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What a Debt-to-Income Ratio Means for a Mortgage

June 21, 2017

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One important consideration that a lender takes into account when deciding whether to approve a borrower for a mortgage or a mortgage refinance is their debt-to-income ratio. This small ratio, buried among all the other percentages and numbers in an application, is often a key deciding factor – even more so than credit scores and savings. Yet more than half of consumers say they do not understand what DTI is and how it effects their chances at being approved for home financing. 

What is DTI?
DTI is a calculation that weighs the payments you make toward your personal debt against your monthly income. Lenders considering a loan applicant will add up the expected expenses that a borrower has to pay on a monthly basis and then compare it to this estimated income. 

This calculation is broken down into two distinct parts. Front-end DTI involves adding together living expenses and housing costs related to the mortgage. Back-end DTI consists of expenses related to credit cards, auto loans and other bills like cable and telephone. 

What is an ideal DTI?
According to the Consumer Financial Protection Bureau, a 43 percent debt-to-income ratio is considered healthy and acceptable for most home financing. That means that the payments made on your monthly debt and housing costs do not exceed 43 percent of what you make in the same period. This, however, can vary depending on the lender and the loan product: Many lenders look for lower DTI while others may be content with upwards of 50 percent.

Why does DTI matter?
Lenders look carefully at DTI because they want to ensure you are able to make full monthly payments on a mortgage without putting undue financial hardship on yourself. Even if your mortgage payments are the bulk of your monthly debt, paying for housing without being able to save money for a possible medical emergency could be dangerous and result in defaulting on the loan. 

Fed Raises Interest Rates, Market Participants Lower Mortgage Rates

June 19, 2017

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This is such a strange credit market because it’s such an unusual market. 

The Federal Reserve raised the range on the federal funds rate to 1%-to-1.25% from 0.75%-to-1% this past Wednesday. That’s not so strange. Everyone expected the Fed to raise the fed funds rate.  (The fed funds rate is the overnight lending rate among banks. Banks borrow at this rate to adhere to minimum reserve requirements with the Fed.) The market’s reaction is what’s strange. 

In days past, when the Fed raised the fed funds rate, interest rates would rise (either by anticipating the event or the actual event). But in days past, the Fed wouldn’t telegraph its punches as it does today. A rate increase (or decrease) would come with no (or little) warning.

These days, fed funds rate increases are telegraphed from a mile away. The market priced this latest fed funds rate increase back in early May. When everyone sees it coming, little more than shoulder shrug is needed to deflect the impact. After the Fed announced its latest fed funds rate increase, yields on government securities fell.  Quotes on mortgage rates drifted lower. Mortgage rates across the board are at an eight-month low. 

In addition to announcing a fed funds rate increase, the Fed announced it was considering shrinking its balance sheet. This would be a big deal if it were to happen.

The Fed’s balance sheet is straightforward. The asset side is larded with government securities, namely U.S. Treasury bonds, and with mortgage-backed securities (MBS), which it bought in droves after the market crash in 2008. The liability side is larded mostly with dollars. When the Fed buys a Treasury security or an MBS it pays with dollars, and these dollars are conjured from thin air. 

“Shrinking the balance sheet” is a euphemism for selling bonds and MBS (or not reinvesting the proceeds when these securities mature). If the Fed sells a bond, it receives dollars. When the Fed sells a bond, both assets and liabilities shrink. Liabilities shrink because dollars are extinguished and removed from circulation. This means the money supply shrinks. 

The strangeness quota rises because the Fed is doing all this during a time consumer-price inflation is falling. The latest reading on the Consumer Price Index showed a drop in inflation. Higher interest rates and reduced money supply are tools used to hold consumer-price inflation in check. According to the CPI, there isn’t much inflation that needs to be held in check.

When Trump took office in November, many market watchers expected the 40-year trend of lower interest rates to end. Eight months later, it’s still game on, but it’s impossible to know for how long. 

Admittedly, we’ve cried wolf on rising rates in the past, but with the Fed committed to raising the fed funds rate (which it will likely do again this year), something lurks in the economic data to support the increases.  These increases often (though not always) work their way to the long-end of the interest-rate curve. This suggests to us that anything below 4% on a prime conventional 30-year loan is still a bargain. We think that any improvement on that rate is an invitation to lock. 

Refis Up, Purchases Down

A meaningful drop in mortgage rates impacts refinances first. It’s everyone in the pool, and refinance activity rises. That was the case last week. Refinances (seasonally adjusted) surged 9% from the previous week to hit an activity level unseen since last November, according to the latest Mortgage Bankers Association data. 

But as what often occurs with refinances, it’s everyone out of the pool if the trend fails to hold. We don’t see rates moving meaningfully lower from here, so we expect activity to assume a lower level going forward. 

As for purchase activity (seasonally adjusted), it was down last week. The MBA’s purchase index showed purchase activity down 3% week over week. The good news is that we remain ahead of the game compared with this time last year. Year over year, purchase activity is up 8%.

As for the present, rates are ideal as we head into the summer home-sales season. At these rates, we expect purchase activity and home sales trend to higher through the summer months. 

June 15, 2017

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An essential part of the mortgage refinance process, a home appraisal is a way to judge what your property is currently worth – and how lenders can ensure that you are able to leverage the full value of your equity. When it comes to an appraisal, it is in the homeowner’s best interest that it be evaluated as high as possible. With that in mind, here are a few simple steps to make sure that your appraiser sees a home at the peak of its value:

Shop around and pick your appraisers carefully 
Since an appraisal is ultimately a subjective assessment of a home’s value, it makes sense that different appraisers may come up with different values. Look for an appraiser who is well-reviewed by their customers, has worked with similar homes in your area and knows the local market. Most important, look to see that they are state certified. 

“Be sure to inform an appraiser of any major renovations or projects you have spearheaded.”

Keep an eye on your neighbors’ homes
Have your neighbors recently had their homes appraised? Talk to them about who they went with and what kinds of issues they ran into. Also keep in mind that part of the home’s value is tied to the property values around it. A gorgeously appointed home in a dingy area is likely to fetch a lower price than a similar home in an up-and-coming area.

Make sure your appraiser has all the facts
Even a knowledgeable, locally-based appraiser is more than likely walking in with limited information on your specific home. That means that some of the home improvements and investment you have made in your property may go unnoticed – unless you speak up. Be sure to inform an appraiser of any major renovations or projects you have spearheaded that may have bumped up the value of your home.

Make sure your safety equipment is full-functional and properly installed
Often in the rush to gussy up the decor of a home, people forget about the non-aesthetic elements that add value. Smoke alarms, carbon monoxide detectors and fire extinguishers properly installed in strategic safety areas will show an appraiser that you are making efforts to protect your home, making it more valuable. 

Make sure your appliances work
While not part of the home per se, appliances like a refrigerator and dishwasher can add value to a property – assuming they are clean and fully functional. Don’t neglect these essential components of everyday life when you do a walkthrough and check for issues.

At New Penn Financial, we want to make sure that you have the home of your dreams. That’s why we offer a variety of home improvement loans and refinancing options at attractive rates. It would be a pleasure to hear from you.

Mortgage Rates Drop Below the 2017 Range

June 12, 2017

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We’re all but assured that the Federal Reserve will raise the federal funds rate (the rate everyone refers to when everyone refers to the Fed raising interest rates) next week. It appears a done deal, and as such, it is priced in market interest rates. 

Because the Fed is in rate-raising mood, an uplift

in yields on the short end of the yield curve — the plot of Treasury yields on 1-month to 30-year securities — has occurred. The slope of the curve remains normal, with each successive yield higher than the next. This is a good shape because it foretells an expanding economy. 

The Fed raising rates should influence the short-end of the yield curve first. We’ve seen some uplift in interest paid on certificates of deposits and passbook savings accounts. But the Fed’s actions have had little influence on lending rates.  Quotes on a 5/1 ARM have generally moved lower with quotes on longer-term loans. If you look at the rate charts of the 30-year loan, 15-year loan, and 5/1 ARM, you’ll find that the rates have moved like synchronized swimmers.

The market today is like no other. Banks hold $2 trillion of excess reserves with the Federal Reserve. Before 2008 they held none, because before 2008 the Fed had not paid interest on these reserves.  The Fed raising and lowering the fed funds rate had a discernible influence throughout the yield curve before then. Today, not so much. 

Five years ago, we thought quotes of 5%-or-higher on a prime 30-year loan would be the norm. A year ago, we thought 4% would be an opportunity if rates would drift so low. So much for expectations, such is the difficulty in predicting the path of mortgage rates. (Better luck is had predicting the flight path of a butterfly. This applies not only to us, it applies to everybody.)

That said, let’s take advantage of what we’ve got. Refinance applications were up last week, and so, too, were purchase applications. Indeed, purchase apps were up 10% week over week. Perhaps we’ll see an upward surprise in May and June home sales.

Is an Echo Bubble in the Making? 

We stumbled across an article titled “Housing’s Echo Bubble Now Exceeds the 2006-07 Bubble Peak” at the financial website Seeking Alpha. The author claims that a housing bubble has reformed after the initial bubble burst because home prices presented by the S&P/Case-Shiller Index now exceed pre-bubble highs. 

First, bubble is a loaded word. Nobody knows when an extended market (bubble) has occurred until after the fact. Second, is there evidence of the same bubble re-inflating? The author claims it’s so, but the evidence is suspect. 

The Internet-stock bubble popped in 2000. The NASDAQ Composite Index, which houses many Internet and technology stocks, took 15 years to trade above 2000 highs. It trades 10% above those highs today. The gold bubble, which popped in 1980, took 28 years to recover. Gold trades above the 1980 highs. As for housing prices, they’re at new highs 10 years after the housing bubble burst.

But so what? Asset and investments move higher over time. If you look at the long-term trend in stock and gold prices, they’re always higher. Why should housing be different? It shouldn’t be because it isn’t. The long-term trend is up. 

As for an echo bubble, we’ve seen no instance when the bubble that produced the previous financial market crash produced the next crash. Whatever sends markets into a tailspin in the next crash, we feel assured that it won’t be housing or mortgage lending. 

Why More People are Choosing Non-Bank Mortgages

June 7, 2017

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Homeowners and buyers have more mortgage options at their disposal than they may realize. That’s truer than ever as a new breed of mortgage lender, known as nonbank lenders, are reshaping the home loan market.

In fact, according to the Washington Post, hundreds of new institutions  have come into the fold of the mortgage market, attracting as much or even more business than some of the nation’s biggest banks. In 2011, the top five mortgage lenders by market share were all brand-name retail banks. In 2016, this changed dramatically, with one private lender cracking the top three, and a majority of new home loans being underwritten by nonbank lenders.

What nonbank lenders can do

There are many reasons behind this extraordinary shift. Primarily, consumers have discovered they can get better rates and a more personalized level of service through a nonbank lender. But why, exactly?

As explained by Paul Noring, a financial consultant who spoke with the Washington Post, many of these new mortgage lenders deal only in home loans. By focusing on just one product, scrapping traditional banking services like checking accounts, nonbank lenders can save money and pass that onto borrowers.

Borrowers also have been attracted to nonbanks thanks to their faster adoption of new technology and support systems that make the application process easier.

In addition, nonbank lenders are tending toward favoring borrowers who may have been rejected by big banks in past attempts to apply for a mortgage. In the aftermath of the financial crisis of 2008, banks became stricter in their mortgage lending requirements, making it more difficult for those with poor credit history to secure a home loan. As nonbank lenders have entered the market, they have also been able to extend loans to more of these borrowers, according to Mortgage News Daily. Credit reporting agencies have also adopted new ways to evaluate credit history that may favor a wider segment of homebuyers.

Through a combination of competitive rates and innovative support systems, nonbank lenders have been instrumental in the revitalization of the U.S. housing market. That’s why it shouldn’t come as a surprise that more homeowners and buyers are choosing these loans.

Mortgage Rates Settle, but for How Long?

June 5, 2017

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We could say that mortgage rates are like the weather: We can talk about them, but we can’t do much but talk about them.

And talk about mortgage rates we do. On that front, mortgage rates drifted lower through most of May; it’s possible they could drift lower still.

Many market watchers focus on the 10-year U.S. Treasury note and its yield. The yield on this influential security (as it influences the yield on mortgage-backed securities, which, in turn, influence mortgage rates) has dropped to 2.21%. Market watchers who watch the yield charts, tell us that we could see lower mortgage-rate quotes if the yield on the 10-year note falls below 2.17% (which is seen as a technical support floor).

For now, though, quotes across the mortgage board are near 2017 lows. Rates have trended lower over the spring months. Concurrently, the federal funds rate — the rate everyone refers to when the Federal Reserve raises rates — has trended higher and is at a multi-year high. The Fed raised the range on the fed funds rate to 0.75% to 1% in March. The effective rate — at 1% — is at the upper boundary of that range.

The fed funds rate is a short-term rate — it’s the overnight lending rate for commercial banks. The fed funds rate serves as the base rate for most other lending rates. A change in the fed funds rate won’t necessarily move long-term rates (as we’ve seen), but you would it expect it to have some pull over time. So far, it hasn’t had much pull, even with the increasing likelihood we could end the year with the fed funds rate approaching 2% — a rate unseen in nine years.

We suspect that the lack of pull is attributable to lack of consumer-price inflation, which runs at 1.5% annually. Inflation expectations exert greater influence on long-term rates than short-term rates. Low inflation expectations are holding long-term rates in check.

The Fed is expected to raise the range on the fed funds rate to 1%-to-1.25% at its next meeting on June 14. In fact, traders in fed funds rate futures contracts are betting a 90% chance that a rate increase will occur. What’s more, most Fed watchers believe two more increases will occur after a June rate increase.

So, the Fed will likely raise the range on the fed funds rate this month. Contrary to popular perception, though, rising mortgage rates need not follow. Indeed, since the Fed began raising the fed funds rate in December 2015, the increase has generally been followed by a slow decline in mortgage rates. If past is prologue, a further decline in rates is within the realm of possibilities as long as inflation remains muted.

 

PENDING HOME SALES POINT TO FEWER IMMEDIATE SALES

The NAR’s Pending Home Sales Index dropped 1.3% in April, which puts the index below April 2016 levels. The NAR blamed the usual suspects — low supply coupled with low affordability — for dwindling sales contracts. Because contract signings lead sales by 45 to 60 days, there’s a good chance that existing-home sales for May and June will disappoint.

We found it interesting that the NAR’s press release mentioned a supply factor that we’ve mentioned in the past: Institutional buying of single-family homes. Lack of supply has weighed predominately on the lower echelons of the existing-home market. One reason for the supply dearth in this niche is that many single-family homes have been purchased by large institutional investors. Less supply, of course, means higher prices and fewer affordable homes for first-time buyers.

NAR chief economist, Lawrence Yun, amplified an additional insight, one we’ve also mentioned, on institutional owners. These institutional owners will be as motivated to sell when rents and returns on investment fall as they were to buy when rents and returns on investment were rising. “The unloading of single-family homes purchased by real estate investors during the downturn for rental purposes would also go a long way in helping relieve these inventory shortages,” Yun opines.

With more millennials and other first-time buyers turning away from renting and turning to buying, we could see institutional investors turn to sellers from buyers. Such an event would help to relieve the supply shortage that constricts home-sales growth.

Builders Cool on Luxury Housing, Target Starter Homes

June 2, 2017

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While demand from U.S. homebuyers continues to outpace the supply of homes on the market, home builders have made significant progress in closing this gap recently. This is especially true now that a broader swath of the homebuyer market…

is seeing a prime opportunity to invest, with low interest rates and higher wages prevailing.

As a result, new data show builders and developers are increasingly targeting starter homes for younger homeowners. The Wall Street Journal reported that in the first quarter of 2017, nearly one third of new residential construction by the biggest U.S. building firms consisted of properties smaller than 2,500 square feet. This puts them squarely within range of what is usually considered a starter home. At the same time last year, only 27 percent of new housing fell into this category, with an even smaller 24 percent in 2015.

Trend reversal

With two years of considerable year-over-year growth, homebuilders and buyers are finally bucking a trend that persisted through much of the post-recession housing market recovery. Too many younger, less affluent Americans were unwilling to risk homeownership. At the same time, construction firms faced their own financial troubles, compounded by a shortage of workers. The result was a glut of luxury homes on the market but very few that could be considered starter homes.

Even as demand for all housing types picked up around 2015, the inventory of new and existing homes could not keep pace. This has driven home prices up quickly, a trend that continues – home values were nearly 6 percent higher in February 2017 than one year prior, according to the S&P CoreLogic Case-Shiller U.S. National Home Price Index.

Still, news of renewed interest in starter homes from buyers and builders adds to the evidence that the U.S. economy overall is growing ever more resilient.