THE MORTGAGE MELTDOWN
Q. What and whom do you believe is at the root of the mortgage
meltdown?
I’m reminded of the adage that when you point a finger of blame at someone, the balance of your fingers point back at youl The mortgage morass and foreclosure Hasco were created by many parties using a dangerous combination of greed and ignorance. And while subprime loans have been seen as the primary whipping boys, the problems go much deeper and wider.
The number one roadblock for first-time buyers has always been accumulating the down payment. Earlier in this decade, mortgage lenders and investors began to focus on inventing a slew of new loan products designed to put home affordability within easier reach of first-time buyers. Not only were they incredibly successful (and continue to be), they skyrocketed U.S. home ownership rates to record highs of
nearly 70 percent.
Meanwhile, another market segment of the industry was being underserved—the credit-blemished borrower. Enter subprime, also known as nonprime mortgages. Although at higher—than-prime (market rate) interest and typically more points, they were touted as a stop-gap loan while borrowers repaired their credit and could then qualify for a cheaper, more cost-effective mortgage. And because the yield spread premiums (read "profit") to lenders was more attractive on subprime than other mortgage products, lenders wanted every opportunity to make them and did so—sometimes even to people who turned out not to have bad credit after all. Those lenders, many now defunct, are the poster children for predatory lending.
But subprime/nonprime mortgages weren’t the only culprits in the mortgage mess. Another loan product that has helped borrowers use leverage to purchase homes that they really couldn’t afford was the hybrid mortgage, also known as the fixed-period adjustable rate mortgage (ARM). Set at a fixed rate for a predetermined initial period of time (usually three, five, seven, or ten years), the loan then converts to an ARM for the balance of the term, adjusting annually And since many of these loans were made at unrealistically low short-term “teaser rates” to entice consumers, a borrower could qualify to purchase more house, and did just that! To top it all off, these mortgages were often made using little or no documentation from the borrower (low-doc/no-doc loans) requiring more than their fair share of points and lender fees to boot.
What was designed as a short-term fix and leverage tool for borrowers is now a living nightmare in homes across America. With these hybrid loans now transitioning to ARMs, monthly payments are slipping out
of reach for many buyers, often more than doubling the monthly payment.
Then came the exotics—mortgages for anyone who could fog up a mirror. They included no down payment mortgages, interest—only mortgages, and an interesting new twist, the payment option mortgage. With the latter, a borrower had the option each month to make one of four types of payments. One that (1) amortized the loan during the loan term, i.e. 30 years; (2) amortized the loan for a shorter loan term, i.e. 15 years; (3) required a payment of interest only on the loan; or (4) required a “minimal" payment of less than interest only whereby the unpaid interest would be added back onto the principal each month (termed "negative amortization”). While there’s no such thing as a bad mortgage program, originating a leveraged loan without regard for the applicant’s financial situation and/ or ability to repay coupled with a borrower who knows he can’t make payments for the long run is a recipe for disaster.
It’s interesting to note that the majority of these highly leveraged mortgages were built around the faulty premise that perpetual double-digit home appreciation would save the day and financially bail the consumer out, no matter how rotten and misbegotten the loan program. In 2007, more than $1 trillion worth of adjustable rate mortgage products had upward rate adjustments causing payment shock and potential foreclosure for American homeowners. Meanwhile, dozens (and still counting) of sizable national mortgage lenders have closed operations, primarily since they are required to repurchase loans from investors in the secondary market if the loan becomes delinquent within a few months after it’s sold. These "collateral calls" or "buybacks" are expensive and the major cause of lender failures. Everyone wants to get their piece of the action in a booming market. Enter the speculators. Some bought property, quickly flipped it, paid off their exotic loan product, and made money. But as the market shifted from a seller’s to a buyer’s, some were left holding the property and a mortgage they couldn’t pay with an inability to charge enough rent to cover the debt service. In order to cut their losses and run, these properties became some of the first to foreclose.
Additionally, there were two equally strong components that impacted the housing market and contributed to the problem of home affordability—a marked increased in the cost of property taxes and homeowner’s insurance. The previously buoyant housing market raised values, resulting in a substantial increase in assessed value resulting in higher property taxes. Today, some homeowners must work two or more months of the year just to pay their property taxes. Then there’s Mother Nature. The hurricane triplets, wild fires in the West, and other natural disasters have impacted home insurance across the board nationwide. If your policy isn’t canceled because your underwriter is out of business, you can at least rely on your premiums increasing. The grim reaper is that the financial complexion of the mortgage market is vastly different from what it was just several years ago and will most likely continue to morph into something different all together before the dust settles.
To sum up the answer to your question about what or who is to blame for the mortgage mess, we all are—overzealous lenders wanting to make a larger proht, investors wanting to cash in on the big returns of the subprime market, "flippers" wanting to double their investment, and consumers who didn’t use their heads and got saddled with mortgage products they couldn’t understand and/ or afford long term.
But there’s good that’s come from the mortgage firestorm. The mortgage industry is getting "back to basics," focusing once again on full documentation, transparent lending, stronger equity positions for borrowers, and, in general, making sensible, cost-effective mortgages that consumers can afford for the long run. While some programs will disappear, many will remain unchanged, while yet others will require tighter underwriting guidelines, larger down payments, and/ or premiums based on the borrower’s amount of risk to the lender/ investor. There ’s never been a better nor more important time for consumers to take an active role in understanding mortgage borrowing and equity management. When the consumer wins, everyone wins.