Well... my previous forecast while calling for tightening of guidelines and a resulting vicious circle of too much inventory and not enough buyers has just gotten worse.
What exactly is going on?
Let me start by explaining the hierarchy if the mortgage lending industry. You purchase a home and apply for a mortgage from your local broker or bank. They close the loan through a wholesale lender who funds the loan with their money. The wholesale lender then packages your loan with a bunch of other “like” loans and sells them to a Wall Street firm or if they are large enough they securitize them themselves and sell them as such in the marketplace. In either case they get their money back plus a small premium over what they paid your broker or bank. Now these mortgage backed securities (MBS) are purchased by large asset funds created by the large wall street firms to give their large personal and corporate clients a place to invest their cash, and believe me, there is plenty of cash out their to be invested!
Got it?
Now you’ve got billions of dollars worth of these “exotic loans” like pay option ARM’s, Stated income, No Doc, etc. at high loan to values ( 95% - 100% ) that were made over the last 5 years sitting in these big asset funds. Now these loans start to adjust, some as little as 2-3% above the original note rate but a lot more are even higher like the case of some pay option ARM's(6-6.5%) above the low rate option.
Now it doesn’t take a rocket scientist to figure out what happened next, right? You guessed it, housing prices stabilized or went down and folks couldn’t refinance their way out of the loans so they defaulted and foreclosures rose! Here is where the vicious cycle comes in, the more loans that defaulted, the tighter the guidelines got because the secondary market ( Wall Street ) wouldn’t buy these “riskier” loans and then more loans defaulted and the guidelines got tighter, and so on, and so on.
Back to our friends with the large asset funds that are chock full of these types of loans.
Those loans that defaulted are no longer making their payments and if no payments are being made, no interest is being paid (which is the funds source of income from these loans) so these loans have no value, they are non performing assets. On top of that the market no longer accepts these types of loans so the funds can’t even sell the loans that haven’t defaulted yet! Oops!
Now this is a somewhat simplified version, I could get into more complexities but, for the purposes of this forecast and the broad audience it reaches, I think you all can get it.
O.K. what does all this mean to you the consumer? Quite simply, you will have to have more skin in the game ( down payment or equity ), document your income and your assets and have a middle credit score of at least 620 (680 or higher will get you a better rate).
Oh, you’ll still be able to get a stated income loan but it won’t be for anymore than 80% of value and you will have to have the assets commensurate with your stated income as determined by the lender’s guidelines.
As for the pay option ARM’s, they’re dead and don’t hold your breath waiting for their return!
Expect these conditions to exist for the next 12 to 18 months. Values across the country should stabilize or begin rising by then.
But hey, if you’ve got the “bling” there are going to be some good deals out there as people will be willing to unload their properties at a lose rather than go into foreclosure.
As with any other part of our economy the consumer always pays the price so, if you are looking for a mortgage you will probably pay a rate that is a .250% - .375% higher than if these conditions did not exist.
My advice if you have an adjustable mortgage that has gone up recently, go into conservative mode and try not to take on any new debt. These conditions will smooth out in the next year to a year and a half, and in that time you probably will only see one more rate increase that should be smaller than the last one.
That’s as complex as it gets folks!
Warm Regards,
JT
I am a 15 year veteran of the mortgage origination business whose experience spans large financial institutions to Brokers. I have seen so many people(in positions that one would associate with intelligence) get led by slick talking originators into over paying for a mortgage!
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