The Wall Street Journal ran a front page story a few days ago about a family in California who is at risk of foreclosure. I feel really bad for the family. Foreclosure isn’t something I would wish on anyone. However, I am sick of the sob stories and I am sick the mortgage brokerage industry being blamed for people’s bad financial decisions, but at the same time I also am sick of the handful of commission hungry loan officers who are willing to do anything for a buck. The WSJ article demonstrated how the lack of accountability from consumers, loan officers, and lenders have gotten us into this mess and that everyone is to blame.
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.
The Devil is in the Details:
What really spurred my question is that later on in the article, the Montes’s mention that their household income is $90,000 per year and that they have hardly any savings. The article also says that their current mortgage payment is $3200 NOT including taxes and insurance which at a minimum are another $500 per month. They also pay about $700 per month for two cars. Last week I explained how banks use back ratios to qualify borrowers. The bottomline is that prior to the rate adjusting the Montes’s have a back ratio of about 59%. This is CONSERVATIVE assuming they have no credit card debt. I would also bet the loan is interest only. Take a look for yourself.
So Who is Really Responsible?
The Montes Family: Why would two seemingly intelligent adults choose to spend nearly all of their income on a home? It doesn’t take a mensa member to figure out if your monthly cash outflow is $4,700 and you only bring home about $5400 per month after taxes in income that you can’t afford the freaking house! At some point, consumers are going to have to man up and admit they just made some dumb choices. The sob stories simply aren’t going to fly. At the same time, when according to a Bankrate.com survey that most consumers don’t even know what type of mortgage they have, it isn’t hard to deduce that many mortgage brokers and loan officers are doing a piss poor job of educating their clients.
The Mortgage Broker or Loan Officer: No client of mine ever gets away without knowing their debt ratios. I make it my duty to explain what it means on every deal. However, we can get into sticky situations by not providing loans that a borrower qualifies for per the lender’s guidelines just because we may personally feel they are over extended. Loan officers do not make the guidelines, nor do we underwrite the loans. Predictably, many politicians have been running their traps about making loan officers have a fiduciary responsibility. However, what does that really mean? Should the Loan Officer in this scenario refuse to do the loan even if they qualify under the lenders’ guidelines?
The Banks: One really has to ask why a mortgage bank would approve a mortgage where the borrowers are basically living check to check and have 50 cents and pocket lint to their name. It doesn’t take a complex risk model to know that the Montes’s loan was a foreclosure waiting to happen. At the end of the day, it was greed and borrower be damned. Why else would you have a two year adjustable rate with a three year prepayment penalty? The margins on these mortgages were 6% or higher after the adjustment. If they can’t really afford it now, what made the bank think they could afford in after the rate adjusts?
I can admit that I am not an expert on secondary mortgage markets. For the life of me I can’t figure out why the existing mortgage holder will not just do a one time variance of these notes to a fixed rate to prevent a future foreclosure. For instance, the Montes’s might be at 7% right now. Just fix the rate at 7% and be done with it. The article says that the home has depreciated preventing a refinance, but the value should be irrelevant to the current mortgage holder if they are keeping the loan. Why would they care about the value if the Montes’s are still making their mortgage payments? Values are constantly changing and only becomes an issue when someone has to sell. It just seems to me that the loss on just converting to a manageable fix rate that insures you have payments into the future would be a lot less than forcing a buyer into foreclosure. The PR damage from this industry fiasco alone doesn’t seem worth holding firm on loan terms either only to have a bunch of crying borrowers on the front page of the Wall Street Journal claiming they didn’t know they couldn’t afford the house and the big bad bank won’t help them out.
So who really is responsible in all this mess? Should the Loan Officer who originated the mortgage take responsibility? Or maybe the Montes’s made their own bed, so they should lay in it? Did a lender really expect the Montes’s to pay back this loan?
Ultimately, it is the Montes’s fault, but the loan officer should have known better and the bank got what they paid for.
What’s even more sad is that that deal could very well have been Stated income. Stated 100% financing (especially for latino families) transactions, sometimes with little more than 3 “reference letters” from alleged customers of these self-employed landscapers and housekeepers were a regular bread and butter transaction for many subprime AE’s for the better part of 2004-2005. In fact, before 2005 you could usually get that same transaction as an I/O 2/28!! Its for this reason that Santa Ana, CA (a largely latino immigrant community here in So Cal) is one of the most hard-hit census tracts with respect to the rising foreclosure numbers.
This harkens back to one of your observations you made in your post on the NAACP lawsuit. Most of these horrible (and probably fraudulent) transactions were submitted by latino Loan Officers who specialized in representing the needs of the hispanic community.
Even though the secondary market soured on those kinds of transactions well before the real industry troubles began with the rising First Pay Defaults, those loans from 2004 and 2005 are now coming home to roost.
I don’t know if I would blame the borrower so much, since a lemming mentality can be expected as a basic part of human nature and I think the point you make about borrowers not being clear on the loan they got is more intrinsic to the typical loan transaction than anyone would care to admit. But borrower culpability aside, if the people who are supposed to be “agents” of their clients, and the people who are supposed to be industry “experts” universally participate or sit silently while thousands of borrowers are led like lambs to the slaughter, then even the most ridiculously naive borrower perhaps can make the legitimate point that no one raised a voice that there was anything wrong when so many were getting so many “too good to be true” loans.
For better or for worse (mostly for better), borrowers are now being forced to deal with reality, just as the mortgage industry is being forced to do. Perhaps now, loan originators who are about making their client a more informed borrower and more adept steward of personal finances, maybe these true professionals will finally be vindicated as borrowers start shopping trustworthy representation ahead of rate, cost and payment.
That’s the hope that I am banking my business efforts on, anyway.
[…] The Wall Street Journal ran a front page story a few days ago about a family in California who is at risk of foreclosure. The article interviews the Montes family who purchased a $567,000 home in a suburb in California (surprise, surprise) with 100% financing. What really spurred my question is that later on in the article, the Montes’s mention that their household income is $90,000 per year and that they have hardly any savings. I can admit that I am not an expert on secondary mortgage markets. Ultimately, it is the Montes’s fault, but the loan officer should have known better and the bank got what they paid for. You can leave a response , or trackback from your own site. read more […]
Enjoy the blog. I have been in commercial banking for 15 years and I remember meeting after meeting where the head of the banks mortgage division would stand up and try to get us all excited about the opportunities they were taking advantage of and what great loan volume they had…and those of us who were financial driven relationship managers thinking he was nuts! The loans just didn’t make sense from any traditional banking perspective. For some families it was the American dream come true…but obviously not for many more. I always asked myself even though I could do a loan if it made sense to the client? Was I doing them any favor putting their company or them into further debt. Obviously thousands of individuals didn’t ask themselves that question.
A lot of bankers would look at these as safe loans since there was collateral…not considering the risk if prices fall, demand decreases and defaults increase.
Tyrone:
Good observation about the lawsuit. I generally don’t place all of the blame at the borrower’s feet since many depend on us to be experts in the area. However, consumers do need to take more responsibility in regards to their finances. Banks also have to man up and admit they were blinded by the yields on these loans.