Following a trend that shouldn’t catch any plugged-in readers by surprise, the number of applications to secure a purchase mortgage loan for an existing home in the U.S. dropped 7 percent over the past week, was down 5 percent on a seasonally adjusted basis, and was 30 percent lower than at the same time last year to its lowest level since April of 1995, according to application data from the Mortgage Bankers Association.
While existing home sales activity has dropped to a 28-year low, mortgage loan application volume for new homes was up 26 percent on year-over-year basis in June, driven by discounting and a drop in the average sale price, resulting in lower average loan amounts. And closer to home, pending sales are currently down around 25 percent on a year-over-year basis in San Francisco despite a double-digit drop in pricing.
It is only fair to point out that *homeselling* activity is also sharply reduced. According to Redfin, 82.4% of homeowners have a mortgage rate below 5% and 62% have a rate below 4%. That could explain a lot. So many homeowners are frozen in-place.
One idea I’ve seen kicked around is to allow/encourage banks to “buy out” the mortgages of people who have mortgages under market rate. Much like how the market price of a fixed rate bond drops when interest rates rise, the value of a fixed rate mortgage (from the banks view) drops when rates rise. There already exists a market between banks & investors to buy and sell mortgage obligations. And to get someone to take a 4% mortgage off your hands during a time of 8% rates, you’d essentially need to pay them (sell it under face value). (If I could write a montage at 8% today, why would I pay “full price” to buy a mortgage from you getting only 4%). Essentially, there is a lump sum cash price to account for the difference in future interest payments between a 4% and 8% note. Banks already pay this to trade mortgages between themselves and other investors, so why not pay this to consumers for the right to extinguish the mortgage?
Many people are in situations that can be looked at as having homes which have lost a great deal of value, paired with holding a mortgage obligation which has gained a great deal of value.
Housing prices and rents comprise a large chunk of inflation calculations, so reducing these costs goes a long way to taming inflation. But as Dixon Hill points out, the housing market is freezing up and inhibiting price discovery. The Fed may not say this out loud, but a “traditional” way to tame inflation relies a lot on increasing unemployment and weakening consumer finances. Losing jobs and increasing financial stress does cause people to downsize their housing needs which does unstick the market. But could the market get unstuck without this?
With high enough housing prices and a low enough rate, this could look a short sale, with cash out to the borrower and no hit to their credit. The market gets unstuck, the consumer gets a cash infusion and banks get to extinguish low rate loans which are a drag on their ongoing interest margins. The stock market tends to look kindly on taking one time charges to improve future financial performance.
I understand what you’re saying – I think – but you do realize that it’s the homeowner that owes the bank? You want the bank to pay the borrower to stop making payments? Or do you want them to surrender a 4% loan for an 8% one?
I’m maybe cynical but I think you’ll have trouble getting everyone on board for this one.
I think in most cases bankers packaged up that mortgage along with similar ones and sold the overwhelming majority of tranches off into the market for mortgage-backed securities. Sure, the value of a fixed rate mortgage drops when mortgage rates rise, but the investor who purchased the resulting MBS is the one that has to accept that loss in value, the bank only has minimal exposure because they only have the regulatorily-required amount left on their books.
If that’s true then the originating bank’s incentive to pay the homeowner to cough up their below-current rate mortgage is much, Much smaller than the amount of money that would be required to incentivize the home owner and actually close out that loan. To implement wilson’s idea, the loan servicer would have to organize and cut a deal with all of the bond holders and get them to put up cash to to execute the buy-out of the loan in exchange for getting out of holding the depreciating bond (and of course they’d want a big fat fee for doing so, because Wall St.).
I agree with Notcom, getting everyone involved to agree to do this would be almost impossible. For the bond holders, it is a lot easier to just sell their bonds.
You may well be right that the loans have been passed to someone else, but I don’t really think who has the loan matters much; it’s the nature of the relationship…i.e. it’s a loan. Typically when someone “buys out” something, the ‘seller’ – if you will – has something of future value, and agrees to give it up in exchange for immediate payment. Here, tho, what the “seller” has is debt; so the
bankcreditor should pay them to…what, exactly?…stop paying back the debt ?? Of course not: it would pay them to assume higher debt payments. I imagine it’s possible the different parties have different discount rates, and it might make sense mechanically, but God what a mess to implement! (and that’s only if the premise is true)The brutal reality, of course, is that years of artificially low interest rates distorted asset values; the basically non-existent returns on debt – at least many of them – encouraged people to buy assets instead, which of course raised the price of the assets, making the disparity even worse. The media did little to help: cheering on appreciation (“good news on home values!”) while simultaneously deploring the affordability “crisis”.
Think of it like a pre-payment bonus. The inverse situation of having a pre-payment penalty for paying off a highly profitable loan early. A cash out payment to extinguish an unprofitable mortgage early. Obviously you wouldn’t pay someone to stop payments and default, the existing debt would need to be settled by either a sale of the underlying home or a refi.
If you look at what came out in the aftermath of SVB & First Republic collapsing, it seems there was a great deal of bespoke lending to HNW/UHNW individuals. I’d actually be shocked if this *didn’t* happen in that segment. Only two parties involved and both are typically financially sophisticated.
For the mass market, I agree that there are many more obstacles. But realistically, investors that trade mortgages have already marked the mortgage portfolios to market. The price hit has already happened. The pitch there to the investor is that the retail homeowner will be offered a worse than market price and someone gets to pickup the spread.
Yes, it’s a loan. But so is a bond. If a company issues a bond for $1,000 you are essentially loaning the company $1,000. If interest rates rise and the market value of the bond falls to $700, then the company itself can buy back the bond for $700 and extinguish the debt. If you have a $1M mortgage at a low rate and rates rise, that mortgage might be bought and sold on the secondary market for $700k. Any third party investor could buy it for $700k, but currently if the homeowner sells the house then loan needs to be paid back at face value. If the home value has dropped to $900k the homeowner is underwater at the mortgages face value, but yet has enough value in the house to buy out the mortgage at its current secondary market value. (And pocket $200k)
There already is a secondary market for mortgages. Prices for low rate mortgages have already collapsed. Other 3rd parties can buy those loans at a discount. But the homeowner themselves currently cannot.
One problem with your idea is Adverse Selection. Bankers know that few mortgages run the entire 30 years due to moving, death of the owner, other change of family circumstance, refinance, etc. When banks are trading these loans among each other, neither side has any special knowledge about the borrower’s plans regarding the loan. On average, the loans being traded are likely to conform to the statistical expectations. OTOH, if a bank were to make me a discounted payoff offer , they would be operating with less information about my plans than I have (maybe the bank is willing to pay me off based on 7 additional years of expected loan duration but I am planning to start a family in 2 years). The lender is likely to be buying out a lot of loans to borrowers who weren’t intending to stay long anyway.
If I intend to stay much longer than 7 years (for example), the offer to buy me out based on an expectation that I will remain for 7 years would not be attractive. The loans that the lender most wants to retire would not be redeemed.
At today’s interest rate, my 3% loan has lost about 1/3 of its value, assuming I live another 28+ years and don’t move. From my point of view, that’s a pretty good deal and I almost want to live that long just to stick it to the bank. I might be interested in moving if the lender was willing to discount my payoff by 20% but I’m not holding my breath.
Certainly if someone was going to sell anyway and thus the loan would be paid off at par, then the bank/investor would forgo a gain by offering to buy out the loan for less. But look at the headline of this post.
Buying activity is at a nearly three decade low and if rates go even higher the market freeze looks to get even worse. Banks and others in the system make money by originating mortgages and if activity crashes then that revenue crashes and banks will need to cut staff and incur the associated costs. While there may be an Adverse selection problem at the individual level, at the market level the problem is crashing transaction volume. Also since this transaction closes out a position (the mortgage) the main risk to the bank/investor is only missing out on a potential gain.
Contrast this to the adverse selection problem in insurance where the insurance company risks incurring a huge liability in return for accepting a small premium. (e.x. raising health insurance premiums makes your policy less attractive to people who know they are healthy, yet still a great deal for people who know they have a expensive chronic condition)
As we’ve frequently pointed out and shouldn’t catch any plugged-in readers, other than the most obstinate, by surprise, a jump in the cost of debt, back to historical norms, has continued to put downward pressure on home values, values that existing home owners are either unable or unwilling to accept in order to move up, over or out, at least for now.
Getting rid of the 6% tax aka realtor fees added on to every single home sale would stimulate home buyer and bring home affordability to many more Americans. In the internet age, realtors are dead weight…
I’ve been wondering about this too. Startup companies leveraging the internet and smart phone apps have disrupted industries like retail book sales, taxi cabs, food delivery and hotels, but real estate agents have been surprisingly immune.
There is such a thing as an iBuyer, but the companies in that space haven’t done so well at cutting out the middlemen and middlewomen of real estate agents. Zillow shut down its Zillow Offers division, laid off 25 percent of their staff and got out of the iBuying business completely in 2021. A year later, Redfin shuttered its home-flipping business RedfinNow and reduced its workforce by 13 percent. There are other firms still doing it (Opendoor, headquartered right here on the edge of the East Cut neighborhood, is currently the largest iBuyer in the United States), but they represent only about 1 percent of total real estate transactions nationally.
The biggest problems with iBuyers as a remedy to the deadweight loss imposed by real estate agent commissions is that:
• iBuyers typically purchase homes for much less than their market value as estimated from other valuation providers so they are worse for sellers than a traditional sale.
• Most iBuyers charge steep fees that can be equal to, or more than, what you’d pay in real estate agent commissions on a traditional sale, so buyers don’t derive any benefit from a real estate agent’s absence.
There seems to be something special about real estate agency which effectively resists the same forces which have supplied continued downward pressure on the salaries of wage earners working in all other sectors of the U.S. economy over at least the last twenty years.
But if proprietaried property promoters are obviated, who will there be to nitpick staging details on socketsite? Think of the children!
UPDATE: While the seasonally adjusted index for purchase mortgage activity ticked up 2 percent over the past week, it slipped (0.3 percent) in the absolute and was 27 percent lower than at the same time last year.