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There has been a lot of buzz going around about a plan to reduce mortgage rates to 4.5%. While none of us knows what is going to be implemented, I can say that I don’t believe 4.5% interest rates are going to save the housing market because low rates do not address the root cause of the current housing market stagnation.

The housing market isn’t suffering from high interest rates. Rates have been at near historical lows for the past six years. The bottom line is that if you can’t afford to buy with 30 year rates at 6%, you can’t at 4.5% either.

The housing market is suffering the consequences of loose lending and an oversupply of homes. Over the past seven years or so, mortgage products allowed people to afford bigger mortgages due to a combination of low interest rates and less strict guidelines such as lower down payments and even lower credit scores. When money is falling off the trees, borrowers are not as price constrained as they would be in a normal market. This leads to ever increasing home prices.

In addition, developers turned every cornfield they could find into the hottest new development to meet the demand from consumers. Condo developments popped up on every street corner in urban areas. Not only were Joe Plumber consumers buying homes, but also Donald Trump wannabes which further inflated prices.

Eventually, supply begins to exceed demand. As any 10th grader taking economics will tell you, when that happens prices must come down. In the case of the housing market, supply begin to exceed demand and to make matters worse, the liquidity that fueled the demand also begin to dry up. In short, the housing market had the rug ripped out from under it. Banks drove home prices sky high with loose lending and then shut off the spigot abruptly with ever increasingly strict underwriting guidelines.

A 4.5% interest rate won’t help anyone if you still need a 40% down payment and a 800 FICO score to qualify or if there are still way too many houses on the market relative to the number of buyers.

If we want to get the housing market stabilized, we need a moratorium on building new homes so that the existing inventory can be worked through. In addition, the government needs to provide reasonable incentives to make buying an attractive alternative to renting for credit worthy borrowers. For instance, the government should consider providing down payment grants. We also need some incentives to encourage the purchase of foreclosed homes.

I don’t pretend to have all the answers, but I do know artificially lowering interest rates will not stop this train wreck.

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USAToday has a front page article today discussing how the increase in interest rates over the past week are threatening the turn around of the housing market.   I take issue with the article because it oversimplifies some of the issues the market is facing right now and also shows how disconnected people who don’t write mortgages for a living are.

The issues facing the housing market HAVE NOTHING TO DO WITH INTEREST RATES.  Mortgage rates are still near historic lows so lowering them further won’t help anything.  You can get a 30 year fixed rate mortgage in the low to mid sixes this morning.  Sure, it ain’t a 5.5% 30 year fixed, however, if you can’t afford a home at 6.5% with a 30 year, the odds are you can’t afford it at 5.5% either!  While there is certainly a correlation between housing prices and interest rates, this isn’t the primary reason the market is not improving.

The housing market is in shambles due to stricter underwriting guidelines.  In other words, lenders have made it damn near impossible for many qualified borrowers to get mortgages.  I am not talking about restricting credit to deadbeat subprime borrowers flipping houses who can’t verify their income and two days out of a bankruptcy.  I mean people who by most measures should be relatively low credit risks can’t get mortgages due to an over tightening of credit standards.  Banks went from the absurdity of lending to anyone with a pulse to the absurdity of turning away good credit risks.  They have thrown the baby out with the bath water.

Here in Chicago, a large number of home buyers, in particular first timers, are being locked out of the housing market due to changes in private mortgage insurance, FHA restrictions on condos,  a lack of solid non-conforming (jumbo mortgages) products, and a non-existant second mortgage market.  In short, except in a few cases, you pretty much have to have a 10% down payment buy a condo in Chicago.  Not many first time home buyers have that much cash laying around when a starter two bed/two bath condo can run upwards of $400k here.  It doesn’t take a genius to figure out that prices are probably going to stagnate and homes are just going to sit on the market when you effectively eliminate a large portion of the buying audience.

What needs to happen is we need some serious financing alternatives for QUALIFIED and common sense underwriting to help buyers get into mortgages at decent interest rates with reasonable down payments.

There are plenty of people who want to buy and there are plenty of people who are trying to sell.  There are also plenty of people who would love to refinance.  However, the mortgage market has added a lot of friction to the process with the stricter guidelines that in my opinion are causing the problem to get worse.  It is almost like the mortgage industry caught on fire and decides to shoot themselves in the head to stop the pain. 

 

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I am not too pleased about the yet to be defined $700 billion dollar bail out that Henry Paulson is proposing.  First, I believe the banks made their bed so they need to lay in it.  Second, I am not sure this is going to do anything to actually stabilize the housing market.  I believe we need to be focusing on a bottom up approach by helping the Joe Blow on Main Street instead of the Fat Cats gambling with our money on Wall Street.  Here are a couple of things I think they could do with the money that would probably have more of an impact:

Federal Works Programs: What is missing from our economy is a wholesale job creation strategy.  I mean real jobs that pay real wages.  Since it is obvious we need more oil refineries and infrastructure improvements, the government should take the bulk of this money and fund building oil refineries to get the cost of gas down and improving the infrastructure of our highways and public transportation systems.  This creates jobs which are what people really need.  Most foreclosures are because of job losses and medical issues, not predatory lending, exotic mortgage programs and the like.  The government needs to focus on helping deserving homeowners get back on their feet with real job opportunities that benefit the public at large.

Stop-Gap Lending:  The housing market is in the toilet and many homeowners are stuck in their mortgages because lenders have constricted underwriting guidelines to the point of absurdity.  Of course no homes are selling and prices are falling.  No one can get a freaking mortgage to buy a home!  They went from making loans to dead people to only making loans to over qualified applicants leaving the bulk of folks with no decent financing options.  

  • Conversion loans:  Allow homeowners in good standing to convert their loans to a fixed rate mortgage regardless of appraised value of the home. 
  • Silent seconds:  Provide silent seconds that will make up financing gaps if the only reason a home can’t be refinanced is due to appraised value
  • Force subordinations: Make it illegal for second mortgage holders to refuse a subordination if the homeowner is simply trying to do a rate/term refinance and not taking cash out or moving to a more risky loan product.
  • Down Payment Assistance:  Not referring to the dead in two weeks seller funded DPA.  Offer federally back funds that can be used for down payments on any conforming loan to first time home buyers who are in professions that serve the public good – teachers, firefighters, policemen, social workers and all branches of military personnel.

Expedite Foreclosures:  Yes, they need to expedite the foreclosure process.  Target this at the specuvestors with the option ARMs and $3 million in properties they though they could flip in the hot new condo development in Miami.  Get these properties foreclosed on quickly.  Next start the public lashings of those involved in obvious fraud from the Loan Officers, Consumers, Realtors, Attorneys all the way to the Wall Street titans.

Incentives to Buy Foreclosures: Provide some significant and real incentives to buy foreclosed properties.   Maybe have a 10 year property tax holiday for buyers of foreclosed properties.  Provide financing programs that allow home owners to buy foreclosed homes with zero down and get loans to fix up the properties as well.  

Moratorium on New Housing Development:  There needs to be a massive moratorium on any new developments from these crap box subdivisions out in the middle of corn fields to over priced yuppie condo ghettos.  We do not need any more developers until we get inventories back to a manageable level.

National Standards & Licensing:  Not going to go into it here in detail, but the rest of the money should go to creating new standards and oversight at the National Level that trump State qualifications for Realtors and Loan Officers.  Turn the fields into a real profession and not the joke that it is today.  We need to purge about 80% of the people who call themselves Realtors and Loan Officers. 

Most importantly, the law makers need to LISTEN to those of us who do this everyday and the lobbyist and executives…

Rant over.

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One of the things I have not been able to figure out since the subprime mess went down is if Wall Street really was just blindsided by the subprime loans or did they know the bag of shit they were buying would soon start leaking and funk up the place.

My gut reaction is that Wall Street knew damn well what they were buying and were so busy reaping the millions of dollars while passing the risk on to the next sucker that no one bothered to stop and say this is insane.  I think they knew because most people who work on Wall Street are pretty smart.  I mean, if you don’t have an MBA from Harvard, Stanford, Wharton, Kellogg, U of Chicago, Dartmouth or any of the other top 15 or so graduate business schools the odds of getting a job on Wall Street are slim to none.

I will certainly say that Joe Blow mortgage broker with the community college Associates degree knew the loans were crap.  All it took was one phone call to any decent mortgage broker to know that the stated income loans went from being a way for legitimate entrepreneurs to get decent financing to the primary vehicle to finance Carleton Sheets students buying investment properties so they could flip them on HGTV programs.

Personally, I am waiting on the emails to start surfacing from the big shot traders who knew these loans were crap.  I mean how can people making millions of dollars per year not know that a person with a 580 FICO score, thousands of dollars in open collections, a bankruptcy, and no kind of stable job won’t run into financial problems at some point and not pay the mortgage back?

Rant over…

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I was going to write something on how to read Good Faith Estimates (GFEs), but an article on CNNMoney.com caught my eye.  As you know, I have been pretty critical of the mainstream media in their reporting of mortgage issues.  Mainly because they don’t have a freaking clue.  This article is yet another piece that is so full of misinformation all I can do is just shake my head.  Journalist have really got to do a better job sourcing information and really understanding the issues they are writing about.  However, I guess this is what you get when you have english majors who have never done anything but journalism writing stories on business topics.

The CNN article is about Yield Spread Premiums (YSPs).  YSP is how mortgage brokers are compensated.  Basically, it is compensation paid by the mortgage lender to the mortgage broker for delivering a mortgage loan at a certain interest rate.  The best way to think about YSP is as a profit margin.  In short, the Wholesale Interest Rate plus the Yield Spread Premium paid to the Broker equals the Retail interest rate.  For those of you with low reading comprehension skills, put another way:

Wholesale Rate + YSP = Retail Rate.  Simple enough, right?

For the life of me, I cannot figure out why this concept is so hard to understand?  In predictable fashion, the article characterizes the YSP as some evil “kickback from lenders in return for steering consumers into more expensive loans – a problem that the Federal Reserve failed to address.”

Let’s address the kickback issue.  Why do lenders pay YSP to Brokers?

Lenders pay YSP to brokers because it is cheaper than paying their own workforce for the broker’s client.  The broker incurs the cost of advertising, marketing, and other business expenses to originate (obtain clients) a loan.   In other words, YSP is an incentive to the broker to use that bank’s products.  The bank has to compensate the broker for their work and YSP is how they do it. 

Doesn’t YSP raise my interest rate?

Yes and No.  Remember, banks offer mortgage brokers WHOLESALE interest rates.  The RETAIL interest rate is the rate that includes the YSP.  Put another way, Bank A may have 30 year fixed rate loans at 6% with no YSP.   This is known as the par rate.  However, if the broker sells the client the loan at 6.5%, the bank will then pay the broker say 1% of the loan amount as YSP.   At 6%, the broker is not being compensated, so they would have to charge the borrower “points”.  The borrower is either going to get 6% with 1% in total points or 6.5% with no points.  No borrower will ever get 6% with no points as that would put the broker out of business since there is no profit margin either in points or YSP. 

The most egregious error in the article though is that it fails to mention that if the broker is offering a borrower 6.5% with YSP baked in, that rate is still cheaper than if that borrower went to the bank directly. 

Does the Broker have an incentive to earn as high of a YSP possible by giving me a higher rate?

The last time I checked our economic system is solidly capitalist.  When I price a loan I want to make as much profit as possible while remaining competitive.  It is the American way.  However, at the end of the day, it is IMPOSSIBLE for a broker to gouge a consumer who aggressively shops for their mortgage.  If a broker is trying to raise the rate on a deal so they can make 2% in YSP on a deal that most other brokers might do for 1% YSP at 6.5%, it wouldn’t take but two or three phone calls to competiting brokers to uncover this as the inflated YSP is going to result in a higher rate being offered than other competitors.  It really is that simple.

Why did the Fed ignore the YSP issue in their ruling?

Because the Fed figured out that YSP doesn’t matter to consumers.  Let’s take a little test.  You are shopping for a mortgage.  Broker A quotes a rate of 6.5%.  Broker B is quoting 6.875%.  Banker C works for Kuntrywide and claims he doesn’t charge the ripoff YSP since he is a banker and his rate is 7%.  Broker A does a lot of loans and has a special deal where he gets incentive pricing and will earn a YSP of $8,000.  Broker B only gets a YSP of $4,000.  Banker C doesn’t disclose since banks are treated differently. 

Which is the better deal?  Broker A making $8k in YSP at 6.5%,  Broker B making $4k in YSP at 6.875% or Banker C with the “free” loan at 7%?

If you are smart enough to own a home, you are going to pick Broker A because it has the lowest rate of all the lending choices you had REGARDLESS OF HOW MUCH PROFIT IS MADE ON THE LOAN.  You could give a rats ass what he is making.   He gave you the best deal out of all the competitors you called.

Real life example.  I just closed a loan yesterday and had a YSP of $5200, no points.  The borrower asked me to lower the YSP after I disclosed it on the GFE.  I said no.  The rate was 5.250% on a 5/1 i/o ARM.  Why did I say no?  Regardless of my YSP, there was no way anyone was going to be able to match that rate.    The borrower soon figured it out and agreed.  End of discussion.  They got freaking good deal and at the end of the day, my YSP was irrelevant because the closest competitor had pricing of 5.75% on the same loan.

At the end of the day, it bothers me that such misinformation is spread around by news sources.  Some consumer is going to read this article and think their broker is ripping them off when it isn’t the case.

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I haven’t been shy about pointing out that the mainstream media seems determined to paint mortgage brokers as the bad guy.  While I am not a conspiracy theorist, I can’t help but wonder if mortgage banks are paying off the media big wigs or are journalist really just not qualified to discuss financial issues.

On Friday, CNN’s Gerri Willis will be doing a show on the Mortgage Meltdown.  While I expect the whole show will be devoid of facts and attempt to absolve the consumer of any responsibility for fiscal mismanagement, something caught my eye today that leads me to believe the media is really biased.

CNN is running a web piece called “The lies broker’s told.”    It then goes on to say, “An ex-Ameriquest mortgage broker reveals how he talked borrowers into loans then couldn’t afford.”  The piece shows Gerri Willis interviewing some guy as a former Ameriquest employee discussing how he duped consumers.

Here’s the problem.  Ameriquest, the poster child of predatory lending, is not a mortgage broker.  In fact, Ameriquest was a mortgage bank.  Ameriquest did not broker mortgage loans.  They were a retail sub-prime mortgage bank. 

Are there bad mortgage brokers?  Sure.  However, the media has done an effective job of placing the whole implosion of the mortgage market at the feet of the broker community.  I don’t think it is accurate and their lack of knowledge of the business shows in hit pieces like this…

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I knew it wouldn’t be long before some bottom feeding lawyers started filing lawsuits against mortgage lenders. Here in Chicago, we have some ambulance chaser advertising all over the airways looking for people who are on the brink of foreclosure to file a lawsuit against the lender. The City of Cleveland, OH has decided to take it a step further and has filed a class action lawsuit against 21 major lenders – pretty much a who’s who of mortgage banking. Bank of America, Wells Fargo, Chase, and any other bank they figure has some deep pockets.

In case, you haven’t figured it out. Cleveland is pretty high up on the list of a foreclosures. There were some 7000 foreclosures in the city in 2007. That is a lot of foreclosures for a fairly small city. The Mayor is essentially blaming the lenders for leaving the city in a mass of foreclosures and Katrina like neighborhoods of boarded up crack houses. On the surface, this sounds like a typical left leaning, tug at your heart strings issue. The big bad greedy banks sucking the equity out of poor old Cleveland.

But let’s put our emotions aside and really examine why Cleveland is fast becoming the foreclosure capital. The last time I checked, no one was running to move to Cleveland. Some folks might even call Cleveland a hell hole. The city is in the heart of the Midwest and quite frankly is getting the smelly end of the stick when it comes to dying manufacturing economy that is in the toilet. The bottomline is that it is hard to pay your mortgage when you don’t have a job! Of course, instead of the Mayor figuring out how to spur the Cleveland economy and bring employment back to the city, it is a lot easier to blame the lenders. Does he really think lenders want to foreclosure on some outhouse in a Cleveland ghetto worth $100,000 with a $125,000 mortgage on it? I didn’t think so.

Let us not forget the same people crying about the big bad lenders were slamming them and filing lawsuits years ago because they wouldn’t lend to poor people. Now that poor people can’t pay their mortgages, they are crying and filing lawsuits that the big bad lenders shouldn’t have lent them money. Good lord.

Here is the article.

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