We’ve all read the stories and seen it on the news. Lenders are going out of business, investors are pulling out of the mortgage market, and people are losing their homes. It’s been declared a ‘Mortgage Crisis’ by the media, but is it really?
Remember the old days of home finance? If you wanted to buy a home, you had to work hard, save money, establish credit, and manage your money well.
The big lending institutions, FNMA (Fannie Mae) and FHLMC (Freddie Mac) came up with guidelines based on millions of loans, which would lessen the risks involved in lending.
In order to qualify for a loan, you had to start with a 20% downpayment, have enough money left in the bank to pay your mortgage if you hit tough times, and you had to earn enough to make the monthly payments and pay all of your other debts, too. Your debts had to represent, in most cases, no more than say, 45% of your monthly income.
Next, you had show, through your credit report, that you had established a pattern of honoring your obligations, paying your bills on time, and not over extending yourself. A credit score of 680 or better would prove it.
Loans that met these and other guidelines were called ‘conforming loans’. Since lenders and investors make, buy and sell loans, conforming have proven to be the most stable and easiest to sell.
The system worked. Every now and then, someone would default, but buy and large, it was considered a safe bet to loan to people under these circumstances. Lenders and investors would get a good stable return on their investments, and millions of people were able to buy homes.
To meet the needs of some of the buyers who couldn’t meet the borrowing criteria, the government came up with a couple of programs. VA loans, which helped our veterans qualify, and FHA, for low income families. Both were guaranteed by the government.
Still, there was an unmet demand. There were millions of people who, because of credit, income, or assets didn’t qualify under standard guidelines, and who didn’t meet the requirements for government programs. At the same time, there were investors who were seeking to make more than what they could off of conforming loans.
New loan programs with new names, started popping up. ‘Jumbo’, ‘non-conforming’, ‘Alt-A’, ‘Pay Option’ and the dreaded ‘sub-prime’ were just some of the programs lenders came up with, to make more loans, and more money.
Lenders and investors offered loans to these ‘outside the box’ borrowers, but increased the rates for every exception to the conforming guidelines.
So, let’s say that the borrower who could meet the guidelines, called an ‘A paper’ borrower, gets an interest rate of 6%.
For non-conforming, they may start with a base rate of 6.25%. Then, for every additional risk factor; lower credit score, high debt to income, interest only, unverified income, no assets, etc., the rate gets bumped, .25% here, .50% there, to the point a borrower might be paying 9% or more for a mortgage when the ‘A-paper’ borrowers were paying 6%.
The broker gets paid for arranging the loan, the lender sells the loan to an investor, the investor gets a higher rate of return, and the borrower gets house. The security for borrower and investor is the ever increasing value of real estate. By the way, if you have a 401k, mutual fund or other investment or retirement account, there’s a chance that you have mortgage backed securities in your portfolio. You may be one of the investors we’re talking about here.
What started out as small exceptions then got ridiculous. There were stated income, stated asset, and even what’s called a ‘no doc’ loan, where basically, they get your name, address, social security number and credit report. You don’t have to tell them where you work, or even IF you work. You didn’t have to provide ANY documentation. People with credit reports showing bankruptcies, collections, previous defaults, and late payments, people who PROVED they did not believe in honoring their financial commitments, or were simply incapable of it, were being granted loans, at higher rates, of course.
When the rules are that loose, there are plenty of people willing to take advantage; lenders, investors, brokers and borrowers all share in the blame.
One client said, “Wow, Mervyns wouldn’t approve a store credit card for me, but I can buy a house! That’s crazy!”
It was crazy, and we all know what happened. These folks struggled. They didn’t get the raises they thought they would. They couldn’t afford it in the first place. The market slowed. Prices fell, they started to default. A lot of lenders and investors got burned.
So what do they do? They get back to basics.
Today, although there are plenty of alternative programs available, for most people, and most lenders, if you want to buy a house, you have to have 20% down, be able to prove your income, have good credit, and prove the ability to make your payments.
It’s back to basics. That’s all it is. There are still second mortgages, stated income, and other exceptions, but guidelines are a lot tougher. Soon enough though, investors will want to earn more, and they will come back to meet the needs of the ‘non-conforming’ borrower. I think they’ll be a little more careful this time around, at least for a while.
By the way, I’ve got this borrower; he can’t prove his income, his credit isn’t so good, he doesn’t have money for a down payment, but he’s planning on getting a new job and his wife’s getting a raise. Care to invest in that one?
Realtor – Mortgage Consultant
Bentley Mortgage and Real Estate Services
916 718 9577