by Steve Friedman, Vice President of Sunshine Mortgage Corporation
By now, everyone in America is familiar with the subprime mortgage meltdown and its after-effects on the housing market. As discussions arise, there is a tendency to point the finger at mortgage companies and loan officers for making ‘bad loans’. While some companies may have promoted and encouraged their employees to sell exotic loans for their own gain, it ignores the complexity of the problem and the consequences for borrowers as we go forward.
First, many of these creative loan products were created by large Wall Street Brokerage firms who gained tremendously by supplying the funds and then packaging the loans for resale to pension funds, mutual funds and others who believed they were buying safe, guaranteed mortgage products. The same firms buried risky loans with good loans to sell the products for the highest prices. Second, the rating agencies we all rely on to grade products for safety and risk failed to accurately assess these products or assign risk and gave out many AAA ratings. The ratings agencies and brokerage firms will face litigation for years to come for their part in the subprime story.
Third, we have to acknowledge the consumer who created the demand for more and more products which ignored the basics of sound lending practice. Fifty years ago, the consumer who wanted to buy a home worked hard to save funds for a down payment and build a solid credit history. This consumer sought to purchase a house that he or she could truly afford. Banks scrutinized the creditworthiness of an applicant who would be borrowing funds from the bank’s deposits. Banks understood that homeownership required a commitment to be responsible, and that homeownership involved years of payments, home repairs, and unexpected expenses which go beyond the excitement of closing day.
Fast forward to 2004, and we have an environment where buyers with sketchy jobs, poor credit histories, and no savings are lining up to buy $200,000 homes with nothing down and fill these homes with electronics and appliances, all due to easy credit. Although some blame can be assigned to mortgage companies who provided the loans, the evolution of this easy credit could not have occurred without the help of the Federal Reserve who kept rates artificially low, Wall Street firms and others who provided the funding and creative products, and rating agencies who failed to assess the quality of these mortgage products. Ultimately, the consumer has to accept final responsibility for applying for and accepting loans for their purchases.
The question which has been poorly addressed is: where does the mortgage meltdown leave us now? Does it affect the average borrower with good credit? What are the effects on housing?
First, much of the funding for subprime products has disappeared. Many mortgage companies who focused on poorly qualified buyers found themselves suddenly broke as their Wall Street funding disappeared. These companies were asked to buy back their bad loans which led to companies going bankrupt in unbelievably rapid succession. The Wall Street firms stopped loaning funds as it became apparent that they couldn’t package and resell these products to anyone.
Almost overnight, the funding for subprime products was gone. Then the funding for other mortgage products suffered as the risk in making each kind of loan was re-evaluated. It became apparent that adequate risk had not been priced in the interest rate of many products and for a short time, jumbo interest rates soared. In time, the interest rates have returned to more normal levels BUT the interest rate a borrower pays will be affected by his credit history. Current borrowers will probably find themselves asked for more information, and will discover that good credit results in obtaining the best interest rates. Conversely, borrowers with poor credit histories will be asked to pay higher rates for their loans.
The first time home buyers of today will still find programs with no money down, if they are qualified; but higher risk clients asked to pay higher rates will not be able to qualify. The effects on homebuilders has been evident for some time, as sales have dropped dramatically. Many of these builders grossly overestimated demand and have since cut back. The resulting foreclosures of consumers who could not afford their mortgages has resulted in more homes being added to the inventory of unsold homes.
As a lender, I am frequently asked why we can’t help the many people facing pressure due to repriced ARMS. Unfortunately, many of these borrowers have no equity (and their home may even be worth less than the purchase price) so they can’t qualify for new loans. Some large servicers have agreed to move these buyers to fixed affordable products. Some consumers are hoping for a government bailout. The effects on the housing market will take time to resolve.
For the consumer, I cannot stress enough the importance of dealing with a loan originator who will assess your needs on an individual basis. Many consumers have been empowered by the internet to learn about available products and pricing; and they prefer to make their own choices. Many consumers view mortgage products as commodities, and have not consulted with a mortgage professional. However, a home purchase is the largest item you can buy. There may be many options available to the homeowner which have never been explored. I have talked with borrowers who spent extra money to refinance when they could have achieved the same goal by making extra principal payments. Consumers who buy off the internet may acquire their intended purchase, but be uninformed about other choices.
Myth #1 Consumers can often find internet banks with no overhead who make great deals. Even internet banks have overhead and may not have the best rates. Customer service reps may have little mortgage experience and training to help you with your specific issues. You may get the loan you are shopping for, but is it the best loan for you? And, if a loan sounds too good to be true, it probably is.
Myth #2 Consumers can go to sites where many banks list their rates on different products. You can shop price yourself or submit information and have lenders contact you. The best rates are on the internet.
These sites are not impartial informational sites. Each bank you see listed has paid a large monthly sum to be listed. These lenders all pay a fee to be seen or receive your name as a lead. There is no guarantee you are hearing from the 4 best priced companies. Often, lenders list rates that few buyers actually receive, usually the best rate on a conventional fixed mortgage with an excellent credit rating. Once a consumer calls a listed company, it is not unusual to find that the rate is actually higher due to credit quality, price of the home, etc, but you have been teased with the lower rate. And, a majority of these firms are brick and mortar firms who are simply using the mortgage sites for internet advertising.
Myth #3 I hear these ads on the radio telling me I can refinance with no closing costs and save money.When a lender doesn’t charge you closing costs, the costs are still there but in a different form. The lender can charge you a higher rate than he is paying. But somewhere, the costs are paid for. How long would your business last if you worked for free? Always compare quotes carefully between lenders. Do business with someone who can adequately assess your needs and not just sell you a loan.
Myth #4 I can save money getting an ARM product or doing an interest-only loan.
There are times when different products can provide significant benefits. These past few years, the rates on ARM products have been slightly better than fixed rates and offered an alternative for buyers who were planning to live in their homes for a limited number of years. Buyers who used ARMS to buy more house than they could afford are now being squeezed as their ARM loans adjust. Shopping rate at the expense of product can be costly in the long run.
As you work your way through the home purchase process, know the qualifications of your lender and his company. Take the time to discuss all of your options and take the best choice for the long-term. Although the current problems with lending may require a stricter application process, it will hopefully prevent headaches for buyers in the future.