Mortgage Backed Securities PRIMER - to understand where the different 100% financing programs go...
A Mortgage Backed Security (MBS) is essentially a group of loans (often called a pool) that have similar characteristics. 500 Fixed-Rate, FHA loans would be pooled together and issued into a MBS but you wouldn't see a couple of JUMBO loans thrown in just for fun. The MBS is then rated by a third party company who audits the files, writes up a prospectus of the history of the company issuing the MBS and the type of MBS issued by that company in the past. The MBS then gets a rating which tells investors how "secure" the pool is and what rates of return to expect on their investment.
My purpose here is to share with you the different places 100% financing programs end up so you can understand the news articles you read...
It helps to keep in mind there are multiple CATEGORIES of mortgage programs that are sold into MBS:
- Government Loans - FHA and VA have not changed in the past 2 weeks. FHA still offers 97% financing and VA 100% These loans are pooled into government MBS which are issued with a GNMA (Ginnie Mae) guarantee that investors won't lose money. That's why these loans continue to have investors and offer low rates of interest.
- 'A' Paper 80/20 Loans - These are for clients with 660 and higher credit scores (generally). The first lien is sold in a normal conforming MBS(mortgage backed security) and the second is typically held in portfolio by a large lender and in some cases sold into a MBS of equity loans. The 80% loan which is sold into a MBS is grouped with other 80% loans, 90% loans, etc. Not every loan in that MBS has 100% financing which offsets the risk. Because the lender with the second mortgage for 20% is the one most likely to lose money in a foreclosure, higher risk on these loans is usually offset by higher rates for the second lien.
- Alt-A Paper 80/20 - Typically, these are 80/20 loans and include one or more non-conforming characteristics such as stated income, no income, investment property, etc. These loans are sold into Alt-A MBS and require credit scores typically 640 and up. In some cases, the first liens are even sold into conforming MBS.
- 100% Single Loans - These loans carry private mortgage insurance which is an insurance policy to protect against loan default. Often the charge of this insurance is paid by the borrower but sometimes is paid by the lender usually resulting in higher closing costs or interest rate to the borrower.
- Sub-prime Paper 80/20 or 100% Loans - These loan programs are sold into sub-prime mortgage backed securities and there is a lot of diversity in this category. There are no standards other than those set by the market and rating agencies. If you put together a sub-prime MBS pool and it performs, then you can write more of these loans and the likelihood is that investors will buy your next MBS.
Buyers of these MBS in recent years have included Fannie Mae and Freddie Mac....no more. Also, due to a down-turn in real estate values combined with many of these loans being 2 year fixed rates, defaults are up and early payoffs are up. In other words, those that INVESTED in these securities are losing money. When that happens, it's harder to find new investors. Take FNMA & FHLMC out of the picture and you can see the crunch.
On 3/12/07 - Fitch (which is a rating agency) rated a 1.7 billion ALT-A Mortgage Backed Security of Countrywide and Indymac Bank paper and upgraded 1 class and affirmed all of the rest. What does this mean? It means that 1 year after this MBS was issued, the security is performing at or even a little above investor expectations. In other words...ALT-A paper seems ok at the moment.
Hopefully this will help you to better understand the news articles you read about the performance of mortgage backed securities. When someone says, "Lender B is still doing sub-prime 100% loans with a 680 score" you now know they aren't doing sub-prime paper because at that FICO they are probably doing ALT-A. If another person claims, "Countrywide no longer does 100% loans" you can know that isn't true. They may have stopped offering 100% sub-prime loans but they still do Alt-A, A paper and Government.
Lastly, keep in mind that not all lenders put loans into a MBS. Some lenders, mainly banks like Bank of America, Chase, Wells Fargo, have some loans they keep in "portfolio" meaning they keep them in the bank. Because of this, they can make any underwriting decision they want on these loans as only the bank and the bank's stockholders have to be comfortable with the decision to lend.
Be informed....be aware....and be prepared so you can face the changes this market is bringing us all.
©2007 Ken Stampe
Ken Stampe is a Mortgage Loan Originator, Mortgage Author and Mortgage Loan Officer Instructor living in Dallas, TX. Ken provided his first client a mortgage loan in 1996 and writes about home buying and mortgages to help clients make smart home mortgage loan decisions. Contact by email at Ken@KenStampe.comWhat resource do SMART home buyers use?… Mortgage Calculator Bank.com
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