The blog at taxloopholes.com is reporting that the IRS is challenging real estate agents who deduct their real estate losses from their ordinary income. The full-time real estate agents believe that they are ‘real estate professionals’ in the eyes of the IRS. The IRS doesn’t always seem to share that view. The two full posts that discuss this are here:

http://www.taxloopholes.com/connect/blog/diane-kennedy/2007/12/real-estate-professional-looph

http://www.taxloopholes.com/connect/blog/diane-kennedy/2007/11/irs-cracks-down-real-estate-pr

The housing market is like a bird with two broken wings, supply (increasing) and demand (falling). New housing that was in the pipeline and is now being completed is one part of the supply problem; the other part is the surge of foreclosed properties hitting the market. Demand is slack for two primary reasons. First, buyers are hesitant to purchase in a declining market, even in a relatively solid economy and with interest rates low. Second, tightening credit standards have taken a substantial percentage of good buyers out of the market; as values continue to drop, and the secondary mortgage market remains illiquid, this problem is continuing to worsen.

On the supply side, nothing can be done about the new homes still hitting the market. However, jawboning lenders to prevent sub-prime mortgage resets at higher interest rates will help the housing market by keeping some borrowers out of foreclosure, easing the supply glut. Secretary Paulson’s work on this problem is commendable, but fixing one wing alone isn’t going to help the bird fly. Without some imaginative and quick action on the demand side, the housing crisis will continue to worsen.

Simply having the Federal Reserve drop interest rates is not going to be enough to fix the problem. When the housing market slowed during past recessions, falling demand and high interest rates spurred lender creativity. Demand was propped up by financing gizmos like negative amortization, streamlined documentation and high loan-to-value lending. However, in the past few years these same products were used during a period of low interest rates and high demand, inflating real estate values.

Now, lenders are pulling back on creative lending at the point in the housing cycle when in the past it has been most useful. As the lenders tighten qualifying guidelines, reduce loan-to-value, and restrict or eliminate certain types of loans, they take potential buyers out of the market, sapping demand and lowering values in a self-fulfilling prophecy. They have gone beyond prudence, and, especially with jumbo loans, those over $417,000, they are keeping good borrowers, and especially first-time home buyers, out of the market.

In the high-cost real estate markets this is having an especially powerful impact on demand. Along those lines, Federal Reserve Chairman Bernanke recently suggested that Congress could consider allowing Fannie Mae and Freddie Mac to buy mortgages of as much as $1 million from lenders, pay the government a fee for guaranteeing them and then turn them into securities to be sold to investors.

These are the kinds of solutions that might fix the badly broken demand wing of the housing market. Until lenders, and investors in mortgage-backed securities, are made to feel confident, the demand wing of the housing market will remain broken. A serious housing price deflation presents a hazard to economic growth that should not be underestimated. Staunching the spread of foreclosures on sub-prime loans will help ease the supply glut, but will not be enough to prevent the housing crisis from growing, with unknown, but certainly unpleasant, results.

Testifying before Congress on Thursday, Fed Chairman Ben Bernanke suggested that the government work with Fannie Mae and Freddie Mac to insure jumbo loans up to $1 million. This would effectively, in terms of underwriting and pricing, make these loans very much like conforming loans. This would be a tremendous support in this market; by providing mortgage market liquidity the government would increase the pool of potential buyers, helping to restore some balance between supply and demand. In high cost markets like the San Francisco Bay area this would be a real boon. Stay tuned, and we will see if Congress can do more than bloviate, obfuscate, and procrastinate.

You are already aware of some of the problems in the mortgage market. I want to address how what has happened in the last week affects the Marin and San Francisco markets. All of the problems in the last week involve jumbo mortgages - those over $417,000. For reasons I detailed in my previous post, lenders are finding it impossible to sell these mortgages in the secondary market. Their response has been to try to dramatically decrease the number of mortgage loans that they are funding. They are doing this in two ways, either by stepping out of the market altogether, or by raising their interest rates. At the same time, underwriting guidelines have tightened dramatically over the last several months, a trend that has accelerated in the last week. Here’s the bottom line.

For buyers:
If you have been pre-approved and are actively out in the market looking for a home, check with your lender and find out whether you still qualify in the price range you have been looking, and, if you do, how much more it will cost you monthly, now that rates have risen.

Conforming loans have not really been affected. If you are looking for a loan not greater than $417,000, you will find that the rates are only slightly higher than what you had been expecting. However, underwriting guidelines for conforming loans have also tightened somewhat. Very high loan-to-value, stated income, and interest-only loan products have seen some changes. You should still check-in with your lender and see if your loan terms have changed.

For those refinancing, or planning to refinance soon:
If you are going to need a jumbo loan check with your lender or broker and see how the situation has affected you. You may find it difficult to refi if you have a high-loan-to-value, a credit score less than 700, want to take cash out, or need to do a loan with limited income or asset documentation. The situation is so fluid that in most circumstances the best advice is going to be to wait a few weeks until the dust settles and the lenders, or, more accurately, the investors in mortgage-backed securities, have stopped panicking.

Most mortgage loans are not held by the lenders who get you the loan, or collect your monthly payment. The loans are separated into different ‘pieces’ aggregated into large pools and sold as securities on Wall Street. When the sub-prime loans that were originated in the last couple of years began to turn bad, investors began to shy away from those securities. Unfortunately, the packagers of those securities - Bear Stearns and Lehman Bros. being two prominent examples - sold them as being far less risky than they turned out to be.

As the sub-prime market began to unravel in the last few months, and as the housing market continued to soften in certain areas of the country, the investors in other mortgage-backed securities began to get nervous. The next tier in risk after sub-prime is what is called ‘Alt-A’. These are, generally, the loans that are done as ’stated-income’ or ‘low-doc’. Many of these loans have borrowers who have good to excellent credit, and adequate to substantial reserves, they just can’t document their income - they may be self-employed with high write-offs, or without a history of their current income, for example. Although these loans are usually far less risky than sub-prime, the investors in these securities began to get nervous, since they had been misled about the real risk in the sub-prime loans that the lions of Wall Street had sold them.

As often is the case in markets, and in life, the contagion of fear began to spread. When American Home Mortgage closed its doors last week - it was the 10th largest home lender in the United States - the investors in mortgage-backed securities walked away from the Alt-A market. There were no buyers of the securities, none. That immediately spread to the ‘A’ paper jumbo mortgage market, because the investors began to assume that if the market melt-down began to negatively affect housing values, then all of the mortgage-backed securities might be much more risky than they had thought, including those backed by full-documentation borrowers with good credit and assets. The worst of the savagery occurred in the secondary market for securities backed by home equity lines and loans; again, no buyers, none. Most smaller mortgage banks, one of the main sources of Alt-A loans, simply stopped taking applications. Every lender dramatically toughened their guidelines, and interest rates increased by 1 to 1 1/2 points in a few days. Home equity loans for loan-to-values over 80% became difficult to find for perfect, full-doc borrowers; non-existent for everyone else.

Every day this week guidelines have stiffened and interest rates have stayed high. The market is still driven more by fear than rationality. As with all markets, this will need to run its course. Hopefully, that will be soon. Prognosis for the future in an upcoming post.

Well, not exactly pillow talk, but I was at lunch last week with a small group that included a prominent economist who is a former governor of the Federal Reserve Board. When the talk turned to real estate - doesn’t it always? - there seemed to be a consensus that the economy is slowing and that a rate cut is imminent. However, the economist disagreed. Here is pretty much verbatim what he said. “You won’t read this in the newspapers, because it isn’t politically correct to say, but with a minimum wage hike looking like a certainty” - the bill is in conference committee and should be going to the White House soon, and the President is expected to sign it - “don’t expect to see the Fed lowering rates any time soon. There is already a whiff of inflation in the air, and the Fed will want to be especially cautious with something as potentially inflationary as a minimum wage hike looming. The hike will be phased in over twelve months, and I would be very surprised if the Fed drops rates in the next six to eight months unless there is some extraordinary economic event that calls the Fed to action”.

What does this mean for mortgage rates? Well, on the surface it is disappointing for a couple of reasons: a Fed cut would have an immediate effect on home equity line rates and adjustable rate mortgage payments. An immediate Fed cut would probably bring down all mortgage rates, although not necessarily: sometimes a Fed cut can be viewed by the markets as potentially inflationary, and long rates - the ones that correlate with the rates on loans fixed for five years and longer - can sometimes rise after the Fed drops the Federal Funds rate. The good news about the Fed pausing for six or eight months before cutting rates is that this will probably add a brake to an already slowing economy; this might cause interest rates in 2008 to drop even more sharply than they would if the Fed started cutting rates sooner. This would be very good news to all the borrowers who need to refinance out of 5 and 7 year fixed loans, and ARMs, in the next few years.

In the new lending environment these are some things that listing agents need to know to protect their sellers, and buyer’s agents need to be aware of to better serve their clients.

Even if you have been working with a buyer, and that buyer’s lender, for some time, you should speak with the lender again before making a new offer. Both buyer’s agents and listing agents should make sure that the pre-approval letter is current – the date on the letter should be no more than 3 days prior to the date of the contract.

It has become more common in recent years for pre-approved buyers to go into contract without a loan contingency, especially in a competitive situation. If you are a buyer’s agent whose client wants to make an offer without a loan contingency, especially if your client is doing some combination of a stated-income/over $1 million/high loan-to-value transaction, you may want to have the lender confirm in writing to you that your client has a final loan commitment and does not need a contingency for loan approval.

In any non-cash transaction, listing agents should get a pre-approval letter and speak directly to the lender before advising their client to accept an offer, regardless of whether there is a loan contingency in the contract. The listing agent needs to know that the pre-approval from the lender is based on a current loan package for the buyer, with updated credit report and financials. Ask the lender for the date of the credit report – it should not be more than 30 (21?) days old –and ask if all of the necessary financial information in the file is up-to-date.

For a pre-approved borrower working with a competent direct lender or mortgage broker a 15-day loan contingency will always be sufficient for an owner-occupied property. Although many of the best lenders can comfortably work in a tighter time frame, in the current turbulent mortgage market 15 days is prudent, and shouldn’t be a red flag to a listing agent.

The buyer’s agent should be getting regular updates from the lender on the progress of the loan: appraisal completion, final loan approval, scheduling of documents to title, and funding. Don’t be shy about letting your client’s lender know up front that you expect this kind of communication.

It’s important for real estate agents, especially listing agents, to remember that we are in a rapidly changing lending environment. Even a well-intentioned buyer working with a good lender can find themselves caught in this shifting landscape – their credit score of 693 might have been fine last week, but this week the minimum is 700. Patience and cooperation, especially if the buyer is working with a lender who has a good reputation, may be appropriate. In the last few years of lowered lending standards, many buyers removed their contingencies before receiving final loan approval because their lenders knew that final approval was a given. Now, a careful lender will want to have a final approval before having a client lift a loan contingency. The buyer’s lender may have alternatives, but may need a few extra days to complete an approval.

The most important thing is for everyone to be aware that the environment has changed – we have gone back to the future, and it is the 1990’s again. Lenders are actually performing a careful review of files before parting with millions of dollars - and this is a major change from the last five years! For both a buyer’s agent and the listing agent, having a lender with a reputation for performance, communication, professionalism and integrity has never been more important.

The collapse of the sub-prime lending market is reverberating throughout the mortgage industry. While many of the sub-prime loan products are simply no longer available at all, underwriting standards are being toughened for many other loan programs, not just sub-prime.� These loan qualification guidelines have been changing rapidly, dramatically, and with little warning, and this is having an impact on loan qualification, especially for first-time homebuyers at the low end of the market, and stated-income borrowers at the high end.� I am not aware of any lender – money center bank, regional savings and loan, internet lender, or mortgage bank – who has not had important changes to their lending guidelines over the last two months.

The primary changes are higher minimum credit scores and higher minimum down payments combined with a much more critical look at all aspects of the loan package - assets, income, appraisal, and credit – especially for stated-income and high loan-to-value transactions.

If you are contemplating a purchase or refinance you may want to contact a lender in order to determine if these changes affect you.� If you have already spoken to a lender, but more than a month has passed since the conversation, you may want to check to be sure that the information you were given then still applies.

One of the most profound recent changes in the mortgage lending environment is the increasing emphasis on credit score for stated-income borrowers. As the sub-prime meltdown continues, the investors in all mortgage-backed securities - not just sub-prime - are looking for greater security. The simplest bone that can be thrown their way is a higher minimum credit score, especially for ‘Alt-A’ borrowers. Alt-A loans are most commonly stated-income jumbo loans (loan amounts over $417,000). In the past five years stated-income borrowers with a credit score as low as 620 could get 95% or even 100% loan-to-value mortgages up to $1 million or more. In the last six weeks there has been a steady tightening of the minimum credit score requirements. For the higher loan amounts and LTVs the minimum credit scores for stated-income borrowers are generally now 680 to 720, depending on the lender, and they are still going higher. There are several important ramifications.

First, maintaining a vigilant watch on your credit score is critical. One late on a credit card bill can lower a credit score by as much as 60 points. Credit scores are very time-sensitive. A very small derogatory item that is very recent - one month late on a $200 credit card, for example - will lower your score more than a bankruptcy that is four years old. For those borrowers who have either ARMs, or hybrid loans (5/1, 7/1, etc.) that will recast soon, one small negative item on a credit report can now make it difficult, expensive, or even impossible to refinance. All three of the credit reporting agencies wil let you know your credit score, and they provide services that monitor your credit for inquiries and derogatory items. Links to those agencies - Experian, Transunion, and Equifax - can be found below. You can also contact me and I can provide you with a copy of your credit report that combines the information from all three credit reporting agencies.
Second, if you were pre-approved for a mortgage more than one month ago, get back in touch with your lender and make sure that your pre-approval is still valid. You will want to have your lender re-run your credit and make sure that your credit score is high enough for you to qualify.

Third, if you bought a home recently and were expecting to be able to refinance you may want to check with your lender and find out if the changes in underwriting standards have affected your ability to qualify for a refinance loan. This is especially important if you thought that appreciation would enable you to quickly refinance into a loan with better terms or a lower interest rate.

Fourth, home equity lines are also being affected, especially for stated-income borrowers with a home that has a high loan-to-value, with an investment property, or with a 2-4 unit property. You may find that you cannot get as large a home equity line as you expected, or that the interest rate is higher.

Credit reporting agency links:

http://www.transunion.com

http://www.experian.com

http://www.equifax.com

If you are considering a price reduction on a property that you have listed for sale there is an alternative to consider - an interest rate buy-down.� This can be a win for both the buyer and the seller.� Let me give you an example of how a $30,000 credit from the seller can be worth over $70,000 to a buyer.� If you have a property listed at $1.25 million rather than reduce the price $50,000, you can offer to buy down the interest rate on your buyer’s $1 million mortgage by one full percentage point by paying three points at a cost of $30,000.� For a $1 million dollar loan, fixed for seven years and with an interest-only payment, that would reduce the payment by $10,000 a year - one percent of $1 million = $10,000 - for a savings of $70,000 over the fixed term of the loan.� At today’s rates, the interest rate would drop from 6.50% to 5.50%, and the payment would drop from $5416 to $4583 per month.� Rather than cost yourself $50,000 with a price reduction, you have only spent $30,000 to buy down the interest rate.� The buyer wins twice - not only is the payment lower, but the points are fully tax deductible to the buyer in the year of purchase, regardless of who pays them, saving the buyer another $10,000++.� If you want more information on how to structure a buy-down give us a call.