By Andrew Roth
If you’ve turned on a television or seen the front pages of any newspaper in the past month, you have undoubtedly learned about turmoil plaguing the mortgage and broader credit markets today. Let me provide one more opinion on what this is all about, why it happened, how it affects you, and where we might be going from here.
Two generations ago, the rules to buy a house were clear and straight-forward. Your local bank would take in customer deposits and turn around and lend that money to its business and personal customers. The bank would offer you, a home buyer, a mortgage of up to 80% of the purchase price of your new home if you could overwhelmingly prove you could afford the loan payments. Your banker would complete a detailed analysis of your credit application and several years of tax returns as well as verify your current and prior income/credit history. The banker would also ensure you had sufficient cash savings available to make mortgage payments in case you lost your job or suffered some other ill-fate during the loan term. This mortgage would have a fixed rate of interest and thus fixed payments for the 30 year life of the loan. If you could not come up with 20% or if you did not qualify according to the conservative underwriting standards of the bank, you would be turned down for the loan because the bank would suffer losses if it had to foreclose on your home.
Since then, the mortgage market has changed. For more than several decades, Wall Street and global capital markets heavily invested in U.S. mortgages, spawning a new range of diverse real estate mortgage products. Over this period, these investments performed well for investors, which bolstered their confidence in the predictive abilities of current underwriting standards as well as risk/return pricing models.
Soon, banks were in on the party. Tracy Andrieni, a loan specialist with First Security Loan in San Francisco explains that banks began to create loans for Wall Street themselves, keeping less and less loans on their own books, thereby by-passing banking regulations. “The Fed and Congress helped out with a loosening of regulations as well. So, banks and Wall Street were able to participate is some of the same easy credit practices,” notes Andrieni.
As the mortgage market matured (particularly over the past 15 years), and underlying real estate values increased, investors began to chase even greater profits, expanding their investments in the riskiest mortgage loans on the market. Sometimes with as little as a credit report and an appraisal of a home, these “sub-prime” loans were issued to borrowers without the normal credit “proof” requirements. Many of these loans were made at higher interest rates (to offset the underlying credit risks) and on shorter adjustable rate terms that might be more difficult to afford in the future.
A month or so ago, investors got spooked about the potential for high default rates in the sub-prime market, and some of the largest mortgage banking investors refused to purchase any more of these loans. This shift created a broad panic that not only spilled into the other “Prime” mortgage market segments but across global capital markets as a whole, which forced the US Federal Reserve to reduce its discount rate to free up global liquidity.
Who should be concerned? “Borrowers most affected are those with fair or less than fair credit with non-conforming (jumbo) loans, along with those who need a reduced documentation loan program, such as stated income or no-doc,” says Andrieni. “Those least affected are those with high credit scores and conforming loan amounts that fit Fannie Mae and Freddie Mac guidelines.”
What can we expect in the near future? Next month, in Part 2 of this article, I will address what implications I’m seeing on the San Francisco real estate market as a result of these recent events, and how it might affect you as a buyer or seller. I will also be featuring the opinions of a couple veteran local mortgage brokers who have their finger on the pulse of the changes they are seeing in their business as well.
To contact Tracy Andrieni of First Security Loan, please call (415) 869-6102 or [email protected]