Watch for Rising Mortgage Costs in 2011

Mortgage interest rates have moved up, then down, sideways and probably other directions as well in recent months.   Yet apart from that daily volatility, there are some other key issues that could make mortgages more expensive for borrowers regardless of where rates eventually settle.

Here’s a list of some trends this spring and how they could raise the cost of a loan for a borrower:

Fannie, Freddie Raise Risk-Based Prices

Borrowers who have weaker credit score, a small down payment relative to the property’s purchase price or little equity relative to their home’s value will be subject to higher interest rates on conforming loans that lenders can sell to Fannie Mae or Freddie Mac.

The higher interest rates occur because the two government-controlled entities implemented adjustments to their risk-basing pricing structures, effective March 1 for Freddie Mac and April 1 for Fannie Mae.
Borrowers can avoid the higher rates by paying upfront points but this adds to the cost of the loan and may not be financially worth it.

Risk-based pricing is a good concept, those with weaker loan characteristics pay more than those with stronger loan characteristics or less probability of default.  However, some borrowers may cry foul as the see low rates advertised but are offered higher rates due to their perceived loan risks.

Feds Restrict Loan Officer Pay

A new federal regulation that restricts how loan officers are compensated might result in higher costs for borrowers as loan officer compensation is limited.

The rule eliminates the option of loan officer compensation being paid partially by lender and partially by the buyer.  The new rule took effect April 1st, 2011.

In the past a loan officer may have offered a borrower a 5% rate with Zero points.  From that they may have been compensated 1% of the loan amount in commission.  Or the borrower could have a 4.75 rate with .5% points.  The .5% paid by the borrower and then the lender also paid .5% to the loan officer for the same 1% compensation.  Now under the new law, that second option is not available.  Thus borrowers may have fewer options.

This is a terrible law that really is going to hurt the consumer by providing less competition and fewer options.  The government would have been better off enforcing prior regulations that required full disclosure of compensation which most loan officers followed. Unfortunately here, a few bad apples are ruining it for both sides.  With less options and less competition expect costs to rise.

FHA Raises Premiums

Borrowers who opt for an FHA loan insured by the Federal Housing Administration, or FHA, will face higher costs.

On  April 18, the FHA raised its annual mortgage insurance premium by one-quarter of a percentage point on all 15-year and 30-year loans.

The extra quarter point is intended to bolster the FHA’s congressionally mandated capital reserves.

On average, borrowers will pay approximately $30 more per month, according to the Department of Housing and Urban Development, which says this “marginal increase” would be “affordable for almost all homebuyers who would qualify for a new loan.”

Many loan officers feel that the increase will push some borrowers’ debt-to-income ratio beyond the allowable limit to qualify.  Thus less people will now qualify.

‘Qualified Residential Mortgage’ Defined

Another development that eventually might lead to higher loan costs is the federal government’s definition, proposed in late March, of a qualified residential mortgage, or QRM.

Federal law will allow lenders to buy and sell whole QRMs, but require them to keep a 5% ownership interest in any mortgages that don’t fit the definition.  Thus by requiring lenders to keep some “skin in the game”, the hope is that lenders will underwrite loan more prudently.  The reality of this is the Banks and Lenders will require more capital in order to retain this 5% pool if they choose to underwrite those types of loans or they will just not do any loan that is not a QRM.

As proposed in late March, certain loans are exempt from the 5% holdback requirement for example  loans that  includes a 20% down payment to buy a home, 25% equity to refinance an existing mortgage and 30% if the refinance has a cash-out component. Loans that feature negative amortization, interest-only payments or onerous rate resets wouldn’t be allowed as QRMs.

FHA loans and loans guaranteed by the Department of Veterans Affairs are exempt from the rule as well.

Lower Limits Mean More Jumbos

Borrowers who live in a relatively expensive housing market and who want a loan of more than $625,500 will pay more for their mortgage later this year.

Effective Oct. 1, the top limit for conforming loans is set to drop from the temporary $729,750 to the general $625,500 in high-cost housing markets. Conforming loans are eligible for sale to Fannie Mae and Freddie Mac, and generally have the lowest rates. When the limit drops, borrowers who want a bigger loan will have to get a jumbo, which entails a higher interest rate and tighter guidelines to qualify.

Borrowers have a few options to contain the cost.
Those include:

• Getting a loan before the limit drops.
• Making a larger down payment.
• Bringing cash into a refinancing.
• Taking out two loans to keep the first lower than the limit.

Loan limits in lower-cost housing markets also may drop in the future due to lower median home prices on which the limits are based.  As prices come down due to weakened housing markets this will effect the median home price.