3 Changes That Could Help Buyers Commit to Buy
3 Changes That Could Help Buyers Commit to Buy
By Rob Jafek, Principal | Boomerang Capital
There are a lot of buyers on the sidelines, and there is a lot of interest in getting them back off the sidelines. The number one reason cited for their absence is affordability. And given that you are a real estate professional, you know this. Here are three areas that could quickly reduce the mortgage rate and help a few of those buyers get over the finish line.
Reduce the mortgage spread
The mortgage spread (30-year mortgage minus 10-year Treasury) is historically wide. The relationship between short-term interest rates, as determined by the Federal Reserve Board, and the 10-year interest rate is weak. In contrast, the relationship between the 10-year interest rate and mortgages is strong since the 10-year is what is used to finance 30-year mortgages, with the extra charged by the bank to compensate for risk and profit margins. The historical average of that extra, since 2000, is about 1.87% and even excluding recession periods does not change that figure much. You can view or download the data here: https://fred.stlouisfed.org/graph/?g=1Lc99
The spread could, and should, be narrowed. For example, Freddie Mac and Fannie Mae are government-sponsored enterprises, and other mortgage companies generally follow their lead. Reducing the spread by 50 basis points would be a straightforward change that would have a measurable and immediate effect.
2. Reduce PMI
Private mortgage insurance (PMI) is required for most first-time buyers, as well as many other buyers. To gain insight into insurance pricing, the primary indicator is the loss ratio, which represents the percentage of premium revenue an insurer pays out in claims. For example, a 70% loss ratio means 70 cents of every premium dollar goes to paying claims, with the rest covering expenses and profit. PMI has a very low loss ratio compared with other insurance products, suggesting it is overpriced.
Auto: 70%–90%
Home: 70%-90%
PMI: 15%–26% (source: https://openyls.law.yale.edu/server/api/core/bitstreams/69d691c3-d27b-4315-b221-7888745117a2/content)
On a $450,000 mortgage (average home price in AZ), PMI can be a couple of thousand dollars a year, which is two to four hundred dollars a month. A reasonable approach could be to remove PMI requirements where the risk is already sufficiently covered, or to work with insurers to bring loss ratios more in line with other lines of insurance.
3. Reduce title insurance costs
Title insurance is required for all transactions and has an even lower loss ratio than PMI, between 4% and 7%.
According to the Urban Institute, reducing these costs and increasing transparency could save the median borrower $5,000 to $10,000 up front and reduce monthly payments by as much as $100. These savings could help cover a portion of a down payment, be directed into savings (which research shows can reduce defaults), or reduce ongoing mortgage costs. https://www.urban.org/urban-wire/rethinking-title-insurance-could-dramatically-lower-costs-homebuyers
Possible approaches include removing the requirement for title insurance altogether in routine transfers, creating a lower-cost centralized service, or allowing Fannie Mae and Freddie Mac to self-insure or purchase coverage directly.
The combined effect
While these may involve solutions that require government action, these are not partisan. Both parties have expressed interest in reducing mortgage rates and have made similar efforts to study and provide recommendations. These are doable, and making these three changes could save hundreds of dollars a month for home purchasers, which is certainly enough to make a meaningful difference in affordability.