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Subprime meltdown and the real estate market

Watching the meltdown in the subprime market the last couple weeks has been kinda shocking. The fact that it's happening or even how fast it's happening isn't the shocking part, it's the fact that how many people act totally surprised by it, is what gets me. The lending standards, particularly over the last two years were almost criminally loose. 100%+ LTV loans, No Doc Loans, Hybrid ARM's with 1% teaser rates, lending to people with insanely high debt to income ratios.

I don't expect to see this contained in the subprime market either, these same types of loans were being made (but to a much lesser extent) in the Alt-A and prime markets too. Just because people have a higher credit score, doesn't mean they weren't getting in way over their heads. Consider in 2006 for Alt-A loans, 81% were low/no doc, 62% were interest only or ARMs, 28% were the incredibly risky hybrid ARMs. So this meltdown will likely extend much farther than what is being reported in the media as purely a subprime problem.

Without talking about the much larger repercussions on the whole economy how is this probably going to affect the real estate market.

Because of the huge number risky loans made, foreclosures are starting rise. They're hitting records already but most of the ARM's haven't started to adjust yet. Somewhere around $1 trillion in ARMs begin adjustment in 2007. Many of these will adjust upwards to their full 2% adjustment cap adding several hundred dollars to the average mortgage payment.
Lending standards are quickly starting to tighten, particularly in subprime. For instance maximum LTV value ratios going from over 100% to 90%. Not only will this take a huge number of buyers out of the market because they don't have a down payment or can't qualify for IO loans at the fully amortized rate, but it will prevent many people to refinancing out of the risky loans they already have.

This appears to mean that inventory will continue to rise at a fairly steady clip, at the same time the pool of buyers rapidly begins to shrink. Supply vs. Demand dictates what effect his will have on the market. Should be some interesting/scary times for the real estate industry. Might be a good time to start brushing up on the in and outs of short sales.

I'd love to hear some of the mortgage brokers hear on ActiveRain weigh in on this as they are closer the the storm than I am.

* Alt-A numbers came from the Calculated Risk Blog.

Posted by Matt Heaton on 03/13/2007 03:22 PM

Comments (46)

subprime, arms, real estate market, housing bubble, credit markets

46 Comments on Subprime meltdown and the real estate market

MAR

2007

Thanks, Matt. Especially thanks for the link to your sources. Jeff Belonger wrote a recent article on this very topic, which goes hand in hand with this. RUMOR ALERT..... 100% loans fading/non-existent.... but are they?

Matt, This does seem to be only the beginning of the downward slide. I don't think we will have hit bottom until the mention of real estate sends people out of the room. It's going to reverberate throughout the economy.

Rich, thanks for the link to Jeff's blog, I'll make a bet that many lenders will phase out 100% financing in Alt-A and even prime over the next year. It wasn't until the last few years that this was commonly available, so I bet the pendulum will swing back on lending standards.

Mainly, it will mean that those people who really shouldn't be buying a home in the first place, and aren't in a prudent financial position to do so, will not be able to obtain loan approval. There will most definitely be a very stated affect on the market, but my sense is that it will stabilize within a reasonable timeframe.

I am going through a little private hell with a loan that is just squeaking by that 100% rule. Lender is now requiring full docs to go to closing which is scheduled for this week which was essentially a last-minute change in requirements after the original approval. Cross your fingers for me everybody!

I just blogged about similar items. And I do have a home currently on the market - yup, it'll be a short sale!

Matt,

The appraisers are really close to the storm. I can't tell you how many times my husband (an appraiser) lost an account because he refused to "hit" a number. With the coming meltdown, I bet there will be a few appraisers out there doing a little squirmy dance.

Diana: Yeah the appraisers have definetely got to be put in a tough position right now.

Matt and Diane thats a great point, this also will affect appraisers signifcantly.

Eddy

I read through SOME of the links in Matt's initial post....but call me an idiot.

Can someone give me a summary of what a Short Sale entails?

Matt, I am a HUGE fan of seeing the sub-prime melt down and wrote a blog Yes, Losing Sub-Prime Loans Is A Good Thing-Bring Pride Back Into Home Ownershp and gave my reasons. There was a day when our parents would not let us buy anything unless we had the money to buy in cash or had a large down payment. Subsidized and sub-prime lending has created a melting pot of buyers that have nothing invested in their home. Many bought a lot of toys after buying the home with Zero down and then could not afford the home and walked away. The result of all this has been the highest credit card debt in the history of our nation coupled with a high number of foreclosures of which we have only seen the begging of. I guarantee you foreclosures will be up a minimum of 30% before years end. Lets get back to having buyers EARN THE DOWN PAYMENT FOR THEIR HOMES AND QUALITY BASED ON THEIR ABILITY TO PAY THE LOAN BACK.

Matt,

I just blogged about lender giant: Countrywide Home Loans CEO Angelo Mozilo who spoke about the meltdown. You can go to my page at http://www.activerain.com/mortgageman

He basically said that the meltdown or chaos as I titled the blog is going to get worse and at the end of the day, Countrywide will still be standing and will have more business. Although it is good in this aspect it is not good for the first time homebuyers who were looking forward to those 100% financing mortgage products that are being pulled off of the lenders shelves!

I personally have a client who has less than 620 credit who was looking for 100% financing and now since he did not make a purchase quick enough he is not going to be able to purchase a home with me. I am 99% sure that I can't help him and no one can help him in the country unless he was to go with a hard money lender which just wouldn't make sense for him.

This makes our job as mortgage bankers, mortgage planners, mortgage advisors, home loan consultants tougher and we will need to spend more time with our clients to fix their credit and see if we can make their homeownership dreams come true.

Great blog and I am happy to be an "active" Active Rain member! Thanks Matt.

Your Active Rain Mortgage Man,

Nima

203.913.6016

http://www.MyNima.com

I have no idea how this will affect the Las Vegas market. We have a ton of untaxed income floating around out there and a home purchase will require some discipline such as not writing off so much for self-employed individuals and tipped income individuals will have to claim mucho tips for two years and save a three percent down to go FHA. The high debt to income ratios going by the wayside may hurt us for awhile here because we are squeezing out a ton of buyers who can afford it, just not on paper. On the flip side, investors with lots of ca$h are swarming the market! The super bargains are being bid up with multiple offers while the bank sits on the paperwork waiting to make a "decision".

Watching the meltdown in the subprime market the last couple weeks??? how about the last 12 months!!! this is the iceberg effect friends, give it another 12 months and watch!!!

This doesn't surprise me at all. For a long time I have been thinking that something big was going to be needed to shake the tree and bring real estate prices back down to reasonable levels. I'm also a consumer and have been looking to buy but prices for what I want are through the roof and a major correction would be welcome to me and a lot of other buyers sitting on the side lines. I agree, there are a lot of people who may make very good money but spend it as fast as it comes in. The savings rate in this country is probably quite low and I think people have been using their homes like piggybanks for too long. Yes, it is going to hurt a lot of people but perhaps they'll learn from this experience and realize that they don't need that brand new Range Rover after all.

Christopher I agree with you, the meltdown has been going on for over a year now. It was a slow day in Iraq, so the media decided it was now time to take this out of the bag.

Your right a large portion of the market will not be able to qualify now. Sub-Prime accounted for about 25%.

It is amazing whal lenders will do to keep their share of the market. They should have seen this coming before they even instituted the process. People are the same today as yesterday and they will likely be the same tomorrow. There is a reason that they are only able to qualify for sup-prime. In most cases they earned it. Serves the lenders right. Of course that' just my opinion, I could be wrong.

Not to sound too harsh on mortgage brokers that were mainly in sub-prime but they are gonig to be the ones biggest affected. They won't have any business now and they will lose their jobs, mercedes benz's they purchased the last few years as well. Foreclosures and IRS knocking on peoples doors for their cars will be seen a lot.

Reality has struck here!

I am glad that I am a mortgage professional for the largest lender in the Country and not a mortgage professional at a sub-prime lender or a small mortgage company. All the small folks will be going out of business slowly and the giants like Countrywide, Wells Fargo, Washington Mutual , etc will reamin standing.

Nima: The big lenders will take their hits too, though most will probably remain standing at the end of the day. I heard some rumors that Countrywide axed the majority of their subprime group on Monday.

Here's some commentary from Countrywide's CEO, some of it reeks of spin...

http://www.reuters.com/article/email/idUSN135862720070313

Matt, that's a damn good Real Estate post you wrote there. My market, Poinciana Fl, is mostly subprime territory and it's getting ugly real quick. I've lost 4 deals since Friday that were all pending with subprime borrowers. So it is going to be interesting to see where it all ends up. Inventory is on the rise and prices are declining. Are you hiring?

Subprime is a big story, Alt-A is a bigger story. A lot of this stuff is refi's to bailout stretched homeowners, what if they can't refi? It really nearer the beginning than the end of this cycle. Government is already talking bailout, but a "few billion" as Dodd suggests won't come close to touching this issue.

Basically, you either have sound underwriting and solid fundamentals when you give a loan (a loan MEANT to be paid back) or you don't. And if you don't you don't solve the issue by throwing good money after bad. You get back to the basics, Documentation, solid DTI, make sure the consumer has a bit of skin in the game and mortgage insurance to protect the downside. Simple changes like that would simply destroy a market like California where the market is out of whack with the fundamentals. The quicker lending returns to sanity the quicker the housing market can bottom and begin a recovery. But I just dont see the lenders dropping the lenient programs without a fight so this will be a protracted mess of foreclosures, lawsuits, and David Lereah calling a bottom with every new months disapointing number.

One of the most interesting charts was in the OC Register regarding subprimes market share:

http://www.ocregister.com/ocregister/money/housing/article_1615833.php

And the alta-a low documentation numbers are staggering.

Realtors and mortgage pros better be getting their customers to work on their credit and start saving. Liquidity will soon be prized (well, actually required).

Read the calculated risk blog for Ivy Zellmans report, Ivy has been right early and often and way ahead of the curve she was saying things in late '05 that people are just starting to think about today. She has the pedigree of being correct. There are several conferences coming up for new home builders, I look forward to hearing them dodge questions on this issue because they don't want to talk about the severity. But watching the lenders and reading what they are saying about the secondary markets appetite for bad paper is far more instructive.

It irks me to no end that people are talking around the issue and not just speaking it for what it is. There are far too many lenders like Countrywide that hire untrained subprime originators. Their FSL division hires people with little to no experience far too often and lets them originate within days.

This is just 1 of the many problems that I believe has caused this trend in the market. You can't expect untrained individuals who are only taught to memorize a script to understand the tenants of responsible lending.

I speak only from my personal experience with the matter and hope to God someday there is legislation passed in each state to prevent this type of lending to continue. Too many times I've heard big names like Countrywide and Wells talking bad about the broker world, yet I've seen those entities get away with more than a broker ever could.

These changes are long overdue and I would be willing to bet that it will affect the big names as much as it does the rest of us.

Jacob: If I had to make a comparison, I would say that you remind me of "me". I just read about you on your AR profile and I like it a lot. I too have been a mortgage professional for about 5 years or so. Let me speak about Countrywide and not Wells Fargo. As far as A PAPER retail side of Countrywide is considered, they only recruit mortgage professionals with 2+ years of experience and mortgage professionals with an actual pipeline of business. Countrywide has a sub prime division in Full Spectrum Lending and I really can't say too much about how their guidelines for hiring go. I can easily say that my colleague at Countrywide/FSL has previous experience and treats my clients/business partners/myself with lots of professionalism. What a wacky REAL ESTATE WORLD we are in right now. Only the strong will survive, great luck to everyone!

ROB - A Short Sale is the lowest price a Lender will accept for a property that is about to go into (or is) in foreclosure. I sat in on one of these with my broker and the sellers lost jobs and so could no longer afford their payment. My broker called the lender and the lender told her that they would accept up to a $35000 loss; this then gave my broker a $$ figure she could work with in order to get it sold.

Hope that helps (though I'm sure the more seasoned agents could provide a more "Content Rich" explaination) lol, I'm just giving it to you cut 'n dried.

Nima: CMD is incredible, you guys are champs and when I spent time with Countrywide I very much enjoyed working with your different departments. I always knew that CMD A paper guys were the cream of the crop. Now that's not to say that FSL was chalk full of people who were clueless, there were always good people to be gleaned in the group. Don't get me started on NSC though.

The point I'm making is more than just Countrywide. It is a greater issue that seems to plague our industry now. Too many people jumped into the business and infected it with their inexperience. I knew a guy who specialized in low FICO 100% pay option purchases...within 2 years almost 30% of his borrowers had foreclosed. He didn't care, he got paid the most on those loans and was driving a mercedes paid for in cash at the age of 23. That is just scary.

I read your profile last night Nima and really enjoy your approach. Continue on your path my friend!

Jacob Morales LoansByJacob.com

It's about time they held these mortgage companies accountable ....it's long ovedue in my opinion. HELLO!

PatriciaAulson/Seacoast NH & ME

CallPatricia.Com

Bad practices are catching up. Accountability has long been overdue. I find the fact that the FED has passed the entire buck a little humorous ~ as if they did not participate....

Thanks for the info and links. Sounds like an area that will become more important each day. I have absolutelly no experience with this area but I'm going to begin learning as much as I can right now.

Thanks again.

Matt,

Are you sure that you are not a loan officer/mortgage broker because you weighed in like one. Frankly, your comments and observations are a bullseye score. I wish I had a crystal ball right now. But it will get worse before it gets better. As professionals Real Estate or Mortgage we need to really did into our bag and dust off the business plan, rename it your survival plan. Those who survive will be well positioned for the upturn.

Wow, this is my second comment on this page. I just finished reading all the comments and they are an education in themselves. Thanks people, keep the comments coming. A grateful agent.

Ron, no I've never been loan officer or mortgage broker :) I've just been following this stuff pretty closely since I got involved with the real estate industry and ActiveRain three years back (wow, I can't believe it's been that long). People that know me, have heard me babble on about this stuff for quite some time. Not sure why I find economics and markets so interesting...

People forget at those high prices people were being forced to exotic lending. The problem in this market is different as the foreclosures are on flooded homes which have decreased in value 60-70%. Many had the houses under insured or the insurace paid nothing. This was no fault of the borrower so many people just walked away with no job and a home destroyed. Be glad this is not your issues.

A declared income loan is just another name for a liar's loan. If someone has a job and a paycheck the only reason I can think of that they would take a declared income no doc loan is because they are lying about their income.

It would be unfortunate if the government outlawed these products for fiscally responsible wealthy people who get paid either by commission or bonuses and don't have a fixed income.

I hear an echo bellowing in the distance of lending experts I've dealt with and learned from, "IT'S ABOUT TIME." While I hate to see individuals lose jobs, consumers get in over their heads unknowingly, and the industry going through a kind of capitalistic Armageddon.....a reality check was/is in tow. Ladies & Gents, welcome to a career in real estate....either you are in for the long haul or you may want to think about a change. This overhaul is overdue, and in the long run will not only benefit the industry...but consumers as well.

The picture you paint is bleak and assumes that markets won't repond with products that will accomodate a significant portion of the "at risk loans." You underestimate capitalism. Where you see darkness, I see a huge opportunity. Someone WILL begin marketing loans that will "smooth out some of the risk. If you think you have seen the end to Hybrid Arms, Interest only loans and stated Income, no Doc, etc. etc. etc. you ignore history. The pendulum has swung and it rests on the loose side of lending right now but it WILL swing back and then back again.

Mikey, thanks for the link on the average amount of a subprime loan in the various markets across the country. I was just wondering about that this afternoon. It seems like it will affect mostly the lower priced homes. Do you think it will have much of an affect on the upper end market also?

Thanks for posting, enjoyed reading and reading all of the comments.

MAR

2007

Matt.... great post with some excellent comments and feedback. I read all of the comments and I don't know where to begin.

Nima, not to rain on the parade, but you can just never say never. The big don't always survive. Countrywide halts no-money-down lending Sure, this is about the sub prime side, but it still affects the total operations of Countrywide. People get bought out all the time. Look at Norwest back in the mid 90's. The largest and strongest lender at the time. Who are they now? Wells Fargo. Just trying to make a point, that it's never safe to assume who is who and what is what. Besides, the good thing about being a mid-sized banker as I am... I can use everyone's programs. I can still do 100% financing on the sub prime side and still do every A paper deal that the big boys can do. FHA people... FHA....

I agree with Randal Keberlein... sure, it's bad not. But we can't ignore history. And as a few others mentioned, this is only bigger news now, because the news is lacking. This has been going on for over a solid year. It takes a while for numbers to come out into the open. Quarterly reports were ignored, CEO's and VP's were hoping for a quick rebound as has happened in the past. Remember the stock market crashing after 911? It rebounded.... people moved forward. Rates jumped a good bit, but then 6 months later, settled down a tad.

And Diane Bell makes a great point in regards to the appraisers. But I have to agree that they should be hard pressed. There is not one appraiser that I ask them to do something that they shouldn't. If value is there, it's there. I had a realtor many years ago tell me that if I was to get business from her again, that I had to use a different appraiser. The value came in $10,000 less. I said, okay, I will pay for another appraisal and sure enough, $8,000 less and that was pushing it. I let the appraisers do their job and don't tell them that I need value.

Matt.... overall, great post with soime great discussion. As some mentioned, this is where you dig deep down. Ron mentioned that some of us have to revamp our business plans. I have... I know Brian Brady has changed focus and it's working for him. We just can't sit around waiting for business, like so many did for the last 4 to 5 years.

Last... I will sign off with this thought. Loan officers, truly get to know your FHA guidelines and talk to your underwriter's.

jeff belonger

Tim- For the upper end, I think the refi will affect them more than the purchase (personal opinion). *IF* this does go into ALT-A where stated gets restricted to high FICO for refi, every level will be affected. The secondary market will geniunely be concerned about reasonably being paid back by the borrower and not just if the house sells or rapidly appreciates (well, they will be concerned about that at current pricing, the appropriate price for risk seems to be much higher than is currently in the market).

Randal said-"Someone WILL begin marketing loans that will "smooth out some of the risk. If you think you have seen the end to Hybrid Arms, Interest only loans and stated Income, no Doc, etc. etc. etc. you ignore history. "

I disagree, for the following reason. This products were only seen as viable because the products themselves created a hot market masking the true fault of the products. They are fundamentally flawed as underwritten and priced (too loosely given out at too low of price). You would need a product that "saves" the current undocumented homeowners at very low pricing, these are people who cant handle any sort of amortization, some can't even afford IO. With the new Federal regulation being passed ("Guidance on nontraditional mortgage"-FDIC) and another on the way. The federal government is going to regulate the heck out of the industry to ensure that documentation and ability to pay are paramount in underwriting guidelines.

I think what you could see is a smart "win-win" type subprime product that reprices itself based on the borrowers FICO score and repayment profile (allowing a IO and amortizing option, the more amortization they take the less risk and lower pricing later) during the history of the loan. Just remember you heard it here first ;-). But this product, and no product, will help those who are in fundamentally over their heads based on the loans they are in. The only thing that will save them (imho) is forebearance by the current note holders or being able to sell.

Matt- We share the same interest, do you know a realtor like you in So. Cal.?

Matt - Great post. I am standing on the mountain top and sharing this same message. I think a lot of our associates are going to be caught out and I want to spread the word. Thank you for doing your part.

James

MAR

2007

As a realtor for the past few years in Riverside County, I can honestly say I have seen buyers of every price range that are buying 100% financing, asking for the sellers to pay their closing cost, and the only money they have in the home is the very small amount of money they put as their ernest money---Then the minute they can, they take out a line of credit on their home and start spending for their "toys" - boats, motorcycles, RVs. No wonder they end up in a short sale situation -- doesn't hurt too bad considering they will be losing only $2,000 to $5,000 cash which they more than made up with all of their great toys!

APR

2007

Hi Matt and everyone:

matt - Your posts always provide good information. But, after just read about your "housing bubble" post written last July, it got me thinking:

Will the affects of this meltdown also regional, much like the upward / downward trend of the housing market? For a particular hot market like Bellevue, WA, where you reside, you know that the market has been going strong for the last few years, and probably still has room to go up. Will a hot regional market like this be badly affected by the meltdown? Will a hot market's price at least stabilize, if not going down?

Thanks :)

APR

2007

Allen, I think I'll respond to your comment in a seperate post later tonight.

JAN

2008

The subprime meltdown has led hundreds of companies to change their investment strategies, while multiple lawsuits are threatening the industry causing what are sure to be sweeping changes to the regulatory landscape. Therefore, events like www.iqpc.com/us/subprimemortgage are very informational and provide business professionals with the solutions to arising problems as a result of the Subprime crisis.

OCT

It is so interesting going back to read these posts from the past.

We are now in a situation where we have approximately 21% of all buyers effectively out of the market. 21% is the number of Alt-A and Subprime borrowers who will no longer be able to get a loan. http://www.irvinehousingblog.com/blog/comments/why-the-sub-prime-meltdown-is-a-problem/

With 12 months of housing inventory for sale and 21% of the demand gone we're actually looking at 15 months of inventory. Add to that the decline in the value of existing homes http://www2.standardandpoors.com/spf/pdf/index/CSHomePrice_Release_082653.pdf and you can see we have a serious problem. The decline in home values is a long way from over. We'll need to work through that inventory but who is going to buy the inventory when they can't get a loan.

To add fuel to the fire, the ARMs, Hybrid ARMs etc. that were written during the boom won't finish adjusting until 2012. We still have a long way to go before we've seen the end of the massive quantities foreclosures.

But wait, the bad news continues. We are now looking at a situation where everyone who purchased a home in the last 2 years, and put less than 20% down, owes more than their home is worth. What is the incentive for those people to hang onto those homes? Have you heard of 'jingle-mail' that's when you send the keys back to the lender in the mail.

There was an excellent article in the WSJ today with quotes from all the democrats - Barney Frank, Chris Dodd, Maxine Waters etc etc etc defending Fan & Fred saying there isn't a problem, they've hit their goals. The regulators are saying this isn't a question of goals it is a question of leverage - 100 to 1. Alan Greenspan weighed in and warned of impending doom and it all fell on deaf ears. It has recently been revealed that the staunchest defenders of Fan & Fred got huge political contributions from Fan & fred. It's time for an independent investigation into the link between the $ and the defenders of Fan & Fred. Even after Raines and the gang cooked the books for bonuses and got caught they simply ignored the many signs of trouble.

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