With the cost of borrowing at historic lows, buying a home makes more sense than renting for many first-time buyers. As such, more than half of all first-time buyers purchased a home because they were tired of renting.
For repeat buyers, 25% said their primary reason for buying was a desire for a larger home, an increase from 21% last year. CA Association of Realtors®
TOP STORY: A Farewell to ARMS (Indexes)
So long LIBOR. Goodbye COFI. We don’t really hate to see you go because many of us didn’t know you were ever here… unless we actually read the small print in our loan documents.
Both acronyms-identify indexes used, or maybe once used, for substantial numbers of adjustable rate mortgages and other loan products. LIBOR stands for the London Inter-Bank Offered Rate or, in people speak, the interest rate at which a sample of banks on the London money-market are willing to lend money to each other. COFI is the Cost of Funds Index. This is a monthly weighted average of the interest rates paid on checking and savings accounts offered by financial institutions operating in the 11th District of the Federal Home Loan Banking System (FHLBanks) which covers Arizona, California, and Nevada.
Scandal and Corruption Uncovered in 2012
The LIBOR is scheduled to disappear because of a juicy scandal uncovered in 2012. In addition to determining the interest rate on mortgages and corporate loans, LIBOR, once dubbed the world’s most important number, is also used in derivative (a type of investment instrument) pricing. Bankers at many major institutions, including some in the U.S. colluded to report artificially high or low interest rates. They were thus able to manipulate the index and profit on specific derivative trades. The fraud had apparently been going on for as long as nine years. Obviously, some trust was lost, lawsuits were filed, and a few people trying for several years to repair the damage, LIBOR’s British regulator announced in 2017 it would not support the LIBOR indices (there are seven different maturities) beyond 2021.
COFI is going away for a much less interesting reason. When the index was developed in 1981 there were more than 200 savings institutions reporting interest rates for index calculations. Casualties from the savings and loan crisis and the Great Recession have left only nine banks that qualify to do so, hardly a representative number.
Can’t Just Flip a Switch
Killing off an index is not a simple matter. There are active mortgages with years left on their terms that use either the LIBOR or the COFI, not to mention a lot of other types of loans. LIBOR is embedded as a benchmark in an estimated $340 trillion worth of financial products $1.2 trillion in US adjustable – rate mortgages. It is the index for 95% of Home Equity Conversion Mortgages (HECMs), better known as reverse mortgages. It is also the most widely used index for adjustable rate student loans. The COFI is not used as widely for mortgages as it once was. In the 1990s it was the index for 40% of all ARMs in the nation and for 70% of those in the 11th District.
Even though the GSEs Fannie Mae and Freddie Mac have not accepted new COFI loans for some time, the index is still important enough that the San Francisco FHL Bank postponed its farewell date from December 2019 to the end of this year and recently extended it again to the end of 2022. However, unless you have a really old ARM, it is unlikely you need to worry about the 11th District COFI’s demise.
Winding down LIBOR is a different matter and has been an even slower process. It is even possible it may endure on the world stage beyond 2021. In the U.S., however, the Federal Reserve acted fairly quickly after the British regulator pulled the plug, setting up the Alternative Reference Rates Committee (ARRC), a group of major financial institutions, to formulate rules for an alternative index. Not all indices are created equal. One reason the COFI used to be popular was that it was not volatile, so there did not tend to be a lot of rate reset shock, while other indices may change on a daily basis. Selecting an alternative needed to be a thoughtful process and the committee ultimately decided to avoid one of several other existing products.
And the Winner is…
They chose instead a brand-new product, the Secured Overnight Financing Rate (SOFR), an index based on the cost of borrowing cash overnight using Treasury securities as collateral. Because it reflects collateralized lending, the SOFR’s rates tend to be a little lower than LIBOR’s. In the two and a half years from April 2018 to November 2020, it has averaged 10 basis points below the 1-month LIBOR and 46 basis points below the 12-month LIBOR. You can find the current SOFR rate on the New York Federal Reserve Bank’s website.
SOFR has been up and running for several years and more and more lenders are adopting it. The GSE’s Freddie Mac and Fannie Mae have recently announced they will stop acquiring LIBOR indexed loans at varying points this year and are accepting new ARMs pegged to the SOFR almost immediately.
Whether borrower or lender, the process of getting a new ARM or writing one will be of little concern. Someone will redo the loan documents with the appropriate changes, and life and lending will go on. Existing loans are a bit more problematic.
Prepping for the Change
Jacqueline Doty, an attorney with the law firm of Ballard and Spahr, warns that lenders and/or servicers cannot wander blindly into the LIBOR sunset.
BUILDING THE WAY TO
Many of the same techniques that make buildings energy efficient might also serve to limit the spread of viruses. Designing a building envelope with Passive House standards for ventilation, airtightness, fenestration, climate-specific insulation, and the elimination of thermal bridges then makes design choices about mechanical systems and renewables cheaper and easier.
One study found that appropriate ventilation (introducing outside air) could control droplet- and aerosol- transmitted influenza equivalent to vaccination coverage of 50-60%. High rated HEPA filters can remove dust, vapors, bacteria, fungi and effectively capture viral particles that may transmit infection. Proper levels of humidity stifle virus growth. Beth Eckenrode, AUROS Group
A portfolio of those loans probably contains a wide variety of terms and provisions. Do the loan documents envision that the index might go away? Do they make any provision for an alternative? Is the lender allowed to change the margin? If not, what is the bottom line vis-a-vis the borrower’s rate?
She adds, there’s a good possibility that many loans will need to be modified because the fallback provisions are either nonexistent, unclear, or impractical. Because LIBOR’s rates tend to be a little higher (as noted in the discussion of SOFR), they generally have lower margins than other indices. If the loan documents don’t allow for the margins to be adjusted for an alternative index, this could skew the reset rate.
If you have an ARM you can easily check on whether yours will be affected by the switch. This information is on page 4 of the Closing Disclosure you received when you bought your house or refinanced it. The Adjustable Interest Rate (AIR) Table is at the bottom of the page (you might have to search elsewhere in the documents for an older loan) and will list an index, perhaps the “LIBOR12M,” which is the 1-year LIBOR. Alternatively, it might be MTA, (the Monthly Treasury Average), CMT (Constant Maturity Treasury) or one of several other indices that will continue to be used. The AIR table will also tell you your margin (typically 2.25% to 2.75%) which will be added to the index to obtain the new interest rate.
Before your next reset date, you might want to check both the current SOFR and the appropriate LIBOR rate (it will continue to be published for some time) and apply the margin to each to determine their relationship. It is likely your servicer will be in touch with you before the reset, and it will be helpful to have this information so you can discuss what is appropriate.
If you have questions or need further explanation, please give us a call.
The coronavirus without a doubt led home buyers to reassess their housing situations and even reconsider home sizes and destinations.
Buyers sought housing with more rooms, more square footage and more yard space, as they may have desired a home office or home gym. They also shopped for larger homes because extra space would allow households to better accommodate older adult relatives or young adults that are now living within the residence. Jessica Lautz, vice president of demographics and behavioral insights at NAR.
The “new normal’ lifestyle changes are expected to alter where and how we live and work and, in turn, the design and location of our houses.
There is wide agreement that people are going to seek more personal isolation and that this may result in an exodus from cities. Eric Rosengren, president of the Federal Reserve Bank of Boston, sees this being driven in several ways. Companies that don’t want to cram employees into headquarter offices are already considering smaller, satellite offices in the suburbs. Others have decided to make remote work permanent now that they have seen it doesn’t hurt productivity. Workers, with no need to commute into the cities, may decide to abandon urban high rises in favor of suburban houses where they can practice social distancing.
Even without the impetus of a changing work environment, people may already be seeking less densely populated areas. Realtors on the outskirts of Philadelphia noted a sudden influx of house hunters from New York City when the virus was raging there.
If the single-family house is going to grow in popularity, how will it change?
Architect Sergey Makhno bases his ideas about how the virus will change home design on the premise that the primary function of a house has always been safety—-from bad weather, predatory animals, real or perceived enemies.
“Today, people need a house that can effectively provide social isolation” as well as safety from viruses and infection.
He too believes this means people will choose a house wherever possible and that the pandemic will bring an end to the open floor plan. That thought was shared by some of the eight “thought leaders” from architecture, home building, smart home technology, and the health fields recently assembled by Forbes magazine to discuss ways the post-pandemic home will be built or remodeled and how it might function in the year to come.
NOT TIGHT, JUST RIGHT
When times get tough, lenders usually tighten up credit standards, but former Freddie Mac CEO Don Layton says the current lending environment is nothing like 2008. Unlike then, the pandemic hit at a time when the economy was strong and home prices were rising. The FHA was created specifically to lend in stressed markets, and so far, the GSEs are operating as normal. Only PMI and some private lenders seem to be tightening up and Layton sees mostly marginal loans being affected. Joint Center for Housing Studies
The open plan will be ended, according to the Forbes group, by a need for more isolated spaces in the home. One of these will definitely be a home office, something recent homebuyer surveys already see as a growing demand. The need for video conferences will require rooms specifically optimized for quiet work sessions, something Forbes says cannot be accomplished at the dining table or in the den.
Rather than the home opening itself to the outdoors, Makhno thinks the entryway will be one of those isolated spaces where family members and visitors will leave shoes, coats, and belongings rather than bringing them, and their dirt and germs into the house. A similar concept was advanced by one of the “thought leaders”; a package drop-off that is accessible by delivery people, but safe from thieves.
And Housing After Covid-19…?
The post-pandemic home will be geared to self-sufficiency. As much as possible people will want backup sources of heat, power, even food. Geothermal wells, wood stoves, solar panels, and gardens—even indoor ones— will gain popularity. There will be germ resistant surfaces, smart filtration systems for air and water, and UV cleaning equipment.
Two other suggestions for the future seem like throwbacks to the past. The need for social connections may make a front porch again the place to safely meet neighbors, maybe even entertain. And remember Moya Mason and her theory about early 20th Century homes switching from places of production to homes for consumers? Well those unnecessary storage areas abandoned back then may return as Americans become, perhaps not consumers, but bulk buyers again.