Home financing in a ‘pragmatic’ environment

[Pacific Publishing Co., the publisher of the Madison Park Times, asked me to write a piece about the current state of the local home-finance market for their City Living section, which is an insert into several of their Seattle community newspapers (not including the Madison Park Times). Since the article may be of interest to some Madison Park Blogger readers, I am reproducing it here.]

You may have seen the story in the local press recently about the supposed new “trend” in home buying: paying cash. Reading a little deeper into the story, however, it becomes clear that this approach is being pursued by a pretty tiny fraction of the population—and only at the very low (or very high) end of the market.

For most of us, figuring out how to pay for a home is the largest financial decision we will ever make in our lifetimes. And for perhaps 99% of us, that means deciding on how to finance the purchase. As we’re all aware, however, the collapse of the residential real estate bubble and the resulting tightening of lending standards have impacted the financing options available for home buyers. But in what way? Is it possible today for home buyers to get a loan approved on reasonable terms, at a good rate, and without undue delay?

“Yes,” says Tom Golon, a home mortgage consultant at Wells Fargo Home Mortgage in Seattle, “but people are realizing that times have changed.” What this means, he notes, is that most people who are now applying for loans are less likely than in the past to “stretch” to get into the biggest home they possibly can qualify for. Also, they are likely to have higher credit scores than was true a few years ago, and they probably are looking for a traditional 30-year, fixed-rate loan rather than an adjustable-rate mortgage or some exotic financing option. “We currently have a more pragmatic population of home buyers,” Golon reports. “People who have been sensible can certainly buy a house today.”

And the timing is certainly right for getting a good deal on the financing, according to local mortgage professionals. They point out that rates continue to be low relative to historic patterns, home prices have fallen to a level where there are some real values in the market, and there are special government programs still available to help support home buying.

The program having the most impact, especially on the lower end of the real estate market, is the $8,000 tax credit for first-time home buyers. The program was extended into this year and applies to qualified purchases that are entered into by April 30 and that close no later than June 30.

Additionally, however, there is a “long-time resident” tax credit of up to $6,500 available for buyers who have owned the same home for a least five consecutive years of the last eight and who purchase a new primary residence. Apparently few buyers are aware of this little perk. An advantage of the program is the fact that those who qualify this year for it (or for the first-time-buyer tax credit) can use it either on their 2009 or 2010 tax return.

Another way the federal government provides support for home buyers is through the Federal Housing Administration (FHA)’s insured-loan program. According to Trevor Bennett, a mortgage loan officer at Bank of America in Kirkland, FHA-backed loans offer several advantages for many home buyers. Unlike conventional mortgage loans which generally require a sizeable down payment, loans insured by FHA can be approved with only 3.5% down.

Additionally, says Bennett, there is greater underwriting flexibility with FHA. “You don’t have to have perfect credit,” he notes, “and settlement costs related to the closing can be paid by the seller.” Additionally, gift funds can be used by the borrower to support the down payment. This is quite different from the standards lenders use to underwrite conventional mortgages. The cost of this kind of loan is higher, since a monthly FHA mortgage insurance premium must be paid until the loan amount declines to no more than 78% of the house value. But the program allows for people who might not otherwise be able to buy a house to have an option. FHA-backed loans currently represent a very high percentage of overall mortgage lending in this market.

For those who qualify for conventional mortgages “it’s a promising scenario right now,” according to Wells Fargo’s Golon, “certainly better than it was a year ago.” A 20% down payment is pretty much the standard for this kind of loan, he says. For a down payment of less than that, mortgage insurance would probably be required. So-called “conforming” loans are those that meet the 20%-down standard and that are not for an amount in excess of $567,500 within the Seattle market, he says. Interest rates for this kind of loan still range in the high-4% to low-5% range for qualified buyers with reasonably good credit scores.

A typical borrower today has a score in the mid-to-high 700s, Golon says. Someone with a lower credit score--but one that’s still good--might have to pay a slightly higher interest rate. (If you are interested in knowing your current credit score you may obtain it without charge by going online to www.annualcreditreport.com).

According to Golon, the typical underwriting standards for “conforming” loans include a requirement that no more than roughly one third of the borrower’s monthly income can go to home-related expenses, and monthly debt payments cannot exceed 45% of income. “Non-conforming” loans (jumbo mortgages) typically have tougher standards and higher rates but are more readily available than they were at this time last year.

Certain loan programs that once proliferated, such as Option ARMs, Sub-Prime, and Interest-Only mortgages, are now out the window, however. “These loans were originated for sophisticated buyers but later were offered to very unsophisticated borrowers who had no idea what they were getting into,” says Golon. Things really got out of hand when these loans were coupled with low (or or no) underwriting standards—including, in some cases, no requirements for borrowers to document income. “Those days are over,” Golon reports, “and people should expect to be able to document their income in order to qualify.” He notes that self-employed borrowers will probably have to provide at least one year’s tax return to verify their income.

Bennett of Bank of America agrees that now is a good time to finance a home, but he notes that buyers should feel a certain sense of urgency. In addition to the fact that several of the government programs will be expiring soon, there’s the added probability that mortgage rates will be rising in the coming months. For one thing, says Bennett, the federal government will be ending its purchase program for mortgage-backed securities in a couple months. This will almost certainly drive rates up at least marginally, making home buying more expensive.

In addition, it is possible that as early as this Spring, the upfront mortgage-insurance premium will be rising from 1.75% to 2.25% for FHA-backed loans. That’s just another reason why it probably makes sense for some prospective home buyers to make their moves sooner rather than later, says Bennett.

Then there’s the issue of refinancing. The general rule has always been that it takes an interest rate decline of at least 1% for a refinance to make sense. There are closing costs and loan fees to take into consideration in addition to the rate decrease. A lot of refinancing has occurred in the past year as rates have remained low, but there’s still a fair number of people who are looking to refinance their existing mortgages, according to Bennett.

Those still seeking refinancing, says Bennett, should consider taking advantage of a government program called “Making Home Affordable.” In general, if you have been current on your mortgage payments for the past 12 months and you originally put 20% or more down as a payment on your residence, you may qualify for a lower interest rate with your existing lender, with little or no closing cost and no mortgage insurance requirement. This assumes, however, that your mortgage is currently no more than 125% of your house’s value. Refinancing this way can save a borrower hundreds of dollars in mortgage payments each month, says Bennett. “We’re processing thousands of these loans,” he adds. “That’s my world right now.” (To find out if you qualify for this program go to makinghomeaffordable.gov. Note that not all mortgage lenders are participating in this program).

So here’s the bottom line: the opportunity exists in the market for both mortgage financing and re-financing on very reasonable terms. Borrowers are more likely to qualify if they have realistic expectations and good credit history. But if you’re interested in taking advantage of today’s market you should probably get moving soon.

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[Mortgages rates, courtesty of BankRate.com, show average rates for mortgages in the 98112 zip code on the date specified. Assumptions: Conforming loans with no points and good credit scores for borrowers.]