I’ve been watching all the hullaballoo over the massive number of foreclosures in the mortgage business with some amusement. I spent the last 7 years in the mortgage business, running a small brokerage with my brother for the last few years, and I can tell you that the current malaise is not the least bit of a shock to anyone in the business – at least not to those who were paying attention.
You know who I feel sorry for in all of this? Absolutely no one. I can’t imagine who it is I’m supposed to feel sorry for. The people who borrowed far more money than they can afford on a variable rate that they knew could only go up? Nope. The disclosure forms they sign not only show that the rate could go up, by law they have to show the highest possible rate they could end up with under the terms of the loan, when it could happen and how much the new payment would be.
They have to sign those documents twice, once at the beginning and again at the closing table. I’m supposed to have sympathy for their lack of planning? I’m supposed to feel sorry for them because they were thinking too short term and just figured things would work themselves out after a few years? Sorry, the well is dry.
The lenders? Not a chance. The lenders, especially the sub-prime lenders, did this to themselves by vastly expanding their lending criteria. Over the last few years I’ve brokered loans for clients that I wouldn’t lend $5 of my own money to. I’ve brokered $200,000 loans on investment property (always the highest risk of foreclosure, far higher than owner-occupied properties) for 100% of the value of the property for borrowers with no income documentation and no cash reserves. Those are loans just waiting to be foreclosed on.
When I first got into the mortgage business, the guidelines were clear and consistent. Your front end and back end ratios were 24 and 36 percent (meaning you could spend 24% of your income on your housing expenses and 36% on your total debt ratio). If you were above that, you weren’t going to get approved. If everything else was absolutely perfect, you might be able to push those to 40%.
In the last few years that’s jumped to 50% and in many cases much higher. Worse yet, stated income loans have become common, where a borrower can just state their income without documenting it, so they don’t even look at the ratios because you can simply state the income as high as it needs to be to keep the ratios in line.
Zero-down loans, stated income and stated asset loans, even stated value (where you just tell them the value of the home without an appraisal) – not only are these loans infinitely more likely to result in foreclosure, they’re more likely to result in foreclosure with no equity in the home. Since lenders only typically get about 70% of the value of a home they have to sell after foreclosure, if they’re holding a 90% or 100% loan on the property, that’s a huge hit.
Add to that the ever-expanding loan programs for those with terrible credit – people who likely aren’t going to pay back the loan faithfully no matter how well they can afford it – and you’ve got a disaster waiting to happen. I’ve seen 90% loans given to people with a 500 credit score, and at a damn good rate too. There’s just no way this is sustainable and the lenders had to know that.
And bizarrely, President Bush actually wants to make it easier to borrow money. The NY Times reports:
In remarks this morning at the White House, Mr. Bush said he would work to “modernize and improve” the Federal Housing Administration “by lowering down payment requirements, by increasing loan limits, and providing more flexibility in pricing.”
Administration officials said in advance of Mr. Bush’s appearance that the goal would be to change its federal mortgage insurance program in a way that would let an additional 80,000 homeowners with spotty credit records sign up, beyond the 160,000 likely to use it this year and next.
Incredible. The reason we’re in this situation in the first place is because the lending criteria have loosened up so much. Now he wants to make down payment requirements lower? There’s a reason why, up until the last few years, lenders required a 20% down payment for a first mortgage: because having such a down payment demonstrates the ability to save money wisely over a reasonable period of time, a commitment to the kind of fiscal responsibility that shows that you’re going to reliably pay back a mortgage. This is smart lending and good public policy; doing away with that is just ducking into the punch we’re already reeling from.
And expanding the Federal mortgage insurance program while encouraging lenders to lower down payments and bad credit loans? An even worse idea. All that does is transfer the risk of those loans from private lenders to the Federal government, meaning to taxpayers. So we tell them to make bad loans that are likely to result in foreclosure, then we give them Federal mortgage insurance that requires taxpayers to pay for the loans that foreclose. This is good thinking only to the insane.
The solution to this is obvious: stop subsidizing and encouraging loans to people who are likely to default on their mortgages. And for sanity’s sake, stop transferring the cost of foolish lending policies and irresponsible living to those who aren’t responsible for those bad choices.