Tuesday, August 14, 2007

The new word of the day is NO!

The mortgage market is undergoing a rapid change that the public at large is only coming around to slowly. People believed that money would flow to anyone with a pulse at terms that were increasingly better than their previous mortgage loan. The game was going fine till people took on more debt than they could pay. The mortgage defaults started and picked up speed at the start of 2007. Then, the investors started to slowly tighten guidelines and then it was a race to the bottom. Small lenders in order to compete and keep volume flowing keep very loose lending guidelines. They then began having trouble selling these to Wall St, who packages the prime and subprime mortgage loans and sells them to investors.

The mortgage interest rates couldn't rise much because people couldn't qualify even with an interest only or a 40Y fixed mortgage. The investors weren't being compensated for the added risk but there was an instatiable appetite for yield or a rate of return better than safe government bonds. Eventually, all this consumption of bad mortgage debt lead to severe problems. Lending depends on keeping the money flowing; borrowers making payments, and default rates staying predictable. Everything has changed and the mortgage investors are in a holding pattern till the dust from the collapse settles.

The biggest toxic mortgage product in domestic and international portfolios is stated income loans for subprime or ALT A clients. People had used stated loans as a way to qualify for rates and loan programs that they otherwise would not qualified for. But, that game ended when we had gardners and secretaries stating that they made 100k+. The investors didn't believe the income and the underwriters turned the files down. Many people had used refinancing as a way to bid time. They couldn't make the mortgage payment but they could refinance, pull cash out and make the new payment again for a few months.

Mortgage loan rates will continue to rise for risky loan scenarios. Millions of people are unable to refinance their loan now. They may be aware of this and list their home for sale, or go into default; or they are clueless staring at their plasma they bought at Bestbuy. The average increase for people with adjustables is 2%. An average loan balance in Southern California for example is 350k. With a 2Y fixed or 5Y fixed interest only done a few years ago the payment would be $1750. With the first adjustment their new interest only payment moves to $2333. If people are complaining about gas prices. Think about the impact of that payment increase on the average middle class family. That payment doesn't include the property taxes or home owners insurance.

Of course, adjustable loans are used from the conforming loan market to the super jumbo loan market for the multimillion dollar homes. The difference with the larger balance loans is that the lenders require larger down payments and much lower debt to income levels. Most jumbo clients can easily handle their first adjustment. This is not true within the conforming loan market. I do not believe that people are prepared in anyway for their first adjustment. Almost, $2 trillion dollars of mortgage loans adjust in the next twelve months. It will be interesting to see how people handle the coming wave of change. Borrowers are more likely to hear NO or sorry a lot over the next few years.

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