What Makes Mortgage Rates Rise And Fall? 10-Year Treasuries

mortgage-rates2-300x249Homebuyers are always interested in mortgage interest rates because it makes a difference in their monthly payments and their buying power. A 1% increase in mortgage interest rates can decrease buying power by 10%! That’s the difference between buying a $180,000 house or a $200,000 house.

Why do mortgage rates fluctuate? Mortgage rates are directly impacted by the rates offered on 10-year US Treasury Bonds.

When rates on 10-year treasuries rise, then mortgage rates rise. When 10-year treasury rates fall, then your mortgage rate falls along with it. And the change is almost instantaneous.

Why Are Mortgage Rates and US Treasury Rates So Tightly Connected?
Home mortgages are bundled by Mortgage Aggregators (mostly Freddie Mac, Fannie Mae, Ginnie Mae) into investments called Mortgage Backed Securities. These investments have an implied government backing (which means safety) so they get a AAA rating. This AAA rating puts Mortgage Backed Securities in competition with US Treasury Bonds.

10-year US Treasury Bills and Mortgage Backed Securities compete head-to-head for investors who want safe, secure medium-term investments. Therefore the two investments must offer competitive returns to attract the investor’s money.

Mortgage rates follow treasury rates. So watch the 10-year US Treasury Bond rates and you’ll know which way mortgage rates are going.

Why Do Mortgages Compete with 10-year Treasuries and Not 30-year?
Investors compare 30-year home mortgages to10-year treasuries and not 30-year treasuries because statistics show that most home mortgages only last for seven years. Homeowners sell the house or refinance the loan, which results in a payoff of the mortgage. Therefore the best correlation is the 10-year US Treasury Bond.

Mortgage Interest Rates Since 2008 and Beyond
Since 2008, mortgage interest rates have been historically low. In 2013, rates were only 3.5%! In 2014, rates have risen to 4.5% or so. However, consider that in the 1980’s, mortgages were as high as 18%…so the 4.5% looks really good by comparison, right?

Since 2010 the Federal Reserve has spent $85 million per month, much of it on 10-year Treasuries. The effect of these purchases is to artificially push down treasury rates, and thus mortgage rates. In 2014 the FED began slowing down their Treasury note purchases, driving up treasury interest rates, so it’s logical that mortgage rates will increase as well. How high will mortgage rates go? No one has a crystal ball to tell us the answer.

My advice is to take advantage of the artificially low mortgage rate environment while you can, if you are in the market to buy a house or refinance. You don’t want to be the person in 10 years who is complaining about missing the opportunity for a cheap loan.

Mortgage Rules Changes Are Coming in 2014

Mortgage_rulesThe world of mortgage lending has changed significantly since the housing bubble burst. Mortgage lenders have returned to traditional loan standards that require extensive documentation of income and assets for a loan approval.

Government regulatory agencies also continue to react to the housing crisis, with more adjustments to mortgage requirements set to go into effect in 2014:

Qualified Mortgage Rules

Whether you’re thinking of buying a home or mulling over refinancing your mortgage, Jan. 10, 2014, could be an important date for you to remember. The Consumer Financial Protection Bureau is in the process of implementing regulations to meet goals set forth by the Dodd-Frank Act in Congress, which was meant to correct the errors that led to the housing crisis. The CFPB’s “Qualified Mortgage,” or QM, rules go into effect in January. Essentially, these rules require lenders to prove borrowers’ ability to repay a loan by meeting several guidelines, including a maximum debt-to-income ratio of 43 percent. While many lenders already limit borrowers to a similar maximum debt-to-income ratio, the new rules won’t allow for any compensating circumstances such as significant cash reserves or a large down payment to be considered in order to offset a higher debt ratio.

If you have credit problems or a high debt-to-income ratio, you may want to push through your loan application for a refinance or home purchase to make sure you close your loan before the new rules go into effect. However, many lenders are already using QM standards in order to make sure they’re in compliance with the regulation. Mortgages that don’t meet QM standards will have to be held by the lender rather than sold to Fannie Mae and Freddie Mac, so most lenders are careful to meet the new standards.

The 3 Percent Rule

The new QM requirements also limit fees for originating a loan to no more than 3 percent of the loan amount. If you’re financing a more costly home, such as a $400,000 home or more, the lender can easily keep fees under 3 percent, which in this case would be $12,000. However, if you’re refinancing a smaller loan balance or purchasing a less expensive home — for example, for $80,000 — the lender might find it more difficult to keep all fees under $2,400. Mortgage lenders are less likely to offer loans for smaller amounts since they won’t always recoup their costs and make enough profit to pay their staff. If you need a small loan, you may want to push to get it closed before Jan. 10, 2014.

Self-Employed Borrowers

One particular group of borrowers will most likely be impacted by the QM rules: self-employed borrowers. These borrowers already are heavily scrutinized and find it more difficult to obtain a mortgage because they must prove their income based on tax returns and profit-and-loss statements, rather than standard paystubs and W2 forms. The “ability-to-repay” feature of QM rules requires all borrowers to prove they have the cash flow to make payments on their mortgage. Self-employed borrowers often have fluctuating income and rely on cash reserves to pay bills in-between payments, but the emphasis on cash flow can make it harder for lenders to approve a loan even for someone with significant funds in the bank.

Potential Lower Loan Limits

The Federal Housing Finance Agency, which regulates Fannie Mae and Freddie Mac, announced in October that plans to reduce the maximum loan limits for conventional conforming loans will be delayed until later in 2014. Typically, loan limits are adjusted on Jan. 1 of each year, but the agency decided to wait to see the impact of the introduction of QM rules before making changes. Currently, the limits are $417,000 in most housing markets and rise to $625,500 in high cost areas. If you need a mortgage near these limits, it would be wise to close your loan earlier in 2014 rather than later in case limits are lowered.

If you would like a referral to a qualified lender, please contact me. 

Reprinted from Realtor.com, December 2013

Breaking Down the Home Mortgage Deduction

Sacred-CowThe home mortgage deduction is one of the few tax write-offs available to the middle class, and it reduces the cost of home ownership. For that reason, it has become a “sacred cow” to many people.

While popular and worthwhile, the perceived value of the home mortgage deduction may be greater than its actual value. Let’s break down the home mortgage deduction and see what it is and what it is it not.

Tax Credit vs Tax Deduction
You need to understand the difference between a tax DEDUCTION and a tax CREDIT. A deduction reduces the amount of your income tax that is subject to taxes, and a credit directly reduces your tax bill. Say you are in the 25% federal income tax bracket. For every $1000 in mortgage interest you pay (over the standard deduction), your tax bill will be reduced by $250. In contrast, a $1000 tax credit would reduce your total tax bill by $1000.

Itemizing Deductions
To take advantage of the home mortgage deduction, you must itemize your deductions. To be eligible to itemize deductions, the dollar value of your itemized deductions must exceed the value of the standard deduction, which was $11,900 for married joint filers in 2012.

If you have a $193,000 loan that is five years old, you will pay $8,104 in interest. So you need $3,796 more deductions before you can itemize and take the home mortgage deduction. If you don’t, then you have to take the standard deduction and you cannot take advantage of the home mortgage deduction.

According to USA Today, only about 25% of tax payers are able to itemize deductions and take advantage of home mortgage deductions. Most of these tax payers are in high cost of housing states, such as California, Hawaii, Washington, Virginia, Maryland and Nevada.

Amortization and Interest
Another concept you need to understand is amortization. It’s the mathematical system that banks use to calculate the payback schedule of interest and principle. In general, the early years of the loan are heavily weighted to paying interest and light on principle. Latter years of the loan are light on interest and heavy on principle.

Using the $193,000 loan example, in the second year your interest payments are $8,562.49 and principle payment are $3,172.35. In the 16th year of the loan you pay $5,785.42 in interest and $5,949.42 in principle, about even. By the 30th year of the loan, the interest payments are $577.30 and the principle payments are $11,157.53.

As the years go by, the value of the home interest deduction diminishes because it gets harder to beat the standard deduction.

Early Loan Payoff
At some point, you may find yourself in position to pay off your loan early. No mortgage payment sounds great, but people worry about the trade-off of losing their home mortgage deduction. There are three things to consider.

1. What is your tax bracket? From our tax deduction example, we know that if your tax bracket is 25%, you get about .25 in benefit for every $1 in tax you pay. So in essence, you are spending a dollar to save a quarter. On the other hand, without a mortgage payment, you’d pay .25 to the IRS and keep .75 for yourself.

2. How many years do you have left on your loan? From our amortization example, we know that if you are past the mid-point of your loan you pay less interest and more principle every year. Therefore there’s less and less interest to deduct as time goes on. Most people in position to pay off mortgages are past the mid-point of their loan.

3. Do your take standard or itemized deductions? If you don’t have enough deductions to itemize, then you can’t take advantage of the home mortgage deduction anyway. So why keep paying interest to the bank?

Did you know that on a $193,000 30-year loan, you will end up paying $159,044.95 in interest! By shaving five years off the loan you’ll save at least $5266 in interest, which goes directly into your pocket. The deduction on that interest: only $1316 (assuming a 25% tax bracket).

Summary
The home mortgage tax deduction is a great thing; if you have to have a mortgage you might as well get to write off the interest. However, talk to your CPA and financial advisor to decide if the deduction is a good financial tool for you.