Real Estate without Freddie and Fannie

“The good news is right now there’s a bipartisan group of senators working to end Fannie and Freddie as we know them. And I support these kinds of reform efforts.”

- President Obama, August 6th

Ending Freddie Mac and Fannie Mae will mean two things to the housing industry: higher rates and probably shorter mortgages. This will result in larger monthly mortgage payments.

Fannie Mae and Freddie Mac are government run agencies that have propped up a troubled real estate market over the last several years. The agencies always had a place within the mortgage sector but over the past several years have been involved in over 90% of new mortgage originations. As they wind down this involvement, the mortgage space may change dramatically.

David Stevens, CEO of the Mortgage Bankers Association and a former Obama administration housing official, in a recent AP article explains what will be the result of winding down Fannie and Freddie:

“You have to assume that almost in any future model being drafted, loans will be more expensive.”

This will be felt in two ways.

Higher Interest Rates

In the same AP article, Mark Zandi, chief economist at Moody’s Analytics, reveals:

“It will mean higher mortgage rates. The question is how much higher.”

According to Zandi, borrowers could pay about ½ point higher in interest rate ($75-$135 extra in interest payments per month to the average purchaser on a $200,000 loan).

Why a projected increase in rates? The average 30 year mortgage rate over the last three decades is 8.69%. From 2003-2008, it was 6.06%. Part of the government’s stimulus program was spent on keeping mortgage rates low while the economy recovered. Many think that rates will return to the 6-6.5 range should Fannie and Freddie cease operations.

Shorter Loan Terms

Once Freddie and Fannie no longer exist, the question becomes whether or not the private sector will any longer feel comfortable issuing a fixed rate loan for 30 years. In Canada, for example, they don’t even have 30 year fix rate mortgages available. The vast majority of Canadian home loans have a 25 year payout with the interest rate being renegotiated every five years. If rates go down, the borrower will wind up with a lower rate. If rates go up, the borrower ends up paying a higher rate. If you want a fixed rate mortgage for 25 years you pay a rate approximately two percentage points higher than the going rate at the time of your closing.

Some believe that the private sector will no longer make the 30 year mortgage option available for at least a portion of borrowers.

Bottom Line
It will be interesting to see how the winding down of the two agencies impacts the housing market going forward.

Is Homeownership a Good Financial Desicion?

Many have reported on Robert Shiller’s recent comments on the investment aspect of homeownership. Shiller, a Yale professor and co-founder of theCase-Shiller Home Price Index, is famous for making provocative comments on house prices and the financial benefits of owning a home. In a recentBloomberg Television interview, Shiller responded to a question about homeownership as an investment this way:

“So, why was it considered an investment? That was a fad. That was an idea that took hold in the early 2000′s. And I don’t expect it to come back. Not with the same force. So people might just decide, ‘Yeah, I’ll diversify my portfolio. I’ll live in a rental.’ That is a very sensible thing for many people to do.”

Today, we would like to debate Shiller’s notion by offering three FINANCIAL reasons to purchase a home:

1.) You Can’t Live in Your IRA

When you buy your own home you are not taking available dollars away from another investment. You are replacing one housing expense (rent) which has no potential for a return on investment with another (mortgage payment) that does give you an opportunity for a return. We realize that there has beenresearch showing that over the last 30 years renting has been less expensive than owning. That research also says that if you invested the entire difference between the rent payment and mortgage payment you may have done better financially. There are two challenges with this conclusion:

§Today, in the vast majority of the country, renting is actually more expensive than owning a home.

§History hasproven that tenants DO NOT invest the difference in their rent and mortgage payments.

2.) Homeownership Creates Wealth

Paying a mortgage creates what financial experts call ‘forced savings’.The Joint Center for Housing Studiesat Harvard University released a study titled America’s Rental Housing: Meeting Challenges, Building on Opportunities. In the study, they actually quantified the difference in family wealth between renters and homeowners:

“[R]enters have only a fraction of the net wealth of owners. Near the peak of the housing bubble in 2007, the median net wealth of homeowners was $234,600—about 46 times the $5,100 median for renters. Even if homeowner wealth fell back to 1995 levels, it would still be 27.5 times the median for renters.”

3.) There Are Tremendous Tax Advantages to Investing in a Home

There is no doubt that selling an investment such as gold is easier than selling your home. However, this liquidity comes at a price. The price is called capital gains. That is the tax you pay on any financial gain you receive from the investment. This tax doesn’t apply the same way when you sell your primary residence:

Theresa Palagonia, a CPA and the Accounting Manager for the firm G.S. Garritano & Associates, was good enough to explain the Home Sale Exclusion Rules:

“You may qualify to exclude from your income all or part of any gain from the sale of your main home.

Maximum Exclusion

You can exclude up to $250,000 of the gain on the sale of your main home if all of the following are true:

§ You meet the ownership test.

§ You meet the use test.

§ During the 2 year period ending on the date of the sale, you did not exclude gain from the sale of another home.

If you and another person owned the home jointly but file separate returns, each of you can exclude up to $250,000 of gain from the sale of your interest in the home if each of you meets the three conditions listed above.

You may be able to exclude up to $500,000 of the gain on the sale of your main home if you are married and file a joint return and meet the requirements. (Special rules apply for joint returns.)

We will let you decide for yourself whether homeownership makes sense financially.