New Mortgage Trends Noted

With slowly rising mortgage interest rates, some new trends are surfacing. For example, more mortgage applicants are selecting an alternative type of mortgage plan instead of the traditional 30-year, fixed-rate mortgage. Plans such as the interest-only mortgage or a hybrid plan are increasingly popular as a means of minimizing the monthly payment.

With an interest-only mortgage, there is no reduction in the balance for the specified no-interest period, thus keeping the monthly payment low. After that period expires, the mortgage reverts to a conventional amortized loan. The hybrid mortgage has a low fixed-rate for a period of years (usually five), then reverts to an adjustable-rate mortgage (ARM) for the remainder of its 30-year term. The interest rate is lower than a 30-year fixed-rate mortgage, but a bit higher than a straight adjustable-rate loan.
Another current trend is for homeowners to refinance their existing adjustable-rate mortgage with a fixed-rate loan, usually for a 30 or 15 year term. In most cases, they want the assurance that their monthly payments won’t continue to accelerate as prevailing rates rise. “With the difference in ARM rates and fixed rates narrowing, consumers are shifting from traditional ARMs to nontraditional products such as Option ARMs and Interest-only loans,” said Doug Duncan, chief economist for the Mortgage Bankers Association.

“Many of our recent mortgage applicants aren’t really sure what type of mortgage is best for them until they discuss it with a mortgage counselor,” said Michael Levy, president-CEO of Home Savings Mortgage, a multi-office mortgage banking firm based in Oxnard. Calif. “In today’s market, consumers are fortunate in having such a wide variety of mortgage types to choose from. But it takes a lot of thought and careful planning to select the plan that best meets the needs of individual borrowers.”

No Bubble Burst Determined in New Study
There will be no “bubble burst” in the housing market, like the situation that plagued the technology (dot-com) industry in year 2000. That’s the conclusion of a panel of monetary experts recently assembled by Indiana State University. Nationwide, housing has significantly outperformed other segments of the economy, growing at a much higher rate than inflation, it was noted in a wrap-up report on the experts’ findings. Average home prices are appreciating at about 13 percent annually. This rapid growth has heightened speculation about a possible market collapse.

While the strength of the housing sector has been subject to cyclical highs and lows, it has traditionally been an area of economic strength, the panel report noted. The country has experienced only one decline in housing values in the past century, and that occurred during the Great Depression. Typically, busts in the housing market have been regionalized in nature following periods of tremendous growth such as the cotton boom, gold rush, and Florida land boom. The recent housing boom has been longer in duration and strength than in past periods with home prices rising 59 percent over the last 10 years.

Annual home price increases have been largest in the Pacific region and New England states. “A housing bust would likely affect no more than 20 percent of the country,” said Michael Bordo, director of the Center for Monetary and Financial History at Rutgers University and one member of the panel. “Beyond geographic amenities, regional housing markets differ significantly based on variables including the supply of land available for construction.”

Mortgage Applications and Home Sales Remain Brisk
Despite rising mortgage interest rates, applications for new mortgages and home sales remain very strong. In fact, it may be those edging-up rates that are driving the brisk activity in mortgage applications and home sales. Even though today’s rates are rising, they are still very low compared with historical rates.

David Lereah, chief economist for the National Association of Realtors, made this statement regarding home sales: “Post-Katrina, our home sales projections for the remainder of this year have moved even higher. Short-term momentum is very strong, and our pending home sales index set a record. “We may be seeing some fence jumping from home buyers who are getting into the market before mortgage interest rates move higher. Inflationary pressures, driven by higher energy costs, have become a concern. We anticipate more hikes in the fed funds rate. The 30-year fixed-rate mortgage is projected to reach 6.2 percent by the end of 2005, and trend up to 6.7 percent by the end of next year,” Lereah said.

The strong activity in mortgage applications is not only from home buyers but also persons who want to refinance an existing mortgage. In many cases, they want to lock-in a rate on a fixed-rate loan to replace their existing adjustable-rate mortgage (ARM) while they can still take advantage of low rates. Currently, about 43.5 percent of mortgage applications are for refinance mortgages, according to a report from Freddie Mac, a major buyer of existing home mortgages. “The most likely pattern is for mortgage rates to gradually rise over time,” said Frank Nothaft, chief economist at Freddie Mac.

Homeowner Tax Deductions at Risk
Proposals are currently circulating in Washington to reduce or eliminate certain tax preferences for homeowners – including sharply reducing the deductibility of mortgage interest. Several economists said a federal commission’s plan to trim mortgage interest deductibility was needed to address broad market distortions. The debate springs from a decision by a special panel, appointed by President Bush, to recommend reducing tax breaks for home mortgage interest and employer-provided health care, while increasing deductions for charitable contributions.

The commission’s report is due to be delivered to the Bush Administration on Nov. 1, then the debate really heats up. Leading the opposition to such proposals are major real estate organizations, such as the National Association of Realtors and National Association of Home builders. Here’s what Jerry Howard, NAHB executive vice president, had to say on the subject:

“When this report is officially issued and the debate then begins, NAHB is going to do its damnedest to protect the preferred treatment of housing in the tax code.” Howard Goold, tax counsel for the National Association of Realtors, said overhauling the tax code would be a long slog. But in the short term, Goold worries the panel’s proposal will “send a lot of chills” through the market. Its likelihood of becoming law is minimal, considering the political ramifications of such legislation.

TiC Investments Growing
A TiC (tenant-in-Common) investment is an increasing popular form of real estate investment. This is where the investor owns a fractional (partial) interest in a property. This usually involves interest in a commercial property, but recently has been used in the co-ownership of apartment buildings with a guaranteed right to occupy one of the apartments. Each TiC investor holds an undivided “common” interest in the property, or in some cases a designated interest of different sizes.

The concept is particularly attractive to investors who are engaged in 1031 tax exchanges of investment properties. Since 2002, those investors can satisfy their tax-deferred requirements with a TiC purchase as a replacement property, according to new IRS guidelines. Before that date, it was unclear whether a TiC purchase was really an investment in real estate (as required by Section 1031). Such an investment property purchase allows the investor to escape many of the responsibilities of totally owning a single property.

TiC (also known as Tenancy-in-Common) properties are usually commercial properties, packaged with management and financing already in place. However, some lenders now offer individual mortgages for each TiC owner, including the fractional ownership of apartment buildings. In some areas, particularly in California’s Bay Area, the concept is competing with condo sales.

Land Price Increases Cooling
The seller’s market that landowners have been enjoying for several years is cooling off, primarily due to rising home building costs. Home builders buy land based on a pro forma cash flow analysis that includes a reasonable profit margin, according to John Burns, a seasoned consultant to home builders and other real estate professionals. “When home building costs go up, the price that builders are willing to pay for land goes down,” he said. “We are aware of a number of deals that were in negotiation that are now being renegotiated due to rising materials costs.

Land sellers don’t like to reduce their prices, so land prices are “very sticky” on the way down, Burns noted. Additionally, since the rise in materials costs may partially be attributable to an overreaction to the demand for materials and labor to rebuild New Orleans, many land sellers are likely to wait and see if the recent increase in costs is permanent. “Overall, we expect that the number of land acquisitions over the next few months is going to dwindle as buyers and sellers have a tough time agreeing on price,” Burns said.

Home Building Activity will Decrease in 2006
Home building activity will probably slow down by early next year, according to a report from the National Association of Home Builders. “The housing market is seeking out a peak,” said NAHB chief economist David Seiders. “While it’s still too early to conclude that it has found one, with current building activity exceeding expectations, there is growing evidence that the Fed has started to hit its mark and housing will begin losing some of its exuberance in the months ahead.

“The power of long-term interest rates for housing is incredible,” he said. “And key to the housing outlook is where those rates are headed. The rates on 30-year fixed-rate mortgages have been moving up and are now above 6 percent. The long-term mortgage rates will probably continue to rise, reaching about 6.6 percent by the third quarter of next year.”

The Federal Reserve will decide to boost its federal funds rate by one-quarter of a percentage point at each of its next three meetings, Seiders predicted. That would bring the rate to 4.5 percent at the end of January when Fed Chairman Alan Greenspan’s term runs out. “The proliferation of exotic adjustable rate mortgages, such as interest-only and payment-option loans, along with a rise in speculative buying that has been boosting home purchases and prices in hot markets, has strengthened the Fed’s determination to gain control over the housing sector,” Seiders noted.

Jim Woodard writes a nationally syndicated newspaper column on real estate news and trends, carried in about 230 U.S. newspapers – along with freelance features. Reproduction of this report, in part or entirety, is prohibited without the express permission of the author. E-mail: Web site:

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