The recent Federal Reserve 1/2-percent rate cut and the proposed measure before the House of Representatives to allow the Federal Housing Administration to assist current mortgage holders to refinance are both good news for home buyers and sellers alike. Neither is likely to be a bailout for those who have overextended their finances to purchase expensive housing beyond their means. The FHA Bill is poised to assist those with sound credit. To refinance a loan, the homeowner must have three percent equity in the home. To take out a new loan backed by the FHA, which provides insurance to the capital markets that a loan will not default, consumers must have a stable credit history. There is no easy out here.
The Federal Reserves cut in the cost of money to banks that provide liquidity to mortgage lenders should have the effect of enticing buyers waiting out the market adjustment to the settlement table. In addition, it will also benefit those feeling the mortgage financial crunch by decreasing slightly the adjustable-rate mortgage increase in loans ending their teaser rates and rising in monthly fees. The additional fifty basis point cut in the overnight rate banks charge each other to lend money for short-term liquidity will also take the edge off the crisis in confidence that banks are experiencing, as they hoard their cash reserves. If allowed to continue, this hoarding would have the effect of making loaned money more costly going forward, with the potential of driving down values in existing homes.
In the D.C. Metro area, with our relatively high salary rates and still-growing economy, the national statistics do not reflect regional trends. Home appreciation rates have climbed over two percent, as our market pursues an orderly correction to the hot real estate market we experienced between 2002-2005. The average gain in home appreciation over the past 28 years is seven percent. However, there is true sadness in the national statistics. In testimony before Congress, Alphonso Jackson, Secretary of Housing and Urban Development, said that, about five hundred thousand of the two million with subprime mortgages scheduled to reset at higher rates appear likely to lose their homes.
Additional measures under consideration to allow Freddie Mac and Fannie Mae to purchase loans exceeding their current $417,000 cap would add liquidity to the mortgage money markets, but they would likely need to tighten their own mortgage purchase standards to meet government approval. To date, Freddie Mac and Fannie Mae have limited their loan portfolios to mortgages at $417,000 or lower, based on median home price trends nationally. The implied risk of accepting loans above this limit would be minimized by the two government-sponsored entities by accepting only those mortgages that meet solid credit lending standards. The reason for the careful regulation of risk by the two mortgage providers is their government- sponsored status. Should either of these institutions falter, the American taxpayer would be at risk of paying to bail them out. In recent policy statements, Federal Reserve Chairman Benjamin Bernanke and other financial leaders in the Bush administration have stated they are loath to take this risk.
In the meantime, Fed chairman Bernanke is calling for tougher credit standards for borrowers and reform in the mortgage industry. The liquidity crunch we find ourselves in is the result of accumulated risk in an over-zealous housing boom period where lenders granted loans to what until recently would have been unacceptable credit risks. For example, many of the anticipated defaults will be the result of loans without income documentation. Another industry tactic to lure buyers into loans they couldnt afford was not including escrow accounts for property taxes and insurance on the home in their loan documents, which fooled many buyers who awoke to the reality their monthly payments were too high. The transparency of loan documents is part of Bernankes proposed reform. And, there is likely to be more to come all geared to providing a solid platform on which to base future housing security and growth.
What we are currently experiencing is a crisis in confidence in our financial system, caused in part by the unraveling of default on many of the high-risk mortgage products we produced over the last several years. These high-risk mortgages were bundled into sophisticated securities and sold internationally. While Wall Street has sliced and diced the risk these financial instruments carry, the global market at large has suddenly discovered they are unable to price their losses and assess risk going forward because the package is too complicated. This has caused the failure of two banks in Germany and a depression-era style run on savings at the Northern Rock Bank in Surrey, England, after it failed and had to be bailed out by the Bank of England. Since much of our debt is packaged and sold globally to provide liquidity in our financial system, our money market securities going forward will be closely examined. We wont be able to sell off high-risk in the same fashion.
While there is much speculation about a contracting mortgage credit market, many local banks, including Burke and Herbert Bank in Old Town, have publicly stated they have money to lend and are open for business to credit-worthy borrowers. This will likely be a strong trend going forward localized lending based on regional home values.
Jeni Upchurch is a former Assistant Secretary, U.S. Department of Housing & Urban Development and now a full-service Realtor with McEnearney Associates in Old Town. She can be reached at 571-216-6701.