Mortgage rates are at absolutely stupid levels right now - the lowest in decades. Bankrate.com is reporting 4.51% for 30 year fixed mortgages and 3.51% for 5 year ARMs. Recently, these rates have been depressed by the United States' reputation as a safe haven in a time of increasing uncertainty in Europe. However, do these rates accurately reflect the risk associated with loaning money to the US homeowner? No way! The only reason rates can be this low is that the US government is still insuring these mortgages and securitizing them through the actions of Fannie Mae and Freddie Mac. But how much longer can this go on?

About a month ago the government passed a sweeping financial reform bill that has generated speculation that the end might be near for these ridiculously low mortgage rates. First, the bill requires that lenders eat their own dog food/ drink their own bathwater - i.e keep 5% of the mortgages they originate. You know...what's good for the goose is good for the gander. It's a better idea than letting one man's meat be another man's poison. Seems like a good idea to me - may actually cause them to act responsibly. Second, there is increasing interest in eliminating Fannie Mae and Freddie Mac. In fact, even Barney Frank is predicting their demise - and that guy never met a government program he didn't like. After all, they have so far cost the US taxpayer $150 billion, with more losses likely to come.

There are even more subtle impacts lurking in this financial reform bill, not all of which will be as logical as what I discussed above, that are likely to negatively impact the mortgage environment. I asked Russ Martin of Perl Mortgage to pontificate on the bill and here is what he had to say:

Yeah, there are a lot of unknowns with that legislation right now.  I don't think it will wind up being as bad as folks make, but like all government intervention, it will probably wind up raising costs for consumers and make an already complicated transaction a much bigger pain in the ass.

The biggest part that had mortgage lenders concerned is that there is some language limiting loan officer and bank compensation to 3%.  While this isn't much of a problem as most deals don't pay us that much, it can be an issue on smaller loans especially when consumers want to do "no closing costs" deals since the costs have to be paid out of that percentage.  3% of a $100k loan is only $3k.  It costs about $2k to process a refinance in Illinois.  That only leaves $1000 for the loan officer which is split between the loan officer and the brokerage.  No loan officer worth anything is going to actively seek to do those deals.  Some states have more expensive costs like title insurance and it would make it virtually impossible to do small deals with a 3% cap.  The long and short of it is that Congress tried to put a cap on profit margins and really have been attempting to outlaw them altogether on mortgages.  Of course, this it isn't reported this way, but that is really what is going on.

There is also some language where they are trying to decouple the bank profit margin/lo compensation from the interest rate on the mortgage.  Right now, as the rate goes higher, we obviously make more.  This functions like any business but for some reason this is considered bad in the mortgage world. Competition helps keep gouging lenders in check and with so much information available on the internet, it is really hard for any lender to gouge consumers like the politicians are claiming. 

There is probably going to be some change in the comp structures at some point where loan officers are paid a flat rate per deal by their brokerage and paid out of a bonus pool.  It also isn't clear how this is going to affect the wholesale mortgage market.  Obviously higher rate mortgages are worth more, so I don't know if the market is going to appropriately price the loan products.

The Feds have really screwed consumers over the past couple of years.  A lot of these laws sound good on paper to people unfamiliar with how the industry works, but when you really sit down and look at what is going on it is borderline idiocy.  Unfortunately, the mortgage industry lobby (Brokers in particular) is too fragmented so it was very easy for uninformed consumer groups to paint the entire industry with a broad brush. 

There will also be some issues with self employed borrowers as well as innnovative products to make the market more efficient.  The so-called liar loans were designed to not have to the most qualified borrowers through hell and back.  Unfortunately, during the bubble the banks allowed these products to be abused as a way for unqualified borrowers to qualify.  Now many self employed borrowers or low income/but large asset borrowers are not going to qualify for mortgages [this is already a problem].

...the bill is too complex and it is really hard to determine what the exact impacts are going to be.  It is very hard to explain this stuff to folks that aren't in the business, but the impact will be real.  Unfortunately, the financial markets are not something that Joe Plumber can relate to, so the public outrage about this stuff doesn't really come up when the bills are debated because the average person can't relate until one of these dumb laws affects them personally.

So the bottom line is that you better party hard before the government takes the punch bowl away.

But the tax credit ended in April so why are we first seeing the impact in July? Because there is about a 1 - 2 month lag between when buyers enter into contracts and when the sales actually close and the numbers reported by various realtor groups focus on closings. As I've shown in the past, when you look at contract activity it's apparent that home purchase activity fell off of a cliff as soon as the tax credit ended. Now that I have 3 months of contract activity post government meddling you can see what happened more clearly in the graph below.



This graph is a little tricky to interpret because it doesn't contain all of 2008's data but what it shows is that contract activity in the latter half of 2009 was up substantially over 2008 levels. Then in the early part of 2010, until the tax credit expired, contract activity was way up over the previous year, 2009. Starting in May, contract activity fell off the cliff and for the first time in a year actually fell below the previous year. This pattern has continued through July, when activity almost matched the level of 2008 (which makes the graph a bit confusing because it looks like 2010 and 2008 are part of the same line but they're not).

It is encouraging that the July contracts were actually pretty close to 2009 levels so it will be interesting to see where August falls. However, I'm not holding my breath.