Monday, August 13, 2007

Time Heals all Wounds.

It has been a few months since I last posted. I find hundreds of other authors doing a good job covering various elements of the housing and lending collapse. Although, I would add that most bloggers are outside observers and a few have very biased views. Of course, I have my bias as I am a mortgage broker here in CA. An unstable housing market isn't good for anyone. Sure it was easy to find a mortgage loan for a client as long as they could fog a mirror. But, all the competition for housing priced out the rational client's that didn't want to take on risky financing.

I didn't hear of pick a payment or negam loan until 2003. After reading through the paperwork, I really thought that the product was being sold to less than savy clients. Wall St created these products because it allowed the investors of these mortgages to make very large returns. Estentially, the balance is compounding at a rate somewhere between 7-10%+. The borrower is only paying 1-3% and the rest of the interest is tacked on to the balance. I have seen clients that went into major banks like WAMU or Indymac and thought that they were getting a fixed loan. Sure, they signed a one hundred page plus loan document, but clients rarely read these forms. They are written by a room full of lawyers and regulators. The average person has trouble setting up their cable modem and setting the clock in their car. Do you think they will get the potential risk of negative amortization in a flat or falling real estate market? The balance is going up and the home owners equity is evaporating each month.

These products were sold as a way to help people buy houses or live a lifestyle they couldn't otherwise afford. The lending industry has been burnt on this product and it is no longer available but for the most well qualified clients. People forgot the old childrens tale about paying the piper. Eventually, you have to pay the money back. It's funny, people used to take pride in paying cars and houses off. The crazy easy money era convinced people that debt was king. Borrower till you don't need or want anything else. The crazy money era ended in March or April of this year when housing started to fall and the subprime lenders began to implode.

Investors will take almost any risk as long as they are compensated with an appropriate return. That's what hurrican insurance is all about. That's why after you have a major car accident your insurance rates go up. Sure, State Farm will cover you, but they need to be compensated for the added risk. Right now in the mortgage market, the investors(banks, pension funds, foreign governments, etc) don't know what the default rates will really be so they can't model the risk correctly so they have decided not to lend to risky credits or risky loan scenarios.

The rates for jumbo loans (417k+) has gone up about .75% in the last two weeks because a default on a 800k home could cost the bank 100-200k by the time the home is sold. The interest rates for second mortgages has gone up about 1-2% for client's with excellent credit because even the most credit worthy get divorced, get sick and lose jobs. If a default occurs on a 2nd mortgage in this market and they have to foreclose, the 2nd is likely wiped out entirely.

It will take 3-5 years in my estimation for this to entirely work out. I expect real estate prices in the hot markets to steadily drop for years. The underlying fundamental of home mortgage finance is the borrower's ability to pay the loan back. Regular residential housing will revert back to a level that can be supported by a dual income household making a regular 30Y fixed mortgage payment. The upper end of real estate 750k+ is largely driven by rolling equity from starter homes, the stock market, and income earners in the top 10% nationally. Don't forget that the wealthest people in the country live in CA, NY, and FL. I expect this market to soften with rising rates. It is a bifurcated market. The middle class became convinced by all the forces that be that they needed/deserved four plasmas, a Hummer and a 50k pool upgrade on the salary of a handy man and a secretary. Everyone should get the most out of life but not at the expense of their future when the piper comes to take their home away.

Lessons are being learned and things will get a lot worse before things get better. But, one persons foreclosure is another persons new bargain home purchase.

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