If you have been following the mortgage industry or real estate news for just five minutes, you have most surely heard about sub-prime mortgage lending and how it is caving in on itself faster than a imploding star in a far away universe on the Discovery Channel. While I don’t want to rehash all that has been going on, in the past six months several major lenders have gone out of business entirely, almost every remaining lender has tightened guidelines and eliminated the riskiest of their loan programs and foreclosures have been increasing. The sub-prime account executives (salesmen who sell mortgage products to brokers and lenders) who come through my office are sweating bullets and many have changed jobs several times in the past year.
Sub-prime mortgages are a subset of the mortgage business that focuses on extending credit to borrowers with bruised credit or who cannot meet standard guidelines. Sub-prime borrowers are risky. How risky? How about it used to be possible for someone with a 580 FICO score to get 100% financing with thousands of dollars of open collections and they were barely two days out of bankruptcy. Oh yeah, we also didn’t have to verify income either.
When I first jumped into the blogosphere a year or so ago, one of the very first post I wrote was about the perfect storm brewing in the sub-prime mortgage market. Unfortunately, since upgrading my site, I do not have it any longer. However, I thought now was a good time to revisit this topic. First, sub-prime lending has it’s place and it has made homeownership possible for a huge number of people who otherwise would have never been given a chance. I don’t want this post to be misconstrued as yet another sub-prime mortgages are evil rant.
A perfect storm occurs when all of the right conditions are present to make life miserable. There have been several developments that have been occurring that are causing this implosion which I am sure will be borne out in the foreclosure statistics as this unwinds.
Rising Interest Rates: Sub-prime mortgages can be characterized by the 2/28 or 3/27 mortgage product. This is industry lingo for an adjustable rate mortgage that is fixed for two or three years. Sub-prime mortgages are almost always ARMs. What makes them unlike ARMs for prime borrowers it that the margins on these loans are five and six percent if not more. The margins on ARMs for borrowers with good credit are usually just 2.25%. This means many of these borrowers are going to see the rates on their mortgages almost double overnight. Keep in mind, these borrowers were marginal to begin with so significant increases in mortgage payments are definitely going to cause them problems. This also results in these borrowers making late mortgage payments which is the death knell for the opportunity to get out of the sub-prime loan into a conventional mortgage prime mortgage. So because of the rising rates they make a late payment which disqualifies them from being able to refinance into a lower rate mortgage product. It gets worse.
Elimination of Programs: Since many of these loans have not been performing Wall Street does not have an appetite for these loans anymore, every lender is eliminating loan programs and tightening underwriting guidelines. I must get a flyer announcing changes in guidelines every week. What is happening is that where a borrower could have qualified for a mortgage last year, they now cannot. So not only is this person’s payment going up 50% or doubling, they no longer can refinance into a better loan product because a better loan product does not exist. But wait, there’s more!
Stagnation of Home Values: The nail in the coffin has been the overall housing market. The one savior for most borrowers has always been increasing equity in their homes. If you have enough equity, there is a mortgage lender that will be willing to take the risk. However, a lot of borrowers who bought with 100% financing or kept refinancing to take out equity now find themselves either upside down or with very little equity. So not only can they now not make the payment or refinance, they also are having a hard time selling their homes and may even owe more than the home is worth. Checkmate. Just another foreclosure statistic.
So there you have it. The perfect storm.
THE TRUTH! Lets start at the
beginning … When a consumer wants to purchase a home, they see a realtor before the get pre
approved . The realtor sends them to a broker. The Realtor having this power makes the broker perform in order to continue to give him business. The broker does everything in his power to get the deal to the closing table in
order to get repeat
referrals from realtor. The client gets a tour of homes that the realtor chooses for the client.
Client falls with a home he/she cant afford before getting a real approval from a lender. This creates a bad business transaction. The broker should be the first to see the client. The broker should be
referring clients to Realtors.
That’s just the
beginning …
Next: broker ethics… Most mortgage Brokers do not care about performance of a loan. They just want to close the deal according to the
guidelines the end lender has prepared for
their portfolio. The bad brokers tell clients, “you make 5000 a month, your payment is 2000 a month your ok… BS!! There are Taxes, Insurance, Car payments, Car Insurance, Utility Bills, landscaping, furniture,
ect …
CREDIT: Credit cards a raping people from their disposable income. Most people refinance and strip
their equity because
they have been approved for credit card with limits to high and interest rates that will take them a lifetime to pay. is it not a coincidence that a lot of Credit Card companies own or are a division of the lending institutions….
Lenders: The
analyze the risk, create the programs,
bombarded
mortgage brokers with their criteria and push to get business.. You going bankrupt… you made the rules, you created the programs, and now that the public needs you the most your pulling out… you made your money and now your gone… Big deal….
Government: The fed had rates at an all time low for to long, the
market
took a historic low rate and made it into a common rate/ A
historic low rate became the cap and
threshold , leaving no room for improvement. Then the reserve raised the rates (after
recommending
adjustable rates to public) and now the rates expire and people have to adjust to a
higher rate because the reserve raised the rate. there is nowhere to refinance into.
Consumer: I make a great living. yet my home cost me 280K in a Chicago suburb. I know so many friends and clients that make far less than I do. But they live in
500K and up homes. Look at how many luxury cars are on the road. When I was growing up, a
bmw meant someone had money, now everyone is driving a luxury vehicle. By the way it takes 10 minute to get approves for a car loan for 80K with good or bad credit. they do not verify income, or ask you to bring in paystubs…. Again these leasing and auto credit companies are the same as some of the lenders in the banking division.
This needed to happen! I am a broker, I do good business, and I care about my clients and
their futures. I know this will make the next year of my life more
challenging . BUT!! It will be survival of the fittest , and the ethical brokers and lenders will survive and do well as long as the market does not tank to deep.
America is over-extending itself on credit. The credit companies and the government are handcuffing us! We need to be smarter and become more educated on what we actually need to survive and live with comfort. These lifestyle we lead make us FAT,
Abandoned Parenting, Workaholics, alcoholics and self indulgent human beings. We need a leader to address this…. We need to change our ways or we will be a third world country very soon.
Very Sincerely
Alexander
[...] The article interviews the Montes family who purchased a $567,000 home in a suburb in California (surprise, surprise) with 100% financing. They are in danger of heading into foreclosure because the interest rate is set to adjust in a few months and they will not be able to afford the new payment. Additionally, their home has decreased in value and is now only worth about $535k so there is no way to refinance into a better loan. They are trapped. Recall I wrote about this was going to happen to people back in March. [...]
[...] A Perfect Storm – The Sub-prime Lending Implosion [...]
I recently came across your weblog and have been reading along. I thought I would leave my very first comment. I don¡¯t know what to say except that I have enjoyed reading. Nice blog. I’ll keep visiting this weblog really often.