The outlook for mortgages

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The global credit squeeze has its heart in defaults in the US subprime mortgage market. Now the effects have spread far and wide but what does it mean for the mortgage market itself in the US and UK?

Ray Boulger, vice-chairman of the UK’s Association of Mortgage Intermediaries, and Harry Dinham, immediate past president of the US National Association of Mortgage Brokers, answer your questions.

Are mortgage lenders to blame for the whole subprime credit squeeze?
Ritch Levis, London

Ray Boulger: US lenders and brokers have quite rightly been heavily criticised for much of the toxic sub prime lending to borrowers whose only chance of paying their mortgage was by remortgaging in a rising market so as to rob Peter to pay Paul. However, this lending would not have been possible if myopic investors had done their due diligence properly rather than buying a pig in a poke purely on the strength of the mortgage backed securities they were buying having been given a certain rating by a rating agency paid by the borrower to provide that rating.

If fund managers don’t have enough expertise to analyse the underlying investments in the securitisations they buy and put their own value on them after understanding the level of risk perhaps they are in the wrong job. Rating agencies now have far too much power, but only because investment houses have effectively outsourced too much of the investment decision making process to them. Outsourcing some admin functions may be sensible. Outsourcing investment decisions isn’t!

If investors hadn’t been prepared to buy these mortgage backed securities at the wrong price lenders would not have been able to offer sub prime mortgages at the rates they did. Therefore a lot of the blame for this whole problem is down to the investors who bought the CLOs, CDOs etc.

I was considering remortgaging to a capped rate deal at 6.2 per cent for the next five years. Is this a good deal or do you think a two year deal at 5.9 per cent would be safer? Also are trackers still variable rates? They just guarantee to track by an agreed amount below the base rate?
Michelle Smith, London

Ray Boulger: A key thing to look for with a capped rate as well as the level of the cap and the fee is what the underlying rate is. Always look for a deal where the underlying rate is a tracker rate linked to Bank Rate, with not too big a margin over Bank rate so that there is a realistic chance you will pay less than the capped rate for part of the period. With some capped rates the underlying rate is the lender’s SVR (standard variable rate), which is typically at least 2 per cent above Bank Rate and with these deals there is little chance of the SVR falling below the capped rate, meaning that the capped rate in effect is likely to also be a fixed rate.

There aren’t any 5 year capped rate deals currently on the market with a cap as low as 6.2 per cent and so I guess the deal you are considering is Marsden’s 6.39 per cent capped rate with an underlying tracker rate of Bank Rate + 0.45 per cent , i.e currently 6.2 per cent . As the tracker rate is lower than the capped rate the initial rate is the 6.2 per cent you have quoted. If you want a five year capped rate this is the market leading deal.

The best comparison is with a 5 year fixed rate, where the cheapest rate currently is 5.39 per cent with a £999 fee, compared with £649 on the Marsden capped rate. The benefit of the capped tracker over the fixed rate is that the initial rate can only increase by a maximum of 0.19 per cent but the rate will fall in line with Bank Rate and so if Bank Rate falls below 5.2 per cent the pay rate will be lower than the fixed rate. The benefit of the fixed rate is obviously the lower initial rate.

I think there is also a psychological benefit in the capped tracker in that there is no risk that during the five years you will ever pay much more than the current level of interest rates.

Do you think there is a paradigm shift in the UK housing market towards a European style Rental market that supports rising house prices supported by Buy to Let investors or do you think such rhetoric is indicative of bubble valuations in an over inflated “hot” market flooded with foolish investors looking at ten years of abnormal growth and not able to see real values now and in the next decade?
Adam Sandell, London

Harry Dinham: I am in the US and the same phenomenon is happening. We call it ’rent to own’. I believe that it is a passing fad here and is indicative of the cooling market. It will pass.

I am a bit unusual. I believe that, in the long run, housing prices are related to real incomes of families. So, if incomes go up, housing prices will rise (adjusting for changing interest rates). If real incomes go down or are level, then housing values will be level. In your area, are you exporting jobs? Is there unemployment? Is the job market growing and creating high paying jobs?

At the end, if wages go up and we feel good about the local economy, housing values will go up. If wages are going down, values will go down.

Ray Boulger: I do not think the UK will see a paradigm shift towards a European style rental market, although of course many other European countries apart from the UK have high levels of home ownership, some higher than the UK’s 70%. Interestingly, according to a recent Commons answer by Housing Minister, Yvette Cooper, the number of home owners actually fell slightly in fiscal 2006, the last year for which figures are available and the first time the number has fallen for very many years. Not surprisingly this is one figure the Government hasn’t re-announced several times!

Whether a country has primarily home owners or primarily renters is something which, if it changes, only does so over a long period of time as it reflects a number of factors which people don’t change their mind on quickly, such as expectations of long term house price appreciation. Even the very serious problems in the housing market in the late 80s / early 90s didn’t change most people’s desire to own their own home.

Most buy to Let (BTL) investors are wise enough to not expect a repeat of the scale of capital growth we have seen over the last 10 years, but of course if they didn’t expect a reasonable level of long term capital gain they would not invest in that market as the rent on many highly geared investment properties is often not sufficient to cover the mortgage payments, let alone other expenses and void periods. One major attraction of BTL for investors compared with, say, stock market investment is the gearing available. This obviously works both ways and so there is no doubt that long term confidence is the property market is a pre-requisite for BTL investors, but most professional investors recognise that there will be some years when prices are likely to fall, or at least not increase.

My cousin is willing to buy a house in Devon together with his wife. They want to finance it with a 100 per cent plus loan from Northern Rock. That means 95 per cent mortgage and 5 per cent loan as deposit plus another kGBP 30 free to use with interest, much like a current account at the bank. The interest rates related to the mortgage will be set for two years and the financing is secure as long as the house price does not decrease. Would you suggest him to do it? What are the stumbling blocks?
Gordon-David Filbry, Devon, UK

Ray Boulger: I don’t think you fully understand this deal from Northern Rock. The way this works is that there is a 95 per cent mortgage and an unsecured loan of up to the lower of 30 per cent of the property value and £30,000. For any property worth over £100,000 that means 95 per cent plus £30,000. It definitely does not mean 100 per cent plus £30,000.

The rates on this type of mortgage has risen sharply recently because of the current situation in the money markets and also Northern Rock’s own position. If your cousin OR his wife is a graduate Scottish Widows have some very competitive two year fixed rates and will lend up to 102 per cent. Other lenders who will lend above 100 per cent include Mortgage Express, Alliance & Leicester and Godiva (a subsidiary of Coventry B S)

The key point to be comfortable with is that whatever mortgage they take they are confident it is affordable because as they will have no equity in the property until they either repay some of the capital and/or the property value increases they will be in a very difficult position if they can’t afford the mortgage and run a big risk of being repossessed.

I am a mortgage broker in Arizona and would like to know with the recent implosion in the mortgage industry, and banks closing their doors one after another, just what does the future of this industry look like for the hundreds of thousands of people that it employs. The buck is routinely passed in most media forms to suggest that your local mortgage broker has contributed to the demise of America in particularly the housing sector. Is there a future in this industry or should we all begin the mad scramble to find new ways to feed our families before the suggested legislation further limits the way in which we do business?
Michael Melenovich, Scottsdale, AZ

Harry Dinham: The future is GREAT! Yes, we are going through a bad patch right now. Doesn’t every industry? If you are real professional, know your products, and are honest, you will do fine in this industry...now...and in the future.

It is sad that some people are blaming the mortgage brokers for all of the problems. However, as you know, mortgage brokers share some of the blame but not all of it. There are bad lenders, problems on Wall Street, issues with regulators, and the rating agencies are being criticised.

Your trade association, NAMB is fighting every day to defend and promote our industry. We will be fine. Hang in there. I hope you are a member. If you are, you will get breaking news and information on what is happening right now.

Our hope is that any legislation or rules by the regulators will cover all originators in the industry....brokers...bankers....banks....credit unions....lenders. Legislation should be a consumer protection standard, not an industry changing competitive dilemma.

I have a seven year ARM that will change on 2013, do you recommend refinance to a 30 year fix rate mortgage?
Juan Carlos Garcia, US

Harry Dinham: When considering a refinance, I would get a good faith estimate of the costs. You might find that the costs (fees, expenses, and more) outweigh the benefits of the refinance.

Also, how long do you expect to stay in your house? If you expect to move before 2013 or shortly thereafter, there is no reason to refinance. If you expect to stay longer, then, you should consider it.

How stable is your income. Will it go up in the next five years? I hope so.

At the end, I would check the refinance prices. My hunch is that the costs will be high and you should stick with what you have.

Are the 80/20 financing loans a thing of the past?
Yolanda Coats, Houston, Texas

Harry Dinham: Yolanda. For the short term, 80/20 loans are in limited supply. I believe that this market will come back when housing prices stabilise both from a supply of homes for sale aspect and we get past the delinquent loan problem. But, when they come back, the interest costs will be much higher.

80/20 loans became popular because lenders believed, in part, that the value of homes would go up each year forever and that the last 20 per cent of the home could be financed with safety. With the recent declines in home values, this assumption has proven to be faulty. Therefore, the risk of these 20 per cent second mortgage is very high. Therefore, lenders are less willing to make these loans. Good question!

My partner and I are first time buyers. We have saved a deposit but we have been told a deposit does not carry the same weight it once did when buying a house and it will not secure a better mortgage/rate - is this the case? What type of mortgage would you recommend for a first time buyer? In the current climate is it worth waiting six months to get a more competitive rate or are things likely to get worse so should we buy ASAP?
Laura Scholey, Huddersfield, West Yorkshire

Ray Boulger: Whoever told you that a deposit will not secure a better mortgage rate is talking rubbish. Although there are plenty of mortgages available for people with no deposit these are more expensive than those available with a 5 per cent deposit. A 10 per cent deposit will get you a cheaper rate still and a 20 per cent or 25 per cent deposit often a yet cheaper rate. Also with at least a 10 per cent deposit most lenders won’t impose a higher lending charge, which many do at 95 per cent (typically 1.6 per cent of the amount borrowed), although bizarrely this is not normally charged on a 100 per cent loan.

Without knowing more personal details it is difficult to recommend a specific type of mortgage but I would suggest you watch the market closely so that when a property becomes available at a really good price you will be able to recognise that. I don’t expect prices to move much in the next few month but in your area would not be surprised to see small falls. Therefore I don’t see any rush to buy. Interest rates are likely to fall over the next six months and so you will probably be able to get a cheaper mortgage in 6 months time, but paying the right price for a property you really like is even more important.

We have recently been house hunting in Walthamstow, North-East London, and feel that in the past month or so house prices have already seen a reduction - and may fall further. As a result, we’ve now decided to wait until the New Year and re-assess the situation. But what is the risk that mortgage prices will go up, we will be able to borrow less, and overall our net position will not be improved?
Louise Ashley, London

Ray Boulger: Overall I agree there is no rush to buy. I don’t expect prices to move much but the longer prices are no longer rising the more chance there is of being able to pick up a property relatively cheaply as a result of a distressed seller. However, if you are selling as well as buying it is swings and roundabouts and the current slower market will make it more difficult to put a chain together and time the sale and purchase together.

The cost of fixed rate mortgages is falling and is likely to fall further and so in my view you will not have to pay more for a fixed rate in the new year and will probably get one cheaper. In the subprme market (for borrowers with adverse credit) lenders are tightening criteria but in the mainstream market this is not happening to any significant degree, except in some cases where people have little or no deposit. Therefore providing your credit status is good and you don’t want to borrow more than 90 per cent of the property value I would not expect the amount you can borrow to change significantly over the next few months.

Apart from fixing rates, do you have any advice on hedging the capital value in the case of buying a new property or moving up the ladder in the UK? It’s no good being affordable from a repayments point of view if - as some commentators say, the price expectation is static at best or has a significant chance of falling.
John Baker, London

Ray Boulger: I don’t agree that ”It’s no good being affordable from a repayments point of view if - as some commentators say, the price expectation is static.” You have got to live somewhere, which for most people who don’t own their own house, with or without a mortgage, means renting. Some important benefits of owning your own property are that you have security of tenure, you can decorate the property as you wish and make any improvements you choose. If you rent you don’t have these benefits, although you also don’t have to pay for any repairs or the buildings insurance.

The best way to compare monthly costs of renting and buying is a 100 per cent interest only mortgage against rent for a similar property. There are, of course, one off costs of buying and selling which you don’t incur if you rent, but if you are simply deferring a purchase rather than renting permanently you will ultimately pay these. If either buying or renting is significantly cheaper taking these factors into account that will be a major factor in deciding whether to rent or buy if you expect property prices to be static, although non financial considerations will also be important to some people.

If you think property prices will fall there is clearly a far stronger case for renting and if you are trying to decide between renting and buying primarily on economic grounds I think there is no rush to buy because I expect property prices to flatline nationally for a year or so. However, there will be regional variations and prices will fall in some areas, although I would not expect falls much in excess of 10 per cent. If you would choose to buy rather than rent providing you expect property prices to go up my advice would be to watch the market closely in the area you want to buy but not rush into a purchase.

Only by having a good understanding of property values in your area will you be able to recognise a bargain when you see one. Bargains tend to crop up in a slow or falling market as distressed sellers eventually decide to take the best price they can get rather than hold on for what they think their property is worth.

Harry Dinham: Wow. I believe that where you live is a home, not a house. Not just an investment. Yes, I know that real estate can go up in value. But, it can also go down. In this case, it is where you live, where you keep your family and where you celebrate life! I would not treat it solely as a financial asset. It is a home.

I would not hedge capital value. If the temporary value goes up or down, it only matters when you sell or when you buy. Timing financial markets is very tough, even for the experts. In the long run, where you live is a home. I would not over analyse it. Good luck!!

PS - real estate has a tendency to go up over time. But it does fluxuate.

Hi Ray and Harry, I am just about to enter into a fixed rate of 6.23 per cent for two years. Do you think this is wise?
Dee, UK

Ray Boulger: Assuming you have good credit and don’t need to borrow 100 per cent there are much cheaper two year fixed rates available than this. A two year fixed rate might make sense. One at 6.23 per cent doesn’t.

For example Britannia are offering a two year fixed rate at 5.49 per cent with a £999 fee. If you are remortgaging for up to 80 per cent of the property value Woolwich are offering 5.59 per cent with a £995 fee but also with a free valuation and free legals.

Harry Dinham: Congratulations on buying a home. Financing is complicated I urge you to ask many questions of your loan officer. Also, get opinions from your counsellor or lawyer of financial person in your life.

It is very hard to say what will happen to real estate prices in the UK. Sometimes they go up. Sometimes they go down. I always urge my friends to buy when the time is right for them and make sure that the price is affordable at that time. There is no ’best’ or ’right time to buy.

I always suggest that people shop and compare between various finance options. Go to at least three places to find out more about different options.

I do not like the two year fixed period and then uncertainty. Try to get more ’certainty’ from the lender.

That being said, I would question the loan officer:

1. What do the payments include? Just interest and maybe some principal? Or other housing costs?

2. I see the payment is fixed for the first two years. That is fine. But, will the amount I owe on the mortgage also go up? Or, is that fixed as well? Or, will it go down? What will I owe after two years and how do I pay it?

3. What will the payment do after the first two years? How will it be determined?

4. I know that we do not know what interest rates will do in two years, but how will they be determined? And, if we look back, how did they work in the past to get a feeling of what will happen in the future.

5. If the value of the house goes down, what happens? Do I lose the house? The extra 5 per cent? Do I have to pay it back? Who determines the value of the house after two years? Do I get sued by the bank? Do I have to come up with cash? If I lose the house, what happens to my credit history at the bank. Will I be ruined?

6. If the house value goes down, what do I do? How do I protect myself? What is the process of challenging the decision of the bank?

If you can get answers to these questions, you will be able to determine the right choice for you.

Final thought: there is no right or wrong time to buy. There is no right or wrong type of financing. Shop, compare, try to get certainty of information. Then, you and your family will be able to sort out all of the choices. Good luck!!!

My fixed rate finishes at the end of November. The current fixed rates I am being offered have large admin fees and my mortgage looks like it will rise by £130 per month. A fixed rate offers certainty but of course a variable rate looks attractive at the moment if the rates are going to drop? I’ve seen a broker who could not offer anything better than my current lender or the internet. Do you think the rates will drop anytime soon?
Samantha Edwards, Plymouth

Harry Dinham: Samantha. I wish I could answer this question. There is no way to know what interest rates will do. I also can not tell you what will happen to prices. I wish I knew! I like to say that if the time is right in your life given your circumstances, go forward. No one can pick the lowest point. To me, a fixed rate of 6.23 percent sounds good. But, who can predict the future?

I think that the mortgage crisis is passing, so by the end of the year, the prices should be lower and more options for financing will be available.

Ray Boulger: I expect fixed rates to fall further but some new tracker rates have been getting more expensive because of problems in the wholesale money market. Obviously if Bank Rate falls tracker rates will also fall in line. I expect tracker rates to work out cheaper than a fixed rate over the next couple of years or so and therefore if you don’t need the security of a fixed rate buying a tracker makes sense. If the broker you saw was not independent, but only used a panel of lenders. you could try another broker for a second opinion.

My daughter has her ARM loan with Countrywide and it comes due 8/08. They insist on charging a prepayment penalty of $4,000. Should she take the penalty and refinance elsewhere? Or wait until it matures and pray the rates don’t go up? The loan is for $130K.
Janie Pharr Texas

Harry Dinham: Ouch! A $4,000 penalty.

While I do not have a crystal ball on future interest rates, the penalty leads me to believe that you should wait. It is only one year. And, I believe that the markets will be better next year, more products and more competitors trying to get your loan. With competition comes lower prices.

Sure, if rates went way up, it would be a problem. But, I do not think rates will go way up soon. When the times comes, shop, shop, shop and compare, compare, compare.

We have witnessed mortgage arrangement fees increase hugely in the recent past. When remortgaging, a client may now end up adding on fees equivalent to the amount they have paid off their mortgage in the last two/three years, leaving them no better off. In your opinion does this go against TCF?
Alex Jones, Wirral, UK

Ray Boulger: High fees per se are certainly not a problem with TCF. The important thing from a TCF perspective is transparency and so providing the fee is clearly disclosed it complies with TCF, however high it is. The FSA is not an economic regulator. A borrower, or their adviser, must consider whether a mortgage with a high fee offers better value than other mortgage with a lower fee in conjunction with the interest rate offered and other features of the mortgage. If a high flat rate fee is used to subsidise the interest rate then the mortgage may well offer very good value for borrowers wanting a large loan. Also, some borrowers coming off a cheap 2 year fix may prefer to take a new deal with a cheap rate subsidised by a high fee because they may not feel confident they can afford the payments on a mortgage with a lower fee and a correspondingly higher interest rate.

Most mortgages allow some overpayments without incurring an early repayment charge and so if a borrow can afford, and chooses to, overpay the arrangement fee can be paid off in this way.

I think recent the UK & US’s economical progress is heavily depending on land price rising. What would you say about that?
Toshio Matsui, Osaka, Japan

Harry Dinham: I respectfully disagree. Economic progress is dependent upon world issues of supply, demand, commodity prices, expectations, inflation in developing economies, the march of technology and general economic activity. No one factor will determine progress. What about unexpected circumstances? If peace breaks out in the Middle East or there is a resolution to strife, wouldn’t that propel economic activity? If there is further unrest, same analysis. War is never good news.

About the experts

Ray Boulger has spent all his working life in financial services, initially training for five years with a firm of Chartered Accountants and then 18 years as a stockbroker. He spent most of this time as an institutional gilt edge and fixed interest salesman. Ray is an IFA and joined Charcol in 1989 as a consultant. He has been in his current role of Technical Manager / Senior Technical Manager - Mortgages for seven years.

Mr Boulger is vice-chairman of the Association of Mortgage Intermediaries (AMI) and is a member of the MCCB Advisory Committee.

Harry Dinham, past president of NAMB, entered the home lending industry in 1967 in Mississippi. He moved to Texas in 1979 and started his own company, Dinham Mortgage Company, in 1990. Soon, he joined and filled leadership positions in both the Dallas Fort Worth and the Texas Associations of Mortgage Brokers.

On the national level, Dinham served on the NAMB board as treasurer in 2003 - 2004, vice president in 2004 - 2005, president-elect in 2005 – 2006 and president in 2006-2007 before becoming past president in June 2007.

During his year as NAMB President, Dinham had been a tireless advocate for the mortgage broker industry. He helped renew Congressional interest in FHA reforms that would allow more mortgage brokers to participate in FHA programs, and he improved the availability of professional education to mortgage brokers nationwide. He has testified before Congress on several occasions on matters pertaining to the mortgage industry. Dinham remains passionate about improving financial literacy and helping policy makers “level the playing field” so that all loan originators operate under the same rules.

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