I recently penned this response to Peter Miller’s post “New FHA Appraisal Standards Take Effect”, and I thought I’d reprint it here with a link to his original article.  Peter’s excellent blog FHALoanPros keeps a close eye on FHA legislation and changes in FHA lending practices and often provides good statistical data on FHA lending.

In this particular article, Peter notes the effective adoption by HUD of the HVCC appraisal rules that now prohibit loan originators from selecting appraisers.  He writes from the regulators’ viewpoint that advocates this separation in the belief that it will “allow borrowers to get a better shot at a fair valuation of their property”.  While in theory this sounds reasonable, in practice the cure is worse than the disease.  Here are my comments:

Even if one believed that the mortgage world was coming to an end with this new rule, it would take a few weeks for its effects to be felt by buyers. And I don’t think any of us feel that. After all, we’ve been dealing with this HVCC processon conventional loans for awhile now already. What we do feel and see is that this new procedure has empowered and unriched a new “middle man” in the process–the Appraisal Management Companies (AMC), often just subsidiaries of the big banks themselves.

Granted, the old appraisal system allowed unethical mortgage originators to coerce weak or desperate appraisers with threats of non-payment or withholding of future business, but there were already good systems in place for appraisals to be reviewed and for appraisers themselves to be monitored and removed from list of “approved appraisers”. These rules could have been strengthened. But at the same time that the HVCC process was brought to life, we witnessed the disappearance of “approved appraiser” lists and the easing of the requirements by HUD to become an FHA appraiser. How does that make sense?

Now we have a mortgage analogue to “managed care” in the health industry, a new tier of companies who raise the costs to borrowers, reduce the fees to the providers who do the actual work, and redistribute the difference as profit to themselves. That has been reflected in several ways anithetical to the notion of helping the consumer who wants to know the real value of what they are buying.

First, less experienced and out-of-the-area appraisers are often the only ones who will accept the reduced fees paid by the AMCs. These fees are often half of what appraisers used to earn. Recently, an agent told me she had met such an appraiser at the property. He was late because he couldn’t find the town and then walked up to the house barefoot and smelling as though he hadn’t showered in several days. I am told that the appraisal code requires an appraiser to be familiar with the area in which he is conducting an appraisal. Someone from out of the area may not understand the differences between neighborhoods, even if they eventually can find the town. And when paid half of their normal fee at a time when regulations require more work, few appraisers will put the time and effort into researching and understanding a home’s true value. They put as little effort in as possible and use the low end of the value range to cover themselves.

Second, despite this separation of originator from appraiser, the banks do not trust the outcome. One would think that if this process truly met its objective of creating greater accuracy and objectivity, the banks would embrace the results. Instead, they appear more nervous than ever. Most appraisals seem to then require “desk reviews” or “field reviews” at an additional cost. So, the consumers pays more for each appraisal and often has to pay for multiple appraisals. Additionally, the banks still run AVMs (automated valuation methods..think Zillow) in the background. When these inferior computer valuation tools yield a lower value that the actual appraisals, banks will still often use those value, despite the acknowledged quality discrepancy. This kills deals and costs consumers money.

The time required to deal with all of this is certainly another cost issue to consumers. Escrows are frequently delayed, per diem fees incurred, interest rate locks blown….all at a cost to the consumer who has not in fact received a more reliable opinion of value.

I am an advocate of good regulation. Without it, the invisible hand of self-interest often leads not to promotion of the public interest or transformation of greed into social good but simply to cheating. But this is an example of bad legislation and unintended consequences. There are better ways to fix the appraisal problem.

In keeping with a general tightening of it’s lending rules to compensate for elevated default rates, HUD has announced an increase in the “up-front” mortgage insurance (MI) for FHA loans from 1.75% to 2.25%. As you know, mortgage insurance on FHA loans is normal split into two parts.  One portion is added to the monthly payment, and the other is added to the loan amount.  Allowing buyers to finance a portion of the MI has the effect of keeping payments lower than they otherwise would be on a similar conventional loan.

While the increase has some people concerned, let’s take a second and put things in perspective.  On a $200,000 loan, the financed portion of the MI increases from $3378 to $4343, so your loan balance grows by less than $1,000.  The resulting increase in the monthly payment (I’m using a 5% interest rate) is less than $5.

However, if you’re buying up to the $417k limit and the payment increase is critical, then you’ll want to be in Contract on a home by April 4, 2010, and make sure your lender has pulled your FHA case number before April 5th when the new rule goes into effect.

Here’s an informative video on this topic. Watch the Chief Economist of NAHB answer frequently asked questions about both the First Time and the Repeat Buyer  tax credits.

Mortgage rates should improve a bit this morning on news that October job losses of 190,000 were higher than analysts expected.  Unemployment topped 10% for the first time in a long time.  The see-saw continues.  Is the economy healing or isn’t it?

The Fed continues to be the primary buyer of mortgage backed securities (MBS), though their purchases declined by $2b to $16b last week.  Year to date they’ve bought $993 b!  Hopefully the Chinese, Japanese, and the petro-states will get back in the game before the Fed runs out of money or stops buying next April as indicated. For those who don’t know this, banks who make home loans sell those loans in the “secondary market” to recoup their cash and make more loans.  Until the credit crisis, foreign investors with fistfulls of US dollars from all our purchases of their stuff (oil, cars, cheap toys, electronics) bought US Treasuries or MBS as a way to park those dollars somewhere safe and avoid the exchange rate risk.

Finally, the First Time Buyer Tax Credit passed in Congress and heads to Obama’s desk.  A lesser known piece is that also eligible are homeowners who have owned for at least five years.  They get $6500. Of course there are phase-outs rules and restrictions on property types.  You have to have Purchase Contract by April 30, 2010 and close by June 30, 2010 in order to qualify.  Call for details…

Are you waiting for lower mortgage rates?  Don’t be silly.

Mortgage rates have started to creep slowly northward these past couple of weeks. The normal volatility associated with stock trading and economic news seems like it has produced more upticks than down.  The government has indicated that it will stop buying mortgage securities by the end of the first quarter of 2010,  and analysts are predicting that this could push rates higher by as much as a full percentage point.

Today’s FOMC meeting may offer clues about the Fed’s plans.  Futures pricing is supporting the speculation about higher rates by early next year.  ADP’s employment data this morning is suggesting that the economy is shedding fewer jobs, suggesting that the recession is slowing for the turnaround.  Rates are up slightly this morning.

So, get ‘em while they’re hot.  By next Spring, today’s rates may be a thing of the past…

In the past few months, we have felt HUD yanking insistently on the leash of of FHA underwriting.   We’ve all been wondering, in the absence of overt policy change announcements, what’s going on and more importantly, how will it affect FHA lending.  It’s already more challenging than ever.  Will it get tougher?  The answer appears to be a clear “yes”.

We feel the change in visceral ways.  First, many banks (but not all) increased their credit score requirement for FHA loans from 620 to 640.  Old timers will recall that up until last year, FHA loan had no credit score minimum at all.   Then, fees became an issue, with some banks capping or disallowing certain fees about which they had been previously unconcerned.

Back in May, HUD suspended Taylor, Bean, & Whitaker Mortgage Corp. the 3rd largest FHA loan originator in the country for concerns about fraud and questionable business practices and announced sanctions against 120 approved FHA lenders.

Now it appears that default rates may deplete FHA’s reserves to the point where taxpayers must be called upon yet again.  FHA loans have replaced subprime loans as the primary source of funds for cash-strapped home buyers.   But if FHA loan defaults require a tax payer bailout, then expect FHA lending to tighten considerably as legislators try to resolve yet another crisis in the making.

This is a repost of an article I wrote in March.  It came to light again because an agent I work with had a deal that hung up last minute over the issue of property taxes.  Here, with a few edits and updates, is  what I wrote:

You’re a shrewd home buyer.  You’ve waited patiently for prices to fall and interest rates have stayed down as well.  Now you’re in Contract, and the price is half of what the seller paid for it.  You won!  Good job.

It’s true, you have made a smart purchase.  But there is one little quirk in all this to which you need to pay close attention.

A Little Nostalgia

Remember the good ‘ole days when homes were appreciating in value?   Back then, each successive owner paid property taxes a little higher than the last. Why?   Because property taxes are reassessed after each sale and rise with values.  In lending, we always estimated the new tax amount based on the purchase price in order to establish the correct amounts for the escrow account.

In this market however, property values are falling. and property taxes should follow along, right?  Yes…eventually.  Remember, property taxes are established for a year at a time, and your purchase does not immediately alter the tax amount.  In fact, with all the activity, it seems to be taking the tax assessor’s office longer than normal to catch up and lower those taxes.

Between property tax appeals by homeowners and an active real estate market, California recently warned that until they are able to complete the reevaluation (and that could take up to a year), new homeowners must continue to pay the previously established property tax amount.  In many cases here in the Sacramento area, that’s several hundred dollars more per month than it will ultimately be.

The Effect on Qualifying

Following that ripple out to the edge of the pond, several things become clear.  First, because lenders are now requiring that borrowers qualify with the higher tax payment in their debt ratios, your debt-to-income ratios may now be too high and your approval worthless.   You may have to reduce the price or increase your down payment in order to qualify to buy that particular home.

Second, if you have a loan that requires impounds for taxes and insurance–FHA, VA, and conventional loans with less than 20% down– your actual monthly payment will be higher until taxes are corrected.  Lenders are insisting on this because they need to ensure that they have adequate money to pay the taxes when due.

Finally, especially at this time of year when lenders are requiring 8-9 months of property taxes at the close to put in the escrow account, this can substantially increase the cash needed to close.

To be sure, the payment part of this problem is temporary.  But you can also end up without a loan if you’re not careful.  In extreme cases, it can result in foreclosure.  I recently spoke with a retired gentleman who is losing his home because his lender had raised his payment from $1300 to $1900 to compensate for incorrectly calculated property taxes.  He couldn’t make the higher payment and the lender, refusing to work with him, had started the foreclosure process.

An Ounce of Prevention

To correct for this problem, check the seller’s current property taxes and use 1/12th of that number for the property taxes and impounds on your purchase.  And be diligent right through the close of escrow.  Despite my practice of using existing taxes, I have had escrow officers reinstate the incorrect numbers at the close of escrow.  So, make sure you can afford the higher payments, and plan to reevaluate each time you find a home you like to make sure your loan isn’t declined at the last minute because your debt ratios suddenly went tilt.