The third and fourth quarters of 2007 saw the end game of one of the most unbelievable runups on the housing market that the United States (and to be honest) the world had ever seen; mortgages were going into foreclosure, foreclosures were doubling from year end to year end, and several dozen mortgage lenders declared bankruptcy within a two week span.
The financial trades have called this the Subprime Meltdown, and with good reason--it bears a strong resemblance to a nuclear reactor going critical and melting down. It's caused repercussions throughout the global credit markets, and is causing doom and gloom among the financial set. However, its root causes, like everything in finance, go back a bit further.
With the stock bubble bursting in 1999, and the country sliding into a recession, the 9/11 attacks caused widespread market panics; in response to the 9/11 attacks, the Federal Reserve started cutting interest rates. The rationale for this is that by trimming interest rates, you stimulate spending rather than savings, and can boost the economy to get it out of the doldrums. If you do this for too long, you get inflation.
What this did to the housing market was give the lowest rates on a 30 year fixed mortgage in over 40 years. Housing starts soared and housing prices boomed. Millions of people refinanced their homes to take advantage of lower interest rates?and due to regulatory requirements about non-discriminatory lending practices, a lot of credit was extended to people who otherwise wouldn't have qualified for a mortgage.
If you were one of the people who was sensible enough to refinance to a fixed rate mortgage in 2003, pat yourself on the back. You're probably happy to have that 4% mortgage right now. Lots of people refinanced, and even more speculated--they bought second homes or condos as 'investments', because the assessed prices kept going up ? and would keep going up for the foreseeable future.
The banking industry thought the same way; there's a type of security, called an ABS or Asset Backed Security that's been in circulation since the Eisenhower administration. In principle, what's done is several loans (with fixed, regular payments) were bundled into one security. Most home loans have very good ratings as investments, because banks and mortgage lenders are very picky about who they lend money to. On top of that, they tend to be long term assets. By bundling them together, you can get a diversified portfolio with a regular payment schedule.
This is all well and good so long as mortgage lenders are being careful about who they're writing loans out to. However, by 2005, there were loans being written to people with no down payment, and in amounts of 25% over the listed value of the house. Unfortunately, due to careful ginning up of the packages of asset backed securities, most of these collateralized debt packages weren't AAA assets, the way they'd been marketed. Short form--a lot of investors made a bunch of unwise gambles.
All of these loans and complex financial instruments are built on the idea that foreclosure rates are more or less constant and predictable. Unfortunately, with the surge in mortgage writing, there was also a surge in strange (and downright predatory) mortgage loans made. The big culprit is the Adjustable Rate Mortgage or ARM. These are usually initiated with a teaser rate that's nothing but interest; after a given period of time, the mortgage rate goes up to something fixed on the Federal Reserve rate.
Well, most of those pigeons came home to roost in late 2006, and entire flocks of mortgages with teaser rates had their teaser rates expire in 2007. Most home owners went from 'I can make the payment if I save' to 'My home payment is twice my monthly income' as the rates jumped from 3% to 9 or 10% - which usually doubles or triples the home payment every month.
This caused a rash of foreclosures; suddenly a lot of those ABSs were worth a lot less money, and banks started writing down loans (which is financial speak for 'We aren't getting paid...')
It's a near perfect storm of opaque banking products and an interest rate yo-yo... and we're going to be dealing with the repercussions for the next two or three years.
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The United States housing market has been battling a difficult correction over the past year but one of the most impacting economic factors that many people are not talking about is the rising number of foreclosures and what it means for many mortgage companies across the country that specialize in subprime lending.
And if you do not care much about corporate America and think that if you have to borrow a subprime mortgage, you will make timely payments and avoid becoming a negative statistic, think again; you may never get the chance.
The article, ?Shifting housing market snubs bad credit,? written by Dave Collins for the Associated Press and then posted February 25, 2007 on sacbee.com, explains how subprime mortgages are no longer going to be easy to obtain.
There has been warning over the past year that mortgage lenders will be tightening their underwriting guidelines on subprime mortgages but that talk was more for legal purposes. But now mortgage companies are seeing the affects of lending high rate mortgages to those who default payment and are taking matters into their own hands. ?Homeowners with troubled credit histories are finding it harder to get mortgages or refinance homes because softening in the housing market is making lenders less likely to handle riskier loans.?
Mortgage companies are looking out for themselves if not for the customer when requiring better documentations and evidence of the possibility to repay a subprime mortgage before agreeing to lend. ?On Wednesday, shares of Kansas City, Mo.-based Novastar Financial Inc. plunged more than 42 percent to $10.10 per share after the subprime lender posted fourth quarter losses of $14.4 million. Company officials set aside $45 million in anticipation of defaulting mortgages and said they were unsure Novastar would turn a profit in the next five years.?
The major requirement that is changing is the minimum credit score to be approved for a mortgage. According to David Zionts, owner of Connecticut Mortgage Lenders LLC, a borrower looking to take out a 100 percent financing mortgage must now have at least a 600 credit score to qualify opposed to the previous minimum of 580. ?A high-value loan with no income verification could be had last year with a credit score of 620 a year ago but now needs a minimum score of 640, he said.?
And these credit score guidelines will be less negotiable unlike what they used to be when mortgage companies valued volume over quality. During the booming years, most companies could afford a few defaults here and there because they were originating so many mortgages. The current correction ahs not allowed that luxury. ??The most immediate impact will be that both the lenders and investors will be more careful on who they make loans to,? said Richard F. DeMong, a bank management professor at the University of Virginia. ?In Finance 101, we try to teach that return should be enough to compensate for risk.??
These stricter guidelines are ultimately being imposed to protect both mortgage companies and you, the borrower but most prospective borrowers would rather be given the opportunity to attempt to borrow a subprime mortgage than be limited. But for the stubborn subprime mortgage borrower, not all hope is lost. ??There's still a saturation of lenders still out there lending in the subprime market,? said Phil Cyr, owner of Equity Lenders, a small mortgage company in Berlin, Conn.?
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