Our good friends at Realty Times report that some in the mortgage industry believe that no-doc loans and other forms of toxic finance “may soon be making a comeback” and that “some people can’t wait for the no-doc loans.”
I have no doubt that some people would be elated by the return of liar loans and other forms of nontraditional mortgages. However, there are more than a few who would object including mortgage insurance companies, mortgage investors and perhaps even financial regulators.
But what about those poor souls who cannot document their income?
Nonsense. You mean these non-documenters don’t file taxes? If they file taxes they must have some records and if they don’t file taxes then why would a lender underwrite a loan for them?
It’s said that no doc loans are great for self-employed borrowers but I don’t see why. I’ve been self-employed since the earth first cooled and never had a problem getting a mortgage. I just provide my tax returns and whatever other information that will make the application easy for the lender to underwrite.
The financial statements of the self-employed are just not that hard to figure out. You just add back real estate depreciation, count 75 percent of rental income, check the returns and make a few other adjustments. No big deal. Underwriters do it all the time.
If toxic loans are coming back just who will be originating such financing? Not the hundreds of lenders who the Mortgage Lender Implode-O-Meter reports have gone out of business. Not Washington Mutual, now a part of JP Morgan Chase. Not Countrywide, now a part of Bank of America.
No less important, would YOU make a loan to someone who would not or could not verify their income? Does that seem like a really shrewd idea? Do you think lenders, investors and regulators have not noticed that so-called affordability loan products are at the heart of the mortgage meltdown?
Right, toxic loans will be back — maybe at about the same time that stores start selling succulent lead-covered toys once again.
For the full story, see No-Doc Loans Returning?
Should bankruptcy judges have the right to modify home mortgages? Would that be fair? Or unfair?
It’s a political question, of course, and when the time came for the Senate to vote in April the count was 51-to-45 against a measure would give judges the right to change home loan terms and rates. For the moment at least, S.61, the Helping Families Save Their Homes in Bankruptcy Act of 2009, is dead.
Or is it?
In reality the Senate vote was just one battle in a war which is going to last for many months. As Sen. Richard Durbin (D-IL), the bill’s sponsor, told The Washington Post that “I’ll be back. I’m not going to quit on this.”
But opponents, according to Forbes magazine, “argued that allowing judges to unilaterally adjust the terms of mortgages (or “cram down” the mortgages, as the financial services industry says) would create an alarming precedent, undermining existing principles of contract law. Eventually, they said, lenders would have to raise mortgage rates for everyone to cover losses forced on them by bankruptcy judges.”
Really? An alarming precedent? Undermine contract law?
This is nonsense.
The truth is that until the Supreme Court’s Nobleman case of 1993, bankruptcy courts routinely changed rates and terms for home mortgages. Contract law was not undone, there were no alarms and the country did not implode into a lawless mass.
With Nobleman, however, the Supreme Court said that bankruptcy judges could not change the terms of first liens on a residential property. They could, however, change the terms on first liens secured by vacation homes, yachts and private planes.
In other words, there is NO centuries-long precedent which says we can’t go back to what we were doing in 1993 except that the banks and credit card companies would be offended. There’s no reason why the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 cannot be undone — this was legislation which says that before a homeowner can file for bankruptcy he or she must first have six-months of financial counseling. In other words, by the time the borrower meets the counseling standard the home has already been foreclosed.
Do you think the Republican House, the Republican Senate and the Republican President who passed this bill in 2005 did not know this? Do you think they did not know that they were making student loans life-long debts that were virtually impossible to relieve through bankruptcy? Or making credit card debt virtually impossible to modify?
Don’t be fooled. Fixing the bankruptcy system does not involve breaking any sort of precedent. There’s no cause for alarm. There’s merely a need to get fairness and balance back into the legal system.
July 14, 2008 should be remembered as a notable date in the long history of mortgage lending. The federal government gingerly stuck its regulatory foot into the warm waters of consumer advocacy and for the first time enacted rules which would protect borrowers. Not all borrowers, of course, and nothing that would materially disturb the status quo of a lending system that under the watchful eyes of federal regulators is now on the brink of failure.
Under the Home Ownership Equity Protection Act (HOEPA), the Fed has the power to fight “unfair and deceptive acts or practices” or, as they’re called, UDAP. In fact, the Fed has had such power since 1994 and therein lies the rub.
The purpose of financial regulation is to create something of a level playing field. In real estate, for example, you can’t have a “net” listing. Yes, such listings could produce big profits for brokers, but state regulators across the country have banned such arrangements because of their obvious potential for abuse.
Federal regulators, in contrast, have traditionally taken a cautious approach to lenders but in the past few years they left the financial marketplace untouched and the result has been obvious: You didn’t have option ARMs or the widespread use of stated-income loan applications in the past because previous administrations telegraphed their positions to lenders: You can go so far, but no further.
Until the second Bush Administration the deal with the lending community was this: You can make profits, big profits, but use some care and caution otherwise we’ll be forced to create a bunch of regulations that will reduce your revenues. In other words, a gentleman’s agreement of sorts, an unspoken arrangement that worked fairly well for everyone.
The Bush Administration has a different view. It is not a “conservative” perspective — remember, no lender issued option ARMs when Ronald Reagan was in office — instead, with Mr. Bush we have a radical and absolutist political philosophy which argues that unfettered markets are the sure solution to all problems.
Under the Bush approach if a lender makes dim-witted loans and doesn’t bother to effectively underwrite mortgage applications the marketplace will respond. There’s no need for government action because in time loans will fail and shareholders will lose money.
The Bush regulatory theory may be worth debating in some seminar regarding abstract political philosophies, but in the real world we are each inter-connected. If large numbers of lenders make large numbers of foolish loans, it’s not only shareholders who suffer, it’s the value of our house that falls when neighbors are foreclosed.
Given the radical and extreme thinking of the past few years, we are now seeing radical and extreme responses. To right the financial ship of state — if that is possible without further dislocations — the federal government has now embarked on an economic path normally associated with third-world countries. For instance:
- The federal government over the summer of 2008 quickly and with little debate established the right to buy Fannie Mae and Freddie Mac. If this were being done by governments in Malawi, Cuba, Venezuela or Rumania, we would be talking about “nationalization” and all that the term implies.
- The Securities and Exchange Commission over the summer applied special rules to prevent short-selling — but only for 19 favored companies. In effect, we replaced the free-market system with two classes of corporations, those protected from short-sellers and those which are not.
- The Federal Reserve has made hundreds of billions of dollars in friendly loans available to selected banks and private entities on Wall Street. These loans are secured by assets of dubious quality — if the quality were so good then surely such assets could just be sold on the open marketplace. Meanwhile, legislation to help 400,000 borrowers with toxic loans was stalled for months because of alleged worries that the cost might total $4 billion.
The tragedy here, the disgrace here, is that none of this was necessary.
Go back to the new Federal Reserve rules introduced over the summer of 2008. They are weak and timid; most “protections” only apply to “high-priced” loans, meaning not prime or ALT-A financing.
But imagine if the new standards had been instituted in 2002 and 2003: For instance, the new rules say that lenders must “verify the income and assets they rely upon to determine repayment ability” when making “high-priced” loans. In other words, stated-income loan applications are out for subprime borrowers. Would there be a subprime crisis today if such baseline standards had been introduced when they were actually needed?
What makes no sense is the lack of anger. If Canadian trade regulations caused $500 billion or a trillion dollars worth of damage to the U.S., the entire country would be irate. But if a few federal bureaucrats, zealots and elected officials produce the same result, no one seems especially distressed — and that should worry us all.
Published originally by The Real Estate Professional and posted with permission.
The question that keeps coming up is this: If only a small portion of all mortgages are failing how come the general financial impact has been so enormous?
To resolve this mystery, let’s go back to the 1970s when the mortgage-backed security — the MBS — was developed. The MBS was a financial device designed to resolve a problem for investors. The problem? Imagine that you’re a loan investor and bought the mortgage on a single-family home. Your total income from the investment would be impacted if your one borrower was late, didn’t make a payment or was foreclosed.
With a MBS you own a security which is supported by a large number of mortgages, perhaps thousands. If someone misses a payment your income continues with little disruption.
In theory mortgage-backed securities make a great deal of financial sense.And in practice, until the past few years, mortgage-backed securities worked well.
Today mortgage-backed securities are troubled, especially those which include subprime loans. But why should this be? Even with subprime loans, the overwhelming majority of borrowers are making their payments.
About as good as an answer as you’ll find comes from Lew Ranieri, one of the developers of the MBS concept. As Ranieri told John Cassidy in The New Yorker, today MBS securities are fundamentally different from the paper that was invented several decades ago.
“They have created the perfect loans,” Ranieri says with irony of today’s mortgage-backed securities. “They didn’t know what the home was worth, they didn’t know what the borrower earned and the borrower wasn’t putting any money into the purchase. The system had gone completely nuts. A loan without a full appraisal, thorough underwriting, and full income verification was never what anyone envisioned when we started the market for mortgage-backed securities.” (See: “Subprime Suspect,” March 31, 2008)
You listen to Ranieri and it becomes obvious why mortgages have been so freely-available during the past few years. The answer has nothing to do with a push for more homeownership or some sort of philosophical imperative: If Wall Street is going to sell more high-profit mortgage-backed securities it needs a basic feedstock. What is that feedstock? More loans.
If it happens that a mortgage fails, who suffers? The loan officer has already been paid. The “lender” is often not a lender in the sense of a company with a vault stuffed with cash, but instead a retailer that instantly re-sells any loan it originates. If the borrower makes payments for a few months, the originating lender is then largely not responsible if the mortgage goes downhill.
With mortgage-backed securities the folks on Wall Street make money selling paper, real estate brokers make money selling homes, governments make tax money every time a home is sold or refinanced, title companies and attorneys make money with each closing. The list goes on but you get the idea.
What started out as a conservative way to protect investors morphed into something strange. You could buy a typical MBS or you could get a little more interest if you bought a somewhat riskier portion of a mortgage-backed security. But why worry — credit-raters gave MBS paper strong marks.
Unfortunately, the push for higher returns outpaced the push for financial sanity. Loans without full appraisals, stated-income mortgage applications, exploding ARMs, option ARMs and large numbers of interest-only loans will inevitably produce large numbers of distressed borrowers and outright foreclosures. Add in a gross lack of federal regulation — regulation that could easily have prevented the current mortgage meltdown — and the results we see today were pre-ordained.
Once a few mortgage-backed securities failed it meant that the assumptions used to value and rate all MBS paper needed to be reviewed. The value of MBS paper fell, so investors suddenly had less net worth and thus a lot less interest in once-attractive mortgage-backed securities.
For the folks on Wall Street, the problem was not lower MBS ratings but fewer MBS buyers. Essentially, brokerages and investment banks got caught with MBS and other sagging securities in their portfolios.
And this gets worse. There are not only mortgage-backed securities (MBS) and collateralized debt obligations (CDOs — securities backed with a variety of debts, including mortgages), there are also derivatives.
Derivatives are simply bets. While there is a limit to the number of MBS and CDOs you can have, there’s no limit to the number of derivatives. The value of these derivatives amounts to hundreds of trillions of dollars.
The good news? Most derivatives are hedged so that the investor has little financial exposure. The bad news? When you deal with hundreds of trillions of dollars a minor “whoops” can be worth billions and billions of dollars.
And that’s how a few foreclosures upset the strange world of mortgage-backed securities, CDOs and derivatives.
Published originally by The Real Estate Professional and posted with permission.
“Nationally and internationally, we must be on guard against predatory lending. It is nothing more than a scam, a crime, a lie.” Alphonso Jackson
It’s doubtful that anyone who has ever looked at the mortgage industry would disagree with the sentiments offered by former HUD Secretary Jackson. Predatory loans are terrible, a scam and certainly a lie.
But oddly enough, predatory lending is not a crime.
For all the talk about predatory lending, and despite the assumption that such activities must be illegal on their face, the truth is different: There is no federal sanction against predatory lending.
According to attorney Benny Kass, a long-term real estate columnist for The Washington Post and an authority in his field, “there are no federal laws making predatory lending illegal.”
“Congress and the Fed keep claiming that they don’t understand it,” says Kass. “Perhaps it’s like pornography: ‘I can’t define it but I know it when I see it.’”
Kass points out that the Home Ownership Equity Protection Act (HOEPA) is a disclosure law, it requires that lenders provide additional notices for loans which charge interest rates, fees or both above a given level. However, HOEPA does not say that such high-cost loans are prohibited
Also, Kass notes that while some subprime loans are predatory mortgages, most are not.
So what’s a predatory loan and isn’t it the same thing as mortgage fraud?
When it comes to federal law there’s a huge difference between “mortgage fraud” and “predatory” lending. As the Mortgage Bankers Association explains:
“It is critical to recognize the difference between mortgage fraud and predatory lending. ‘Mortgage fraud,’ as understood by law enforcement and the real estate finance industry, is the ‘material misstatement, misrepresentation, or omission relied upon by an underwriter or lender to fund, purchase or insure a loan.’ A lending institution is deliberately deceived by another actor in the real estate purchase process — such as a borrower, broker, appraiser or one of its own employees — into funding a mortgage it would not otherwise have funded, had all the facts been known.”
And predatory lending?
Predatory lending, says the MBA, “is a term used to describe a range of lending practices harmful to borrowers, including equity stripping and lending based solely on the foreclosure value of the property. Some of these practices can be fraudulent, but defining an exact set of predatory lending practices has been difficult.”
In other words, when a lender suffers then the problem is the well-defined crime of “mortgage fraud.” When a borrower is hurt by the acts of a lender or someone in the lending process then there are no federal standards to breach.
“It’s fair and appropriate that we protect lenders from acts of mortgage fraud,” says Jim Saccacio, Chairman and CEO at RealtyTrac.com, the leading online foreclosure marketplace. “At the same time, it is equally fair and appropriate that we also protect borrowers from predatory lending. Given the lending community’s persistent calls for an end to predatory lending, you have to wonder: Who benefits from the absence of effective federal laws against predatory lending? Reduced levels of predatory lending would result in fewer foreclosures and bankruptcies and that’s good for borrowers, lenders and mortgage investors.”
The FBI says in its 2006 Financial Crimes Report To The Public, that “the defrauding of mortgage lenders should not be compared to predatory lending practices which primarily affect borrowers. Predatory lending typically effects senior citizens, lower income and challenged credit borrowers. Predatory lending forces borrowers to pay exorbitant loan origination/settlement fees, sub-prime or higher interest rates and in some cases, unreasonable service fees. These practices often result in the borrower defaulting on his mortgage payment and undergoing foreclosure or forced refinancing.”
In fiscal 2006 the FBI reports there were suspicious activity reports (SARS) indicating 35,617 possible mortgage fraud violations, 2,409 commercial loan fraud reports and as many as 21,203 false statement cases.
And the total number of possible predatory loan cases shown in the report? Zero.
The FBI is entirely right. There are no predatory lending crimes to list because unjustified interest levels, bloated origination fees and inflated servicing costs are not federal crimes, therefore there is nothing to measure.
If we can define mortgage fraud why is it that we cannot define predatory lending? Why can we protect lenders but not borrowers?
Predatory lending comes in many flavors, so we can’t just say it’s one thing or another. Instead, we have to look at predatory lending as a crime with a variety of possible components.
For instance, we could define “predatory lending” as any lien secured by real estate which includes one or more of the following characteristics:
- Requires borrowers to pay interest rates, fees and/or charges not justified by marketplace economics in place at the time the lien was originated.
- Is based on a loan application which is inappropriate for the borrower. For instance, the use of a stated-income loan application from an employed individual who has or can obtain pay stubs, W-2 forms and tax returns.
- Is materially more expensive in terms of fees, charges and/or interest rates than alternative financing for which the borrower qualifies. For instance, financing a borrower who qualifies for an FHA loan with a higher-cost subprime mortgage.
- Is marketed in a way which first, fails to fully disclose all material terms; second, includes content designed to mimic federal documents or envelopes; and/or third; includes a mock or facsimile “check” made out to a specific prospective borrower.
- Includes any terms or provisions which are unfair, fraudulent or unconscionable.
- Does not include, in a format established by federal regulators, contact information for the party servicing the loan as well as the initial loan owner.
- Is marketed in whole or in part on the basis of fraud, exaggeration, misrepresentation or the concealment of a material fact.
- Does not plainly and prominently disclose on the good faith estimate of closing costs the size of any yield spread premium paid directly or indirectly, in whole or in part, to a mortgage loan officer.
- Allows servicing and collection fees and charges above cost when payments are late or not made. This provision would prevent so-called “predatory servicing” fees.
- Allows interest rates to increase when payments are late or not made. This provision would end the classic predatory strategy of making loans with initial low rates to individuals who are unlikely to make prompt payments, and then increasing interest levels when a borrower is late.
- Is underwritten without due diligence by the party originating the loan. This would force lenders to fully document loans.
- Is originated by an individual or entity compensated for two or more real estate liens during any 12-month period to parties other than immediate family members. “Immediate family members” shall be defined to include an individual’s parents, grandparents, spouse, inlaws, siblings and/or children.
Looking at the list of predatory acts above, one can expect members of the lending community to object because such rules will increase their liability to borrowers and investors. But why is that unfair? If borrowers can have liabilities for mortgage fraud, why should lenders be exempt from any penalties or prohibitions related to predatory lending?
As the old expression goes, what’s good for the goose is good for the gander.
Published originally by RealtyTrac.com during October 2007 and posted with permission.
It was in 2005 that Bill Dallas — then president and CEO of Ownit Mortgage Solutions, at the time on one of the 15 largest subprime mortgage lenders in the country — said “underwriting guidelines developed in the 1950s don’t address the needs of today’s homebuyers and brokers. Loans that met the needs of Ozzie and Harriet were not intended to fill the needs of the Desperate Housewives.”
I’m not so sure Ozzie and Harriet were off the mark. Ownit closed in December 2006.
Ozzie and Harriett — the Nelsons of early TV — didn’t do too badly. The Nelsons were a prototypical one-wage earner household. They no doubt financed their home with an afforable fixed-rate loan. The mortgage choices then available were pretty much limited to VA, FHA and conventional financing with 20 percent down, financing that usually came from a local savings & loan association.
Today’s mortgages might well have confused the Nelson’s — they certainly confuse a lot of current borrowers. How could one explain the joys of interest-only financing or option-ARMs to visitors from the 1950s? What would they think of such ideas as negative amortization, interest rates based on LIBOR movements (a European index that did not then exist) and monthly payments that might double in a few years?
The Nelson’s lived in a country that was the world’s largest producer of cars and steel and by far the largest producer and exporter of food, but let’s not idealize the ’50s — schools and neighborhoods were segregated; women were relegated to a second-class status; businesses and colleges openly discriminated against Jews; lenders engaged in redlining; there had never been a Catholic president; the Korean war had ended — and the Vietnam war loomed ahead. But at least in the sense of real estate and mortgages, things were understandable.
The worry at the start of 2007 is that the market for subprime loans is less stable then investors would like and perhaps not so understandable. For instance, a 2006 study by Friedman Billings Ramsey found that default rates for adjustable subprime loans originated in 2005 were “15.4% and 6.3% higher than the default rates of those originated in 2003 and 2004, respectively.” (See the June 2006 MarketPlus Report from FRB for details.)
Well sure, you might think, interest rates reached record lows in the summer of 2003. As rates have risen so have foreclosures.
Not quite. Yes, interest rates have risen since 2003 but the Friedman Billings Ramsey study found that most of the subprime loans (74.9%) were 2/28 hybrid adjustables — that is, financing where the payment stays the same for the first two years of the loan term. “Hence,” says the report, “most of the adjustable-rate subprime loans originated in January 2005 will not reset at the earliest until January 2007.”
If rising interest rates aren’t doing it, then why then the rash of subprime foreclosures?
FBR looked at subprime foreclosure rates in 361 metropolitan statistical areas and found that 95 had particularly steep default rates. The reason: slowdowns in areas dependent on auto manufacturing, weak labor markets in New England and Golf Coast areas still reeling from hurricanes Katrina and Rita.
If you remove these 95 metropolitan statistical areas from the mix you find, according to FBR, that default rates increased from 4.16% in in July 2005 to 5.84% in July 2006. An increase, but not as bad as a superficial figures suggest.
It’s just a guess, but I would suggest that those fiscally-conservative folks from the ’50s might look at the FBR survey results and map out a mortgage investment program that looks something like this:
If I’m a mortgage investor I’d look at rising subprime default rates and say more risk means I need more interest. That, of course, is a problem given that subprime rates are already steep. Can the market absorb higher subprime rates without steeper default levels?
I’d stay away from areas with especially high default rates — that would unfortunately mean less financing for the metropolitan statistical areas where the need for mortgage capital is especially accute.
I’d look ahead and wonder about areas that have high levels of interest-only and option ARM activity. FRB reports that in the first six months of 2006 more than a quarter (25.8%) of the loans in California allowed negative amortization. In the same period interest-only financing was remarkably popular (or necessary) in Charlottesville, VA (47.1%), Ventura, CA (46.3%) and Santa Cruz-Watsonville, CA (45.7%).
I’d wonder what would happen with those 2/28 hybrid adjustables, the ones that will begin resetting in big numbers in this month. Does anyone seriously think that higher interest rates will not compound subprime problems?
The Nelsons may not have had home computers, electronic games or DVDs, but each month they could easily pay their steady mortgage bill. For a growing number of homeowners, that’s not a bad deal.
Published originally by RealtyTrac.com during January 2007 and posted with permission.
We usually define a “conventional” mortgage as financing with 20 percent down. Since most people don’t happen to have 20 down much less 20 percent plus closing costs, there has always been a market for mortgages that somehow require fewer dollars up front.
The way you get loans with less down is to find a financially-strong co-signer, someone or something that will bail out the lender if you can’t repay your mortgage. Loans guaranteed by the VA, FHA or private-mortgage insurance (MI) all allow borrowers to buy with little or nothing down.
But — and you knew this was coming — insurance requires an insurance premium, so to buy with little down AND without the cost of insurance, borrowers and lenders during the past few years increasingly turned to piggyback financing or financing with a simultaneous second.
With porker financing you get a first loan for 80 percent of the purchase price and a second loan for 10-, 15- or 20-percent of the home’s value. The result is little or nothing down, plus no cost for mortgage insurance.
Who makes such second loans? Sometimes a second lender, but often the very lender who provided the 80-percent first mortgage and also finances a second loan for the same transaction.
Once-common piggyback deals are now increasingly rare. The reason: That second loan is immensely risky. If a home is foreclosed the odds are overwhelming that the entire value of the second mortgage will be lost. Unlike a first loan, of course, there is neither insurance to offset a loss nor the equity represented by a significant down payment to protect the lender.
The evaporation of piggyback loans is a marketplace “correction” that’s long been overdue. Such financing is cute and clever — but only when home values are rising. Since home values do not always rise, the once-popular piggyback loan is now toast, nicely browned on both sides.
With the virtual disappearance of subprime loans — and with a substantial decline in interest-only mortgages, option ARMs and stated-income loan applications — what we have today is your father’s mortgage marketplace: Take your pick: You can get a conventional loan or a mortgage backed by FHA, VA or private mortgage insurance. Exotic mortgages are out, piggyback loans have been barbecued and dull loans that borrowers can actually understand are back.
Unfortunately, some buyers will not be able to get financing or refinancing under the new standards or they’ll be forced to borrow less. That sounds fairly gruesome until you realize that prudent borrowing means fewer foreclosures and a gradual return to normal markets, things which benefit us all.
Published originally by Realty Times on July 23, 2008 and posted with permission.
With newsstands dominated by scary headlines, Hollywood break-ups and still more diet plans, Harper’s magazine is typically somber and understated. However, for those with an interest in real estate the May 2006 issue offered a jarring cover story that’s tough to ignore: “The New Road to Serfdom: An illustrated guide to the coming real estate collapse” by Michael Hudson.
Using 20 illustrated steps, Hudson explains some of the conditions which will lead many households into a lifetime of debt and too many others into an inevitable pit of foreclosure and bankruptcy. He acutely understands that “affordability” today is too often measured in terms of monthly payments rather than overall debt load.
“Why is the demand for mortgage debt so high?” he asks. “There are several reasons, but all of them have to do with the fact that banks encourage people to think of mortgage debt in terms of how much they can afford to pay in a given month — how far they can stretch their paychecks — rather than in terms of the total amount of the loan.”
The problem, of course, is that for too many borrowers paychecks are essentially fixed while monthly mortgage costs are not. If interest rates rise — or if loans automatically convert from low “start” rates to bigger payments in three — five or seven years, then many owners will face one of three realities:
- They will not be able to sell at a profit or a break-even basis (because prices will have declined as more homes come on the market);
- They will not be able to rent at a profit or a break-even basis (because too many owners will try to rent unsold units at once); and
- They will not be able to hold (because monthly payments will be crushing).
At first it may seem as though the inability of someone to pay their loan is a problem just for those who bought and financed imprudently. However there are other parties who will be impacted, not a minor matter since one of those parties may be you.
Even if you’ve been financially cautious to the point of absolute boredom, the value of your property does not exist in a vacuum. If a few additional homes above the norm in your neighborhood are foreclosed, if they sell at distressed prices, guess what happens to the value of your home?
It’s not just homeowners who will suffer if there are price declines. Lenders too will be walloped by the marketplace.
At the 2006 annual meeting of BerkshireHathaway, billionaire investor Warren Buffett gave his usual clever and insightful performance before investors.
According to Money magazine, Buffett said with regard to lenders and their annual (10K) reports that “dumb lending always has its consequences. It’s like a disease that doesn’t manifest itself for a few weeks, like an epidemic that doesn’t show up until it’s too late to stop it. Any developer will build anything he can borrow against. If you look at the 10Ks that are getting filed and compare them just against last year’s 10Ks, and look at their balances of ‘interest accrued but not paid,’ you’ll see some very interesting statistics.”
In other words, there’s no value to a loan which potentially produces a lot of interest if the interest is not actually being paid.
The issue, of course, is that a nonperforming loan secured by a property which has lost value or cannot be quickly sold or rented is not an “asset” in the usual sense of the term. Instead, nonperforming loans are a financial albatross that when spotted can undermine balance sheets, valuation models and stock prices — something that no doubt interests Buffett and other investors.
Published originally by Realty Times on May 16, 2006 and posted with permission.
The lending community will plainly tell you that foreclosures are on the rise — in part because of rising interest levels — but don’t worry. According to the party line, there’s no need for alarm because the problem is contained to subprime loans and just a few states.
For example, John Robbins, Chairman of the Mortgage Bankers Association, told reporters at the National Press Club on May 22, 2007 that 35 percent of all homes are mortgage-free. He added that “among homeowners, 5.1% of them are subprime borrowers with adjustable rate mortgages.”
“We are seeing a foreclosure rate of 10.8% annualized among subprime ARMS,” Robbins explained. “So what percentage of homeowners are we talking about? Ten percent of five point 1 percent of all homeowners.
“And of that half of one percent of the whole, fully half of THOSE will find some solution that avoids a foreclosure sale.
“In other words, one quarter of one percent will ultimately face foreclosure.
“As we can clearly see, this is not a macro-economic event. No seismic financial occurrence is about to overwhelm the U.S. economy.”
Robbins concluded that the subprime foreclosure rate had to be seen in context.
“Out of 75 million homeowners and 50 million mortgage holders, it’s not an eyebrow raising number, when looked at over that period of years,” said Robbins. “It’s within what we as a society deem as an acceptable risk for the rewards and opportunities of homeownership.”
The official line is that if the number of foreclosures goes up that’s not really worrisome because even a bigger number of distressed properties would still represent just a small fraction of all homes. Such logic avoids the reality of the marketplace.
Buyers don’t care how homes are financed. It makes no difference to them whether an owner finances with a fixed-rate loan, an adjustable product or if the property is mortgage free. What counts is price and terms, and owners facing foreclosure are not likely to hold out for either premium prices or stiff terms.
Consider what happens in a new subdivision with 1,000 condo units where the builder begins offering a few at a $50,000 discount to clear out inventory. Can anyone in the subdivision sell units for more? Have not the value of all units fallen — including those owned free and clear of any mortgage debt? Do not low-ball prices show up when comparables are checked?
Most owners in the subdivision will continue to meet their monthly mortgage payments and not sell, thus the fact that large numbers of homes have been devalued will not show up in foreclosure statistics. While this may please lenders and regulators, owners — especially those who had hoped to sell or refinance — may not be too thrilled.
To believe that an increasing number of foreclosures will not have a marketplace impact is neither logical nor believable. Just ask the people in the subdivisions and condo projects where developers have recently cut prices on just a few units. Or folks who live down the street from a home which has been foreclosed.
Published originally in part by Realty Times on May 2, 2006 and posted with permission.
Foreclosures used to be a rarity and for the most part that’s still the case. As of the second quarter of 2008 only about 2.75 percent of all loans were in the process of being foreclosed, according to the Mortgage Bankers Association.
That term “in the process of being foreclosed” is important. Neither borrowers nor lenders benefit from foreclosures. For borrowers the loss of a home is a personal tragedy as well as a huge credit stain that will impact finances for years. For lenders, foreclosures suggest losses, legal bills, vanished interest, unrecovered principal and lots of explaining to regulators.
The result is that a large percentage of homes which are “in the process of being foreclosed” are never actually foreclosed. The property is sold before the foreclosure, the loan is re-worked, the property is refinanced or back payments bring the loan current and the matter is resolved with as little damage as possible to both lenders and borrowers.
But figures from RealtyTrac, the online foreclosure marketplace that gets data from 2,200 counties nationwide, show that in August 2008 the number of homes entering the foreclosure process reached a new plateau: For the first time in a single month more than 300,000 American families received foreclosure notices of some kind.
Eternal optimists may say this is good news for those who deal in foreclosures. But while foreclosure clean-up is necessary, if there’s an increased number foreclosures in your neighborhood and properties begin to sell at low values, guess what happens to local home prices? Guess what happens to the value of your home?
You have to wonder: Are we seeing more foreclosures than last year as toxic mortgages mature? These are “nontraditional loans,” a sterile description for mortgages with ridiculously low monthly costs at first (but higher costs later) as well as mortgages that feature limited documentation and overly-large initial loan balances. Specifically, we’re talking about option ARMs, interest-only loans, stated-income financing and super-jumbo mortgages.
In April 2005 we asked Rick Sharga, RealtyTrac’s vice president of marketing, about the impact of toxic loans on the rising number of foreclosures and here’s what he had to say at that time:
Question: Are toxic loans linked to the rise of foreclosures?
Answer: While we haven’t seen any report that definitively links the two, it’s logical to surmise that higher risk loans will default at a higher rate than more traditional loans. And the fact that a larger percentage of home loans fall into the high risk category than at any time in recent memory makes the possibility of a spike in foreclosures more likely.
Question: Have toxic loans begun to impact the marketplace?
Answer: It’s hard to assign the increase in the number of properties in default and foreclosure specifically to high risk loans, but they’re almost certainly a contributing factor. As large numbers of ARMs reset this year and next — we’ve seen numbers as high as $300 million in loans this year and $1 billion in 2007 resetting — we’ll be better able to gauge the impact on national foreclosure rates.
Question: Will we see a further increase in foreclosure levels?
Answer: We anticipate that foreclosures will increase throughout 2006 for several reasons.
First, the number of properties in foreclosure has been below historic averages for several years, and the market appears to be moving back toward more “normal” levels.
Second, increasing interest rates are driving up monthly payments for homeowners with ARMs, and will significantly increase monthly payments for people with 3/1 or 5/1 ARMs due to reset.
Third, house values appear to be cooling off, which gives homeowners less equity to leverage in the event that they find themselves in a financial bind — and limits the opportunity to sell a property at a profit for homeowners in default.
There are ancillary economic factors that also come into play. Rising interest rates have had an effect on monthly credit card payments in an economy with a very high amount of consumer credit card debt. Energy costs have risen faster than anticipated. In some parts of the country, major employers such as Ford and GM have announced plans for massive layoffs, and there tends to be a strong correlation between higher-than-average unemployment rates and higher-than-average foreclosure rates.
Question: How long will it take to clean out weak borrowers?
Answer: It’s almost impossible to answer that question because there are so many factors involved, ranging from house appreciation rates to rising and falling interest rates to supply and demand within any given market to how far lenders are willing to extend themselves to “save” a troubled loan and even to the overall strength of the economy.
Question: Any general industry comments?
Answer: One of the trends we’re following is the number of properties that actually end up becoming REOs (bank repossessions). Over the past year, even as the general numbers of properties entering foreclosures has increased, the number of homes that actually end up as REOs has consistently stayed below 20 percent of the inventory. That relatively low number suggests that the market has been strong enough to allow owners to either re-finance, work out new terms with lenders, or sell the properties before they’re foreclosed on. It’s a statistic we’ll be watching closely, as we believe that a spike in the percentage would be a red flag.
The other statistic we’ve been tracking is the sales price of properties in foreclosure relative to estimated market value of the properties. In “hot” markets like CA, foreclosure properties have retained 80- to 88-percent of full market value over the past six months, whereas in other areas the numbers have been significantly softer (Minnesota, for example, was just below 50 percent). These relative prices also bear watching as a dramatically lower price combined with a high number of foreclosure properties could have a definite impact on home prices in a given area.
What we may be seeing is the coming together of slowing local markets at the very same time that large numbers of borrowers are facing stiffly higher payments. This combination of events will surely test those who believed that rising home values were assured, certain and guaranteed; an easy escape valve if monthly payments could not be met.
Published originally by Realty Times on April 28, 2006 and posted with permission.