Thoughts on Keeping the 30-yr Mortgage; Tax Implications of Cancelled Mortgage Debt
There continues to be a debate about whether or not 30-yr mortgages/liens are a good idea or not. The MBA's president - Dave Stevens - weighed in on the argument last week. "On the one hand it could be argued that the fully pre payable 30 year fixed rate loan was not a necessity in looking back historically. There is some truth to that - to be clear - mortgage interest rates have been on a steady decline for over three decades since their peak in 1980. While clearly home-owner preference for the 30 year mortgage has been high, borrowers would have clearly benefited from an adjustable rate product that would have adjusted naturally downward over the past three decades. In hindsight, borrowers would have avoided all of the expense and time associated with refinancing as mortgage interest rates essentially dropped from their peak of 18% down to about 3.5% at bottom a few short weeks ago. Yes, there were a few spikes along the way, but these were very short lived and would have been more than offset by the eventual rate declines that followed these infrequent corrections. So yes, to those that that argue this point, they are correct - in hindsight. And hindsight is always perfect."
Mr. Stevens note goes on. "The concern I have is the effect of a mortgage market that is absent the 30 year fixed rate on a forward looking basis where almost absolute certainty calls for interest rate increases. Let's think about a few variables associated with this climate we currently face. 1. The Spike - Hybrid Arms or Balloon loans have a built in adjustment period where the borrower has to face an interest rate adjustment. We know that the future won't be anything like the past, that there is little hope for further rate declines; after all you can't go below zero. The planning of the rate change at the first adjustment in an ARM or Balloon can be modeled by risk managers. The "spike" is something that ARM investors have long modeled as they had to plan for prepayments, either from default rates or wealthy borrowers who would pay off their loan. The question is how does a senior citizen on a fixed income deal with a spike? If a 5 year balloon was at 3.5% on a $300,000 loan and rates rise 2%, their payment would climb $350 per month. If on a fixed income, this could cause defaults to those individuals. The point is non-fixed rate mortgages pose significant default risks to borrowers in a rising rate scenario - we just haven't experienced that.....yet."
And furthermore, "2. Compensating factors - One thing we know is that the largest segment of home-ownership demand over the next decade will come from first time buyers. The borrowers will have low down-payments. Layering risks of low down-payment mortgages combined with a shorter term mortgage that will have a spike, leaves little cushion for the borrower. I'm not passing judgment here on whether lower home-ownership rates are good or bad, but the impact to home-ownership rates could be implicated as a result of the higher risk of these combined effects. 3. TBA - The 30 year fixed rate predominance is largely the result of the ability of the GSE's (Freddie and Fannie) and GNMA to make a market, hedge basis risk forward, and drive enough liquidity to provide this nation with the 30 year mortgage. In the United Kingdom, as a comparison, there is no 30 year mortgage. The vast majority of mortgages are 5 year balloon loans that require larger down-payments. "Generation Rent" is the outcry in England as the home-ownership rate has been dropping and access has become a huge concern. Those that would completely eliminate government support for housing should look at the UK as a model for what the market in the US could look like. 4. Private Sector Role - One thing we have learned in history is that the banking industry is not good at long rate mortgages. Lending long and borrowing short has created enormous issues for the banking sector, once having been the fuel for the savings and loan crisis of a few decades ago that cost the taxpayer hundreds of billions of dollars in bailout funds. We should not expect to see a viable, functioning 30 year market without some formal support."
And lastly he states, "Look, I'm not advocating to keep Fannie and Freddie in their current state, I have spent a lot of time working with others on ideas to transition them and yet consider the need for liquidity in the mortgage markets. I am saying that I don't think anyone can forecast how important the fixed rate mortgage will be in the years ahead as rates move in the opposite direction from where they came and perhaps expose our nation's housing market and millions of Americans to a very serious set of challenges that could have their own systemic impacts. Getting this right, in a balanced way, will be critically important as we move forward."
It's tax month! Here is some information that LOs may want to read if they are advising borrowers on cancelled or forgiven mortgage debt. If your lender cancelled or forgave your mortgage debt, you generally have to pay tax on that amount. But there are exceptions to this rule for some homeowners who had mortgage debt forgiven in 2012. The IRS has released some facts about mortgage debt forgiveness. Cancelled debt normally results in taxable income, but you may be able to exclude the cancelled debt from your income if the debt was a mortgage on your main home. To qualify, you must have used the debt to buy, build or substantially improve your principal residence. The residence must also secure the mortgage. The maximum qualified debt that you can exclude under this exception is $2 million. The limit is $1 million for a married person who files a separate tax return. You may be able to exclude from income the amount of mortgage debt reduced through mortgage restructuring. You may also be able to exclude mortgage debt cancelled in a foreclosure. You may also qualify for the exclusion on a refinanced mortgage. This applies only if you used proceeds from the refinancing to buy, build or substantially improve your main home. The exclusion is limited to the amount of the old mortgage principal just before the refinancing. Proceeds of refinanced mortgage debt used for other purposes do not qualify for the exclusion. For example, debt used to pay off credit card debt does not qualify. If you qualify, report the excluded debt on Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness. Submit the completed form with your federal income tax return. Other types of cancelled debt do not qualify for this special exclusion. This includes debt cancelled on second homes, rental and business property, credit cards or car loans. In some cases, other tax relief provisions may apply, such as debts discharged in certain bankruptcy proceedings. Form 982 provides more details about these provisions. If your lender reduced or cancelled at least $600 of your mortgage debt, they normally send you a statement in January of the next year. Form 1099-C, Cancellation of Debt, shows the amount of cancelled debt and the fair market value of any foreclosed property. Finally, check your Form 1099-C for the cancelled debt amount shown in Box 2, and the value of your home shown in Box 7. Notify the lender immediately of any incorrect information so they can correct the form. But here you go: http://www.irs.gov/uac/Newsroom/Important-Facts-about-Mortgage-Debt-Forgiveness.
Turning to the markets, it was a quiet Easter weekend after the markets were closed on Friday. Not only are many markets closed around the world today (most of Europe along w/Hong Kong, Australia, and others, are all shut Monday), but many school districts have Spring Break. The Fed is continuing to expand its balance sheet at $85 billion per month, and there was no indication last week that they would change the bond buying program. The fed is expected to hold interest rates near zero until 2015 and future changes between now and then are expected to only affect the pace of bond buying. Again, the Fed repeated a promise to hold interest rates near zero until unemployment reaches its target of 6.5% and inflation stay below the 2% target.
U.S. Treasuries prices continued to gain for a third straight week as investors renewed their fears over the euro zone. 10-year notes closed Thursday at 1.85% coming off highs of 2.09% back on March 8th. Many still expect to see yields to move higher as the economy continues to strengthen - but rates are not expected to move that much higher. Generally speaking, U.S. economic data from the first quarter shows sustained momentum in the early stages of fiscal tightening, something that is not a "one and done" event, but rather a process that will continue for much of 2013.
But this is a new week, and although we're off to a quiet start, there is some meaningful economic news coming out peaking on Friday with the unemployment data. (The unemployment rate equals the number of unemployed divided by the total number of persons in the labor force, but is full of statistical nuances.) If there's any report that can move the markets, this is it. Wall Street reacts dramatically when the results falls outside expectations. Until then, today we'll have Construction Spending & ISM Manufacturing, tomorrow is Factory Orders and a slew of European & Asian news, Wednesday is the ADP employment numbers & ISM Non-manufacturing composite, and Thursday is Challenger Job Cuts & Initial Jobless Claims.
We start off with the 10-yr, which closed at 1.85% Thursday, at 1.88% and MBS prices better a tad.