This was an email that was originally delivered to my subscribers July, 2021.
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“Brace yourself” … for an email loaded with memes.
I hope you know what a meme is, and if not, you most certainly will at the end.
Memes are kind of like a visual play on words.
A recognizable image, video, or text is altered slightly, and intentionally taken out of context, in order to convey a different point.
(We humans are so easily amused)
Take for example, the subject of this email and the opening sentence, which are a reference to the popular show “Game of Thrones”.
The phrase “Brace yourselves … winter is coming” is an infamous line from the show.
Which brings us to our first meme.
I just need to alter the words with some subtle irony, add a visual reference, and bam …
THE GAME OF LOANS
“The Game of Loans” is a more clever pun, and makes a better meme, than “Game of Margins” which is a phrase I use often as it best describes what the mortgage business has become.
Unfortunately, these days people might be watching a little too much Game of Thrones, because when it comes to finance it seems many are lost in medieval times.
Specifically, regarding how they “think” mortgage companies operate.
The lure of a mythical interest rate seduces many, but the journey is rife with danger and in the end, futile, as there is no hidden treasure awaiting them in some far away land.
That is because your loan is destined to be part of a mortgage-backed security (MBS), where it will be bundled together with countless other mortgages that have a range of similar interest rates.
If your loan meets what are called “agency” guidelines, then the GSE’s (government sponsored entity) Fannie Mae and Ginnie Mae will purchase the loan.
Then a secondary market of investors, including large insurance companies, pension funds, sovereign wealth funds, bond funds, etc. will invest in these mortgage-backed securities.
The lender or servicer (the company to whom you make your payment) doesn’t actually own your mortgage. No one person or entity does, it’s part of a pool of mortgages owned by a variety of different types of investors.
The MBS investors are the ones with capital at risk, not the lender or servicer.
Because there is really just one major market where these loans are eventually sold, every lender in the entire mortgage market is selling YOU the exact same product with the exact same price tag.
So the company who eventually offers you the best deal will be the one that can operate on the thinnest margins.
This is why I call it the “Game of Margins“.
Because ALL LENDERS get paid the same and it’s simply a matter of how low can they go before it is no longer profitable.
Just realize that there is very little out there that will differ from one company to the next, unless of course you compare an inefficient entity like a bank with a hyper-efficient low margin company like mine.
By the way, if you still go to a brick-and-mortar bank to get a mortgage you have skipped medieval times, and have leaped all the way back to the stone age.
Don’t be fooled into thinking “because they are local, or because your family has banked with them for multiple generations, that they will “give you a good deal”.
WRONG.
Banks are in business to make a profit, and profits on mortgages are all about that MARGIN.
QUICK NOTE ABOUT BROKERS
For the record, brokers are just intermediaries that connect borrowers with lenders. (I am a lender, NOT a broker)
There was value in the broker’s role prior to 2008 because the variety and complexity of loans was so great you truly needed someone to navigate it all for you.
This is no longer the case today with the majority of mortgage loans because almost everything needs to meet “agency” guidelines, otherwise the GSE’s won’t buy it and therefore no one will want to fund it.
Thus, most loans today are pure vanilla, and because of securitization everyone is selling you the exact same range of options.
The main difference is the PRICE of those rates from one lender to the next, which is determined by how thin on profit margins they can get and still survive.
So, why add another hand in the pie (the broker) who will further eat away at the net profit margins and make your loan more expensive (or rate options higher)?
LOAN SERVICING PORTFOLIOS
There is another aspect to the “Game of Margins” that you need to realize.
THIS IS VERY IMPORTANT.
When your loan ends up in a mortgage-backed security, the company collecting your payments is your SERVICER.
They collect your payments, but they DO NOT “own” your mortgage.
Sometimes the servicer is the same company that funded your loan, sometimes it is not.
The investors who invest in the mortgage-backed security get paid the majority of the interest, and the servicer gets a small cut.
This is where it gets interesting …
Based on how the loans get packaged together, which is in half-percent increments, the servicer is getting paid roughly the same amount for a servicing a loan regardless the rate.
This greatly erodes the fiduciary role of a lender because they are selling off most of the risk to MBS investors.
They also have little concern about your rate because whether you have a 5.25% or a 2.25% they will collect the same income for servicing your loan.
I’ll give you a quick, over-simplified example, and then lets move on to more memes.
The different packages (or coupons) offered to MBS investors are in half-percent increments, and represent the interest received by the investor.
For example:
5.0, 4.5, 4.0, 3.5, 3.0, 2.5, 2.0, etc.
Interest from your mortgage payment pays the investors, and so the loans securitized into each tranche would be higher than the interest which gets paid to the investors.
However, don’t forget about the servicers!! They need their cut too.
Therefore, a 5.00% mortgage loan would not be securitized in a 5.0 MBS, because there would be nothing left for the servicer.
The lowest rate packaged into a 5.0 coupon, would likely be 5.25% (or higher).
This means the servicer would collect 0.25% on that loan simply for sending you a statement each month.
Why do you think they so badly want you to set up automatic payments??
The servicer is going to receive approximately 0.25 – 0.50% regardless how high or low the actual mortgage rate, and irrespective of how much you paid for that rate.
The only concern the servicer has is if your loan gets refinanced and the new servicing rights are sold to a different company, because then it’s goodbye easy money.
This is why the company servicing your loan “coincidentally” calls you out of the blue when you start exploring your refinance options.
Credit vendors (companies that generate and monitor credit reports) sell “trigger lead” services, so as soon as you have your credit pulled at the beginning of a refinance process the servicer is alerted.
(Is this a violation of your privacy, yes, but I fear that war was lost a long time ago.)
The servicer will usually come out guns blazing offering you the lowest rate the GSE’s will buy.
However, because they aren’t worried about your long-term financial well-being, and they only care about their 0.25 – 0.50% spread, they don’t fret about how bad you get screwed by paying a truck load of fees for a lower rate.
In fact, they will happily torch every last dollar of your home equity by having you finance huge closing costs.
Whatever, it takes just as long as you remain in their servicing portfolio.
It is even better if you get suckered into the “new” low rate of the day.
Think about it, the lower your rate, the longer it will be before you refinance again, which means the longer they keep getting a monthly cut of your interest payments.
JON’S LAW OF RECUPERATION
Of course by now you have heard me explain to you the pitfalls of CHASING RATE so many times you have it burned into your brain.
Just like “looking both ways before crossing the street” you intuitively know NOT to pay closing costs and to always use a recuperation analysis to confirm the best loan option.
You would NEVER forget that a lower rate does NOT mean a better loan.
Right? Rrrrrrrright?? RIGHT!!!!!????
Well, “just in case” you have forgotten these rules here is a link to the article explaining my LAW OF RECUPERATION.
Low Rate does NOT equal a better Mortgage – Jon Kutsmeda
RATES ARE ON THE MOVE
In March I wrote an email blast entitled “Are You Afraid of the Boogie Man?“
The “inflation” narrative was everywhere, but I wasn’t a believer.
In that email I put together an extensive argument for why I felt rates would soon resume their long term trend lower.
Interest rates topped only a few short weeks later, and have been in decline ever since (I will write more about this in a subsequent email).
Naturally I have been locking the loans that were already in the pipeline waiting for this dip.
I have also been reaching out to clients who are close to fulfilling the seasoning requirements (210 days) and will soon be eligible to refinance.
This also means a few “triggered” loan servicers.
Just remember they have one objective in mind, keeping your loan in their servicing portfolio so they can get their cut every month.
Because of this goal, they will likely tempt you with as low a rate as the market is willing to buy, regardless how much harm it does to you.
FLOOR RATES
As I just mentioned, rates have started trending lower again after a steep climb from August 2020 – March 2021.
Because of this recent bond rally, the mortgage bond market has started to show an appetite for the next tranche of mortgage bonds.
For most of this year government loans (VA, FHA, USDA) for owner occupied properties were trading in the 2.25 – 3.25% range (depending on fees, rebates, etc.)
Conventional loans of the same type were more like 2.75% – 3.75%.
Now with this recent rally the next tier of rate options is starting to surface.
Since I was predicting that we would see 30-year fixed mortgage rates in the 1% range two years ago, you should not be shocked to know that they are now an option on government loans.
HOWEVER …
Investors don’t have much of an appetitive YET for the lower rate MBS.
Remember the investors who buy mortgage-backed securities choose from half-percent increments.
(5.0, 4.5, 4.0, 3.5, 3.0, 2.5, 2.0, etc.)
So, this new lower range of mortgage rates would mean a half-percent lower interest for the bond investors.
Since SERVICERS are in the game for their little cut (0.25 – 0.50%) a mortgage rate between 1.75% – 2.00% would need to be packaged in no higher than a 1.50 MBS.
Meanwhile, a 2.25% can still find its way into a 2.00 MBS.
This is why a 2.25% and a 2.00% can be dramatically different in price, despite being so close in rate.
This phenomenon is also why I use the term FLOOR RATE when discussing rate options with clients.
There isn’t really a floor, per se.
It is more like a wall that needs to be climbed in order to reach the next batch of lower rates.
At the moment the wall for government loans is 2.25% (2.00 MBS) and 3.25% for conventional loans (3.0 MBS).
Until these walls have been conquered, the lower mortgage rates on the other side will require paying excessive fees.
Therefore, they are not worth pursuing … yet.
DO NOT CHASE RATE
In time, the lower MBS coupons, such as the 1.50, may get bid up.
Eventually the increased demand becomes so great that investors need to pay a premium in order to get access to the mortgage-backed security and the cash flow it provides.
For example, if demand continues to increase for the 1.50 coupon investors will need to PAY A PREMIUM to receive that interest.
This is how mortgage rates in the range of 1.75% – 2.125% will become less expensive for YOU.
Mortgage rates, in theory, are not getting lower, instead the price you pay for a lower rate is merely getting cheaper.
Technically you might find an investor for any rate you want, but without the existence of real demand (liquidity) the premium to receive that magical rate becomes your expense.
When you “PAY POINTS” you are incentivizing the mortgage market to take less interest than they want by offsetting the reduced cash flow from a lower interest payment with an upfront lump sum.
However, when you pay fees for a lower rate it is not until you recuperate those costs that you actually save a single dollar.
This goes back to my LAW OF RECUPERATION article I shared with you earlier.
If you spend $6,000 to get a 1.75% vs. a 2.25% at “no cost” the extra savings you get from that 0.50% is going to be approximately $150.
However, you spent $6,000 to get that extra $150 each month, so it will take 40 months, more than 3-years, before you fully recuperate the expense. Until then the lower rate has only cost you money.
Unfortunately, no matter how many times I explain this, some people still behave like junkies when it comes to chasing rate.
They just can’t help themselves when they receive marketing that promises a fancy low rate, despite the glaringly different APR (which means closing costs).
By being patient my clients are able to avoid these traps and eventually get the “new” low rates for FREE, instead of foolishly paying for it in haste.
REFINANCE FATIGUE
Occasionally someone might fuss about refinancing multiple times.
This is purely about putting in effort, and has nothing to do with the loan strategy.
The borrower is experiencing what I call “Refinance Fatigue“.
Even though they respect and trust the path on which I am guiding them, they just don’t feel like coming along for the ride anymore (or so they think).
I sometimes here things like:
“I want this to be my last refinance, so I’m willing to pay for the lower rate.”
Even if someone was stubborn enough to go against everything I’ve detailed in this email, the lowest they could get is a 1.75% (on a government loan).
However the fees would mean years of recuperation, meanwhile the probabilities are quite high that mortgage rates continue lower into the 0.75% – 1.25% range.
I joked with one client recently who was experiencing refinance fatigue:
“Unless you are allergic to money this won’t be your last refinance, regardless of whether you follow my advice and do a no cost loan or pay for the lowest rate available today.”
Let’s be honest though, the process is pretty painless.
We request the same documents every time, some of which we reuse from the previous refinance.
You can do almost everything digitally, and we even pay to send a notary to your home when it comes time to close.
I’m sure when you had a 4.25% rate a decade ago you felt like rates would never go lower.
You probably felt the same about the 3.25% rate you received not long after.
Yet, somehow today you have managed to convince yourself that 1.75% is the lowest it will ever go, this is of course without any analytic or data driven evidence.
What will you tell yourself when rates are below 1%??
That most surely will be the lowest it will ever go, right?
Well, I have something to tell you and your refinance fatigue…
IN CLOSING
The EXCLUSIVE BENEFIT you receive from working with me and “trusting the process” is that I help you outsmart the market.
I have mingled with a lot of smart finance people and I have been swimming with the big fish in the mortgage pond for a long time.
Nobody is giving their clients this type of edge.
DO NOT FORGET …
Mortgages are vanilla.
Every lender has access to the same rates at the same price, it is a game of margins.
Servicers are only in it for a small cut and do not care if you overpay for a rate that will be “no cost” in the near future.
Brokers are just another hand in the pie.
So, the next time you get a fancy pitch in the mail or a loan servicer tries to offer you a refinance, ignore it and remember…
You are in good hands WITH ME.
That’s all for now.
I hope you found this email informative and entertaining.
Until next time…
This was an email that was originally delivered to my subscribers July, 2021.
If you want to get access to this type of market insight before it makes it to the blog then you need to be on my list.
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