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This week, the Federal Reserve reaffirmed its intention to stop buying mortgage-backed securities, signaling the likelihood that the mortgage rates you can get today are as good as they’re going to be for a long while. Once the Fed stops buying, after all, rates are likely to go up.
And current rates are quite good. At about 5 percent, in fact, they’re so good that they’ve helped change the age-old debate over whether homeowners should make extra mortgage payments to pay off their debt well before their loan periods are up.
Back when rates ran at 7 or 8 percent, making extra payments offered what amounted to a guaranteed return on your money. When you’re ridding yourself of debt that costs you much less, however, it’s easier to imagine a future when you could more easily earn a higher return by investing those potential extra mortgage payments someplace else.
Meanwhile, at a time when just about everyone knows someone who is unemployed or who owes more on a home loan than the house is worth, keeping extra cash someplace more liquid than a mortgage seems like a safer approach.
So is the case against extra payments closed for good, given that so many people have locked in rock-bottom mortgage rates for the long haul?
The answer depends on two things: how likely you are to leave the extra money in savings and how good it would feel to wipe your debt out years earlier than your mortgage requires.
THE BASICS First, let’s dispense with the standard boilerplate. Don’t even think about making extra mortgage payments unless you’ve paid off higher-interest debt. Credit card debt is the easiest win here.
Also, if you’re not saving enough to get the full match from your employer in a 401(k) or similar account, increase your savings there first. And don’t make extra mortgage payments if you don’t already have a decent emergency fund set aside.
YOUR REAL INTEREST RATE Now, take a look at the interest rate on your mortgage. That 5 percent? It’s not your real rate if you get some of the interest back each year in the form of a tax deduction.
Let’s say you have a household income of $175,000 and are paying 35 percent of that in total to the state and federal tax collectors. If you pay $20,000 in mortgage interest each year on a loan that charges 5 percent, the deduction effectively brings your taxable income down to $155,000.
As a result, you’re paying $7,000 (35 percent of $20,000) less in taxes than you would have without the deduction. So ultimately, you’re not really paying $20,000 in interest at all; your net cost is $13,000 after you subtract the $7,000 tax savings.
And that makes your effective, after-tax interest rate on your loan just 3.25 percent, which is simply 35 percent (your tax rate) less than the original 5 percent.
BETTER RETURNS? So any money you set aside in lieu of making extra mortgage payments would need to earn more than 3.25 percent annually. That seems like a reasonable possibility in the future.
In fact, you could have done that well during the supposedly lost decade we just finished. Vanguard Wellington, for instance, a popular low-cost mutual fund that holds about 65 percent stocks and 35 percent bonds and other short-term securities, earned an average annual return of 6.15 percent in the 10 years ended Dec. 31, 2009.
The Vanguard Balanced Index Fund would not have outperformed our 3.25 percent benchmark, however, as it only returned 2.64 percent over the same 10-year period.
STORING THE SAVINGS Wouldn’t taxes eat into the returns from the money you’d save instead of making extra mortgage payments? Not if you place it into an account shielded from taxes. A Roth individual retirement account would fit the bill here, as would a 529 college savings account or health savings account.
Bruce Primeau, whose note to his financial planning clients at Wide Financial Group in Minneapolis on this topic inspired me to re-examine it, adds that this isn’t simply about keeping more assets under his watch so he can earn a better living. “I’m not telling them that the money has to come to me,” he said. “A 401(k) match beats the return on paying a mortgage off automatically. There’s real estate and buying employer stock through a purchase plan at a 15 percent discount and all kinds of things.”
Then you need to preserve those savings. When extra money goes toward a mortgage, it’s hard to get at it when the urge strikes to flee to an Asian beach for a few weeks of playtime. If the money is not locked up in retirement or college savings, however, you may be tempted to spend it.
THE LIQUIDITY PROBLEM Capital-gains taxes might eventually come due with some of these investments, and the rate could well rise above the current 15 percent long-term rate before too long. Still, having some of your savings in a taxable account makes sense for several reasons.
If you hit a stretch of long-term unemployment after having plowed most of your extra cash into paying down your mortgage, your bank probably won’t pat you on the back for being a good saver and give the money back to you. Nor is it likely to let you borrow it through a home equity loan if you have no income with which to repay it.
Elaine Scoggins, who had the mortgage department chief reporting to her at a bank before she became a financial planner, suggests imagining a situation where you need to move quickly but can’t sell your home or extract equity to use as a down payment in your new town. Given that possibility, why create more home equity through extra mortgage payments than you have to?
“The whole housing debacle has reminded us all, including me, that real estate is not liquid,” said Ms. Scoggins, who is the client experience director for Merriman, a planning firm in Seattle. “And it takes cash to support it.”
Those who have used their cash in an attempt to be conscientious have learned some tough lessons, meanwhile. Imagine people who scraped together a 5 percent down payment and bought a home in Florida or Arizona in 2005 and then made extra mortgage payments the first two years to try to increase their equity. Now, post-collapse, they owe, say, 30 percent more than their homes are worth and need to seriously consider walking away from the loan — and all of those extra payments.
REASON AND EMOTION So the reasoned case for making no extra payments is very strong. But there’s one counterpoint that almost always carries the day, even when there’s only a mild risk with the financial strategy of putting extra money elsewhere.
And it’s this: I need to be able to sleep at night.
Even Mr. Primeau concedes here. “Emotionally, you’re right, and financially I’m right, and emotionally, you win,” he said. “If emotionally, people want to pay down their debt, then that’s what I help them to do.”
If you’ve just started paying down your mortgage, any extra payments should go toward principal (make sure your mortgage company is applying it properly). That will have the effect of shortening the term of your loan from, say, 30 to 25 years, depending on how many extra payments you make. The extra payments won’t lower your monthly payment, but they will reduce your balance.
Many people who are years into their mortgages — and perhaps paying less in interest and getting less of a tax break as a result — tend to develop stronger feelings about making extra payments. Those feelings are often even more acute as retirement approaches and homeowners become determined to quit work with no debt to their names.
Those who do retire their debt rarely regret it or wring their hands over the big gains they might have scored by investing the money elsewhere. Tim Maurer, a financial planner and co-author of “The Financial Crossroads,” describes the feeling that washes over people who have paid their last mortgage bill as “beholden to no one.”
So he doesn’t feel as if it’s his business to separate people from their emotions if they feel strongly about working toward a debt-free existence. “The whole point of planning is to make life better,” he said. “It’s not to have more dollars at the end of the day.”
BORROWERS have had fewer mortgage choices in recent years, and now the list is shrinking further.
Freddie Mac, one of the two government-sponsored companies that set lending standards for mortgages, announced last month that in September it would stop backing interest-only mortgages, or loans that give borrowers the option of paying only the interest on the principal balance for a period of time.
Michael Cosgrove, a Freddie Mac spokesman, said the company had actually begun phasing out the loans last year, after big losses on the mortgages in the previous three years.
At the end of 2009, Mr. Cosgrove said, nearly 18 percent of the interest-only loans in Freddie Mac’s portfolio were at least three months delinquent, versus 7 percent for all of the company’s loans.
Fannie Mae, too, has announced huge losses on interest-only mortgages, but a spokeswoman would not say whether the company might shut off these loans.
Borrowers will still have options. Smaller lenders say they will most likely continue making interest-only mortgages, but only to the borrowers best suited to them.
“For the right people, an interest-only loan is a great product,” said Michael Moskowitz, the chief executive of Equity Now in Manhattan. The loans work best, he said, for wealthier and financially disciplined borrowers.
In a typical interest-only mortgage, borrowers choose a fixed- or variable-rate loan, and they pay only the interest on the mortgage for the first 10 years. They then pay the principal and interest for the next 20 years.
The monthly mortgage bill, therefore, can jump in the 11th year. On a $500,000 loan with a 5 percent fixed rate for 30 years, the monthly payment for the first decade is $2,083, but then it jumps to $3,300 for the remaining 20. (Payment on a traditional 30-year mortgage would be $2,684.)
Because such loans are considered riskier than conventional ones, fewer lenders offer fixed-rate interest-only mortgages, and the rates from those that do are typically a percentage point higher.
But interest-only ARMs, or adjustable-rate mortgages, still carry attractive rates. In mid-March, Mr. Moskowitz said, borrowers with good credit could get a 4.5 percent initial rate that would remain fixed for five years, then increase a maximum of five percentage points over the following five years.
These days, borrowers cannot qualify for the loan unless they show they can pay that 9.5 percent rate, known as the “fully indexed” rate. Before the mortgage crisis, borrowers often could qualify for the loans simply by showing that they could afford the lowest rate.
John P. Bonora, a vice president of Fairfield County Bank in Ridgefield, Conn., says that an interest-only loan is most appropriate for someone who doesn’t intend to keep his home for many years, or who needs greater cash-flow options.
But many of those who took out interest-only loans at the peak of the market did so because that was the only way they could afford the payments, he and other mortgage executives say.
These borrowers assumed, given the market’s seemingly unyielding ascent, that they could simply sell their homes for a hefty gain before the interest-only period ended. Or, they reasoned, they might refinance the loan into a conventional fixed-rate mortgage as their earning power increased with time.
Financing out of an interest-only loan may not be easy.
Regina Mincey-Garlin, an owner of RCG Mortgage Solutions in Montclair, N.J., says laws in New Jersey stipulate that interest-only borrowers (and all other borrowers, for that matter) refinance only if their payments are going down, or they are adopting a fixed-rate loan.
Marissa Aquila, a staff lawyer with Bankers Advisory in Belmont, Mass., says similar laws exist in many states, including New York and Connecticut.
A version of this article appeared in print on March 21, 2010, on page RE6 of the New York edition.
BOSTON — Jane Petion lived in her home for 15 years and saw its value rise slowly, rise rapidly and, when the housing bubble burst, plunge at a sickening pace that left her owing $400,000 on a house worth closer to $250,000. Last June, her lender foreclosed on the property. The family received notices of eviction and appeared in housing court.
Then they discovered a surprising paradox within the nation’s housing crisis: Their power to negotiate began after foreclosure, rather than ending there.
In December Ms. Petion signed a new mortgage on her house for $250,000, with monthly payments of less than half the previous level. She and her husband now have a mortgage they can afford in a neighborhood that benefits from the stability they provide. A nonprofit lender made the deal possible by buying the house from her original mortgage company and selling it to her for 25 percent more than its purchase price — a gain to hedge against future defaults.
“It was exactly what we needed to get back on our feet,” said Ms. Petion, who works for a state agency. “We have income. But another bank, it would have been easy to look at our foreclosure and say, ‘I’m sorry, we have nothing for you now.’ ”
This counterintuitive solution — intervening after foreclosure rather than before — is the brainchild of Boston Community Capital, a nonprofit community development financial institution, and a housing advocacy group called City Life/Vida Urbana, working with law students and professors at Harvard Law School.
Though the program, which started last fall, is small so far, there is no reason it cannot be replicated around the country, especially in areas that have had huge spikes in housing prices, said Patricia Hanratty of Boston Community Capital. “If what you’ve got is a real estate market that went nuts and a mortgage market that went nuts, what you’ve got is an opportunity.”
Two years into the nation’s housing meltdown, and after hundreds of billions of dollars of federal rescue programs, government officials and housing advocates denounce the unwillingness of lenders to adjust the balances on homes that are worth less than the mortgage owed on them.
Research suggests that such disparity, rather than exotic interest rates, is the main driver of foreclosures, in tandem with a job loss or another financial setback. The financial industry lobbied aggressively to defeat legislation that would empower bankruptcy judges to adjust mortgage balances to properties’ market value.
That reluctance, however, eases after foreclosure, when lenders find themselves holding properties they need to unload, Ms. Hanratty said.
“We found, frankly, the industry wasn’t ready to do much pre-foreclosure,” she said. “But once it was either on the cusp of foreclosure or had been taken into the bank portfolio, banks really do not want to hold on to these properties because they don’t know how to manage them, don’t know what to do with them.”
Working with borrowed money, Boston Community Capital buys homes after foreclosure and sells or rents them to their previous owners, providing new mortgages and counseling to the owners, who typically have ruined credit. During the process the families remain in their homes. Since late fall it has completed or nearly completed deals on 50 homes, with an additional 20 in progress, Ms. Hanratty said. The organization is now trying to raise $50 million to expand the program.
Steve Meacham, an organizer at City Life/Vida Urbana, is one reason banks may be willing to sell their foreclosed properties to Boston Community Capital. When families receive eviction notices, his group holds demonstrations or blockades outside the properties, calling on lenders to sell at market value. It also connects the residents with the Harvard Legal Aid Bureau, whose students work to pressure lenders to sell rather than evict by prolonging eviction and “driving up litigation costs,” said Dave Grossman, the clinic’s director.
“So they’re being defended legally, and we’re ramping up the pressure publicity-wise,” Mr. Meacham said. “And B.C.C. came in; they had a part that buys properties and a part that writes mortgages. It wouldn’t work without all three.”
A focus of the program has been the working-class neighborhood of Dorchester, where home prices dropped 40 percent between 2005 and 2007, compared with a 20 percent drop statewide, according to research by the Federal Reserve Bank of Boston. Foreclosures and delinquencies there are more than twice the state average, the bank found.
In such neighborhoods, lenders and residents are hurt by evictions, which often leave vacant properties that invite crime and drive down values of neighboring houses, Ms. Hanratty said. “So it’s in the lenders’ interest to get fair market value as quickly as possible, and in the interest of the community to have as little displacement as possible.”
The program is not a solution for all lenders or distressed homeowners. After months of post-foreclosure negotiations with her bank, Ursula Humes, a transit police detective, is waiting for her final 48-hour eviction notice. Her belongings are in boxes.
Mrs. Humes owed $440,000 on her home; her lender offered to sell it to Boston Community Capital for $260,000. But after assessing Mrs. Hume’s finances, the nonprofit asked for a lower selling price, and the lender refused.
On a recent evening, Mr. Grossman of the Harvard law clinic counseled Mrs. Humes on her options. “This is a case that doesn’t have a happy ending,” Mr. Grossman said.
Mrs. Humes said, “I depleted my retirement account and everything I owned, but I’m still going to lose it.”
Many commercial lenders, similarly, would shy away from such a program because it involves writing mortgages for borrowers who have already defaulted once — a high risk for a small reward.
For other homeowners, though, the program is a rescue at the last possible second. Roberto Velasquez, a building contractor, lost his home to foreclosure last November, owing the lender $550,000. After extensive wrangling, during which his family stayed in the house, he bought it again in March for $280,000, a price he can afford.
On the night after he closed, he joined other members of City Life/Vida Urbana at a foreclosed four-unit building in Dorchester from which most of the tenants had been evicted. A group of artists projected videos on sheets in the windows, showing silhouettes of families re-enacting their last 72 hours before eviction. Garbage filled one of the units. Mr. Velasquez said it hurt to stand amid such loss, but he was jubilant at his own perseverance.
“We’ve been fighting for so long,” he said, “and we win, because we’re still in the house.”
A version of this article appeared in print on March 22, 2010, on page A12 of the New York edition.
By ROLFE WINKLER and ROBERT CYRAN
Published: March 23, 2010
// JPMorgan Chase this week became the latest big bank to say it is willing to modify second mortgages for some struggling borrowers. While it’s a baby step in the right direction, it won’t do much to fix America’s foreclosure woes.
Second-lien loans, essentially top-up mortgages, look like a good place to start addressing the problem of borrowers who cannot keep up with payments. After all, second liens are subordinate to first mortgages. So when it comes to cutting interest or principal payments, they should logically come first.
But the government has primarily tackled first mortgages — and has not made much progress even there. The Home Affordable Modification Program, which is intended to facilitate mortgage payment reductions, is aimed at several million struggling borrowers. Of 1.4 million trial modifications offered so far, only 170,000 have resulted in adjustments that the program calls “permanent.” In reality, even after modification many borrowers are still overburdened, and further defaults look inevitable.
That ought to focus banks’ attention on their second-lien loans. There may be little or no chance many of them will ever be repaid. But banks have avoided writing down second liens because accounting rules allow them to consider the loans performing so long as borrowers make interest payments.
It’s easy to understand why the banks are avoiding the issue. According to Amherst Securities, of $1.05 trillion in outstanding second liens, commercial banks hold $767 billion. Bank of America, Citigroup, JPMorgan Chase and Wells Fargo alone hold $442 billion of them.
A government modification program for second liens, known as 2MP, was first put forward a year ago. But Bank of America, Wells Fargo and now JPMorgan Chase have only recently joined. It is not likely to reach many borrowers since it focuses on only those few who achieve “permanent” modifications under the federally sponsored program. Assuming around half of distressed homeowners have second mortgages, this would cover some 85,000 second liens, of the millions that are outstanding.
It’s good that banks are finally willing to discuss second-lien modifications. But to keep more borrowers in their homes — a better outcome for banks and borrowers than foreclosure — banks need to forgive loan principal on a much larger scale so that borrowers again have skin in the game.
An Expiration Date
Capstone Therapeutics, a small biotechnology firm, has developed a radical new therapy — for investors. The company itself is effectively adapting a biological process called apoptosis, a preprogrammed cell suicide of sorts. Under the proposal, shareholders would be given put options that could be redeemed for their proportional amount of the company’s cash. It’s a minor scientific breakthrough.
Capstone is giving itself an expiration date of June 2011. If its lead drug, an anti-scarring compound, succeeds in clinical trials, it stands to reason that few of its investors would exercise their right to cash out. But if it fails, they may well withdraw their capital, and potentially kill the company.
The market doesn’t ascribe much value to the drug now. Capstone’s market capitalization is $42 million — barely more than the $39 million of cash on its balance sheet. However, the puts provide some downside protection. Capstone estimates it will have 35 to 40 cents a share in cash left over in mid-2011. The stock trades at more than $1.
The company could just wind itself down. It’s a theoretically preferable option, as intellectual property and other assets could be auctioned off, allowing the total proceeds available to shareholders to exceed cash in the bank.
Even so, the Capstone puts are valuable protection for investors. Biotech executives prefer not to throw themselves out of a job. Often, a new drug of questionable merit is suddenly found in the labs, its possibilities played up and another round of cash raised, ultimately diluting existing shareholders.
The alternative is to merge with a private biotech company, trading cash for a pipeline. Unfortunately, the money spent developing or buying these lottery tickets is often wasted. Shareholder activists have pushed similar companies, like Northstar Neuroscience, into liquidation, but the campaigns can be expensive and the payoff uncertain.
It’s never pleasant to think about mortality, but a “living will” at least provides a graceful exit when a company’s time has passed.
By AGNES T. CRANE
Published: March 22, 2010
// Mortgages should be made less attractive. That’s one lesson of the recent housing bubble and bust. As long as borrowing seems like the easy road to riches, people will do too much of it. But right now in the United States, the tax code encourages many people to take out big mortgages. That’s why it’s a good idea to put the elimination of the tax deductibility of mortgage interest on the political agenda.
American homeowners can for tax purposes deduct interest on mortgages of up to $1 million. It’s a politically popular arrangement, and the lure of paying a bit less to the government has been an incentive to stretch housing budgets up to, or past, the limit. Even extra cash borrowed under home equity loans can share in the tax largess, whether or not the funds go to home improvement.
Take a married couple spending $400,000 on their home, a bit more than twice the $164,700 median price reported by the National Association of Realtors. The mortgage interest deduction, plus the deduction of property tax, is worth well over $20,000 a year, based on a 20 percent down payment, a 6 percent interest rate, and a 1 percent property tax. That’s an alternative to the $11,400 standard deduction the couple would otherwise be entitled to, but at a 28 percent tax rate, it would still reduce their annual taxes by some $3,000.
And the more the couple borrows, the more they save. A $900,000 home could reduce their taxes by nearly $13,000, assuming a 33 percent tax rate on income.
But not everyone benefits from the mortgage interest tax perk. The gross tax deduction for a married couple in a median home, as measured by the real estate agents’ association, would come to a bit more than $9,000, not enough on its own to make it worthwhile to forgo the standard deduction, which is available to every taxpayer.
The high income needed to take advantage of this tax benefit undercuts the claims of supporters that tax deductibility of mortgage interest promotes home ownership, which almost all Americans seem to assume is a good thing. In fact, it is a distortion in favor of those who need the least help.
The tax logic also encourages families to borrow rather than save. When the personal savings rate is a paltry 3 percent and policy makers are wringing their hands about global imbalances, this is the wrong message to send. Moreover, potential investment is skewed toward housing rather than, say, infrastructure, manufacturing and education.
Economists have been pointing out these distortions for years, but for politicians, advocating the elimination of this deduction is seen as suicidal. One problem is that an immediate elimination would probably pull down house prices, the last thing the already weak housing market needs.
The danger comes from the lower purchasing power that higher taxes would bring. For the couple who used to be able to afford a $400,000 home, the maximum purchase price would fall by 11 percent. The $900,000 home would have to drop about 21 percent in value to offset its owners’ higher tax payments. That sounds like an invitation to open another chapter of the financial crisis.
But even such a big change in tax policy could be phased in slowly enough to avoid disaster. Britain removed the tax advantages of home ownership over a period of 12 years. In the 1990s, the mortgage tax relief rate gradually fell from 25 percent to 10 percent before disappearing completely in 2000.
The British experience teaches another lesson besides the feasibility of a fairer approach to housing tax. Mortgage tax relief ended just as a housing bubble began. Far from slumping, the median British house price rose 145 percent from 2000 to the peak in 2007, according to the Halifax bank.
Higher taxes for mortgage borrowers would not prevent excesses in the United States housing market either. They would need to be complemented by careful controls on lending. But it would be a step in a good direction. As policy makers consider how to reshape this troubled sector of the economy — and the need to raise taxes to shrink an enormous deficit — getting rid of a poorly designed tax incentive is good place to start.
By SEWELL CHAN
Published: March 16, 2010
WASHINGTON — The Federal Reserve on Tuesday affirmed its plan to stop buying mortgage-backed securities, expressing a degree of confidence that it could eliminate that pillar of support without undermining the nation’s economic recovery.
The move came as the Fed voted to keep its benchmark interest rate unchanged, at nearly zero percent, citing evidence of economic weakness and little sign of inflation.
The Fed’s purchases of mortgage-backed securities, which will total $1.25 trillion and end March 31, have helped hold mortgage rates to near-record lows, and the Fed left open the possibility that the purchases might have to be resumed, particularly if the housing recovery stalls.
The Fed said it would “continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to promote economic recovery and price stability.”
Marvin Goodfriend, a former research director at the Federal Reserve Bank of Richmond, said the Fed was essentially conducting an experiment by trying to end its purchases of mortgage securities. “It would like private money to come back into the mortgage market, but if the interest-rate spread on mortgages over government securities that is needed to bring private money back is too high, it could impede the recovery of the housing market,” he said.
Ideally, the Fed would like to see only a slight rise in mortgage rates, he said.
In announcing that it would hold its benchmark fed funds rate near zero, the Federal Open Market Committee, the Fed’s chief policy-setting arm, said that “the labor market is stabilizing.”
That was a slight improvement over the assessment given after the Fed committee’s last meeting, in January, when it said “the deterioration in the labor market is abating.”
The committee added: “Household spending is expanding at a moderate rate but remains constrained by high unemployment, modest income growth, lower housing wealth and tight credit. Business spending on equipment and software has risen significantly.
“However, investment in nonresidential structures is declining, housing starts have been flat at a depressed level, and employers remain reluctant to add to payrolls.”
The committee maintained its position that “inflation is likely to be subdued for some time,” and left the target range for the fed funds rate, the rate that banks make overnight loans to each other, at zero to 0.25 percent, where it has been since December 2008.
And as it has said since last March, the committee projected that the rate would probably remain “exceptionally low” for “an extended period.” Many economists have taken that language to mean that the Fed would not begin tightening monetary policy until the second half of this year.
As of last week, the Fed has bought just over $1 trillion in mortgage-related assets, through a program that started in November 2008. It also had bought, as of Wednesday, $169 billion out of a target of $175 billion in debt guaranteed by federal mortgage-financing agencies, primarily Fannie Mae and Freddie Mac.
Stephen H. Axilrod, a retired Fed official and the author of “Inside the Fed,” a book about monetary policy, said of the committee members: “They’re gathering the nerve to end this response to the crisis and revert to normal, which is not to buy large amounts of long-term securities to lower interest rates.”
Traditionally, the Fed’s balance sheet has mostly comprised safe Treasury-securities.
But Ian Shepherdson, the chief United States economist at High Frequency Economics, a forecasting company, said the end of the asset purchases would “expose M2,” a measure of the money supply, “to the full force of the credit contraction, and it won’t be pretty.”
He wrote in a research note: “The Fed reserves the right to buy assets again if needed; we think it will have to.”
Mr. Goodfriend, now a professor of economics at the Tepper School of Business at Carnegie Mellon University, said: “The Fed can’t fund the mortgage market forever. There has to be an exit where the Fed pulls out, lets the spread move around a little, and assures investors that they can get a return commensurate with the current risk in housing.”
So far, the gradual tapering off of the purchases has not had a major effect on mortgage interest rates, which many Fed officials view as an encouraging sign.
The committee approved its public statement by a vote of 9 to 1. Thomas M. Hoenig, the president of the Federal Reserve Bank of Kansas City, who is known for his wariness about inflation, dissented, as he did in January.
Mr. Hoenig “believed that continuing to express the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted because it could lead to the buildup of financial imbalances and increase risks to longer-run macroeconomic and financial stability,” the Fed said in its statement.
With interest rates unable to go any lower, the Fed has had to use other instruments of monetary policy to help stimulate growth. Chief among those tools has been the asset purchases.
“The Fed, if it wanted to, and it may yet need to, could continue buying assets and expanding its balance sheet,” Mr. Goodfriend said.
“That’s an option the Fed has, even though interest rate policy is immobilized at zero. The reason we have a central bank is that it retains flexibility to move in either direction, depending on what the economy requires. It needs to make the most of that flexibility, because it’s very hard to see the future.”
The Fed also injected liquidity into the markets by making huge amounts of loans at the peak of the financial crisis in 2008.
Less than a month ago, the Fed took steps to normalize lending by raising the interest rate it charges on short-term loans to banks to 0.75 percent, from 0.50 percent.
While the Fed emphasized that the change in the discount rate did not represent a shift in monetary policy, it was interpreted by some as a clear sign that an extraordinary era of easy money was going to end gradually.
By DAMON DARLIN
Published: March 12, 2010
“IT’S a great time to buy a home.”
Real estate agents were saying that in 2001, as home prices were rising. They also said it when home prices peaked in 2005 — in fact, David Lereah, former chief economist of the National Association of Realtors, published a book that year titled “Are You Missing the Real Estate Boom?”
And many real estate agents said it was time to buy as prices began to drop — and continued to say it over the past several years as prices fell by an average of 33 percent in America’s 20 largest cities.
Mr. Lereah would acknowledge that he had gotten it wrong. But from the perspective of many real estate agents, it is always a good time to buy.
“What they are really saying is that it is a good time to be involved in a transaction that generates a commission,” says Barry Ritholtz, C.E.O. and director of equity research at FusionIQ, a quantitative research firm. He’s also author of “The Big Picture,” an irreverent blog on markets.
If agents are always motivated to make a deal, buyers are often asking an impossible question: “Will the price of this house go up?”
Although the National Association of Realtors said for many years that home prices historically don’t fall, actually they do, and sometimes quite sharply. The housing market is complicated, and the future unknowable. Still, for clues to the overall direction of prices, Mr. Ritholtz advises buyers to look at three metrics: the ratio of median income to median home prices, which suggests whether people can afford a house; the cost of ownership versus renting; and the value of the national housing stock as a percentage of gross domestic product.
All those measures were aberrationally inflated during the housing bubble. And they still aren’t back to historical norms. We can get back to the norm in either of two ways, Mr. Ritholtz says: home prices can either drop an additional 15 percent or go sideways for seven years or so, while G.D.P. and income presumably grow.
To complicate matters, even if home prices rise or fall nationally, they may not follow that pattern in Las Vegas or South Florida or Maine, to say nothing of the neighborhood where you want to buy.
There may be a better way, however, for potential buyers to approach the problem. “Predicting interest rates is a whole lot easier than predicting home prices,” says Glenn Kelman, chief executive of Redfin, a multistate discount online real estate brokerage company based in Seattle. “Before you buy the house, you buy the money,” he says.
It’s a little like walking into a dealership to buy a car, and finding the saleswoman immediately jotting down what your monthly payments will be and starting the negotiations there. That’s absolutely the wrong way to buy a car. But for a prospective homeowner, it’s a good place to start the analysis to determine how much house you can buy.
Instead of betting on home prices, you make a bet on whether money will become cheaper or more expensive, allowing you to buy more or less house.
That’s where the regular Joe has a pretty good shot of being right. You won’t know day to day, or week to week, what’s happening to rates, and a jolt like a default in Greece or a change in Chinese monetary policy can throw everything off. But, generally, the Federal Reserve is telegraphing where things are headed over the next six months.
“I can’t prove to you that housing prices have definitely bottomed out,” Mr. Kelman says. “I can say with a fair degree of certainty that the cost of money will go higher.”
OF course, if rates go up, home prices tend to dampen. Borrowing $300,000 at 5 percent costs you $1,610 a month. If rates rise to 6 percent, that’s $188 a month more, or $67,680 over 30 years. Would the price of a $375,000 house fall because of a half-point rate hike? Now you are back to guessing about home prices. Don’t go there. Maintain your focus.
“People are frequently buying for the wrong reasons,” says Frank LLosa, a real estate agent working in northern Virginia. In most cases, he says, they think that they are getting an income tax break or that their home is an investment.
He points out that a buyer of a $300,000 home would have to see the house appreciate $18,000 just to cover the commission and closing costs. Then figure in the predictable costs of maintenance, the opportunity costs of the mortgage down payment and the amount one could have saved by renting a similar place more cheaply.
Then there are property taxes.
In California, taxes alone can be $5,000 a year on that $300,000 house. In New Jersey, where property taxes are the highest in the nation, the extra cost can be even more. (The Star-Ledger of Newark calculated that, on average, residents in the town of Lodi pay 10 percent of their income in property taxes.) But who would have guessed that property taxes in that state would keep climbing, doubling over the course of seven years in some cases, even as home values stopped appreciating?
Mr. LLosa thinks that many people — including him — would be better off renting. People ought to buy a house for what he calls “warm and fuzzy feelings,” but they shouldn’t try to predict home prices. Nor should real estate agents, who aren’t much wiser.
“I don’t think real estate professionals should be in the business of telling people when it is a great time to buy,” he said.
By ELIZABETH A. HARRIS
Published: March 11, 2010
THESE days, lenders have a long list of what they want to see in a building and in a prospective borrower. One potential obstacle is your credit history. Here are a few things you should know about your credit:
• To get a good rate on a mortgage in this market, you’ll generally need a credit score of 720 or higher. Many banks will also want to see that you have at least four sources of credit — two credit cards, a mortgage and a car loan, for example.
• One major factor in determining your credit score is your debtto-credit ratio. If you have $25,000 of credit available and $5,000 of debt, it will hurt your credit if the larger number falls to $15,000. This might happen if a bank lowered your limit. If you are not carrying any debt, a lower limit will not change the ratio, so it shouldn’t hurt your score.
• One way to bolster your credit is to become an authorized user on a card belonging to someone else, like a parent or a spouse. This will increase your debt-to-credit ratio without affecting the other user’s credit. The arrangement, however, can be risky. If you don’t make a payment, you’ll harm the other person’s credit. If he or she misses a payment, your score will drop, too.
• You can check your own credit without affecting it, but generally, when other people check, your score takes a small hit. If, however, the checking takes place within a 30-day window, several checks can occur with no problem. This allows you to shop for a mortgage.
• The most recent 12 months carry the most weight. So if you are hoping to buy a home, be sure to stay on top of your payments.
Here are questions to help determine how tricky it could be to get financing in a given building:
• Does any one person or entity own more than 10 percent of the units?
• Is more than 20 percent of the building used as commercial space, as in a hotel or a doctor’s office?
• Is there enough money in the reserve fund?
• How much insurance does the building have and what kind? It may need to have fidelity bond insurance, which protects against theft by employees and management, as well as hazard insurance.
By BOB TEDESCHI
Published: March 10, 2010
A HIGH credit score won’t necessarily insulate borrowers from the home-foreclosure crisis, according to a new study from FICO, which creates the credit-scoring formula used by most lenders.
In fact, the report, which was released in late February, suggests that these premium borrowers might be more likely to default on their mortgages than their credit card debt should they encounter financial difficulties.
From May through October 2009, the mortgage default rate for borrowers with credit scores of 760 to 850 was 0.32 percent, versus 0.12 percent for credit cards, according to the report. (FICO considers loans 90 days or more past due to be in default.)
Of course, that mortgage-default level is still far lower than the 4.5 percent rate for all mortgage borrowers during this period, according to FICO, which is based in Minneapolis. But the numbers are nonetheless worrisome, said Rachel Bell, a director of analytics in FICO’s global scoring solutions business, because they mark the first time the mortgage default rate for this category of borrowers exceeded credit card defaults.
In 2007, the mortgage default rate for high-scoring borrowers was 0.08 percent, versus 0.10 percent for bank cards.
Housing counselors offer at least one possible explanation for the shift: some people with financial reversals who are in danger of losing their homes anyway might be more likely to pay back their credit cards, because they still need them to buy groceries and other essential items.
Ms. Bell declined to speculate about the motivations of borrowers. Because the FICO analysis did not look at specific households, she said she could not determine whether a particular family carried both a mortgage and credit cards, and defaulted on one before the other.
But she did say that the growing mortgage problem among households with high FICO scores might be linked to two areas of increasing trouble in the mortgage industry — namely, defaults on vacation homes, and so-called strategic defaults, in which owners abandon homes that are worth less than the mortgage.
The Mortgage Bankers Association, which closely tracks foreclosures and defaults, says it does not track such statistics for vacation homes. But Walter Molony, a spokesman for the National Association of Realtors, said that if foreclosures had risen among vacation homes, their owners would most likely have bought the properties recently and for investment purposes.
The more value a home loses, the more likely an owner will be to consider a strategic default. A study in late 2009 by three university researchers — from the European University Institute, Northwestern University and the University of Chicago — found that when the mortgage exceeds the home’s value by less than 10 percent, homeowners rarely consider a strategic default. But if the value was just half the mortgage amount, 17 percent would abandon the house, and the loan.
FICO did not break out its recent data by state, but its regional data suggest that those with high credit scores in the Northeast were faring better than such people elsewhere. In the Northeast, borrowers with high FICO scores were still twice as likely to default on their credit cards as their mortgages. In 2005, they were four times as likely to default on their credit cards as their mortgages.
Borrowers with FICO scores of 760 and higher generally qualify for a bank’s best mortgage rate, as long as the down payment and monthly income also fall within the bank’s limits. A score of 720 is considered “prime,” and is usually the lowest rate that will allow borrowers to secure the most widely advertised mortgage rates.
FICO does not publish an average FICO score, but the company said the median score was about 720. And for the high FICO borrowers who default, even 720 is a dream score. One default drops such people into the mid-600 range, at best.
By DAVID STREITFELD
Published: March 7, 2010
In an effort to end the foreclosure crisis, the Obama administration has been trying to keep defaulting owners in their homes. Now it will take a new approach: paying some of them to leave.
This latest program, which will allow owners to sell for less than they owe and will give them a little cash to speed them on their way, is one of the administration’s most aggressive attempts to grapple with a problem that has defied solutions.
More than five million households are behind on their mortgages and risk foreclosure. The government’s $75 billion mortgage modification plan has helped only a small slice of them. Consumer advocates, economists and even some banking industry representatives say much more needs to be done.
For the administration, there is also the concern that millions of foreclosures could delay or even reverse the economy’s tentative recovery — the last thing it wants in an election year.
Taking effect on April 5, the program could encourage hundreds of thousands of delinquent borrowers who have not been rescued by the loan modification program to shed their houses through a process known as a short sale, in which property is sold for less than the balance of the mortgage. Lenders will be compelled to accept that arrangement, forgiving the difference between the market price of the property and what they are owed.
“We want to streamline and standardize the short sale process to make it much easier on the borrower and much easier on the lender,” said Seth Wheeler, a Treasury senior adviser.
The problem is highlighted by a routine case in Phoenix. Chris Paul, a real estate agent, has a house he is trying to sell on behalf of its owner, who owes $150,000. Mr. Paul has an offer for $48,000, but the bank holding the mortgage says it wants at least $90,000. The frustrated owner is now contemplating foreclosure.
To bring the various parties to the table — the homeowner, the lender that services the loan, the investor that owns the loan, the bank that owns the second mortgage on the property — the government intends to spread its cash around.
Under the new program, the servicing bank, as with all modifications, will get $1,000. Another $1,000 can go toward a second loan, if there is one. And for the first time the government would give money to the distressed homeowners themselves. They will get $1,500 in “relocation assistance.”
Should the incentives prove successful, the short sales program could have multiple benefits. For the investment pools that own many home loans, there is the prospect of getting more money with a sale than with a foreclosure.
For the borrowers, there is the likelihood of suffering less damage to credit ratings. And as part of the transaction, they will get the lender’s assurance that they will not later be sued for an unpaid mortgage balance.
For communities, the plan will mean fewer empty foreclosed houses waiting to be sold by banks. By some estimates, as many as half of all foreclosed properties are ransacked by either the former owners or vandals, which depresses the value of the property further and pulls down the value of neighboring homes.
If short sales are about to have their moment, it has been a long time coming. At the beginning of the foreclosure crisis, lenders shunned short sales. They were not equipped to deal with the labor-intensive process and were suspicious of it.
The lenders’ thinking, said the economist Thomas Lawler, went like this: “I lend someone $200,000 to buy a house. Then he says, ‘Look, I have someone willing to pay $150,000 for it; otherwise I think I’m going to default.’ Do I really believe the borrower can’t pay it back? And is $150,000 a reasonable offer for the property?”
Short sales are “tailor-made for fraud,” said Mr. Lawler, a former executive at the mortgage finance company Fannie Mae.
Last year, short sales started to increase, although they remain relatively uncommon. Fannie Mae said preforeclosure deals on loans in its portfolio more than tripled in 2009, to 36,968. But real estate agents say many lenders still seem to disapprove of short sales.
Under the new federal program, a lender will use real estate agents to determine the value of a home and thus the minimum to accept. This figure will not be shared with the owner, but if an offer comes in that is equal to or higher than this amount, the lender must take it.
Mr. Paul, the Phoenix agent, was skeptical. “In a perfect world, this would work,” he said. “But because estimates of value are inherently subjective, it won’t. The banks don’t want to sell at a discount.”
There are myriad other potential conflicts over short sales that may not be solved by the program, which was announced on Nov. 30 but whose details are still being fine-tuned. Many would-be short sellers have second and even third mortgages on their houses. Banks that own these loans are in a position to block any sale unless they get a piece of the deal.
“You have one loan, it’s no sweat to get a short sale,” said Howard Chase, a Miami Beach agent who says he does around 20 short sales a month. “But the second mortgage often is the obstacle.”
Major lenders seem to be taking a cautious approach to the new initiative. In many cases, big banks do not actually own the mortgages; they simply administer them and collect payments. J. K. Huey, a Wells Fargo vice president, said a short sale, like a loan modification, would have to meet the requirements of the investor who owns the loan.
“This is not an opportunity for the customer to just walk away,” Ms. Huey said. “If someone doesn’t come to us saying, ‘I’ve done everything I can, I used all my savings, I borrowed money and, by the way, I’m losing my job and moving to another city, and have all the documentation,’ we’re not going to do a short sale.”
But even if lenders want to treat short sales as a last resort for desperate borrowers, in reality the standards seem to be looser.
Sree Reddy, a lawyer and commercial real estate investor who lives in Miami Beach, bought a one-bedroom condominium in 2005, spent about $30,000 on improvements and ended up owing $540,000. Three years later, the value had fallen by 40 percent.
Mr. Reddy wanted to get out from under his crushing monthly payments. He lost a lot of money in the crash but was not in default. Nevertheless, his bank let him sell the place for $360,000 last summer.
“A short sale provides peace of mind,” said Mr. Reddy, 32. “If you’re in foreclosure, you don’t know when they’re ultimately going to take the place away from you.”
Mr. Reddy still lives in the apartment complex where he bought that condo, but is now a renter paying about half of his old mortgage payment. Another benefit, he said: “The place I’m in now is nicer and a little bigger.”
