Mortgage Industry News

THE FUTURE OF THE HOUSING MARKET: 2009-2010 – Foreclosures, Recession and Loan Resets.

Ruth Lee

While the financial markets have seemingly stabilized in the wake of massive taxpayer intervention, many Americans have started to feel optimistic about the economy. Independent mortgage bankers across the country have seen enormous demand for refinances with a relative resurgence of purchase demand. However, are we feeling a little too good about the economy? Are we still solely using Wall Street as a litmus? Actually, yes we are…. because it is easy…and we still believe that the market is somehow “smarter” than we are – being able to neatly tie in economic metrics and reporting into a simple number with a plus or minus next to it. (The Dow rallies – we are golden… the Dow falls – things are not so good.) However, in truth, the Dow has been a poor harbinger of future financial information. Three months before the meltdown, financial gurus were still promoting investment in financial services – which turned out to be a “double plus ungood” financial plan.

We cannot be lazy about viewing the economy and our place in it. We cannot continue to take the “infomercial green means go, red means stop” method of analyzing our financial futures. While the media has been entirely focused on the evils of subprime… you can review the chart below to see that ARM resets are just getting started… The green bars from subprime resets have bottomed out in Q2 09… however, the tide of resets for Option ARMS and ALT A are just getting started.

What does that mean? Specifically, subprime loans were made to marginal borrowers with poor credit and/or an inability to prove income and assets enough to qualify for standard mortgages. In the early 00s, Option ARMS and ALT-A were given to marginal borrowers with good credit and/or an inability to prove income and assets.

ALT-A comprises a whole subset of loans… mostly developed by Wall Street firms to feed their hunger and demand for mortgage backed securities. The ALT-A loan was fantastic for a borrower with good credit that couldn’t prove income and/or assets ( a common problem for the self-employed and sales types) or had too many investment properties or required high LTVs not available in Agency or FHA paper. Option ARMs – aka “pay-option” ARMs or “cash-flow” ARMs – were initially designed for investors or sophisticated borrowers that anticipated growing income and appreciating home values. With low teaser rates, Option ARMS were an easy method of having borrowers obtain a higher mortgage debt load than they could reasonably expect to repay at the time of origination. How else would a second year teacher in Rancho Cucamonga get a home in a gated community with granite countertops and a pool…??? After all, “starter homes” are for chumps. They offered “options:”

• “interest only,” where the borrower only pays interest on the loan for a few years, leaving the principal untouched. Like making the minimum payment on a credit card…only on your home!
• “negative amortization” where the borrower pays a low monthly payment for a period of a few years that often didn’t even cover the full interest monthly… the lender just added that amount to the principal balance. Borrowers, at the time of reset, often owe more than their original principal balance. So like paying less than the minimum payment on your credit card…only on your freaking home!
• “fully amortizing payments” for borrowers that want the option of actually paying the original principal balance… but why would you do that when your 14 year old needs a new Prada bag because the $3000 Fendi from last year is just soooo out of fashion?? – gawd! (Honey, bring the Hummer around, I have to get to my Fortune 1,000,000 job as a dental hygienist.)

With the assumption that the collateral (home) will appreciate forever at 20% per annum (a totally rational assumption – the realtor said so), the borrower assumed that appreciation would cover their non-investment in their home. And by the time the loan reset and required a full payment, well they would have already made their first million in what? Wall Street? Amway? Babysitting? Scrapbooking sales? OR… they could just sell the home, net out the 100% appreciation and start a cable program highlighting their success in living above their means while getting rich quick in real estate with LITTLE OR NO MONEY DOWN!

Don’t buy the hype that this was a conspiracy of mortgage brokers to force poor, ignorant borrowers into bad loans. In 2004, Greenspan argued that many borrowers were wasting income by ignoring the wonders of Option ARMs. “American consumers might benefit if lenders provided greater mortgage-product alternatives to the traditional fixed-rate mortgage,” he said. “To the degree that households are driven by fears of payment shocks, but are willing to manage their own interest-rate risks, the traditional fixed-rate mortgage may be an expensive method of financing a home.” So lenders went about their business developing ever more permissive products once only offered to the wealthy and democratized them to fit well… everyone… Geez… who am I to contradict ALAN GREENSPAN?

Looking at the chart, you can see the runoff of subprime resets are quickly replaced by resets in Option ARMs and ALT-A starting… um….RIGHT NOW, peaking in mid 2011 then falling off after Q1 12. The question is … was the Option ARM borrower and the ALT A borrower impervious to recession? Or, like so many others, did they also lose their jobs, businesses or just become a single income household? Will they be able to absorb a payment shock of an additional 25% or more? If they took a loan at 103% LTV in 2005, can they really expect that they have somehow avoided the broad devaluation of home values and will now be able to refinance or sell these homes? We know that these borrowers didn’t have a ton of savings or investments – or they would have used them for a down payment or to prove assets. We know that these borrowers often used “future” income expectations to make these loans… and unless they are the best small business or commissioned salespeople on the planet – that future income was actually hypothetical and overly optimistic.

It’s a little scary. Today, reports show that foreclosures are increasing rather than decelerating. The MBA estimates that one out of eight U.S. households with a mortgage was late on loan payments or in the foreclosure process as of March 31 as the country faces its highest unemployment rate since 1983. While many comment that unemployment will guide these figures through the next year… it seems that bigger problems are on the horizon. By definition, these loans have principal balances higher than their homeowners were able to service under traditional underwriting guidelines at origination – so I find it unlikely that those homeowners are now in a significantly better position financially today than a few years ago.

Banks are going to take those REOs on the chin. Local communities will see more neighborhoods (especially upscale ones) littered with foreclosure signs. Borrowers will jump on Larry King and tell the tales of their evil mortgage broker/banker who didn’t explain that the loan would reset (they just missed the ADJUSTABLE RATE MORTGAGE in 26pt font at the top of EVERY SECOND PAGE of their closing package…. um… sure they did.) Tax bases will continue to suffer… and people like myself, that pay our mortgage, will see our home values slide.

Quick aside – I saw two borrowers on a “talking head” show complaining about how they were trapped in a 3-2-1 buydown that continued to reset now in their 5th year (they even used the words 3-2-1 buydown…which doesn’t make sense to ANYONE in the industry until you realize they are talking about their escrows going up… GENIUS! On some level, I felt like offering them the Darwin award for the financially clueless.) The panelists were “appalled” and called for decisive action. Again, I protest that fools, amateurs and ideologues continue to define the problem and its solutions without any real knowledge to vet the veracity of claims. It’s like claiming I can review medical malpractice cases because I watch House. Please let the legislators and regulators only listen to those that know there is a “t” in mortgage… oh please oh please oh please.