Print Article for : Subprime Mortgage Crisis Explained

Your Online Guide » Guide to Finance » How To Handle Finances

[S1121]Subprime Mortgage Crisis Explained

by Jim Kemish, Jim

Over 20 percent of all mortgages originated from 2004 through 2006 were subprime mortgages. Nearly one quarter of all American homeowners in recent years purchased homes using subprime mortgage programs. The majority of these programs have now been eliminated. Mortgage expert Jim Kemish discusses the potential impact.

The End of the Subprime Industry

In late 2006, as real estate values continued to fall, the subprime lenders that made it possible for these borrowers to own homes begin to shut down. Within a period of 90 days between December of 2006 and March of 2007 the entire subprime industry as we knew it, vanished. And as these lenders either shut down or tightened their guidelines, millions of potential homeowners have discovered that they don't qualify for mortgage financing anymore.

The Real Issue

As disappointing as it may be for those millions of hopeful homebuyers now discovering that they no longer qualify for home loans, the real problem lies elsewhere. Subprime mortgage programs, as accommodating as they were of borrowers? credit profiles, were strictly structured to compensate the lenders for taking on the additional layers of risk associated with these poor credit loans.

The Adjustable Rate Impact

With few exceptions these loans carry adjustable rate features which are normally timed to adjust upward at some point during the first five years. The most popular of these programs is called the 2/28 which is timed to adjust upward after two years. Most borrowers using these loans expected to refinance after the two year period. Refinancing was not expected to present a problem. After all, real estate values were increasing and home financing was easy to obtain.

A Changing Real Estate Market

In a perfect world, a subprime borrower would purchase a home using a product like the 2/28 and be worry free. The booming real estate market would virtually guarantee that he would have sufficient new equity in his home to be able to refinance into a better mortgage when the time came. Or maybe he would just sell, and with his windfall be able to make a large down payment on a new home.

No One Believed it Could Happen

The worst case scenario was unimaginable. Real estate values had moved upward for over a decade. Mortgage lenders had become more and more accommodating. Who imagined that home prices would slowly stop climbing and then sickeningly begin to fall? And even if this were to occur, who thought that every single subprime lender would hit the brakes simultaneously within a 90 day period of time?

A Personal Story

A personal acquaintance of mine went through a difficult divorce in 2005. During the divorce his credit, once without blemish, was seriously affected. When the divorce was finalized he decided to move to Florida to make a fresh start. He was lucky to have enough money to be able to afford a 20 percent down payment on a new home. Because of his credit he was in a subprime category and elected to use a 2/28 for his financing.

A Reasonable Expectation

It was not unreasonable for him to feel fairly secure. He was purchasing a home in beautiful south Florida. Home prices were strong. His Florida mortgage was easily approved, and he had made a significant enough down payment to feel secure with his equity. It is now 20 months later. Four months remain before his mortgage rate will increase a full 2 percent. He figured that the timing was right to start planning his refinance.

Reality Dawns

His first shock was the discovery that home values on his neighborhood have fallen so much that his initial 20 percent equity is nearly gone. He no longer has enough cash to reduce his loan to 80% of the value, so he figured that he would have to refinance at a higher loan to value and just find a way to manage a higher rate than anticipated. Unfortunately, there was more disappointment to come.

The Result

He quickly discovered that he could not obtain financing at all. The combination of his impaired credit, the lack of equity in his home, and the elimination of the subprime products that made it possible for him to purchase the home, have now made it impossible for him to refinance. Instead he is being forced to try to sell his home in an environment where he will just get enough money to pay his mortgage and his closing costs.

Where to Turn

There are millions of homeowners like my friend. The adjustable rate features built into their mortgages add a degree of urgency as borrowers will be facing higher rates. We have two suggestions. Consult your mortgage broker now. Don't wait. There are new Fannie Mae programs that just might accommodate you. And consider credit repair. If your credit is marginal a credit repair professional might be able to help you improve your credit score enough to make all of the difference.

Copyright ? 2007 James W. Kemish. All Content. All Rights Reserved.

With all of the foreclosures and bankruptcies that are being triggered by the subprime mortgage crisis why don't lenders just put all of these homeowners in better loans? We are asked this question on our mortgage blog quite often. It's a reasonable question too. If it's the bad loans that are causing the problems wouldn't be cheaper for the lenders to just bite the bullet and fix the bad mortgages? Meaning, wouldn't it cost banks less money to lower interest rates and fix adjustable rate mortgages on their loans than the billions they are losing from all of the foreclosures?

In some cases banks are doing just this because it does make sense. However as I will explain, this is much easier said than done for most banks. The reason is that very few banks these days “own” the mortgages they service. A few regional and national banking chains do maintain a portfolio of loans that they originated, but by in large most banks do not. Most mortgages are owned by a pool of investors and are merely serviced by the company that homeowners send their payments to.

This is why when you call your current lender that you already have to refinance they make you re-qualify for a new mortgage again. While I was originating mortgages, I had countless borrowers call me to refinance that were disgusted with their mortgage company for that very reason. It seems to reason if you have paid your mortgage on time for ten years the bank would just lower your rate to keep from jumping-ship to another lender. The problem is that they have to put your new loan in a new portfolio and sell that portfolio to other investors, this is called securitizing.

Banks and lenders buy money to sell much as retailers do for the inventory that they keep on their shelves. For instance, a toy store can purchase a crate full of toy soldiers at a wholesale price then put them on the shelves and retail them for a profit. Banks buy and sell money the same way from their retail, or mortgage divisions. The only difference is that banks reach their loan capacity they have to take these groups of loans and sell them to investors on Wall Street. If banks didn't do this they would loan all of their money and be out of the mortgage business.

Now you have a group of loans that is being serviced by the bank that is owned by 1 to 100 different investors. That group of loans is treated like the wholesale the box of toy soldiers that is sold by the case not individually. To ask the investors to reach into the “box” and pull one soldier out and alter it would disrupt the total value of the box as a single unit. This would also upset the other investors who have money tied up in the box of toys.

Staying with the toy soldier analogy, what has happened to banks in this crisis is they can't sell the box of toys to the investors anymore. The retailer has $100 invested in the box of toys and investors believe that the toy soldiers are a bad investment and will only offer $70 dollars for the box. This means that the retailer has to hold onto the box until prices rise back to $100 or sell the box for the $70 dollars and take the loss. This is the same with banks today; either they cannot afford to sell their loans or they have chosen not to and ride out the storm.

Both way lenders and banks have stopped buying and selling money as freely as they used to and cash is in short supply. When supply is short and demand is high prices typically go up. This is why the Federal Reserve Chairman keeps lowering the prime rate in an attempt counter higher rates that would almost drive a nail in the coffin of retail lending. As of this article Atlanta mortgage rates are around 5.75% for a thirty year fixed mortgage and would probably be in the mid-sevens without Bernanke's involvement.

Passing legislation that over regulates banks and lenders will not solve our problems. Neither will instituting individual government plans aimed at helping a finite amount of borrowers like some in congress have suggested. The answer to this subprime mortgage crisis will be derived from a plan to restore confidence in mortgage backed securities that will allow the flow of money to open up once again. The free market will correct its mistakes and lending will begin a new day.

Article Source : Pg. 55

About Author

Both Jim Kemish & Aubrey Clark are contributors for EditorialToday. The above articles have been edited for relevancy and timeliness. All write-ups, reviews, tips and guides published by EditorialToday.com and its partners or affiliates are for informational purposes only. They should not be used for any legal or any other type of advice. We do not endorse any author, contributor, writer or article posted by our team.

Jim Kemish has sinced written about articles on various topics from College Student Loan, Credit Loans and Free Credit Report Score. Jim Kemish is the president and founder of Power Mortgage, a company based in Delray Beach, Florida. Jim is also the President of Sky Blue Credit, a n. Jim Kemish's top article generates over 301000 views. to your Favourites.

Aubrey Clark has sinced written about articles on various topics from Credit Cards, Home loans and Finances. Aubrey Clark is and editor and writer for lendfast.com, a directory. He lives in Atlanta Georgia with his wife and 4 children and write. Aubrey Clark's top article generates over 14800 views. to your Favourites.