Archive for March, 2007

Trickle-down-sub-prime-meltdown-nomics

March 30, 2007

The sub-prime mortgage market meltdown continues to make headlines on the internet and in the media,  and the fallout continues to shake-up the mortgage world.  I myself, have never been a big-fan of sub-prime mortgages.  In general, I think that sub-prime mortgages are a decent tool to be used for a specific borrower under specific circumstances.  And to make a long argument short, in comparison, a lot of people who (unfortunately) have been placed into a sub-prime mortgage would have been much better off (and better advised) to have rented for 12 to 24 months, taken the time to get their finances and credit in-order and then moved forward in purchasing a home (at a reasonable rate and program).  For more on sub-prime mortgages, read last week’s post.

The melt-down of the sub-prime mortgage business has had, and will continue to have, an effect on the mortgage and housing markets as a whole.  And when things start to melt-down (like the ice-caps for instance . . . or are they?), people start to get all kinds of (read: crazy) ideas and theories.

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Note:  This photo has the earth facing right-side up, thankfully

Here are a few theories that you can count on . . .

1. 100% mortgage financing guidelines will tighten across the board — although the recent problems have been mainly from low credit score, high-risk borrowers, investors who back mortgages are not as excited about 100% financing options to borrowers.  Over the past few years, guidelines for 100% financing have become increasingly inclusive and the difference between a rate with 5% down and 0% down has become smaller and smaller.  As a result of the problems in the sub-prime market (and the fear that similar problems will eventually come to bear in A minus, Alt-A and A-paper loans, first mortgages with 100% loan-to-value (LTV), and/or 2nd mortgages with 100% combined loan-to-value (CLTV) will steadily become harder (more exclusive) for marginal to average borrowers to obtain.

2.  The Feds will not lower the Federal Funding rate due to problems in the sub-prime mortgage business.  The Feds number one job is to control inflation, and one of their favorite measures of inflation is the Personal Consumption Expenditure which came out today showing that inflation increased by 0.3% in February.  This increase (the largest since August) came in above expectations of 0.2%.  Year-over-year core rate rose to 2.4% — well above the Feds target PCE of 2.0%.  Don’t expect a Fed rate cut until this numbers sits below the 0.2% Fed-target for consectutive months.

3.  The US Government (along with the un-helpfulness of the media) will try to figure out why all this happened, why the debacle, who is to blame, etc.  And in the process, the general public will be reminded of how working with a mortgage professional is much  different than working with a guy (or gal) who simply “does” mortgages, and will hopefully be reminded that the best interest rate is not always the same as the best mortgage. 

Along that same thought I am reminded of the great words of the late President Ronald Reagan, “The nine most terrifying words in the English language are, ‘I’m from the government and I’m here to help.” [end quote] 

Hi Mr. and Mrs. 580 credit score, my name is a 2/28 ARM, I’m from the sub-prime mortgage world, I have a 7.25% margin, a 12 month LIBOR index, and a 2 year pre-payment penalty . . . and I’m here to help (well, not really).

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The Sub-prime Mortgage Meltdown

March 19, 2007

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Someone had to know that this was going to happen.  Certainly, someone could look at the inherent risk associated with borrowers with huge red flags, huge layers of risk and know that eventually it would catch up with the industry and create a serious problem.  Apparently, no one (or at least not enough people) thought it all the way through . . . and the lenders that were making lots and lots of loans (and great money — who can’t make great money when you are charging rates at 8.5% or 9.5% on 2 year adjustable rate mortgages with big $$ pre-payment penalties) are the same sub-prime lenders who are now closing their doors and going out of business. 

So what is a sub-prime loan?  and why all the trouble?

 Sub-prime mortgages have been around for years.  Any loan that doesn’t fit into the category of an “A” borrower (recent credit problems, bankruptcy, collection accounts, past foreclosures, etc) can get an alternative loan using a sub-prime mortgage product.  Most of these products are meant to be short-term solutions or what is sometimes referred to as band-aid loans.  A borrower with past credit problems can purchase a house (with a higher interest rate and possibly a higher downpayment requirement), keep the loan for two to three years and then refinance out of that loan into a loan with more favorable terms.  Most sub-prime loans are short-term adjustable rate mortgages (fixed for only two or three years), which then adjust after the fixed term.  If advised correctly, these loans are perfect for borrowers who have had credit issues in the past and are in the process of re-building their credit and getting their finances back in order.  They can purchase a house now (taking advantage of the tax deduction of owning a house as well as the other benefits of owning versus renting) . . . and after two years, their negative credit is that much further behind them, and with a 24 month perfect mortgage payment history and other re-established credit, they can refinance out of their higher interest rate loan into a conforming “A” borrower loan immediately after the pre-payment penalty expires.

In the past few years, investors had become more and more aggressive as to their credit and financing guidelines . . . allowing borrowers to purchase homes with $0 down at credit scores in the high 500’s; some lenders approving loans to borrower’s with no established credit history, excessive debt to income ratios (borrowers with debt obligations taking up 50 to 55% of their gross monthly income), up to $5,000 in outstanding collections, rent history late payments, and pretty much any other credit malady that you can imagine.

So, with the excitement of the possibility of homeownership (and possibly even a pushy-loan originator), some borrowers found themselves in homes (which are 100% financed) at payments they can’t really afford (probably more than what they had been paying in rent), with a track record in the past of damaged credit, collections and late payments.  And in the scenario above (the plan of getting into the house for a couple of years and then refinancing out of the mortgage), it only really works if the client’s credit is PERFECT for those 24 or 36 months.  One late payment (even on a small account) could be enough to where refinancing at the end of the fixed-term is difficult . . . maybe even impossible.  And then the interest rate adjusts and the problems get even worse.

All adjustable rate mortgages are based on two components — the index (a floating variable such as the LIBOR index or the MTA index) and a margin (a fixed number associated with the loan and established at the time of securing the loan).  Most borrowers (99.99%) only focus on the interest rate of their mortgage, never even asking (or knowing to ask) about their margin.  Most “A” type loans are based on the LIBOR index and carry a margin of 2.25% to 2.75%, so an “A” type loan that adjusted today would adjust to 5.203 (12 month LIBOR index) + 2.25% = 7.45%, rounded down to 7.375% and subject to any cap associated with the mortgage.  A sub-prime mortgage may be based on a similar index, but may have a margin of 7 to 8% . . . the equivalent of adjusting up to 12.5% based on today’s index.

So now, at the time of adjustment, for the borrowers who were not able to better their credit situation, they are left with a mortgage payment increasing by hundreds of dollars (hundreds over what they could barely afford to begin with) to a house on which they owe a loan for close to the entire value of the property (100% financing . . . even over the course of two to three years, if the house increases in vale at 4% per year, they may have just enough equity to break-even on the sale of the house once realtor fees, closing fees, inspection repairs, etc. are paid for).  And with a softening housing market (houses not selling as quickly and houses not realizing the same appreciation rates as in the past), many loans are going into default and the properties into foreclosure.  The foreclosures and defaults have caused lenders to tighten their guidelines making it even more difficult for troubled borrowers to refinance and the whole thing snowballs.  Troubled borrowers can’t sell (easily) and can’t refinance . . . so they walk away.  A foreclosure on their already “less than perfect credit” has now wrecked their credit and it will be four to five years (or more) before the possibility of owning a home again is even a possibility.

So will sub-prime mortgages disappear all together?  Probably not.  There are still instances where ‘bad-credit happens to good people’, and a sub-prime loan is the perfect tool to help fix the situation.  There are other instances where, well maybe it’s just better that those loans just aren’t around anymore — kind of like the saber-toothed tiger . . . have you ever heard anyone say, “Man, I really miss that program where I could borrow 100% of the value of my house at 9.25% rate on a 2 year interest-only ARM with a 8% margin and a 5/5 cap and a $2,000 prepayment penalty.”  Yeah, the good-ole saber-toothed . . . I sure do miss that tiger.

Understanding your credit score.

March 2, 2007

Credit scoring is (deservedly) a big topic.  In the mortgage industry, your credit score reigns supreme.  You know the commercial (one of the ones with the family and the dog and the children and all the smiling) and they say, “Your more than a score” or something like that, remember that one?  Well . . . they’re lying.  Ok.  So, maybe they aren’t lying, but it’s not like a mortgage lender is going to give you a great rate on a big mortgage debt because you are a really nice person, right??  The truth of the matter is that YOU aren’t a score, but your credit certainly is.

In the past, the credit scoring models of each of the three credit bureaus were guarded as closely held secrets.  Even for people like me in the mortgage industry, the score was described as a “black box” of the credit bureaus — customer data goes in, the computer “looks” at it (that’s anthropomorphic, I think), the computer looks at all of the data and returns a credit score between 400 and 850.  Computers thinking?  and looking?  and deciding things about our lives?  Hmmmm . . . .

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In the last couple of years, credit companies have begun to disclose what factors affect your credit score.  While this information is very helpful, it is impossible to say with certainty, “If you do this . . . your score will go up by this many points.”  However, there are a handful of easy things you can do to improve your credit score.  Here are a few suggestions to help you understand your credit score (these suggestions are in addition to the obvious of making your payments on-time, not letting accounts go in to collections, clearing tax liens, judgments, etc):

1.  Don’t carry a balance on your credit accounts of more than half of the available credit.  The credit score model hates maxed-out credit cards.  A credit balance that is at or above the credit limit hurts your credit score; it hurts less once you owe less than 75% of the available credit, even less if you owe less than 50% of the available credit.  Here’s an example:  if your credit card has an available credit of $1,000, your goal should be to have a balance of $499 or less.  If you aren’t able to pay down your credit accounts to below half, then call and see if the creditor is willing to raise your credit limit amount.  Raising your credit limit may accomplish the same thing.  For instance, if you owe $499 on a credit card with a high balance of $500, your score is going to be lower . . . if the creditor would raise your available high credit to $1,000, your score would improve.  I have had clients with seemingly perfect credit (no late payments, no collections, etc), but because of the number of accounts with balances and because every account was somewhere between 50% to 90% maxed-out, their credit score suffered . . . in the 620’s (no so good).

2.  Don’t close old accounts.  In the past people would recommend closing old accounts.  And in the mortgage world, underwriters would look at what a borrower might be able to borrow in credit on old accounts and even require that the borrower close those accounts (especially if income and debt numbers were tight on the loan).  With credit scoring models and automated-underwriting even trumping some underwriters these days, the length of time is no longer a factor and the fact that accounts have been open (and have a long term, well-established credit history) is a big plus.

3.  If you have little or even no credit, ask a relative, spouse, significant other, lover, or parent to add you as an authorized user to one of their accounts.  This will add additional credit history to your credit report (and the act of adding an authorized user to an account is usually as easy as a phone call and generally does not require any type of approval or credit inquiry). 

Speaking of credit inquiries . . . credit inquiries (or the number of times you have had your credit pulled) does have an affect on your credit score.  BUT, it is almost never the top thing affecting someone’s credit rating.  In the grand scheme, or let me re-phrase that, in the grand-matrix of credit scoring, the credit model  has to assume that an excessive number of inquiries means one of two things:  either, one, the person continues to apply and get turned down for credit (and has to have more and more and more people pull their credit) or, two, they are desperate for credit and are looking to open up multiple accounts (to borrower as much as they can).  If you are shopping for a mortgage, you need to have someone pull your credit as early in the process as possible.  Waiting until the last minute to have your credit pulled (for fear of losing 4 or 5 points) makes very little sense (for too many reasons to go into here).  However, once you have had one mortgage broker pull your credit and you know your credit rating, it is usually not necessary to have anyone else pull your credit until you are ready to move forward (to lock-in your rate, complete an application, etc.)  If the mortgage person you are talking with will not or does not give you your credit rating, it is probably because they are afraid you will use that information to shop for a mortgage.  And usually those people are afraid for a good reason.

4.  A few points may make a HUGE difference . . . or it may make NO difference at all.  Credit scores generally range from 400 to 850.  In the mortgage world, a 660 credit score is considered average, 700 is considered excellent and anything below 580 is somewhere between difficult and very-difficult to get financing.  At a credit score in the lower tiers (580 to 660), every point counts.  On mortgage financing, the products available and the interest rate you may be able to qualify for is driven (partly) off of your credit score — and almost all 1st mortgage products have guideline minimums such as 580, 600, 620, 640, 660 or 680.  On 2nd mortgage financing products, the credit score can be even more important.  However, in most situations, at the higher tier of the credit scores (720+), there is absolutely no difference between a 720 credit score and an 820 credit score.  Both are considered great credit and both are able to get the best rate and best terms for financing.

And as far as your credit and your credit score . . . you can take my advice or leave it . . . but remember (in the wise-words of Morpheus) ” . . . I can only show you the door. You’re the one that has to walk through it.”  (Sometimes I even make my own self laugh — where do I come up with this stuff??)

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