The Mortgage Reports Blog

Falling Prices And Adjusting ARMs : Real Estate Investors Have A Way Out

Unless you live on the moon, you've heard about the issues facing American homeowners with respect to mortgages.  You've heard it on TV, in the papers, and on blogs. 

The good news is that relief is on the way (somewhat).  Momentum to "help the homeowner" started with the states (Ohio), moved into Congress (FHASecure), and is now heading onto mortgage servicers (Countrywide).

The bad news is that not all homeowners are going to be relieved equally. 

The least protected class of homeowners in America right now are real estate investors that bought homes from 2001-2007.  There's not a line of legislation that will come to the rescue of any member of the over-extended-real-estate-investor class.

One television pundit was overheard saying this:

"They bought their tickets, they knew what they were getting into.  I say, let 'em crash."

Now, with respect to real estate investors, it's important to differentiate between the two types who may have bought from 2001-2006.

1. The buy-and-hold investor who makes money off rent, tax write-offs, and long-term property gains.  This is a long-term strategy.
2. The buy-and-sell investor who makes money off selling a property for more than its purchase price within a short period of time.  This is a short-term strategy.

For Type #1, the current market conditions are a stress, but nothing major.  Because their real estate strategy is a long-term one, the home was likely financed with a long-term fixed mortgage, and excellent rent prospects for the unit(s).

For Type #2, however, the financing tends to be much different.  Because their strategy was a short-term one, the home was likely financed with a short-term sub-prime ARM, and in an area that was designated as "hot", or "likely to appreciate".  Rent prospects were not necessarily a factor when the purchase was made.

Now, both investor types likely bought with very little downpayment.  Lenders didn't require it, so the investors didn't give it.  Real estate investment is about leverage, after all.  In a rising market, buying one property with 20% down generates a dramatically lower ROI versus buying four properties with five percent down.

But now the market is changing. 

As we mentioned, the long-term investor basically shrugs it off.  He knows that weak markets come and go and -- long-term -- real estate is a winning investment. 

By constrast, the short-term investor is facing some very real problems. 

First, sub-prime loans are no longer available for real estate investors.  And second, real estate property values are declining in many of the areas that attracted investment between 2001-2006.  The short-term investor hadn't expected the market to change while they were still in the midst of their "flip".

To impress upon how big of a deal this is, let's look at a "Sunny Skies" scenario for a short-term real estate investor.  We know that most investors have "Stormy Skies", but this is meant to show how all short-term investors are feeling a pinch:

In 2004, a person buys an investment condo in Chicago for $300,000, and mortgages $285,000 with a 3-year ARM that includes principal + interest.

The condo appreciates 4.000% annually and is now worth $338,000.  The mortgage balance is now $275,000.

Today, the home's LTV is 81% and the loan is about to adjust. 

So, for the "Sunny Skies" guy, it looks like everything's coming up roses.  But is it really?

For one, nearly every investment property home loan over 80 percent loan-to-value is going to be considered sub-prime, and the market for those loans vanished months ago.  In order to get out of sub-prime territory, it's necessary to pay down the loan to at least 80 percent.  75 percent is ideal.

Plus, if the investor decides to sell the investment property, he's competing for sales with every other investor nearby that also wants to divest.  The extra supply means lower prices for everyone.  It should also equate to more time on the market.

Meanwhile, the clock on all of those ARMs is still ticking so if an investor has a fire sale just to cut his losses, it's going to drop the value of every other unit nearby.  Ouch.

In other words:

• To remortgage will cost money as a paydown
• To not remortgage will cost money as a mortgage rate hike
• To sell the home will cost money in the form of depreciation
• To not sell the home will cost money in the form of lower home values

Ouch again. 

But, it's not all bad!  Many short-term investors can readily convert their short-term strategy into a long-term strategy by re-assessing their real estate portfolios.  And it starts with the mortgages.

See, in the current market, the biggest risk to a highly-leveraged investor is that there are no highly-leveraged mortgage products available for refinancing.  When the mortgage begins to adjust, therefore, the investor has no choice but to absorb the adjustment.  This impairs cash flow and usually leads to financial distress. 

Probability of Foreclosure: Very High.

This is why the first step to convert a short-term real estate strategy into a long-term strategy is to convert to long-term mortgages.  And, in order to do this in our current market, the home has to become un-highly-leveraged.  This requires the principal balance to be paid down to at least 80 percent, and preferably 75.  With less leverage, the loan is considered less risky and the mortgage moves from sub-prime territory into the conforming world.  Backed by Fannie and Freddie, the home loan programs are plentiful and relatively cheap.

Once the capital is ready, the next step is to remortgage the investment property into a long-term home loan with a lower LTV.  The new mortgage doesn't have to be a 30-year fixed, but it should be long enough to match your long- and short-term investment goals.  Your mortgage planner can help you formulate a plan.

Now, with a long-term mortgage locked in, the long-term payment is locked in, too.  By knowing the payment, you can set a monthly rental price and know exactly how much cash will be required to cover the monthly nut on the home.  Having a fixed cost also helps to build a predictable monthly budget.

Probability of Foreclosure: Very Low.

Yes, the hardest part about converting from a short-term real estate strategy to a long-term one is finding cash for a principal paydown; most people don't have access to that sort of capital at a moment's notice, nor do they know where to find it. 

Surprisingly, most investors ignore the most likely source because -- despite investors' tendency to leverage non-owner-occupied properties -- they don't always take the same approach on the homes in which they live.  The primary residence is an excellent source of capital and the equity existing on paper can be accessed and redeployed somewhere else. 

The same applies for second homes and vacation homes -- the equity is there and is sitting idle. 

So, let's come full circle on this. 

Remember that states, Congress, and mortgage servicers are trying to help homeowners, but not investors.  Therefore, there are loads of mortgage programs available for primary and secondary residences.  Plus, cash out transactions are still be approved to high LTVs.   This means that the equity required to go long on your real estate investments may be waiting there in your own home(s).

Buy-and-hold strategies works in real estate -- we've seen it historically.  In fact, other than baseball, long-term increases in real estate prices has been the one constant in America.  It's this short-term flipping that is causing problems. 

The good news is that with available equity, a real estate investor can change his tune, thereby protecting his assets, his credit, and his investments.

In mortgage planning circles, we call this process "equity repositioning" -- removing home equity from properties in order to meet financial goals.  There are risks inherent in strategies like this and it's not something to undertake on your own.  If you don't have an experienced mortgage planner with whom you work, email me and I'll walk you through it.

(Images courtesy: Captain Zoom, Scout Slides)

Looking For Specific Sub-Prime Mortgage Information?

I get an unusual amount of hits from Google and other search engines for the term "sub-prime crisis", and related phrases.  Maybe that's how you ended up here, too.

About this blog: If you're looking for information on sub-prime mortgages, this category is sorted in reverse chronological order.  You can see my first post on the topic from two years ago, all the way up to September 2007.  I don't blog on it much anymore because there hasn't been much change -- the market for sub-prime loans all-but-evaporated.  So...

Homeowners with concerns about an existing sub-prime mortgage: I encourage you to contact me directly.  The reason I blog is so people like you can get reliable information about mortgages.  If you have an issue or situation you want me to review with you personally, let's do it privately.  My phone and email address are all over this Web site -- don't feel bashful about using them.

Member of the press looking for information, quotes, or statistics, please email me and I will be happy to accommodate you.  The best way to prevent prolonged fallout from the sub-prime mortgage market is to educate the public. I have a lot to say on the matter and believe that the right approach from media can help to soften the impact of sub-prime lending on Americans.

Thank you.  Enjoy your stay at The Mortgage Reports.

More Signs That Liquidity Is Returning To The Mortgage Markets

The worst may be over for home buyers, debt consolidators and other folks in need of mortgages.  That is, unless you're a Michigan fan -- in that case the worst may be ahead.

Author's note: I graduated from Penn State and currently live in Buckeye country. Showing this video is different from publically rooting for the Cubs or the White Sox and alienating half my audience, right?  Isn't it...?  Anyway...

A few interesting notes from last week and today make me think that some form of order is being restored to mortgage markets.

Good News For Mortgages #1: Pricing incentives on jumbo loans

A very large bank is offering pricing incentives for all jumbo, fixed, full documentation loans.  If you meet the criteria below, your rates won't be as bad you may have been told.

• Mortgage greater than $600,000 mortgage
• 30-year fixed mortgage
• Willing to prove income and asset with documentation

So far, I only know one bank that is making this discount available.  You may need to work with a broker to make sure you get it, or hope that you do your banking there.

Good News For  Mortgages #2: Large Alt-A lender places jumbo mortgages in secondary market

IndyMac sold $590 million in mortgage bonds to the markets for the first time since July 19.  About 40% of those bonds were rated "AAA", meaning the risk is deemed to as close to nil as possible.  Only government bonds are rated safer.

IndyMac's placed offerings were for jumbo mortgages.

Good News For Mortgages #3: Foreign National lending pricing continues to improve

Foreign National lending is a niche and one in which I like to work.  It's very encouraging to see that mortgage rates are still improving for this portfolio product.  Lending to a non-U.S. citizen can be a risky proposition for a bank because a foreign borrower has a different incentive system to pay a mortgage. 

If a U.S. citizen walks away on a mortgage from a U.S. bank, getting a loan from another bank in the future is a huge challenge.  For a foreign national, it just means limiting their real estate exposure to the other 193 countries in the world.

Because the risk premium is reducing for foreign nationals from Ireland, England, Spain or wherever, it suggests brighter skies for all mortgage borrowers.

UPDATE: 1:30 ET -- Additional placements reported in secondary mortgage market

From the Wall Street Journal Online, Thornburg Mortgage securitized approximately $1.4 billion in adjustable-rate mortgage loans over the past few days.  Liquidity, it appears, is returning.

Professor J. Randall Woolridge Warned Me About This In Penn State Finance Classes

The screenshot above is from Countrywide's Web site, taken a few minutes ago.  Without context, it seems like a regular advertisement.  Get a 12-month CD issued by Countrywide and backed by FDIC.  Earn 5.65 percent.  Sounds like a good deal.

But, out of context, the ad does us no good. 

In context, let's look Countrywide's offering versus what other banks are presenting for the same FDIC-insured, 12-month Certificate of Deposit.

The chart at right is from Fidelity's Web site.  It shows that eight banks are offering anywhere between 5.000% and 5.150% for the same product.

As Professor Woolridge asked: "What can we infer from the data?"

I hate to answer a question with a question (and especially with a rhetorical question), but what does it say when Countrywide offers a CD yield a half-percent higher than everyone else? 

And then brags about it!

To me, it says that Countrywide is desperate to borrow funds from as many channels as possible and that the company's problems may be deeper than believed.

The company stock is off 42% in the last month, it's tapped an $11.5 billion line of credit recently, and layoff notices began circulating Friday.

And then the story takes an interesting twist when we consider that its CDs are priced so far out of the market. 

Remember: Certificates of Deposit offer an interesting debt opportunity to Countrywide because each "deposit" is FDIC-insured for up to $100,000. 

In other words, even if Countrywide defaults on its CDs, the holders of the CDs stand to lose nothing except the opportunity cost of giving their dollars to the Calabasas-based lender.  The FDIC (i.e. U.S. taxpayers) will replace their "lost" principal balance.

This is a clear case of Moral Hazard if I've ever heard one.  By paying a half-percent more than every other bank on Fidelity's Web site, Countrywide appears to be taking on risk for which they won't be responsible if the company fails.

And this is what Professor Woolridge told us.  Sometimes the bank with the highest yield is the bank with the biggest troubles.

In Countrywide's case, he may have been right again.

The Quick Snap Back To 2002

All around me, I hear screams of panic.  Some with merit, most without.  Yes, the mortgage market turned sour in a very big hurry, but credit standards are still looser than they've been historically and there are plenty of homes for borrowers-in-need (pardon the pun).

The products getting flushed right now are the high risk loans that would never have had a prayer six or seven years ago.

Check out the two charts above (grâce à Kit Mueller).  The top chart shows how loans were split on a dollar-for-dollar basis in 2002.  The bottom chart shows last year.

In the current market, sub-prime and Alt-A loans are history so it's likely that we'll snap back into some 2002-like form until debt issuers can figure how to properly price risk.

After that, it should be a slow crawl back for the sub-prime and Alt-A markets.  But rest assured -- so long as there are creative mathematicians on Wall Street, there will be debt instruments available for the tenants of Sub-Prime and Alt-A-ville.

It just may not be for a few months, or even years.

(Images Courtesy: Real Estate Charts)

Fed Fund Futures Go From 0 to 100 in Six Weeks

This graph is from the Wall Street Journal and shows how the stock market's losses last week may lead to lower mortgage rates.

Translating the graph:

• The Plunge represents expectations that the Fed will lower the Fed Funds Rate. 
• The colors represents the date of the Fed meeting at which the Fed is expected to do it.

If the Fed lowers the Fed Funds Rate, it usually signals that the economy is slowing down, or that inflation is less of a worry.  Because inflation is the enemy of mortgage bonds, less inflation means good news for mortgage rate shoppers.

Mortgage rate movements are based on expectations of the economy's path and this explains why mortgage rates were increasing from March to June, and why rates idled from June through the end of July.  Mortgage rates have somewhat followed the same path as the colored lines.

In the graphic, as soon as the colored lines pass the -100% marker, it means that the likelihood of a drop in the FFR are 100%.  An absolute certainty (according to traders).

So, on June 15, the probability was 0%.  On August 1, the probability is 100%.  That's a pretty big deal considering that there hasn't been any data to prove that the economy is slowing at a rapid pace.

This is all fallout from the credit markets.

For now, the Fed maintains that it's still focused on fighting inflation.  The markets, however, seem to be betting otherwise.

(Image courtesy: The Wall Street Journal Online)

The Biggest Banks Are Eliminating The Most Prevalent Sub-Prime Loan

One more sign that the sub-prime apocalypse is upon us...

Washington Mutual, Countrywide, Wells Fargo, and Merrill Lynch's First Franklin all recently announced the discontinuation of the staple 2/28 sub-prime mortgage product. 

The "2/28" is an adjustable rate mortgage in which the interest rate remains fixed for two years, and then adjusts for the loan's remaining 28 years.  Think of it like a 2-year ARM, if that helps.

But that's not the end of the changes. 

WAMU and First Franklin took it a step further, eliminating the 3/37 from their respective sub-prime product menu altogether.

Because the four lenders named above are the market leaders and are major buyers of sub-prime loans nationwide, expect other sub-prime lenders to follow their lead very, very soon.  I won't document the list of lenders, but just be aware that's happening.

As it has been since September 2005 when sub-prime first exploded, life as a sub-prime borrower is a challenge.  The importance of keeping your finances in order cannot be underestimated. 

One missed mortgage payment, or a late credit card bill won't do you in, but a series of them will because that is one characteristic of a sub-prime credit profile.

Look, folks, sub-prime mortgages are not designed to be long-term solutions.  The proper use of a 2/28 is to apply it to reach a short-term goal (i.e. pay off debt, purchase a home) and then manage and monitor your finances to get "a better loan" as soon as possible. 

Sub-prime mortgages are stepping stones into Conforming World and nothing else.  Sub-prime homeowners should approach their sub-prime loans as their gateway to a better financial life.

If you believe you are a sub-prime borrower, speak with your loan officer and/or financial planner.  If you don't have a plan to exit the sub-prime arena, make one -- your ability to get a sub-prime home loan in the future will certainly get harder before it gets easier.

Sub-Prime Loans: An Endangered Species

As the Bald Eagle removes itself from the Endangered Species list, sub-prime loans may be replacing it. 

Bear Stearns is (was?) a leader in sub-prime mortgage markets and it recently announced that its investors in its highly-exposed-to-sub-prime-loans funds are now holding paper that is virtually worthless. 

Several months ago, the value of the combined funds was approximately $1.5 billion, according to the L.A. Times. 

Today, the assets in the funds are failing so rapidly that there is almost no demand for them at all.  No demand = no value.

I wish I had an analogy to make this easy to understand for the average person, but I can't think of anything with the same gravitas.  Therefore, here's the plain English version:

Investors liked sub-prime loans for two reasons: 

1. They offered higher rates of return (read: mortgage rates) than other home loans
2. They didn't default as often as expected while home values increased nationwide

Because they didn't default, investors wanted more of them so Wall Street made more of them. 

When home values stopped rising, sub-prime lending reversed course and began to default at a rapid clip.  Suddenly, the rates of return were not high enough to compensate for the risk.

Rather than hold a worthless asset, some investors sold the loans for less than "face value".  This is akin to selling a home for cheap in a down market because you'd just "get it off the books" and move on with your life.

Others did not sell -- they bought.  Bear Stearns is one of those others.  Says the L.A. Times, they added to their losing bet to the tune of $20 billion.

Now that Bear Stearns' funds have collapsed, the next investor will be gun-shy because of risk and the only way to compensate somebody for risk is to pay them handsomely.

As a homeowner, this means that sub-prime loans are about to get even more expensive, if you can believe it.  12 percent may be just a starting point for some folks -- or there may not be a starting point at all.

(Image Courtesy: RLRouse.com)

Lest We Think Nobody Cares About Sub-Prime Lenders Anymore

After the Q1 blowouts of New Century and Fremont, fellow Orange County and former high-flying Accredited Home Lenders just agreed to be sold for $400 million.

I never worked with Accredited personally, but my peers recount tales of two tactics used to increase its loan portfolio value for Wall Street investors.

1. Selling 2-year ARMs with 3-year prepayment penalties
2. Adding nine-thousandths (0.009%) to every interest rate in a loan bundle.  7.99% became 7.999%, for example.

I am sure other lenders used these tactics, too.  I just never saw it.

The sale of Accredited Home Lenders reminds us that there is still a fair amount of contraction coming in the sub-prime lending space.  In the end, it adds up to fewer choices, more stringent guidelines, and higher interest rates for consumers.

Looking back at my August 2005 purchase files and I see a client that bought a home using an 80/20 sub-prime scenario.  The details were:

• Full documentation of income
• Salaried employee
• 661 FICO score
• Single Family Residence
• 2/28 ARM with interest only
• $204,000 first lien; $51,000 second lien
• No prepayment penalty

The financing broke down as 6.77% for the first lien.

Today, the same lender doesn't even offer the product above; 95% combined-loan-to-value is their maximum.  At 95% CLTV, the rate would be 9.60%.

Again, fewer choices with tougher guidelines and higher rates.  The market for sub-prime clients is tightening and with each lender's passing, it will be more difficult for current sub-prime borrowers to remortgage into a new home loan.

If your current home loan is sub-prime -- fixed or adjustable -- do the safe thing and call your loan officer for a mortgage review.  Better to act before you run out of options completely.

As GM Says Sub-Prime Lending Is Hurting Sales, Toyota Posts Its Best Month Ever

This quip yesterday from the Washington Post story, GM's Lutz says mortgage 'meltdown' hits auto sales:

[GM Vice Chairman Bob Lutz] expected the whole automotive sector would feel the impact of the stress on the housing finance market.

"The market as a whole has been a little weakish... as a result of the housing market problems and the mortgage industry meltdown."

Monday's comments from Lutz followed other cautionary remarks from GM executives on the expected impact from the subprime mortgage crisis on the world's largest automaker.

Then, today's headline about a GM competitor : Toyota Reports Best Sales Ever.

"Toyota today reported all-time best-ever monthly sales of 242,675 vehicles, an increase of 7.7 percent over March 2006."

Nothing has changed since yesterday in the sub-prime lending arena, so what gives?  Why is GM saying that the housing market will hurts its sales hurt while Toyota posted its best month ever?

Clearly, there is more to this analysis.

The issue with GM (and Ford and Chrysler, for that matter) is not that sub-prime mortgage lending is hurting car sales -- Toyota can refute that claim on its own.  The issue is the same issue as anything in sales: People want to buy a good product at a fair price.

An Expectation Changing Week Lies Ahead. It's An Arm Jerker.

Expect a wild one this week, folks.

Sub-prime mortgage news dominated the headlines this past week and a lot of ink was wasted on the topic. 

At this point, the casual observer and/or mortgage rate shopper should not be concerned with the fallout from sub-prime lending -- he should be concerned with the shifting landscape in the markets.

Remember that mortgage rates are -- in some sense -- a prediction about how the economy will fare over the next x years.  When those predictions change, so do mortgage rates.

That's why this week could be very ugly, or very pleasant for rate shoppers. 

It all depends on how markets view soon-to-be-released housing data and the words of the FOMC.

The most major expectation setter this week is Wednesday's Federal Open Market Committee meeting.  The FOMC will discuss U.S. monetary policy then issue a press release that will be heavily scrutinized by global investors.

Investors expect that the Fed will leave the verbiage from their last meeting unchanged.  In that press release, the Fed stated:

Recent indicators have suggested somewhat firmer economic growth, and some tentative signs of stabilization have appeared in the housing market. Overall, the economy seems likely to expand at a moderate pace over coming quarters.

The key phrase "tentative signs of stabilization have appeared in the housing market" is a biggie and markets will look for some rehashing of the same sentiment.  Stable housing means that economic growth will continue at a manageable pace.

However, there are a growing number of economists who think housing may be slowing down the economy.  Those in this camp believe that the Fed may allude to sub-prime mortgage defaults and the negative impact that it may have on the national housing picture.

Text like that would drop mortgage rates, if only for a short while, while markets try to guess the Fed's next move -- raise the Fed Funds Rate, hold it steady, or drop it?

The other expectation setter this week comes in two parts: Monday's Housing Starts data and Friday's Existing Home Sales data. 

Markets will be looking at both of these figures to see if sub-prime mortgage defaults spilled over into builders' development plans and the general housing market, respectively.

Similar to the Fed's press release, investors will be re-setting their expectations for the future direction of the economy based on the data contained in the reports. 

This will be a volatile week for mortgage rates with so much uncertainty ahead.  Be prepared.

(Images Courtesy: National Western, Wall Street Journal)

You Can't Stop Duke or the Sub-Prime Shakeout. You Can Only Hope To Contain It.

Anyone care to hazard a guess -- which is more likely?

1. The Kansas Jayhawks choke in the NCAA tournament
2. Creditors for Accredited Home Lenders choke the sub-prime lender's credit line

What about this match-up?

1. The Big 10 once again shows that it's the most over-hyped hoops conference in the country
2. The NAR shows that it's the most over-hyping organization in the country

And, lastly: what qualifies as the best shot ever?

1. Christian Laettner's turnaround jumper at the foul line against Kentucky?
2. Economist Douglas Duncan on Senator Dodd's plan to protect defaulting homeowners with a federally-funded "cash stash"

Discuss amongst yourselves...

How Sub-Prime Markets Are Turning Into Celebrity Magazines

 
10 years from now, which Britney will we remember? The "good ol' days" version, or the one that replaced it?

Sub-prime lending is the Story du Jour for the MSM.  You can't open a newspaper, or turn on the news, or talk to a neighbor without something related to sub-prime lending coming up.

"Homeowners bit off more than they can chew and now they're feeling the repercussions."

"The lenders gave money to borrowers with shaky credit and these people should have never been approved in the first place."

"The worst is yet to come.  Housing's rebound will be wiped out completely."

It seems everyone has an opinion about sub-prime lending this past week and it's media saturation at its best.  I asked you earlier this week, "Tired of Sub-Prime News Yet?"

I hope the answer is "no".

Over the next several months (and maybe longer) sub-prime lending and the companies that engaged in it will get dragged through the mud and then held up to the spotlight by the media and by our government for all that has transpired since January. 

This is the same market sector that was hailed just three years ago for adding tremendous amounts of liquidity to the housing market and showing more Americans the path to homeownership.  Wall Street was making a mint and everyone was happy.

Today?  Not so much.

The finger pointing in the sub-prime shakeout/crisis/tsunami/meltdown has already made its way to Washington D.C..  Care to blame the Federal Reserve?  Take a number.  What about using taxpayer money for a bailout?  Not if Douglas Duncan has a say.

We get it.  Sub-prime lending is a national news story, but can't we get a reprieve?  Do they have to talk about it all the time? 

I am hoping somewhat that the Anna Nicole Smith stories find their back to the spotlight.  Or, maybe we'll hear something new about the Runaway Bride.  Just something to create new Page 1 news.

Heck, even Britney.  She's been pushed to the :22 minute of the news while sub-prime mortgages take her rightful place as the headline story.

What is this world coming to?

See, because like Britney, or like Anna Nicole, or Paris, or Lindsay, or Tom and Katie, we're tired of hearing about it, and yet we can't quite look away.  Like the proverbial train wreck.

And that's why sub-prime lending is resembling celebrity news.  Every day, it's the lead story whether you still care about it or not.  And all the while, the images and stories are being burned into your subconscious and opinions are being formed -- right or wrong.

Years later, what will our opinions of sub-prime lending be?

Will we all remember it for its early work in 2001-2005 and the good it did for homeownership and credit markets?  Or, will we remember it for the crash of its later years in 2006 and beyond and the carnage left in its wake?

If we can debate this on Britney, why not for 100% W2-stated deals on second homes?

Inman News Covers "Subprime Tsunami"

Inman's Matt Carter just penned Subprime tsunami threatens to extend housing downturn (subscription required), an article that discusses how everyone from home owners to Wall Street are dealing with the seismic shift in sub-prime lending.

Matt phoned me for a quote or two about what I am seeing on the streets:

"It's a cycle -- loans default and the risk goes up," said Chicago-based mortgage planner Dan Green. "Wall Street demands a higher return, so lenders have to increase their interest rates. That causes more defaults, because more people are stretched, so rates go up again.

"What's making this cycle a little interesting," Green says, "is that [lenders] are trying to reduce risk by reducing the pool of people they will lend to."

Aside from me ending a sentence in a preposition, well said!

Tired of Sub-Prime News Yet?

Well, it's the story three years in the making.  Hope you're not bored by it yet.

The latest chatter in markets is how rising sub-prime mortgage defaults will create additional home supply via the foreclosure process, thus kicking the housing market's rebound clear in the shins.

Weak housing leads to weak spending and the U.S. economic engine starts to sputter.

Look, folks.  The sub-prime story is everywhere and there's a lot of talk on both sides of the aisle. 

The truth is that there are more questions than there are answers right now, and it will take months (or years?) to find out just how big of an impact the sudden sub-prime market implosion will have on housing and on lending standards.

My advice is free, so take it for what it's worth, but current sub-prime borrowers with adjustable-rate mortgages should call their mortgage lenders and ask about remortgaging the home into a fixed rate mortgage while products are still available. 

Think of it like playing from the deep sand. Sometimes, you're better off playing it safe by taking a drop.  It's better to lose one stroke and get a good lie than to risk two or more shots in hopes of a look at the green.

Metaphor over. 

Yes, by switching to a 30-year fixed mortgage, the monthly payment will be higher.  But at least you can go to bed each night and know what your worst-case payment scenario is going to be for the next 30 years. 

Your payment will never be worse than it is on the day you close.

Meanwhile, if credit profile your improves over the next several months or years, you can always remortgage into a different home loan with more favorable terms.  But, at that point, it will be a choice for you -- you won't have to do anything.  Your mortgage, remember, is a fixed-rate mortgage and your payments are unchanging.

Like Me And You, Sub-Prime Lenders Have Credit Limits

Turbulence in the sub-prime lending market forced several big name lenders to shut their doors to business in recent weeks.

In a healthy sub-prime environment, institutional investors buy mortgages in large bundles called "pools" from sub-prime lenders.

The current environment is not healthy, however.

Loans are defaulting more quickly than in the past and investors are requiring that the sub-prime lenders "buy back" the bad loans instead of including them in the loan pools.

Unlike a traditional bank, sub-prime lenders don't typically have a deposit base from which to make loans; the lenders often use a bank-issued credit line which carries an interest charge for every dollar used.   

As a result, the bad loans sit on the books while the lender is forced to pay interest on them.  To add an additional challenge -- just like you and I have limits on our credit lines, so do sub-prime lenders.

So, with enough bad loans hanging around, the lender may be paying interest on the loans nobody wants and may be maxed out on their credit line.  This can generate a tremendous loss for the lender who may have no choice but to sell the bad loans for cents on the dollar and/or exit the business altogether.

This is a simplification, of course, but if the default trend continues, more sub-prime lenders will find themselves in a similar pinch in the coming months.

Why Money Left Stocks And Got Picky About Bonds

This graphic from the Wall Street Journal shows last week's losses across a few of the world's major stock markets.

Money leaving stocks has to go somewhere and investors have two choices:

• Hold the money as cash
• Invest the money in bonds

Usually, investors don't want to be on the sidelines.  So, they will often take the proceeds of a stock sale and use it to purchase bonds.

Remember that mortgage rates are the by-product of prices and yields in the mortgage-backed securities market.  When demand for bonds increase, it drives up the price and drives down the yields.

This is why rapid stock sell-offs often lead to lower mortgage rates.

This past week was a little bit different, though. 

Despite the worldwide losses, mortgage rates decreased only about 0.04% on average, according to Freddie Mac's weekly survey.

The benchmark 10-year treasury note, however, dropped 0.165%.  This is the biggest gain in over five months for the treasury market.

Investors chose to park their money with the U.S. government last week and that reminds us that one very important fact about the oft-confused bond markets:

U.S. treasuries and MBS tend to move in the same direction, but treasuries cannot be used as a predictor of mortgage rates, nor can they be used to price mortgage loans.  Only the mortgage-backed securities market can be used to price mortgages.

One major reason why treasuries excelled while MBS markets laid flat is because investors are concerned that sub-prime lending's carnage will spill over into other mortgage markets.  That renders mortgage-backed bonds much more risky than in weeks and months prior and, in a period of volatility and uncertainty, the markets turned to Washington D.C. for safety.

Source
Out of Stocks, And Into...?
E.S. Browning
Wall Street Journal Online, March 5, 2007
http://online.wsj.com/article/SB117304961563826411.html?mod=home_whats_news_us

Fremont Shuts Down

I just got an email from a friend at Fremont Investment and Loan that their doors have closed. 

There was a lot of rumor surrounding this story as of Friday afternoon; that possibly Fremont would be bought by a Wall Street bank.  Apparently not.

What's Left on the Sub-Prime Lending Menu? Not Much.

Reflecting the tough times still ahead for the sub-prime lending sector, I received an email from a sub-prime lender this morning listing all of the scenarios that are "still can dos".

The list is decidedly shorter than what loan officers and homeowners have seen in recent years.  Heck, it's even much shorter than what we all saw prior to January 8.

USA Today ran a story about how homeowners are trouble now, too, as lenders tighten up their guidelines.  Unfortunately, McPaper highlighed a family stretched too thin from their most recent home purchase.

"I don't know what I'm going to do," says Furakh, 24, who was bathing and feeding her two daughters after work. "I'm trying to work on my credit, but sometimes you can't be that good. I've got two jobs. I've got two kids. Sometimes, I am just late."

Just to rehash an old SNL skit: don't buy stuff you can't afford, folks.  Being late on your mortgage makes it much harder to escape sub-prime borrowing.  Don't be late on your mortgage.  Fannie Mae and Freddie Mac don't have much tolerance to insure loans for homeowners with poor payment histories and the credit bureaus agree. 

If you think you're going to be late, contact your lender.

Sub-Prime Coverage Goes Mainstream

Sub-prime lending is the topic du jour among financial reporters and I am fielding many, many phone calls about it.  In the past few days, Bloomberg, Chicago Tribune and Inman News all came calling for input, among others.

Rather than me put me my own spin on it (like I have been for the past 16 months), I'll leave it to you to sift through some of the headlines:

• Lenders tighten standards on subprime customers, Holden Lewis, Bankrate.com
• Fed: Use caution in sub-prime mortgages, Marcy Gordon, Business Week
• Countrywide Says Late Payments on Subprime Loans Rose, Bloomberg, Will Edwards and Jody Shenn
• Subprime Lender New Century To File Annual Report Late, CNBC

There's also been considerable blogging on sub-prime mortgages.  Check it out on Technorati.

Monday Market Notes

A few casual observations on the market over the past few days:

Observation #1: Alan Greenspan has really lost his juice. 

The Maestro says in plain English that a recession is possible -- nay, likely -- and the markets barely bat an eye.  This is the man that once moved markets with a single word.  This reminds me of when Stan Ross stepped back in the batting box after nine years.  He looked the same, but the fear he invoked in others was gone.

Observation #2: Iran is a mortgage rate wild card

Iran has said that they can't "turn off" the nuclear program that they've started.  Some folks in international political circles think that the United States is planning a strike.  This is creating a subtle flight-to-quality in the markets right now and is putting downward pressure on mortgage rates.

Observation #3: Sub-prime lending fears are misdirected

Sub-prime lending is getting a ton of press right now but the focus is on credit quality and the "contagion" into other lending market.  It won't happen.  More importantly, the Human Interest story is getting missed.  There will be more than a few tales of homeowners that couldn't remortgage out of their adjusting mortgages because their individual credit profile is no longer served by Wall Street.

Observation #4: Humiliation can be a great teacher

If the airline industry can be embarrassed into self-regulating, why not the mortgage industry?

Fremont Drops 80/20 Combo Loans

Between the Wall Street Journal and Bloomberg, there must have been 10 separate articles, charts and Op-Ed pieces about trouble in the sub-prime lending sector. 

Companies like HSBC and New Century dominated the headlines and none of it was good news for sub-prime borrowers.

Today, I received an email from Fremont Investmont and Loan that says the lender is no longer offering 80/20 combo loans, recommending instead that brokers instead use 100% "one loans".

In isolation, this is no big deal but when you group together all of the news coming from lenders' headquarters, it's frightening.

When the sub-prime shake-out is through, the stockholders of these publicly-held companies won't be in nearly as bad of shape as the homeowners that were on the fringe and secured financing two years ago. 

Today, the fringe folks no longer meet any lender's underwriting guidelines.

Faced with the option of remortgaging, or allowing their interest rates to adjust 1.5% higher every six month, these folks may have no choice but to go with the latter; there may not be a mortgage product on which they'll qualify for new terms.

Fremont's move is just one more step away from the ledge for sub-prime lenders.  Expect others to follow suit soon.

Another Sub-Prime Lender Narrows Its Lending Guidelines

Another day, another sub-prime lender getting tough on guidelines.  This time, it's New Century.

In an email titled "Guideline Changes on 1st Time Homebuyers", a New Century employee advised that effective immediately, New Century will no longer allow first-time homebuyers to finance more than 90% of a home's value if their income documentation is considered "W-2 Stated".

"W-2 Stated" means that the borrower's income is not verified by the underwriter and the borrower is a full-time employee somewhere. 

W-2 Stated is very different from "Self-Employed Stated".  When people are S/E Stated, it's usually because their income taxes include write-offs associated with their business.  This makes their reported income calculate lower their actual income.

With W-2 Stated, it is generally the exact opposite.  Applicants (and their brokers/bankers) usually state their income higher than their actual income in order to help them qualify for loans.

This is a practice that is drawing scrutiny in Congress right now.

According to the email, New Century is making this change because W-2 Stated loan "are not performing well".

Sub-Prime Lenders Make Drastic Changes To Stay Afloat

It may be a nice day at "the beach", but the storms are rolling in.

Washington Mutual-owned Long Beach Mortgage announced yesterday that it's underwriting guidelines are changing, effective Monday, January 8.

I posted a portion of the fax Long Beach sent to me so you can see it for yourself.

When a mortgage lender says that it will be "implementing new underwriting guidelines", it's a fancy way of saying that the pool of eligible applicants will be narrowing.   This i because underwriting guidelines are really just a set of rules for approving mortgage applications.  If an application meets all of the conditions that the rules set forth, the lender will lend on it. 

For example, some sub-prime lenders have guidelines that state if a first-time homebuyer wants to purchase a home with no downpayment (i.e. 100% financed), he must have a history of managing at least three separate credit accounts for at least the last 24 months.

Other sub-prime lenders do not have the minimum tradeline requirement -- but may require something else such as a minimum credit score, or work history.

This is one of the areas in which Long Beach is expected to restrict their borrower profiles.  Another area is to limit the combined loan-to-value for mortgage applicants for whom income is stated.  Long Beach currently requires a 640 FICO score to go 100% on stated applications.

Long Beach Mortgage is the same as other major sub-prime lenders in that it operates as a product distribution channel for a supplier. 

The suppliers of money/product are large financial firms such as Merrill Lynch or Goldman Sachs and these suppliers send their product through multiple channels, much like Fox sells the season DVDs for 24 in Wal-Mart, Best Buy and Circuit City.

So, when Long Beach says that their underwriting guidelines are changing, it really means that their money sources are trying to reduce their overall mortgage portfolio risk.  Long Beach's new "rules" will prevent the riskiest borrowers from borrowing money which will improve the overall asset of the loan pool, thus earning a higher return for Wall Street.

The failure to change guidelines fast enough is one of the reasons why Ownit Mortgage and Mortgage Lenders Network had to close their doors.  Guidelines were very loose and many risky borrowers were able to get money for ther homes.  That is not a bad thing, of course, but when the market shifted, these lenders will left with bad loans. 

Expect to see more lenders to make headlines as the follow Long Beach's lead in the coming months.  The ones that don't may make a different kind of headline.

Source
Fox Broadcasting Company : 24
http://www.fox.com/24/

How To Keep A Cleared-to-Close Loan From Funding

Three quick stories of sub-prime mortgage lenders shutting their offices in recent weeks.

Mortgage Lenders Network, originator of $3.3 billion in loans in Q3, shut its doors Tuesday, stating that "the economics of this market are not good".  Either way, MLN is going out in a blaze of glory, taking everybody and everything with them.  According to Bloomberg, MLN refuses to fund loans that were already cleared-to-close.  Not only are clients are out of luck, but brokers must be mighty angry, too, that their chosen lender for the client made them look like a complete jackass. 1,440 employees were "temporarily furloughed" in the move.

Ownit Mortgage filed for Chapter 11 Bankruptcy last week, only a few weeks after it stop originating loans.  It is presumed that Ownit's investors wanted Ownit to buy back loans that defaulted on their first payment (i.e. bad loans) and Ownit didn't have the assets.  Ownit cited "unfavorable market conditions" as their reason for shutting down operations in December 2006.

Sebring Capital closed down in December, too.  Sebring was not a major player, but employed 325 people.  The company spokesperson said that a combination of market forces contributed to the closure.

Each of these lenders is citing "market conditions" as the reason why they are shutting down but the real problem lies in management.  Strong management beats bad market conditions, much like Rock beats Scissors.

The markets were strong in 2002-2005 and almost every sub-prime lender made good money.  When revenues are strong and margins are high, managers tend to overlook business process inefficiencies.

When markets tank, however, margins shrink and companies that were once making multiples on the dollar, now earn pennies on them.  Those same inefficiencies that were once ignored can now exert their influence on a company and bring it down to size.

That is exactly what we're seeing right now. 

Expect more and more sub-prime lenders to shut their doors in the coming months.  We talked about this last year, too -- 12 months almost to the day -- you'd think that they'd have an Internet connection in that Ivory Tower so somebody could read my blog...