contributed $1,500 during those first five years, her portfolio is worth nearly $30,000 more. For most people, that’s enough to retire a full year earlier, and all it cost her was a monthly contribution of $25. Even someone earning an entry-level salary can afford that.
The same principle applies to debt. Even if you defer your student loans, keep making payments on them as much as you can afford to. Taking time off will only delay your debt payoff and increase how much you pay in interest.
Always compare rates before taking out a loan and get at least three quotes. Each percentage point matters when you’re borrowing money, especially for long-term debt like a mortgage. You can also limit compound interest by borrowing money for as little time as possible.
A 30-year $200,000 mortgage at 4.85% interest will cost $379,940 in total. A borrower who takes out the same loan for 15 years will only pay $269,910. That’s a difference of $110,000, which is more than half the total mortgage principal.
Takeaways: The Power of Compounding Interest and Growing Your Wealth
Compound interest can help you grow your wealth and secure a more stable financial future. Even if you can’t afford a large principal or large ongoing additions to your investment, you can still extract value from small investments with compounding interest. The key is to start as early as possible and do adequate research to ensure that you’re making investment decisions that make sense with your overall financial goals and situation. With these tips, you’ll be on your way to stabilizing your financial foundation and making your money work for you.
For more information on compounding interest, you can check out dolv.gov for more resources.
Save more, spend smarter, and make your money go further
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Zina Kumok is a freelance writer specializing in personal finance. A former reporter, she has covered murder trials, the Final Four and everything in between. She has been featured in Lifehacker, DailyWorth and Time. Read about how she paid off $28,000 worth of student loans in three years at Conscious Coins. More from Zina Kumok
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