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2018 US Economic Outlook

He’s back! Each January, Barry Habib, Founder and CEO of MBS Highway and mortgage & real estate market expert returns to unveil his economic outlook for the year.

Barry’s newest economic outlook explains what dynamics are in place for 2018, where the stock and bond markets are headed, the future direction of interest rates and housing, and how the new composition of the Fed will affect the markets.

2018 Economic Outlook Dynamics

  • Possible stock market pullback – How would this effect housing and rates? Housing will have a bit of a headwind. If people start to see their stocks investments dwindle some they’re less like to make big investments.
  • The new look of the Fed – Fed officials have expressed a range of views about the frequency of rate hikes in 2018 – with opinions ranging from 2-4 hikes. They are also scheduled to further unwind their balance sheet. How will this impact mortgage rates?
  • Rates are set to rise in year ahead – How much and what will the impact be?
  • Housing & Tax Reform – Can housing continues its impressive run and will tax reform be a drag?

Key Areas To Consider This Year

1. Stocks

Stocks appear toppy and a bit vulnerable. We’re entering 2018 with extremely high investor optimism, in fact the US is at a 30-year high in optimism. This is often a dangerous sign.

We’re in the most expensive stock market on a price of a stock to sales on the S&P ratio ever. The last time we saw a run this high was in 2000. While he’s not saying we’ll will experience the same type of downturn we did then, it’s something to be concerned about and we could see a cooling off period.

As we begin the new year, we have seen over a 100-month consecutive expansion without a recession. The current market cycle, started back in early 2009, is the 3rd longest expansionary stretch in history. The current market cycle started back in early 2009 and has been chugging along for over 8 years. (the first was 120 months ending in early 2000’s), so we may begin to see a slowing in this cycle.

Barry’s Prediction: There will be a significant stock market pullback during 2018 after such a big 2017.

2. The Fed: Changing Of The Guard

With a new sheriff in town and all the appointments that need to be made, this will be a very different Fed than we saw in 2017. Jerome Powell will succeed Janet Yellen as the new Fed Chairman when she steps down on February 3rd. Powell, viewed as a centralist, is expected to follow Yellen’s cautious approach to interest rates.

Trump may need to appoint up to 4 Fed Governors in 2018, including replacing Vice Chairman Stanley Fischer and NY Fed President, William Dudley. Also out are two of the monetary doves Neel Kashkari and Charles Evans.

The bigger impact to rates, however, will come from the unwinding of the Fed’s balance sheet. Last October they began to reduce their reinvestment of mortgage bonds by $4 billion/month. (Prior to that they were buying back $25 billion in mortgage bonds, and even more than that in treasuries.) They’ve been very active in bond market to keep yields lows. This month they’re doubling their curtailment to $8 billion, buying back $17 billion in bonds. Each quarter will see another $4 billion reduction – ending the year at a $5 billion buy back.

Without the Fed in the market to keep up that buying could make for an interesting 2018. The purchase of mortgage bonds needs to replaced somewhere, the question is, how much do rates need to move up to entice that? That’s the biggest reasons Barry thinks rates will move up slightly in 2018.

Barry’s Prediction: If we see a stock market pullback we expect 1-2 hikes. Probably with the first in March and the second in September. There may be another one in December, but unless Trump appoints a very hawkish Fed, we probably won’t see it.

3. Rates

The main driver of rates, inflation, should remain tame as the Fed won’t be as active. Rates will move higher, but not by too much.

As we discussed in the last section, the Fed reinvesting less in mortgage bonds less will be the main reason for an increase in rates.

On the opposite side, since both stocks and bonds compete for the same investment dollar, a pullback in the stock market could help rates.

Barry’s Prediction: The 10-year Treasury Note Yield will trade between 2.18% and 2.64% for most of the year. Mortgage rates will move .375% higher on average.

4. Housing

We closed out 2017 with incredible numbers both on new construction and existing and this is a market has an incredible amount of momentum and strength going forward. Some of the drivers are:

  • Low Inventory
  • Rents rising at 4% per year
  • A modest move higher in rates won’t derail housing market
  • Demand remains strong

Although tax reform did reduce the deductibility of a mortgage from $1 million to $750,000, that will hurt more on the high end. Since the standard deduction has been doubled, there’s a bit less of an inventing to buy to get the deduction, which makes renting more attractive from a tax perspective.

Barry’s Prediction: 4.5% – 5.5% Appreciation (U.S. Average)

 

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How Your FICO Score Affects Your Interest Rate

Why Your FICO Score Matters to Lenders

Most of us know that you need to have “good credit” to get a mortgage loan. But, did you know that without a high credit score, you won’t be able to get the best mortgage rates available? Why is this the case?

This is because lenders would rather take a chance on borrowers who have established an on-time payment history. These borrowers are more likely to be serious about meeting their obligations, and are more likely to pay back their lenders. Someone with a spotty payment record is a higher risk, and the lender offsets this risk with higher rates.

Most of the time, your credit score is calculated using the FICO (Federal Insurance Contributions Act) scoring model. This combines information found on your credit reports, compiled by the credit reporting companies. These reports contain all the details of your past payment habits.

If your credit score could be a stumbling block for you, just keep in mind that while it’s one of the most important pieces, it’s still just part of your entire application. The additional elements your lender will consider? Sufficient assets, income, and credit.

Best FICO Scores For Conventional Loans

It’s still possible to qualify for certain kinds of loans if your FICO score is under 680. But if you’ve got a FICO score of 700+ (especially, say, 760 or above), you’re usually sitting pretty and can feel confident about getting a good interest rate.

For a little more perspective on the lower end of a FICO score: 680 is considered average, while 640 might put you in jeopardy of not securing a traditional loan (meaning a loan backed by Fannie Mae and Freddie Mac) from a bank or online lender.

The lending industry has created a credit score scale that’s laid out in 20-point increments. The rates offered to borrowers gets adjusted each time a credit score moves up or down by about 20 points. So a change in score from from 740 to 720, can increase you monthly mortgage interest expense and significantly increase the monthly cost of private mortgage insurance (PMI). It’s known as “loan-level pricing,” and every time you go down a level, your costs increase.

Example: How 60 Points Can Change Your Payment

The chart below shows the increased cost of a 30-year $400,000 mortgage with a 5% downpayment,* when the buyer has less than a 740 credit score.

What happens if your score was an “average” 680 instead of 740? You’d be looking at an extra $216 a month in interest and mortgage insurance ~ that’s $2,592 per year.

FICO Score Chart

Bottom line: you’d be paying an addition $77,760 over a 30-year period.

On the other hand, the impact of a 720 score vs. a 740 score isn’t so huge that you should derail your plans just so you can raise it – especially if it turns out that mortgage rates went up while you were scrambling to boost your FICO score.

What Other Loan Options Are Out There?

In the world of conventional loans, a lot is riding on your credit score. But what if this route just isn’t an option? It might not be the end of the road for you.

Government-Insured FHA & VA Mortgages
These may sometimes accept a score as low as 580. It’s certainly worth a try – with government loans, you’ll generally find more leniency when it comes to both your credit score and underwriting guidelines. The downside: the loan fees on FHA loans are usually considerably more expensive since you’ll need to pay both an upfront mortgage insurance premium and annual private mortgage insurance.

Don’t give up hope! If one lender says you’re not qualified, it may simply mean you’ll need to investigate and find someone willing to accept your credit situation on its face or someone to assist you with getting into a better credit situation.

Check Your Credit Ahead of Time

We highly recommend checking your FICO score at least 6-12 months before you’ll need it to apply for your mortgage. Your credit score is simply too important when it comes to both the mortgage rate you’ll receive and whether you’ll receive financing at all.

If you go shopping for a mortgage without knowing your credit score months in advance, you’ll feel stressed out as you rush to make the necessary changes – if you have time to make changes at all. Credit mistakes can sometimes take several months to complete.

Otherwise prepared buyers find mistakes on their credit all the time. Even if an item on your report is an error it can still decrease your credit score substantially, maybe even by a percentage point or more.

Wondering How To Fix Your FICO Score?

We’ve spent lots of time talking about the importance of your FICO score: why it matters to lenders, why it should matter to you, and what different scores might mean for your financing options.

If you’re ready to dedicate yourself to improving your low credit score, however, stay tuned – in an upcoming post we’ll make sure you know everything you can do to increase your FICO score.

When it comes to your dream of owning a home, it’s never the end of your story.

*Scenario assumes a 5% downpayment. Less than 20% down means you’d be paying PMI (Private Mortgage Insurance).

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US Economic Forecast for 2017

He’s back! Every January, Barry Habib, Founder and CEO of MBS Highway and mortgage and real estate market expert returns to unveil his predictions for the year.

Barry’s newest economic forecast will help explain what dynamics are in place for 2017, where the stock and bond markets are headed this year, the future direction of interest rates and housing, and how the new composition of the Fed will affect the markets.

But first, let’s take a look at how Barry’s 2016 predictions worked out.

Barry’s 2016 Economic Forecast

Prediction: The 10-year Treasury Note Yield would drop below 2%.
Actual: The 10-year began the year at 2.245%, then dropped down to 1.325% on July 6th, 2016.

Prediction: Home price appreciation would be 5% – 6%.
Actual: It was up 6.2%.

Prediction: Stocks, as measured by the S&P 500, would decline by 300 points.
Actual: Stocks indeed declined by 200 points in February from the start of the year, but then rebounded at the end of the year due to Trump Election optimism.

Prediction: The Fed would hike only once (everyone else forecasted 4 rate hikes).
Actual: Barry’s forecast of just one hike turned out to be right on the money.

Looking Ahead: Dynamics you’ll see affecting 2017

  • The effects of the new Trump Administration – anticipated changes to corporate tax reform and slowing down regulatory over site have businesses optimistic.
  • Inflation pressures may start to heat up – increases in wages and oil prices will move inflation higher, but may be tempered by a strong dollar.
  • Home inventory levels continue to be very low – only a 4 month supply and foreclosure inventory is gone.
  • Modestly higher rates – this won’t derail the housing market but will slow refinances.
  • The US manufacturing sector will continue to be flat – the US has become a service economy.
  • The Fed is planning three rate hikes.

Key Areas to Consider

1. Stocks

From a bird’s eye view, stocks appear a bit vulnerable this year. We’re entering the new year with extremely high investor optimism, which can actually turn out to be dangerous. If everyone is optimistic and in the stock market, where does the new money come from to fuel prices higher?

Prediction: There could be a potential for a Stock market correction.  20,000 on the Dow seems like a given, but there could be a pullback after breaking through it.

To put this in perspective, when the Dow broke above 1,000, stocks pulled back soon after—then it took 10 years to break above it again. When the Dow broke above 10,000, stocks pulled back and it took 9 years to break above it again.

It’s not at a guaranteed part of this year’s economic forecast, but often these milestone levels are tough ceilings. With the extreme optimism, the recent surge into the stock market and the achievement of this milestone, this may be a time to see stocks take a breather and that could benefit bonds.

2. The Fed

The make up of the voting members of the Federal Reserve (below) dictate whether or not they will raise rates. In 2016, the voting members were made up of 3 Hawks, 2 Centrist members and 5 Doves – creating a dovish Fed. Since Hawks are more likely to vote for a hike and Doves are less likely to hike, you can see why they only eked out one rate hike last year.

How about the make up for 2017? Now there is only 1 Hawk, we still have 5 Doves, but those 2 Hawks positions have become Centrists. With this make up, it will be even harder for the Feds to hike.

2017 Fed Reserve Voting Members

Barry’s prediction: With the new 2017 composition of the Fed, hiking 3 or 4 times will be pretty unlikely, especially considering how much the Fed likes to drag their feet when it comes to hiking.  Barry’s economic forecast comes in at 1-2 Fed Rate hikes.

3. Housing

The reality going into this year is low inventory, with rents rising at 4% per year. These increases add up quickly, motivating more people to buy. The housing market won’t be derailed by these modestly higher rates, especially when it comes to first time home buyers.

Meanwhile, incomes will be rising at a pace to easily support appreciation, while demand remains strong.

Barry’s prediction: 5% – 5.5% appreciation.

4. Rates

The main driver of rates? It’s inflation. And in 2017, rates will move higher, but it shouldn’t be anything to worry about. Global yields will rise and pressure US yields a tiny bit higher. Meanwhile, selling additional bonds will finance infrastructure projects under Trump. This excess supply is a negative for rates.

Barry’s prediction: The 10-year Treasury Note Yield will gradually rise towards 3%. This will push mortgage rates up above 4.5%. This won’t be enough to slow down purchases, but will likely slow refinances.

How did you feel about Barry’s economic forecast? How will it impact for plans for homeownership? You don’t have to figure this out all on your own! For a FREE review of your current mortgage or what you might qualify for if you’re looking to buy this year, contact us anytime, we will be happy to assist!

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The Impact of Mortgage Bonds on Interest Rates

Election Results Influences Rates

Long-term U.S. mortgage rates continued to surge in the aftermath of the election of Donald Trump. Since the election, the value of mortgage bonds has dropped significantly, causing  mortgage rates to climb roughly half a percentage point to a 16-month high.

The turnaround, that was in part driven by post-election market expectations that a President Trump would lift corporate profits, cut taxes and spend money on infrastructure and roads, caught most experts by surprise.

However, there are other factors that have impacted mortgage rates. Before we dive into them, let’s first take a look at how mortgage bonds work…

How Do Mortgage Bonds Work?

Understanding how mortgage bonds work and why rates move higher and lower is best explained by an example. Let’s take a $100,000 loan that seems like a “perfect mortgage.” It has a 10% LTV (loan-to-value) with no second mortgages allowed, an 800 FICO (credit score), and a 5% back ratio. For this example we’ll say this loan has a 4% rate, which at simple interest nets a yield of $4,000 per year.*

It looks like a really safe loan. This is where misconceptions about how mortgage bonds work comes into play. Most folks (even those in the mortgage industry) would say this is a great loan..that it’s risk free. In actuality the risk isn’t in repayment, the risk is in the market.

To illustrate this point, say you wrote this loan with your own money. What would happen if a year from now if rates went to 8%? Is this asset still worth $100,000?

The answer? NO.

If this $100,000 were in cash, you’d be free to be able to do whatever you like with it. However, it’s not in cash –  it’s tied up for 30 years – tethered to a return that’s fixed at 4%. So if the open market rates rose to 8%, your rate at 4% would be far less.

If rates change, how then do you determine your investments value? You compare it – asking the question “How much would need to be invested in an 8% market to yield the same $4,000 a year return that you’re getting in the initial 4% year example?” The answer is $50,000 (column 2). An 8% rate at simple interest on $50,000 equals the same $4,000 per year yield. While this example isn’t exact numbers, the key point is  as interest rates rise, the value of a loan decreases.

perfect mortgage scenario

Let’s take this example in the opposite direction. What would happen in that same scenario if interest rates went to 2% (column 3)? This signifies a climbing market. In this example, the asset appreciates. We determine the level of appreciation by asking the same question…how much needs to be invested at 2% to yield the same $4,000 per year return? The answer? $200,000.

Return To Zero From Negative Interest Rates

“Zero” use to be as low as we thought interest rates would go, because who in their right mind would give money and then pay people for taking it? However, according to the central bankers in Europe and Asia, about $11 trillion dollars worth of their loans have negative interest rates.

Why buy a loan with a negative yield? It’s not because of the yield, but because of the potential capital appreciation. In our initial example when the 4% rates drop to 2%, you can make a lot of money. So, lets say you invested when rates were at -1%, even though you’re paying 1% per year for that investment, if rates went to -2% or -3% you could make a tremendous amount of money seeing rates drop lower into the negative. Once the floor of zero was broken, people thought the bond market was infinite and they continued to buy at a negative rate.

Recently however, the central banks of Europe and Japan realized it was not generating the economic activity they thought it would. It was hurting their banking system by crushing margins and hurting the stock market so they brought it back to a common sense floor of zero. With this change, investors are not buying as much in mortgage bonds as we had seen, and this has caused rates to rise.

Rising Global Yields

Another reason we’ve seen interest rates go up is the global rise in yields. Thanks to Brexit, the pound in the UK has dropped in value, equating to cheaper exports and more costly imports. When the currency drops, it’s good for your exports because they appear cheaper to someone, but your imports get more expensive. If you import a lot like Great Britain does, then these more expensive imports bring in inflation.

What does Great Britain’s inflation have to do with the US? When the UK experiences inflation, their bond yields have to rise. And as their bond yields, they rise in Europe, they rise in Japan and they’ve been rising here in the US.

Inflation’s Effect on Mortgage Bonds

Inflation causes the yield from mortgage bonds to rise because it erodes the buying power of that bonds fixed payment over time.

For example, in the US a $100,000 investment at 4% is $4,000 a year in simple interest or $333 per month. Let’s say you spend that $333 on a basket of goods and services every month, like your cell phone bill, household items, some recreational stuff, some medical costs. Overtime, because of inflation, you can’t buy as much stuff – it starts to erode your buying power. How much? Let’s take a look.

With just 2% inflation (first column in the chart below), which is the Federal Reserves annual target, in 1 year that $333 still feels like $333 a month. However 5 years later, it would only buy you what $301 would buy you today. 10 years later, it would buy you what $272 would buy you today and 20 years later that $333 a month will feel like $222.

Even a light inflation of 2% creates significant erosion of value. What if instead of 2%, it was 4% inflation (2nd column)? In this instance you can see the erosion happening more dramatically. So as inflation rises, the erosion happens more rapidly.

When we have inflation – or even if it’s just perceived to be coming –  interest rates rise. This is because interest rates are compensating for this erosion. In other words, even if you can’t do anything about inflation, the next time you lend money, if inflation is higher, you’ll want to make sure you preserve some of that buying power.

inflation's effect on bonds

So how do you do it? You start off at a higher rate (Column 3 show a rate of 4.92% with expected 4% inflation) that returns a bigger yield so over time it will average to about the same number. In year 1 that rate yields $410 a month, and in year 11 will yield $273 providing the same buying power it did with only 2% inflation (highlighted area). This is why when inflation moves higher, interstate rates move higher.

The Impact on Home Purchases

While rates appear to be headed modestly higher in 2017 because of some of these global factors and inflation, they shouldn’t adversely affect the strong real estate market that we currently have. However, this should create a sense of urgency and opportunity folks to make purchases before yields rise further.

Why? Because just a 1/2% increase in rate to a $350,000 loan will add over $100 to the monthly mortgage payment.

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Use Home Equity To Your Financial Advantage

Refinancing your home mortgage can be a very savvy move, especially in today’s housing market. Right now, home price appreciation in the United States is on a huge upswing, increasing at a rate of 5.4 percent—that’s twice the rate of inflation.

Metro Denver’s home price appreciation is experiencing an especially significant increase. It’s growing at about twice the national rate, rising 10.2 percent in January 2016. It’s also the 12th consecutive month of double-digit annual price increases for the Metro Denver area.

In this promising housing market that continues to thrive, there are several rock-solid reasons to consider refinancing.

A Cash-Out Refi Accesses Your Home’s Equity

A quick refresher: you build equity by making a down payment on your home, making monthly payments on your mortgage balance, and experiencing appreciation.

A cash-out refinance replaces your existing mortgage with a new larger mortgage, and you (the borrower) take home the difference in cash. The property you just refinanced is the collateral.

While it’s not a wise idea to refinance simply so you can travel the world or buy a flashy new car, here are four investments that can be worth borrowing from your home’s equity:

1. Home Remodeling and Improvements
If you need some major home repairs or need to make upgrades to your home, a cash-out refinance might be a great option. Your mortgage is also a tax write-off, so it’s wiser to refinance your home than to put this type of investment on a credit card.

And of course, some of the money you invest in upgrades and repairs can add value to your home down the road.

2. Paying For College Expenses
With today’s historically-low interest rates, your refinanced monthly mortgage payment may be less than your potential student loan debt. It may also be tax deductible.

When planning for college, there are certainly lots of long-term family goals to think about. It’s important to plan carefully and consider consulting a financial advisor.

3. A Second Home or Investment Property
If you can afford the costs of owning an investment property, it might be wise to buy now before both rates and prices increase.

On the other hand, despite strong rental demand, investment-home sales have been considerably less robust. Before you take on another mortgage, be sure you research the market carefully and do the math to ensure you can afford the costs while still living comfortably.

4. Superfund Your Retirement Account
Did you know that most Americans reaching retirement don’t have enough money saved to last them through their senior years?

Your retirement is hugely important and could be a very sound reason to consider refinancing your home. When it comes to investing for the future, many people aren’t even sure of the basics.

The “Rule of 72” offers a simple method for calculating how long an investment takes to double, (assuming a fixed annual rate of interest).

Simply divide 72 by the annual rate of return you receive on your investments. The number you get is a rough estimate of the number of years it will take to double your money. For example, if you have $10,000 in a savings account that yields 1% a year, it would take about 72 years to double in size.

Now think specifically about your own financial details: How is your retirement savings looking? Could you benefit from an extra infusion of cash from refinancing your mortgage?

Refinancing Can Reduce or Eliminate Your PMI/MIP

If your home equity is 3% or more and you used a down payment assistance program, you may be eligible to refinance into a conventional loan after 6 months. Not only does a conventional loan offer a lower rate, but the increase in equity can reduce or eliminate your private mortgage insurance (PMI) or mortgage insurance premiums (MIP), adding up to additional savings.

Federal Housing Administration (FHA)-backed loans are popular with home buyers and refinancing homeowners, but FHA mortgage insurance premiums (MIP) can be expensive.

The trick to getting rid of FHA mortgage insurance is to get rid of your FHA loan. With home values up and current mortgage rates down, there are millions of U.S. homeowners in a position to refinance their FHA MIP away.

If you have 20% equity in your home, you can also eliminate PMI payments through a refinance. You can either pay your mortgage down or arrange for a combination of payments and appreciation verified by an appraiser.

Refinancing Is A Better Option Than A Reverse Mortgage

If you’re 62 or older, you may convert your home’s equity into cash with a reverse mortgage. This allows you to borrow against the equity in your home and get a fixed monthly payment or line of credit. Repayment is delayed until you move out, sell your home, or you pass away. At that point, your home is sold and anything left over after repayment goes to you or your heirs.

But simply refinancing your existing mortgage decreases the size of your monthly payments and helps you build equity in your home faster than a reverse mortgage. Another reason it’s preferable: if you refinance instead of getting a reverse mortgage, your home remains an asset for you and your family when all is set and done.

While refinancing your home is a big step that no one should take lightly, it’s absolutely worth considering, especially in a housing market like the one we’re experiencing today.

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