Dear Colleague:
This is unquestionably one of the most challenging times in the history of the mortgage industry, further complicating an already tough real estate market. The repercussions of the subprime fallout and growing credit crunch have far reaching consequences beyond the real estate/mortgage environment.
This leads to the question of how we got to this point and how we in the real estate/mortgage industry will operate and thrive in these challenging times?
Few understand that basically all mortgages are sold to give liquidity to lenders allowing them to make more loans. Lenders give loans and then sell the mortgages to investors to replenish their funds to continue lending. The federal government created Fannie Mae and Freddie Mac during the Great Depression solely to add liquidity to the mortgage market.
The secondary market purchases these mortgages in the form of mortgage backed securities (MBS). This private secondary mortgage market is panicked and has not been buying any mortgage-backed securities, leading to unprecedented illiquidity in the mortgage market. The secondary market is apprehensive due to the increase of foreclosures and declining home prices.
The result has been mortgage program cutbacks, tightening of program requirements, increases of rates on non-agency (Fannie Mae, Freddie Mac, and FHA) products, and the closure and bankruptcy of dozens of national lenders.
Many parties are to blame: Wall Street, lenders, mortgage brokers, regulators, real estate agents, bond rating firms, and mostly, borrowers themselves.
As interest rates dropped, everyone refinanced, reducing the supply of homes on the market. As the economy improved, demand increased and the shortage of supply resulted in incredible increases in home prices.
Five years ago most buyers were not even pre-approved. The internet, mass media advertising, direct mail, and telemarketers, found ripe pickings in a new mentality of borrowers that thought themselves to be finance experts. These borrowers no longer needed the trusted advice of local bankers and mortgage professionals; they wanted the cheap money they were promised, "getting approved in under twenty minutes on the phone" and "rates as low as 1%".
Predatory lenders flooded the industry with great success due to the greed of borrowers wanting what was too good to be true and to purchase what they could not afford. Americans used their homes like credit cards, cashing out on their newfound equity. Buyers used negative amortization loans to purchase what their eyes wanted, but their wallets could not afford.
We at Mortgage Trust Group, lost a great deal of business during this time. Many borrowers went elsewhere when they got a phone call and the "other guy was less". Yet, our past customers are currently very comfortable with low 30-year fixed rate mortgages. Many of the borrowers we lost now come pleading for our help, as that great ARM they took isn't so great. They always say they were ripped off or taken advantage of, but they chose to be, as they ignored sound advice.
In 2008, an estimated $680 billion of adjustable rate mortgages are due to reset.
I received dozens of calls from potential borrowers or their real estate agents over the past several years stating how they had found this great house. Problem is their dream home was more than they could afford. I was always asked "what about a stated income or no income loan". I would reply that they could then get a mortgage, but as they cannot afford it, they would get foreclosed on and we don't want that would we? Many lenders didn't care. Many borrowers didn't care. Many real estate agents didn't care.
Lenders offered more liberal mortgage programs to qualify a greater percent of potential buyers, as Wall Street couldn't get enough mortgages to buy. Wall Street wanted more mortgages as they were using the MBS as collateral to issue bonds in order to buy more mortgages, or make other investments. By compounding their returns, Wall Street made huge profits, even though they increased their risk. They believed the cycle was never going to end.
Some firms created new investment products called collateralized debt obligations (CDO), which are bonds issued on a pool of mortgage-backed securities. Bond rating companies gave these CDOs high ratings, even though the CDOs included very risky loans. As the real estate industry was the engine of the economy, regulators turned a blind eye.
Risky loans are risky. As these risky loans started to fail, without the payments from homeowners, Wall Street had a problem paying off their bonds. As the bonds lost value, the issuers had to either put up more collateral or sell the bonds at a discount, causing the bonds to lose more value.
As mortgage-backed securities lost value, Wall Street stopped buying loans, causing a tightening of credit. The tightening of credit caused more loan programs to be cut. As credit tightens, fewer potential buyers qualify for a mortgage and less homeowners can refinance out of their bad loans, further depressing home prices.
This is a self-perpetuating cycle.
How do we get out of this cycle? I believe everyone must do their part to get back on track.
1) Acknowledge the true problem. The press blames predatory mortgage brokers and subprime loan products. The regulators want to regulate these horrible mortgage brokers and subprime products. Yet, the worse predatory lenders were the huge national lenders with their telemarketing departments, advertising, and the internet. The small predatory lenders are basically out of business and the terrible loan products have pretty much disappeared. The regulators want to regulate what isn't there anymore.
2) The regulators should ban trigger leads. Trigger leads are the names and numbers of individuals whose credit was just pulled by a mortgage company. The leads are sold by credit companies to basically predatory lenders. The borrowers are then called and offered an unbelievable deal, such as a rate of 1%. Trigger leads are banned in many states already.
3) Lenders and investors should minimize foreclosures by taking a smaller hit now, versus a larger hit in the future. These adjustable-rate mortgages that homeowners cannot refinance out of should be re-written to reasonable fixed rates. This would reduce the value of these loans, but by shrinking the foreclosure rate, the mortgage pools ratings would increase. Any reduction in foreclosures would increase confidence in the real estate market and the lender, and help reduce the downward pressure on home prices.
4) Real estate agents should do their part by pricing homes to sell and using short sales for homeowners that are inverse. Lenders should work with homeowners and take short sales versus foreclosing. It is better for the real estate market and the lender to sell at a market price versus an auction or bank owned price. Real estate agents need to correctly advise homeowners versus trying to "buy" the listings.
5) The federal government should pass the FHA Reform Act increasing the loan limits on FHA mortgages. A higher loan limit would allow not only more buyers to qualify in high cost areas such as New England, but also allow more homeowners to refinance and save their homes. FHA was the subprime loan before there were subprime mortgages.
6) Borrowers should look for trusted advisors that tell them the truth about mortgages versus what they want to hear. Mortgage brokers are actually the best source as they have many investors and banks with which they can place the loan. Then, if a lender such as FirstMagnus or American Home Mortgage closes their doors, the loan can quickly be moved to another investor.
7) Politicians need to realize that not only subprime mortgages are in trouble. The majority, 60% to 80% depending on the area, of foreclosures are prime and Alt-A loans. One reason for this is that property taxes have gone up 25% a year every year; insurance 20% a year every year; utilities 30% a year every year; etc. Many people with fixed rate mortgages they got several years ago can no longer afford their house not because the mortgage payments went up, but because everything else did.
8) The Federal Reserve should lower the Fed Funds rate even though this will not really affect mortgage rates, but because it will make everyone fell better. Any increase in confidence would do more then a reduction in the mortgage rates.
9) Everyone needs to realize that not everyone deserves a home, or a mortgage, and not everyone can afford one.
By reducing foreclosures, reducing downward pressure on home prices, increasing confidence, and increasing liquidity, this cycle can be broken.
Together we can plot a course through the current storm in the real estate/mortgage environment.
Thank you,
Norman Rosskothen
Branch Manager
Mortgage Trust Group, Inc.
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