FHA Rule Change Helps First Time Home Buyers

The majority of the home sales in depressed real estate markets like Phoenix, Southern California, Las Vegas, & Florida are lender owned properties. The deluge of foreclosures in those markets has greatly increased the number of home sales as lenders take ownership, and then sell those homes. That increase in sales is good news for those of us whose livelihood depends on homes being bought and sold. But let's look at who is buying those foreclosures. A great number are investors.

Investors Role Important
I have been critical of the large number of home sales in our markets where the new owner is an investor. My argument is that true stability in the housing market can only come from homeowners who intend to occupy the properties. Investors that intend to flip properties only contribute to a bubble that will eventually pop after being over-inflated. However, even I must admit that investors play an important role in rebuilding our market.

That role involves the remodeling and even rebuilding of homes. Unfortunately many of the homes that lenders foreclose are in terrible shape. Prior owners often strip homes of appliances, fixtures, counters, cabinets, wiring, plumbing, and anything else that seems valuable. Homes are even damaged out of spite as angry occupants move out.

The average prospective home buyer cannot afford to make the repairs needed to make the home habitable. First time home buyers are typically scraping together savings to afford a minimum down payment. Investors have the funds to pay cash for the properties and make the necessary repairs. After the investor's work is through, the home is in move-in ready condition. They list the property and sell it to a willing buyer.

90 Day Seller Seasoning
Most home purchases today are financed with an FHA insured mortgage. However FHA rules require a seller to own the property for at least 90 days before a buyer can use an FHA to finance the purchase. Most of the time, the investor can make the necessary repairs to a home in a few weeks. So they were required to hold the property, unoccupied for an extra couple of months before they could sell to an FHA buyer.

On Friday FHA announced a temporary waiver of the 90 day rule. Investors, and any seller for that matter, can now sell the property immediately. There are some restrictions.

• The waiver begins February 1, and lasts for one year.
  
• Sales must be arm's-length transactions.
• Restrictions apply to sales that increase by 20% or more.
  

More information can be found in HUD's press release.

This is good news for markets that need lender owned properties to turn over. It will motivate more investors to purchase and repair distressed properties, and get them into the hands of homeowners that will live in these homes.

Are Higher Rates on the Horizon?

"What goes up must come down...," the song goes. In the world of interest rates gravity works both ways, and so the reverse "What goes down must come up..." also applies.

Federal Reserve MBS Purchases

There is some concern that 2010 will mark higher rates than in 2009. That shouldn't be a surprise. The Federal Reserve kept rates down last year to try and stabilize the economy. Not only has the Fed Funds (short term) rate been at near zero, the Federal Reserve helped to keep mortgage rates low with a massive spending spree for mortgage backed securities. The fact that it is a "spree" implies it cannot last forever, and it won't.

The Fed now holds $909 billion in mortgage backed securities. It sounds like a big number, and it is. Last year, the Fed and Treasury combined to purchase 73% of all Fannie Mae, Freddie Mac, and Ginnie Mae mortgage backed securities. The Fed's spending spree, when completed in March will result in $1.25 trillion in MBS purchases. Unless you are a politician, $1.25 trillion is a lot of money.

Effect on Interest Rates

Those purchases had a big impact on mortgage rates, and therefore on housing affordability. Home prices are based on what potential buyers are willing to pay, and what they can afford. Rising rates will result in higher monthly payments on new mortgages. That means for someone to be able to afford the same payment with a higher rate, the loan amount (and the sales price) must go down. The bottom line, higher rates equals further declines in home values. Further declines in home values equals more foreclosures. Therefore higher interest rates equals more foreclosures. Here are the equations for any math nerds that are reading this.

Higher Rates = Lower Home Values;
Lower Home Values = More Foreclosures;
Higher Rates = More Foreclosures.

With continued falling home values, and rising foreclosures, will the Fed really stop the MBS purchase program. They recently warned banks to be prepared for "instantaneous and significant changes in rates, substantial changes in rates over times, changes in the relationships between key market rates (mortgages versus Treasuries?) and changes in the slope and shape of the yield curve."

Prediction or Regulation?

Was that a warning from the Fed as to what is to come? Or are they just trying to be a better regulator since they did an obscenely poor job leading up to the recession? What about the President and Congress; will they let allow rising rates to beat down an already bloody housing market? Reeling from worse than expected unemployment numbers for December, there is political pressure to continue to stimulate the housing market.

Knowing that the Fed is ending its MBS purchase program in March, the Treasury's announcement of "unlimited support" for Fannie Mae and Freddie Mac makes sense. Perhaps they will pick up where the Fed is leaving off in the purchase of mortgage backed securities. If not, the absence of such a large buyer will drive up mortgage rates as yields must be bid up to attract new investors.

The Bottom Line

There is great pressure on the government to continue stimulating housing. One way or another they should keeps rates low (continue Fed MBS purchase plan, or use Fannie & Freddie). We are still in the midst of a housing crisis, so it is undesirable to intentionally trigger another one. Eventionally the housing market must be weaned off the stimulants, but this market is not yet ready for that.