Hello everybody, it's Sam from Financial Samurai, and in this episode I want to talk about the real estate market and the mortgage industry. The bottom line is that the real estate market is hot, and the mortgage industry is doing very well. Refinancing is through the roof. Purchases, purchases look very strong.

If you look at the May mortgage purchase applications index, it closed at close to 11-year high. 11-year high, because there's a lot of pent up demand after sheltering in place for so long. And I think this is interesting data, because this is what we've been talking about somewhere around the end of March and in April, looking for deals, trying to look for real estate deals because the stock market bottomed out at the end of March and started to recover.

So I was thinking to myself, well, let's go look for real estate deals from sellers who are thinking the end is near. And frankly right now, even in June, end of June, things are looking still very, very dicey. But real estate tends to outperform when the stock market is down about 10-15%, because money flows into a more stable asset class such as real estate, and mortgage rates start declining.

And right now we're basically at all time lows, with a 10-year bond yield at about .7%. The 15-year fixed rate is very low. The average rate is around 2.5%. If you want to refinance to a mortgage or get a new mortgage, a 15-year is not a bad idea. It's probably a great idea.

Personally, I'm biased towards the 7-1 and the 10-1 arm, because the average ownership duration is about nine years in America. So it makes no sense to get a 30-year fixed and pay a higher rate if you're going to pay it off or sell it or own the home for nine years.

So this demand, this surge in demand for real estate is very interesting. It's because mortgage rates have hit all time lows. There's pent up demand, three to four months of demand for real estate, because not a lot of transactions happened at the end of March, April, May, and in June so far.

Transactions are way down. So that's not great for the real estate brokerage industry, because they make their money on commissions. However, from a buyer's point of view, I think there's an opportunity. There's always an opportunity if you look hard enough. And when there is a lot of fear and panic, there's opportunity if you have the cash and you can get pre-qualified.

So the demand for real estate goes up also because there's a realization that having a home is more valuable, because more time is spent at home. I realized this in 2012 when I left my day job. So instead of being away from the home for 12 to 14 hours a day, I was suddenly stuck at home, well not stuck at home, just spending more time at home reading, writing, relaxing.

So I was much more willing to spend money on remodeling, building out a deck, getting a hot tub. I knew I would enjoy these things much more because I was simply home much longer. And I think the world is recognizing this truth that the more you spend time at home, the more valuable it gets.

And there's also this desire to have a nicer home, because we are spending more time at home. So in the past, maybe you were okay with renting a one bedroom apartment in a not so nice area, a noisy area, because it was temporary. And you were out for 14 hours a day, so all that noise and the smells and the crime didn't really bother you.

But now that you're at home, hey, let's make it nicer. Let's paint the walls. Let's get that hot tub. Let's get that $1,000 Toto washlet bidet, which heats the seat and shoots warm water at you. I mean, that's wonderful if you're going to be going to the bathroom five more times, 10 more times a day, right?

So it's just really logical that the demand for real estate has increased. But before you buy a home, I think it's very, very important to understand what's going on in the mortgage industry, because the mortgage industry is very tight in terms of its lending standards right now. And the reason why it's very tight is because it has liquidity and profitability concerns.

There's forbearance programs right now where people don't have to pay their mortgages, people aren't paying their rents, so landlords have a difficult time paying their mortgage as well. And so banks are being very cautious. They went through 2008 and 2009. A lot was learned. And the lending standard dramatically increased post 2009, which is why I'm quite sanguine this time around that the housing market isn't going to implode, because a lot of people have a lot more equity piled up in their home, especially after a strong run since about 2012.

But the mortgage industry is the key to keeping the housing market strong and upwards if you are bullish. Because without that capital, the housing market is going to be really suspect, because there are so many people unemployed. So the mortgage industry, the lending industry is really important. And I talked to my lending officer for about an hour the other day, and I wanted to just share some key points with all of you.

So the first thing, like I said, was that there are liquidity or profitability concerns amongst all the banks. They're wondering, OK, what can we do to protect profitability, improve shareholder value, and make sure everybody keeps their jobs in this uncertain time? Because they don't know when the economy is going to come back.

They don't know when forbearance rules are going to be fixed or changed. There's just a lot of uncertainty. So the banks are doing the best they can for themselves and for their shareholders. And at the same time, they're trying to be competitive, because inevitably, there will be a recovery.

And consumers don't want to hear news headlines saying, this bank denied me of this mortgage because X, Y, and Z, especially in this environment. Because when there's a recovery, you could see banks who are uncompetitive during bad times or unfeeling or uncaring will probably lose out on many, many customers to competing banks.

So profitability, liquidity concerns, and social concerns, top of mind. And so if you are a borrower, you're just going to have to find that lender who's going to be a little bit more aggressive during this uncertain time for that best loan. The second point is obviously stricter lending standards.

Due to liquidity and profitability concerns, banks have significantly tightened lending standards. And here are some interesting points that you should know. One, cash out refinances, that's going away. At least this bank is not allowing cash out refinances anymore. Two, banks are no longer fully counting RSUs. Those are restricted stock unit values when calculating how much a person can borrow.

So if those RSUs are not counted, then the person cannot borrow as much. If you work at a tech company, for example, and you have $500,000 in RSUs that suddenly are not counted, well, you're definitely not going to be able to borrow as much. Three, this is the most interesting thing that I got out of talking to my mortgage lender.

He said that his bank is no longer including Schedule E income. That's all the rental income you earn if you're a landlord. So they're not including Schedule E income when calculating how much a person can borrow. That is a big shocker, and I don't think I've ever heard of that before.

Because hey, look, if you're gaining $40,000 a year from your rental property, that's $40,000 a year. Why would you discount that completely? Underwriters have traditionally discounted rental income by about 30%. I know through all my previous refinances, they would only assign a 70% value to any rental income I had.

So $70,000 instead of, let's say, $100,000, because they wanted it to be conservative. They wanted to account for vacancies and maintenance expenses and so forth. And I understand that 70%, that's about right. I guess I would probably do the same if I was a lender. But to discount 100% of all rental income, that is pretty extreme.

So you can take this both ways, in a positive or negative way. The positive is that there's so much demand for property right now with mortgage rates so low that despite not including Schedule E income, rental income, mortgages are still going through. So when banks finally do allow for Schedule E income, which my mortgage loan officer said is coming over the next one or two months, it's kind of like rolling lockdowns, phase one, phase two, phase three.

Slowly getting released, it's getting a little bit better and looser. That could very well unleash a lot more capital into the system. On the negative side, I would just say that lenders are perhaps exacerbating the situation. Unemployment, tough to get credit and all that. And so there's going to be a bifurcation of who will get mortgages and who will not.

And then over the coming years, I think if things recover right, there's going to be a widening of the wealth gap spread once again. All right, let's continue on other tightening lending standards. This bank, it's a top five bank in the country. Everybody's heard of it. It's no longer approving home equity lines of credit.

They have raised the minimum down payment to 20% and they've raised the minimum credit score to qualify for a mortgage to 680. And for the jumbo loans, I think they raised it to 740 and above. So anything above 720, 740 is considered excellent credit. So the bank is only lending to people with large down payments and excellent credit.

So again, this, if it continues, it could be good in terms of the people getting the loans, the capital are going to have a lower chance of defaulting. Right now, the default rate, well, as of October 2019, the research that I saw was about 1.9%. I think the default rate might be higher now, but I'm not so sure because the government has implemented, you know, you can't default because there's forbearance rules and you can't go bankrupt because of COVID-19 and all that stuff.

So everything is kind of suspended in air with a lot of uncertainty. So the bottom line is lending standards are strict and everybody is feeling the crunch, including the banks, and they don't know exactly what the future holds. In terms of jumbo loans, jumbo loans are loans that are above the conforming loan limit.

So nationwide, the conforming loan limit, according to the Federal Housing Finance Agency, is $510,400. However, in different states and cities, the conforming loan limit is different because housing prices cost more. So in San Francisco, for example, the conforming loan limit is $765,600 for single family home or condo. And it's different all throughout, but that is one of the top conforming loan limits in the country.

So it is much easier to get a conforming loan than a jumbo loan. Conforming loans can be sold off to government-backed Fannie Mae and Freddie Mac. So what happens is the bank gets the loan, they underwrite it, it's good to go, they sell it to Freddie Mac and Fannie Mae and offload that risk off their books so they can do more loans.

However, there's something really interesting that I heard from my mortgage loan officer and he said that there's new regulation that states if you sell a mortgage to Fannie Mae and if the borrower of that mortgage was late on even a single payment or is in forbearance, his bank would be required to not only buy back the entire mortgage but also pay an 11 point penalty.

An 11 point penalty is 11%, folks. So an 11 point penalty is equivalent to $77,000 penalty on a $700,000 loan. And I have never heard of that before. And whoa, no wonder if this is true, which it has to be true because he told me it's true that banks are being much, much more stringent.

And to clarify, these are for new loans. These aren't the past loans. These are new originated loans that they sell to Fannie or Freddie. This rule isn't enforced. So you can see from a lender's perspective how they are much, much more stringent because paying that 11% penalty is massive compared to the spread that they earn on these loans because the interest rates are so low.

11%, wow. Jumbo loans cannot be sold to Fannie Mae or Freddie Mac. They can be sold and bundled to the private mortgage market, secondary market. However, my lender was saying due to more regulations, his bank is keeping most of the jumbo loans on its book. Therefore, they've got to be very, very stringent on their lending standards.

Another interesting thing I learned from my lender is that small business owners are getting more scrutinized and they seem to be getting more penalized than normal W-2 earners. In other words, the PPP loan, the Paycheck Protection Program loan, could be a red flag. He was saying that when the bank takes a look at a small business owner's books and does the thorough P&L calculation and whatnot, if the bank sees a PPP loan, that could be a red flag regarding the viability of the business.

I think this is an interesting stance because you can also make the argument that a small business has a greater chance of surviving because it has received a PPP loan. If the loan is forgivable, which the government says it is, why wouldn't more money be more beneficial to the business?

But banks, again, really conservative right now, are just looking at everything and wondering, "Hmm, maybe we shouldn't lend to a small business owner because it may never recover. He may never recover." Whereas, in contrast, there continues to be only a routine concern about the W-2 employee loan applicant potentially losing his or her job.

But that is probably elevated too because there are tens of millions of people unemployed right now. And if you are a small business owner or if you're thinking about creating a small business, it is important. It's important for you to make your business unshutdownable. The government has forced shutdowns for three to four months of millions of small businesses because of the lockdowns.

So in other words, you should really think about a business that's online, that will go and operate regardless of whether there's a pandemic or whether there's a government directive. So long as you're not doing anything shady and wrong online, it can continue to operate and grow. Not only should you have higher operating profit margins, the value of your online business should grow as well because the sustainability and the security of those future earnings and cash flow are stronger and higher.

So there's something interesting to note and something that I'm very appreciative about with Financial Samurai as I try to run it more like a small business now to take care of my family. And that is, gosh, yeah, traffic could be down, revenues down or whatever. But so long as Financial Samurai stays up, it's fine.

And I am, interestingly enough, fielding a lot more inquiries about buying Financial Samurai and I myself am looking for online businesses to buy because valuations are relatively low, especially compared to the S&P 500. And these businesses are very, very defensible. And I'm seeing a lot of online businesses do very well in this time because more dollars are directed for certain types of products like hot tubs, like home gardening and landscaping and so forth.

It's just a really, really interesting time right now. So if you have some capital and you think the stock market is overvalued and maybe you don't want to invest in real estate property, I would look at online real estate. Frankly, I've talked about this in the past. You can check out my archives.

But online real estate to me is, I think it's number one asset class right now. So let's put all this together regarding how a tighter mortgage industry will affect housing. Well, it's logical to conclude that a tighter mortgage industry will negatively affect the housing market. However, as I spoke earlier, there's an overwhelming amount of demand to purchase property due to confluence of all the reasons I stated in my introduction, right, lower mortgage rates, the desire for better property, because you're spending more time, the desire for investing in a more stable asset that you can actually enjoy, and so forth.

I say that the real estate segment that's doing the best is the price point where you can buy with a conforming loan. So what is the conforming loan limit again? $510,400 nationwide up to $765,600 for expensive cities like San Francisco. So assuming an 80% loan to value ratio, which is putting 20% down, there is a strength in the 638,000 to about 960,000 price point.

Obviously, if you put more down, you can still borrow a conforming loan limit. So for example, a person can afford a $2.765 million home using a conforming loan if he or she puts down $2,010,000, right, so a 72.5% down payment with a loan to value ratio of about 28%.

Conforming loans are easier to get than jumbo loans. Therefore, the housing price point that is going to do relatively well is where conforming loans are able to be used to buy this price point. So the higher you go, the harder it is to get a loan, and once you get into the jumbo loan, this is where borrowing gets more difficult.

In other words, if you want to find a real estate deal, and if you can afford it, obviously if you can afford it, then you want to look at that price point where jumbo loans start getting into the equation. And the higher the price point, the more deals will be had.

Because in this environment, extraneous stuff, vacation properties, mansions, whatever it is that you don't really need are probably going to be the weakest, because those are the types of property that will be sold off first, and those are the properties that are not going to be desired by people the most, because you don't need all that extra space, nor do you want to spend as much money during this time of uncertainty.

It's really up to you to find that higher price point in your city where there are more deals to be had. If you're looking for property deals near your city's median home price, let's say plus or minus 25%, maybe plus or minus 30 to 40%, it's tough right now, because a lot of people can afford that price point, which is why it's the median price point of your city.

To find value, you've got to go up the price point, which is going to entail obviously more risk and more expenses and more costs, but if you've got the cash and the income and so forth, you're going to find much better deals. There's one last thing I want to leave you with, and that is this.

If you get pre-approved for a jumbo mortgage in this tight lending environment, you can pat yourself on the back. Congratulations to you, it's not easy. However, you need to immediately turn that feeling of triumph into caution. Caution, caution, caution when it comes to buying anything with debt. Remember, leverage always enhances returns on the way up, but destroys returns on the way down.

Leverage is very dangerous, and right now is a time of uncertainty, so you probably don't want to take too much leverage. Turn your feeling of triumph into caution. Getting pre-approved for a mortgage today is like being a part of a small team of soldiers landing on the beaches of your enemy.

Just think about that a little bit. The beaches are there, you can't see your enemy, but they're there in the hills behind the trees ready for you. Your combat skills and artillery may be top-notch, but your enemy will still wipe you out simply because it outnumbers you 10 to 1.

In order to win the war, which is to have the property market go up, you would rather have 100 times more people on your side with fighter jets and warships as well. Maybe this analogy is getting a little out of hand, but the point is you'd rather have everybody qualified for a mortgage instead of only a small few.

You don't want the small few to represent the whole. Remember during the last downturn, let's say you owned a condo and you were diligent in paying your mortgage and everything was good, but a couple people in your building decided to foreclose or short sale or whatever because of whatever reason they want.

That negatively impacts everybody's valuations and that's really, really tough. You can talk about the guy in your block, single family home, foreclosing and that hurting neighborhood property values as well. It's the small few during a downturn that can really hurt the overall property market. At the same time, it's the small few.

If you can get a win, it's just not strong enough. You need the masses, the majority, the vast majority to do well for the property market to do well. Just because you've locked down an ultra low mortgage rate that's burning a desire in your heart to buy property, you shouldn't do it.

That's like the tail wagging the dog. Instead, you should buy property if you've identified the ideal home, can afford the payments, have run various scenario analysis and plan to live or own the home for years and years to come. The unemployment market is scary and I think the longer that it lasts, there's going to be a bigger and bigger fallout.

Right now, we're hoping for the good graces of the federal government and the federal reserve to save us, to save us from falling into the abyss. There needs to be hopefully another round of PPP loans, for example. There probably needs to be another round of stimulus checks and there needs to be an extension of enhanced unemployment benefits because fighting this virus is taking a long time and I don't know if we're going to be able to completely fight it off by July 31st when the enhanced unemployment benefits of $600 more a week are set to expire.

I'm always trying to throw caution in the wind, especially when it comes to buying property and getting into debt. So just take it for what it is and run the numbers and be cautious. My lender said the demand he is seeing for purchase applications is the strongest he's seen all year.

His business is booming because refinancing continues to be super strong as well. I was able to lock in a 7-1 arm jumbo at 2.125%. 2.125% is ridiculous. It is so cheap. I just want to buy up everything that I can, but you know, I'm trying to be reserved and be measured because buying a home is a very big decision.

So please talk to your lender. Ask him or her what he or she is seeing in the market, what they are doing, when do they expect to return to its pre-pandemic lending standards. I mean, pre-pandemic lending standards were already pretty strict, but now it's super strict, right? No Schedule E, no RSUs, credit scores high, down payments and so forth.

What you have to think about as a home investor and a home buyer is when the standards will be loosened. If it's by the end of the year and we expect the Federal Reserve and the Federal Government to have more stimulus, I think real estate is probably going to continue to do fine.

The desire for real estate, because we're spending more time in our homes, is overwhelming. At this moment, the fear of losing your job and your income, and I think a lot of people are thinking, "Well, I can afford it right now because interest rates are so low, and worst case, if I lose my job or whatever, I can hang out and hold out for one or two years while enjoying a nicer piece of property, and I want to live my life now." And this is something that I've been thinking about a lot that I'll talk about in the next episode or write about in a new post, and that is whether to stack cash and not utilize my hard-earned savings and earnings, or actually spend the money to try to make a better life.

And this is something that I think a lot of people are thinking about, and buying real estate is something where a lot of people think could help improve the quality of their life. And if the real estate market starts going down, and there's going to be more price cuts, which there are at higher price points, and if the lending standards continue to be tight well into 2021 and so forth, then we should expect property prices to fade.

And that's not going to feel good if you buy the property, but at least you'll be able to enjoy your home, which is again what I think most people are thinking about right now. Let's buy a home to live a better life today because tomorrow is not guaranteed. I would say this if you want to buy a property.

One, you should try to get a discount of between 5 to 10% from pre-pandemic levels. So February 2020, for example. This 5 to 10% buffer is necessary, I think, just in case everything drags on for longer. Second, I think you've got to promise yourself that you're going to own the property for at least 5 years, if not 10 years, because of transaction costs and so forth.

Those transaction costs really eat things up. It's probably going to cost 5 or 6% to sell a property. Hopefully not in 10 years as the internet reduces friction in selling costs. But still, let's say it still costs 2 to 3%, you've got to hold on to that property for a while.

Another criteria I urge you guys to follow if you want to buy a property is to not borrow more than 3 times your annual household gross income. So if your annual household gross income is $200,000, try not to borrow more than $600,000, despite rates being so low. Okay, fine.

If you really, really want to push that multiple as 5x, definitely don't borrow more than 5x your annual household income. And it's gone to 5x because mortgage rates are so low right now. In the past when it cost 5%, 6% to get a mortgage, yeah, the 3x multiple is probably more appropriate.

But now I guess you can go to 5x, but I personally am not going more than 3x. It is really interesting time to buy right now because there are no open houses. Open houses, I think that's one of the biggest contributor to bidding war because people see other people like it.

And as soon as you see someone else like it, you start feeling this FOMO, this frenzy. And that's what happens at least here in San Francisco. I remember buying my property in 2000, I put an offer in end of 2004, early 2005, because I saw another couple sitting in the living room during the open house and I was thinking to myself, "No, you can't buy this house.

This is my house. I got to buy it." So I ended up offering about $25,000 more than I wanted to, which in retrospect, fine. It turned out okay because I sold it in 2017 for a good profit. But not having to deal with the emotional buying aspect of it by seeing other people competing for a property you want is actually really powerful.

It's very powerful if you're a buyer right now because you can really get better deals. You can offer more rational pricing. I promise you this, folks, because I have seen private open houses, I've done like four or five over the past two months on properties I really, really like.

And it's just a different feeling. I'm just thinking to myself, "Much more rational. I'm much more calm when I'm thinking about the numbers." And as a result, I'm going to be able to get a better deal. So I think once open houses start becoming commonplace again, let's say everybody has to wear a mask and let's say it's only 10 at a time or five at a time, whatever, that emotional frenzy, folks, I promise you is going to come back.

And I think that could really ignite the housing market again, besides all the pent-up demand, lower interest rates, and so forth. All right. I'm rambling on a long time, but I'm very passionate about this. And I really want you guys to get this right because a lot of us didn't get this right.

And I didn't get this right in 2007 when I bought my vacation property. That was a terrible, terrible investment and idea. You got to get this right. Understand the mortgage market. Do your best to understand the housing market. Be rational. If you have not found the ideal property, move on.

It's okay. You deserve to buy the ideal property. There's always going to be another one coming along. So you just got to be patient. Be wise. All right, everyone. If you enjoyed this episode, I'd love a positive review. I'd love a share. Stay safe. Let me know how your property hunting is going.

And let's all hope for the best.