Mortgage Meltdown
There is no doubt that what we are experiencing today is unprecedented in real estate and mortgage lending. My name is Jason Fontaine, and I am a mortgage professional with Family Choice Mortgage.
The purpose of this letter is to give you a brief overview of what is taking place within mortgage lending at this time and to offer you insights that you can share with both your sellers and buyers. This information will allow you not only to profit in today's market, but it will help you advise your clients so that they can make educated decisions about buying and selling property.
What I'm going to do for you today is similar to what a pilot of a hurricane-hunter airplane does. I'm going to take you right into the eye of this hurricane, so that you can prepare for the kind of storm that's about to come ashore. And, from what I can tell, the storm we are about to be hit with is major, even catastrophic.
The mortgage meltdown of 2007 is one those storms. If you were to try and compare the economic damage of this financial storm to that of the storm in this picture, don't even try. In the past few weeks alone, over $2 trillion was lost in global markets, and I don't think we are anywhere near the worst of it yet. And, to add salt to the wound, we are seeing signs that what's taking place here in the United States is starting to infect other countries as well. Within the global economy, not only are other countries dealing with their own subprime woes, other financial companies in these countries have invested in our mortgage-backed securities as well.
To get an idea of what it is that brought us here, we have to wrap our arms around what's happened. We have to understand the key determining factors. As with anything this major, there wasn't just one thing that brought this situation to light. No, quite the contrary. There were a number of factors that, once aligned, produced the laser-like heat that ignited and culminated in the meltdown we have today.
First of all, we have what is known as Subprime and Alt-A lending. Subprime lending is for people who would like to get a mortgage but haven't done a good job of paying their bills. However, as we're in the days when tracking one's FICO score has become a hobby for some, lows scores - even in conjunction with no late pays - can force someone into a subprime mortgage. Other factors mandating the necessity of a subprime loan could be little-to-no down-payment, the inability to validate income with tax returns, or the inability to source funds for a down-payment. Or, it could just be a combination of all of the items mentioned here.
Alt-A lending is a lot like subprime lending, except that the borrower will predominantly have good credit. With Alt-A loans, borrowers are unable or unwilling to provide documentation for income and/or assets. These types of loans are commonly referred to as Stated- or Reduced-documentation type loans, or the infamous No Doc or no-documentation-required loan.
All told, including some A Paper type loans, in which little to no docs were required, these loan types accounted for anywhere between 40%-70% of the mortgage business in the last few years. Folks, these accounted for a lot of the loans that were getting done.
During the time of the real estate boom, rampant appreciation was seen in the housing market. Investors clamoring for ever-higher returns turned to the real estate market and credit markets to take advantage of the boom. This insatiable appetite for new profits led to some pretty wild and loose underwriting guidelines.
To give you an idea of how loose things had become, we were able to provide someone with 100% financing for a $685K purchase - this person was recently self-employed, had two foreclosures, and a bankruptcy within two years, all on stated income and stated assets. I don't think you personally would have extended money to this person, but the financial markets were willing to. The person was granted a mortgage based on perfection within the markets, both housing and investment. Today, this borrower would not be granted anything even remotely close. If this person were to slip on a banana peel, do you think he might miss a mortgage payment or lose his house? In short, yes.
I can't tell you whether or not the individual in question is still paying his mortgage on time, but others clearly were not. Consumers started showing problems in the third and fourth quarters of last year, and mortgage delinquencies started to mount. As such, bond investors started pulling back and companies started to fall.
We started to see weakness in the mortgage market last December, when the first of several large companies was set to take a fall. Own-It Mortgage, a subprime company that was set to close over $20 billion in loans in 2007 was hit with a lack of desire by investors to buy the loans they had funded. Unable to fund the loans themselves, Own-It was forced to close their doors, becoming one of the first ten companies to go down the tubes and be featured on the Mortgage Implodes website, which now lists 114 companies that have gone away.
Let's take a brief look into the world of mortgages. Few mortgages are held by the bank or the investor that funds them. Over the past ten to fifteen years, the securities markets have grown markedly as the appetite for higher yield products has grown immeasurably. With this appetite grew a desire for riskier loans that companies package and sell in pools known as mortgage-backed securities. Mortgage-backed securities are sold on the open market and are traded much like any other bond, with the expectation that people with mortgages will pay monthly on their obligations, netting an expected yield for the end investor.
What happens is that a company may package a group of $100 million in loans and sell them on the open market for anywhere from $100-101 million. As investors realized these loans were not performing, they were now willing to pay only $95 million for the same batch of loans. And, in some cases, even less. In addition, as many of these investors used the loans as leverage for other investments, they were used on margin, similar to what you might do in an investment account. As the value of the funds was decreasing, the mortgage companies were also forced to pay into the investment to make their margin calls, forcing additional pressure and cash drains. In a sense, this was the perfect storm for mortgage companies, and they are paying for it with their company's life. This was seen with the recent demise of American Home Mortgage and other companies, as investors decided they didn't want these loans, forcing the companies out.
What happened next is we saw the slowdown in the real estate market, as home prices started to deteriorate in 2006. However, we've never seen a real estate market on a national scale where home prices fell. The investment and underwriting models for which these loans were originated were, in part, based on this.
As home prices started to stagnate, many people who obtained loans based on the premise of continually escalating home prices were caught in a trap, as they were unable to sell and unable to refinance their loan. The homeowner who had been living a lifestyle based on their equity was now maxed out, having spent way beyond their normal means. With no more equity to pull out to consolidate or lower their payments, they were now in trouble.
As a result of these problems, we now have loans in the investment markets where even if a lender were willing to approve them, they wouldn't be able to sell them, effectively turning them into "Officer and a Gentleman" loans, screaming, I got nowhere else to go!
What's next for real estate? Let's think about this. With changes to credit tightening, a huge number of people will now be unable to purchase a home. On a percentage basis, we're talking about a minimum of 15% of borrowers will be impacted by processing styles and loan availability alone. In a U.S. market where six million people buy homes, you just took 900,000 buyers off the market. It doesn't mean that people won't still need to sell though. Consequently, we're seeing increasing inventories and increasing marketing times. I don't think that 12 months of inventory is an unreasonable estimate, as many areas of the country are already experiencing well in excess of 18-24 months. Accompanying this will be more foreclosures. Foreclosure activity in July was double what it was for the same time last year.
It's estimated that in the next 12-18 months, over 2 million people will be faced with their Adjustable Rate Mortgages resetting, resulting in an increase in their minimum payments of anywhere from 30-100%. While this one action will not push people over the top, what it does do is add additional strain to an already over-leveraged consumer. Add in any life events - such as injury, loss of job, or increasing payments due to rising interest rates in the consumer arena - and you have a recipe for financial disaster.
If I am a seller, I need to be aware of this in light of a slowing housing market. For anyone who has seen rapidly appreciating property values the past few years, it could be difficult to accept the fact that their home is now worth less than before. However, to use a stock market analogy, if you need to sell stock that yesterday warranted $10,000 and today was worth $8,500, would you decide not to sell, even if you were now losing money? Of course not, provided you had the means to absorb the loss. Well, the same beliefs should apply here.
The borrowers who will be caught up in this mess are the ones who were looking to obtain minimal-to-no documentation type loans. This includes those with great, good, and poor credit alike. Some have estimated that these types of loans account for nearly 40%-70% of all the loans originated in 2005-2006. What this means for real estate moving forward is that there will be far fewer buyers who are able to qualify under the terms of their last mortgage. While this won't necessarily take all of these people off the market, obtaining financing going forward will be a much more difficult process for them.
Not everyone is caught up in this mess. For the plain vanilla type of borrower, someone who has a job, savings, and the ability to provide documentation - as used to be required - these borrowers are still fine. And, with some products, there will still be some stated income opportunities without exorbitant rates. In addition, government loans will pick up a lot of the slack for those individuals with credit issues and minimal down payments.
However, as this situation continues to evolve, things are subject to change. So it's important not to get too comfortable.
Let me ask you a question. What would your business look like if you were to close 50% fewer deals over the next 12 months? All of the factors mentioned here so far could very well have that kind of impact on many in our business.
However, it doesn't have to be this way. There are opportunities for everyone in our business. There are opportunities with sellers and with buyers, but we have to act fast, act decisively, and get started now.
For sellers, it's important that they get real about their price, and quickly. They cannot afford to wait as pressures will build rapidly, and, when they do, money will be lost. The lowest price that they may be willing to accept today could very well become an unrealistic wish six to twelve months from now. And, if they don't reduce their price, their home may never even get shown. Also, as lenders have now pulled back on second mortgages, sellers may need to consider holding a second in some cases.
Absolutely do not accept an offer from a buyer who has not been pre-approved by a reputable lender under any circumstances. And make sure that the approval is recent. With buyers becoming few and far between, sellers don't want to take their home off the market, only to have the deal blow up six weeks from now.
Finally, get sellers pre-approved. You don't want to have a deal blow up because the seller can't buy later.
What about buyers? For buyers who are seeking 100% financing, where it is available, it will be more expensive - either in the form of higher rates or non-available seconds. This doesn't mean that for some programs, as in community homebuyer, etc., that it isn't available. But, for more expensive homes, it's going to be difficult in many cases.
With second mortgages cutting back, it's time to start thinking about getting PMI again. For many people, it's become tax deductible this year.
Before a buyer gets too busy shopping, they need to take a look at their credit. In many cases, improvements to FICO scores can be had through just some minor changes to their profile.
Finally, borrowers should go ahead and start collecting their paperwork. This includes all the traditional information like tax returns, bank statements, and pay stubs. This will always help someone to achieve the best possible rate.
The reason checking credit is essential is that FICO scores are very important. There are some hard, fast lines in the sand when it comes to certain approvals, and the numbers we're looking at are 720, 680, and 620. Depending on the loan program, a certain score is needed and, without it, you can forget it. Exceptions are now basically non-existent.
Proper credit repair and maintenance can be the difference between a homeowner and a tire kicker today. When you have control over the buyer, try to get them started on this process 3-6 months in advance. The difference this could make to them and to you is a home priced tens of thousands of dollars higher.
In order to obtain the best-priced loan, let your clients know that they need to get their documentation together. Once we have it in hand, we no longer have to make estimates on what people can afford and qualify for. It will save them money and help them to buy more home.
Now is not the time to go it alone. And it's not the time to refer three lenders. Partnerships are critical to your success. Unfortunately, too many people became comfortable with the idea that everyone could get a loan and it wasn't important who a buyer got their loan from. Not today. You need one "go to lender" who not only has product, but who's also an expert in underwriting and credit analysis, has a great credit repair partner, and is local and accountable. A loan officer from Quicken Loans, or an out-of-the-area lender, doesn't stand to lose much reputation-wise if your deal goes south. I do.
The news isn't all bad though, and there are future possibilities. Instead of focusing on what the media is harping on each day, think about the fact that subprime only accounted for a little over 12% of mortgage production last year. There is still massive opportunity. But I'm going to need you to keep your head up and do things a little differently from now on. Whether you work with me or another lender, you need to have them involved from the very beginning with both buyers and sellers. We can present facts together that may be more compelling and also keep the fire under them.
For those who follow the steps I'm suggesting here, there's definitely profit for you ahead. However, you need a plan. Part of that plan includes educating your sellers regarding what's taking place today, not just in real estate, but in mortgages as well. Let them know what's on the horizon, and obtain significant reductions. Make sure any buyer, while desirable, is properly scrutinized. By positioning the property appropriately, you can get it off the market and save marketing dollars. And, by all means, make sure your sellers get pre-approved. We don't want them to be the reason why they're unable to move.
For buyers, many of the same rules apply. First and foremost, don't spend time showing them a home without checking them out first. This will benefit both you and the buyer. Even the best of candidates may have issues we don't know about. Also, keep in mind that investors are more important now than they were during the boom. Cultivate these relationships, they will be important.
What I want you to leave here with is a plan to meet with not only your sellers, but also any buyers you may be working with as well. Have action meetings with them. Inform them of the current crisis, and educate them in order to get them to act. When it comes to sellers, use me to find out what they are really willing to do under a worst case scenario. When you find their dollar amount, market the heck out of it to other agents, letting them know you have someone who is hot to sell, I mean REALLY HOT!
Start to think of buyers as almost the same as listings today. Once you let them know that they may not be able to qualify in the future, they should be more motivated to act today. Get them pre-approved and keep them pre-approved based on current conditions. Once you have them, direct them towards your realistic sellers. Also, be sure to communicate with other listing agents and make them aware that you have a real buyer. They'll let you know who it is that they're working with who's hot to sell.
Together, we can work through this and position ourselves to really succeed when this cloud lifts, ensuring great years ahead.
Family Choice Mortgage is in their 10th year lending in New England, we work mostly with new home buyers. I am always looking to add experienced agents to my team. Most of my clients do not have a realtor when they come to me and I look to refer then out to one of my partners. Again my name is Jason Fontaine with Family Choice Mortgage and I look forward to working with you.
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