Mortgages - The system is still broken - but I know how to fix it....

How it happened -

In the early 2000's everyone was making money, spending money and buying houses. Life was good. It was common to see houses involved in bidding wars with escalation clauses exceeding 10 - 20 percent of the list price. Think about that…. houses selling for more than you ask for it. Besides, getting approved for a loan in those days required a job, a heart beat and that was pretty much it. In fact, many if not most, argue the mortgage system broke because of liberal underwriting standards. After taking thousands of loan applications and reviewing thousands of credit files and job histories, you get a keen sense if an applicant would be on the good side of a performing home loan.

One thing is very clear. Consumers will pay their mortgage and car before they pay anything else. When those loans from the liberal underwriting days began to go delinquent, it wasn't because the home owners did not want to pay. Even the so called "over spenders", who could never pay all their maxed out charge accounts, had a steady income stream and would always pay their mortgage over credit card bills.

Too much of a good thing -

Consider my theory above for a moment and just assume liberal credit underwriting guidelines were not a major factor in the real estate downturn of the late 2000's. Here is what happened. Home owners monthly income declined and in many instances, ceased. And then homes stopped selling. In late 2009, I remember getting a call from a friend who just purchased a home on a canal in Clearwater, Florida. He said the house sold in 2005 for 700K + and he stole it for 350K. Today the house is worth about 210K and he is well underwater on the mortgage, as real estate values have yet to level off.

I've fallen and I can't get up! -

As the number of foreclosed properties began to increase, many people blamed a long overdue and much needed market correction. It was something economists claimed had to happen to smooth out the cycle. But the correction never happened and real estate values collapsed in many areas of the country.

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Picture this-

A married couple living in Las Vegas, Nevada. Both husband and wife work and each make 75K a year, which is a monthly take home income of about $8500. They have a $2800 mortgage payment, $400 a month in credit card bills, two monthly car payments of $900 combined and spend $1000 a month for food, electric, phonon car insurance and other necessary expenses.

Take their monthly income of $8500 and subtract their monthly expenses of $5100. You get $3400 disposable and readily available income remaining every month. All of a sudden, husbands company shuts down and he can't find a job for weeks, maybe even months. Their monthly income is now $4250, still enough to pay the mortgage but not enough to cover their monthly bills. Available credit has been suspended and their credit scores worsen.

They lay awake in bed at night and ponder this decision over and over.

House is worth 250K - Owe 390K …. Potentially 10 - 15 years of mortgage payments before home is no longer underwater … I can rent the same house down the street for half my mortgage payment … My credit stinks anyway … I need a brand new start … The smart business decision for my family is to just walk away …

How do you fix it? -

Declining real estate values and excess homes for sale on the market dragged the economy into the current state it's in now. Doesn't it make sense that real estate values lead us out of this economic funk we are in? This means homes must begin selling again. This means we need to increase the pool of eligible borrowers that qualify for a mortgage to purchase these homes. But in today's world of credit risk underwriting standards and and investor guideline overlays, the pool of eligible home buyers continues to shrink.

Stop pointing fingers, look forward and get the recovery underway. The married couple described above could be a performing loan. Most their debt is charged off and their cars are both paid off. They now have $4250 monthly income and no debt. If credit was not a factor, they could buy the very house they walked away from and have a monthly mortgage payment of half their old one. That's a monthly disposable income of $4250 minus a mortgage payment of $1400 giving you $2850 remaining per month.

This couple wants desperately to get back on their feet and one day be home owners again. Their income qualifies them. Their credit does not. I believe if approved for a mortgage, their loan payments would always be made on time. They in fact are a good credit risk. But banks don't see it that way.

Swing the pendulum back the other way -

Increase the pool of eligible home buyers which in turn will stimulate the housing market. The only way to accomplish this is to loosen credit guidelines. In the days before credit scores, the complete credit file was reviewed in search of answers to these questions: + How long do the applicants keep a job? + Do they have the ability to repay a mortgage? + What happened that caused their credit to go bad? + What could have been done different to prevent their bad credit? + Are they back on their feet again? + Will they pay a new mortgage in a timely matter?

Banks must return to the days of manually reviewing loan files and away from today's credit scoring standards and automated underwriting approvals that rely on algorithms created by mathematicians that issue an approval or denial. The algorithms are too tight and credit guidelines must be loosened up. Common sense underwriting and make sense loans must return. Until that happens, the system is still broken.

It's very simple. Approve more borrowers, sell more homes and set the economy back on it's feet.