The Sub-Prime Mortgage Fiasco and What it Means to You - Part IV

Last month, I addressed the “stability” that had returned to the market place after the effect of the sub-prime fiasco and other credit woes rocked the financial markets in early and mid-summer. One month later, there is continued stability, but far more restrictive credit market, as well as some interesting collateral damage from the sub-prime problems. Following, please find this months summary.

Borrowers: – If you are a traditional “vanilla” borrower in the market for a conforming loan (<$417,000), with good credit, a strong loan to value ratio, and full employment, you remain in good shape. Rates have held steady over the past month, with very little difference in 30 year Fixed and Adjustable Rate Mortgages. Rates are still at their lowest since early spring. Borrowers with poor credit or without the ability to document income or assets will have very few places to turn. If you do manage to pass underwriting expect very high interest rates. Sub-prime rates may be as high as 12% - 13%. Products: Jumbo mortgage (>$417,000). Rates have dropped slightly as hoped, but in my opinion there is still room for rate improvement, as both banks and investors realize that the majority of jumbo loan borrowers are the cream of the crop – high income, good credit scores, and modest loan to values.
ALT-A (No Doc, Stated Income, Stated Asset, etc). There is continue fall out, as this market has been almost eliminated, and those still offering these products, including Chase, continue to tighten guidelines. Probably an over reaction, but it may take many months, if not longer, for lenders to re-enter this market.
FHA – The only growth spot for lenders, as many borrowers formerly steered towards higher rate sub-prime loans find they qualify for this government backed agency.

Lenders: - There is continued fallout as many lenders and brokers simply shut their doors. This is for 3 reasons.
Small lenders lines of credit from which they fund loans are being cancelled.
Brokers - Banks who wholesale mortgage products to brokers are canceling relationships or holding them to tighter underwriting standards than the banks retail arm, as they are discovering much of the abuse and “bad” loans were generated by brokers.
Economic – Some lenders and brokers without alternative streams of revenue are simply closing shop as revenue does not meet expenses, and they can not weather the storm.
Headline News – Countrywide and WAMU continue to receive horrendous press as their business and lending practices and/or treatment of trouble borrowers are further investigated.

Home Prices: - As expected, August home sales reports were disastrous:
New home sales and prices fell the most, with the greatest percentage drop in prices in over 20 years. Cancelled contracts are escalating.
Existing home prices faired better, with smaller declines.
Depending upon your perspective, the numbers may have been skewed by the sale of foreclosed homes included in the numbers. The drop in average price for those homes offered by realtors was not as dramatic.
The numbers are very regional. In the Northeast, there was actually a slight increase in average prices.

Collateral Damage
The sub-prime mortgage spread to have international ramifications, not just in the amount of sub-prime debt purchased by international investors, but by foreign banks and institutions that participated in the lending practices.
The home rental market. Rents are increasing due to an increased number of people who do not qualify for purchase mortgages, and from an unanticipated reduction in rental units due to foreclosures. When a bank forecloses on a home, they typically want the units empty. Therefore, upon taking over a foreclosed property, banks are immediately evicting tenants. Many of the foreclosed properties are 2-4 family units and small commercial residential units that investors purchase with little or no money down, and low introductory rates. With rates adjusting higher, and values falling, the owners can not refinance or sell their properties. Many of these properties are standing empty.

So again, what does this mean to you? Not much different than last month, with the exception of a little more predictability, and in many areas perhaps the bottom of the market.

If you are a home buyer, chose to work with a bank for your mortgage. Banks have a diversified stream of income, and are required to keep a strong balance sheet and reserves.
In many areas, real estate prices may have reached bottom. This could be the time to act, as sellers are tired or houses lingering on the market, and most have been priced reasonably. This may be a time of opportunity.
If you have an adjustable rate mortgage whose initial rate expires in the next couple of years, consider refinancing NOW! After an initial drop in rates with the Fed cut of the prime rate (it lasted one day), inflationary fears negated the hope for continuing falling rates. It will be a battle over inflation, a weakening economy, and international competition for asset backed debt that will determine future interest rates.
If you are a real estate broker – Remember, make sure that your pre-qualification letters are from a bank, not from a broker or mortgage company. At the least, have your clients provide a back up letter from a bank. It was reported that 30% of brokered transactions in August did not close. If your client is stuck at the closing table without funds, nobody wins.

As always, I welcome your comments.