How low can rates go?

Jay Vorhees at JVM Lending recently shared a great blog, which I have posted in its entirety below. As usual, I’ve added my two cents to the topic at the end. Hope you enjoy!

One of the most interesting aspects of the COVID-19 crisis is its effect on interest rates. In “normal” times, mortgage rates correlate closely with the 10 Year Treasury Bond. In other words, when the 10 Year moves higher, so do mortgage rates and vice versa.

Also, “the spread,” or the difference between the 10 Year Yield and mortgage rates in normal times averages about 1.5%, meaning the average mortgage rate is usually about 1.5% higher than the 10 Year Yield. Since the COVID-19 crisis started, however, the “normal” correlation and spread have disappeared.

10 Year Treasury Yields have plummeted much farther and faster than mortgage rates. In addition, mortgage rates don’t always move in conjunction with the 10 Year, and the “spread” between the 10 Year and the average 30-year mortgage rate has jumped to over 2.6%!

Mortgage rates remain higher than expected for a few reasons that I have illuminated many times. One reason is that lenders could not handle the onslaught of refi volume if they lowered rates any more. But the important reason has to do with risk. Mortgages are much riskier now because of unemployment, forbearance, and liquidity concerns; higher mortgage rates simply reflect that risk.

HOW LOW WILL RATES GO?

If the market returns to “normal;” if the 10 Year remains as low as it is now (around 0.6%+); and if the “spread” between the 10 Year and mortgage rates drops back to the 1.5% range, we could see 30-year mortgage rates drop another 1%!

Yes, that means 30-year mortgage rates as low as 2%!

SHOULD BORROWERS WAIT TO REFINANCE?

Absolutely not, and this is why.

First and foremost, the above scenario requires a lot of major “ifs.” And in this extremely volatile economy, anything could happen to derail the downward rate spiral, including inflation, new regulations or government actions, less competition in the market, renewed liquidity crises, and/or a faster than expected economic rebound.

Additional reasons to refinance now rather than waiting include: (1) most refinances are “no cost” so borrowers can simply refinance again if rates fall further; (2) borrowers can save hundreds of dollars per month by refinancing now at no cost, so why defer the savings? And (3) refinancing is relatively painless now with all of the new technology in place, so refinancing again should not be a concern.

This has been our mantra for years and it bears repeating – borrowers who wait for pristine market conditions (with respect to both housing prices and interest rates) often get burned. And that is because in this world of extreme volatility, nobody really has a clue what will happen.

Kristin’s take: I have had many conversations with buyers who are wanting to “wait and see,” and many keep asking if prices have come down. Prices have not come down (with the exception of the luxury market) and we are currently seeing multiple offers or properties pending in 5 days, especially in the entry-level market. Of course, it depends on the home: is it updated? Is it priced at fair market value or lower? And so on. I believe the window to negotiate or get a great deal was within the first 6 weeks of our shelter-in-place because there was so much unknown. For those who had a higher level of risk tolerance or just needed to buy a home, I believe hindsight will show they got a deal (comparatively).

Homeowners: Cash in on all-time high equity

I came across a CNBC story recently about homeowners and the $14.4 trillion in equity they’re about to be able to dig into. New research, according to the article, suggests that home equity is about $1 trillion higher than its peak in 2005 before the Great Recession.

With interest rates rising on consumer debt, the article states, home equity loans or lines of credit could be an appealing option for consumers looking to borrow money at a lower cost. Homeowners no longer need to refinance just to take out equity. This is the aspect of the story I really want to focus on. First, a graph from the story:

Why consumers tap their home equity

Use	Description	Percent using*
Major expense	Take cash out, often for a large expense like home remodeling	91 percent
Debt consolidation	Consolidate balances from other accounts	41 percent
Refinance	Refinance to get a better rate or term	23 percent
Piggyback	Concurrent with a mortgage origination, often used for down payment	4 percent
Undrawn	Not used immediately (i.e., a rainy day fund)	2 percent

[Source: TransUnion, CNBC story]

(*Based on 2.4 million home equity loans originated between July 2016 and June 2017)

During the meltdown, people were using their homes like they were ATMs; as interest rates dropped they kept refinancing and taking out money to buy a boat, a big trip, etc., but when equity dropped, or they lost their job, they were in trouble. Use a HELOC (Home Equity Line of Credit) wisely. If it helps you get into a home or remodel a home to add value, it will be a smart decision. And always remember as rates go up, so does the interest on a line of credit.

Is there a recession coming in 2020?

Is there a recession coming in 2020 or sooner? And if so, what does that mean for the real estate industry? Additionally, how do Chinese buyers affect California real estate? Jay Vorhees of JVM Lending (with a little help from The National Real Estate Post) has you covered:

The National Real Estate Post had a great video today with information I thought was well worth sharing. Marketing commentator Barry Habib discusses margin compression, the coming 2020 recession, why he is bullish on real estate even if a recession hits, and why Chinese buyers influence California real estate so much.

RECESSION IN 2020 – WHY?

Mr. Habib agrees with other prognosticators I have cited in previous blogs and illuminates two reasons why a recession is likely in 2020:

Short-term rates are almost the same as long-term rates. I won’t explain the economics, but I will say we are at this stage in the interest rate cycle now; and
Unemployment has likely bottomed out and will only increase at this point.

BULLISH ON REAL ESTATE EVEN IN RECESSION

Mr. Habib remains very bullish on real estate – even if a recession hits. He thinks a 10% correction is very unlikely for several reasons:

1. It is different this time for reasons we have explained in previous blogs – tighter lending guidelines, more structural housing demand, etc.
2. Rates come down during recessions and that props up real estate prices; and
3. According to Mr. Habib, if you look at data from the last six recessions (other than the 2008 meltdown) you will see that real estate prices usually do not decrease significantly.

CA PRICES HURT BY CHINESE BUYERS PULLING OUT

15% of the money spent on real estate transactions in California is from China. But b/c China’s currency is now so much weaker than it was relative to the U.S. dollar, Chinese buyers are now sitting on the sidelines. This drop off in demand is already affecting prices, particularly on the high end. But, according to Mr. Habib, this too will end and Chinese demand will return.

I hope this helped you learn a little something about the impending recession, how it affects real estate, and why Chinese buyers may affect the market long-term!

Now, with a little input from us:

Comments from Bob Schwab – Inverted Yield Curve

Our in-house lender has remarked that one of the indicators a recession may be on the horizon is an inverted yield curve. I asked what that means, and here was his response (note any errors are mine via translation):

“The U.S. runs a deficit, and in order to pay on the deficit, they sell treasury notes and pay interest to the purchaser. Normally, the longer the you take the note, the higher the rate or return; [in the] shorter term, the lower the rate the government will pay you. When the short-term notes have a higher rate than the long-term is when we have an inverted yield curve. That margin has been steadily decreasing, and we have been about 30 points away from an inverted yield curve, and thus why the buzz of a correction is coursing through the media. I am seeing a different effect; in June we had a wave of listings come on the market, when it usually quiets a bit due to summer vacations. I believe sellers are thinking prices might have reached a peak and now is the time to get their home on the market, which means we now have more inventory and more for buyers to choose from. The outcome is price reductions, things sitting longer, etc., because buyers now are thinking they will have a wait-and-see strategy!”

Why higher interest rates are good

This may surprise you, but higher interest rates aren’t always bad! In fact, sometimes they can be really good for the real estate market. Jay Vorhees at JVM Lending gives us some good reasons why. I’ve summarized those points below with commentary.

After the most recent presidential election, interest rates went up 3/8-1/2%, and the real estate market seemed to come to a standstill. It scared everyone into thinking that higher rates would severely impact the market overall. But, it was really just “uncertainty” that kept everyone on the sidelines, and not the higher rates.

Rates might continue to rise, but that’s a good thing, and here’s why:

Slowly climbing rates often push would-be home-buyers off the fence. Higher interest rates heat up the market by pushing people to buy sooner, rather than later.
Higher rates give the Fed “ammo” for the next recession. One of the Fed’s most powerful recession-fighting tools is lowering rates. But, if rates are already low, that tool becomes worthless. To restore the power of this, we need higher rates.
Retirees and savers get higher returns. Artificially low rates that benefit big banks and borrowers hurt savers who live off of their savings. The higher the rates, the better for retirees and savers.
Banks lend more money with high interest rates. There is a much better incentive to lend when rates are higher. More economic growth, higher wages and more home-buyers result from higher rates, too.
Stronger dollar and continued tamed inflation. A stronger dollar makes traveling abroad cheaper, investing in the U.S. more appealing, and importing goods cheaper. Higher rates also keep inflation in check for a variety of reasons.

Higher rates hurt mortgage companies that rely on refinance business instead of purchases, and it hurts home-buyers to the extent that their payments will increase.

But the payment factor is often overstated. A rate increase of 1/2% might push a payment up about $150 for a $500,000 loan. That is real money, but it won’t break the bank for most of our borrowers whose income is well into the six-figure range.

What are your thoughts and how would higher rates affect you directly?

Supplemental property taxes can confuse a buyer

Have you recently purchased a home and been thrown off by getting bills about “supplemental property taxes?” Our friend Jay Vorhees at JVM Lending breaks it down for you:

Supplemental property taxes often create significant confusion for new homebuyers. When someone purchases a property in California, the County Assessor is required to immediately re-asses the property for property tax purposes. This re-assessment usually correlates to the purchase price and can take up to six months to complete.

When a home is purchased, property taxes are usually based on the property tax bill of the current owner or seller. But usually, their property tax bill correlates to the price the seller paid for the property – often much less than the buyer is paying. Then, buyers mistakenly believe the property tax payment estimate when they purchase is an accurate reflection of their actual property tax. Usually, that’s false.

Anywhere from three months and beyond, buyers should expect a “supplemental tax bill” from the County Assessor. Even if a buyer has an escrow or impound account, they have to pay for the supplemental taxes, which can be sizable. As soon as a supplemental bill is received, a buyer should contact their loan servicer.

Also, when new buyers refinance into a new loan less than a year after a purchase, supplemental tax bills can cause confusion. Even if a borrower is refinancing into a lower rate, the housing payment can appear to increase. This is because lenders are basing the new housing payment on the new property tax liability, while borrowers are still basing their housing payment on the seller’s property tax liability, which is too low.