Mortgage Lending 2008. How We Got Where We Got and How We Might Get Back!

By Karen Moran, Director of Lending, Colorado Credit Union
May 8, 2008 | COMMENTS

700 Mid Credit Score? Check. 80% Loan-to-Value with no subordinate financing? Check. Purchasing a primary residence? Check. Getting the best rate available? Check again. On June 1st, there will be another round of pricing adjustments released that will affect even a great borrower with characteristics listed above if the LTV is over 60%. It is almost impossible to keep up with all the changes. And my how things have changed. The industry which had seen an enormous boom just a few years ago that practically replaced FHA loans with “non-traditional” mortgages is now seeing FHA increase its market share from 2% to 10% and counting. And let's not even talk about jumbo loans and the pricing that those large loans can come with. All these items to consider if you can even get them approved. So what has happened?

You could place the blame on just about everyone who had a hand in any mortgage transaction including the borrower, lender, investor, Wall Street and so on. You could say it was the increase in non-traditional mortgages being originated, less stringent underwriting, current economic factors putting a strain on finances, or the increase of my personal enemy – the declining market. Representatives from the Colorado Mortgage Lenders Association were in Washington, D.C. recently to visit with legislators and were greeted outside of their hotel with a crowd chanting “Mortgage Lenders: Liars and Cheats!”.

Recent History

Alan Bahr, Director of Secondary Marketing for CMGMI, helped me understand what happened in the subprime market at a seminar I recently attended. (A more detailed version may be in some marketing material in the near future if you are interested). After the tragedy of 9-11, the Federal Reserve lowered the Fed funds Rate 5.5% down to 1% in July of 2003. What this movement did was make housing more affordable since mortgage rates fell and made real estate values rise as demand increased. This combination encouraged home owners to borrow against their home equity, some of which was used to purchase 2 nd and investment homes which continued to increase demand for housing which increased values. Defaulting homeowners had other options in this environment, like refinancing. When defaults did occur, the losses were mitigated with increased collateral values.

As rating agencies, Wall Street firms and investment houses analyzed the risks in subprime loan pools, they relied on past performance data. Previously, the subprime mortgages market history “was short and unusually sunny” and loan guidelines had previously been far more restrictive. The default assumption for the sub-prime loans was actually high at 30%. The error occurred when the assumed dollar loss was calculated. The rate at which the housing market would depreciate was underestimated and so there were not enough reserves built up to fund the losses being seen throughout the industry. That made investors hesitant to continue to invest in mortgage backed securities, which caused the original lenders to either tighten up or hold more risk in their own portfolios.

The Current State of the Housing Industry

According to the Case-Shiller Housing Price Index, housing prices have declined on average 15% since June 2006. Of course there are areas that are more depressed, such as California , Southern Florida, Arizona and Nevada . February 2007 experienced the highest volume of existing home sales; since then there has been a 24% decline. New home sales have decreased 35% since its peak back in April 2007. Housing starts have slowed by 28% since its highest point in March 2007. In 2006, 64% of mortgages originated were non-agency type loans as compared to 48% in 2007.

The change in the delinquencies from 2006 to 2007 is staggering. Prime Loan delinquency has gone from 2.79% to 3.55% with foreclosures increasing 42 bps to .96%. Sub-prime mortgages saw an increase from 14.27% to 18.82% with foreclosures going from 4.53% to a staggering 8.65%. Investors so far have asset write-downs and credit losses totally $312 billion since the beginning of 2007. Some say this number will peak near $1 trillion. Sub-prime mortgage servicing companies used to be able to fund their delinquency reserves with loans that were being prepaid or refinanced.

With the underwriting standards tightening up and housing values declining, not as many people can refinance their loans so the amount of funds these companies are receiving from prepaid loans is dropping. With delinquencies rising, these companies are forced to take advances and borrow money to fund the reserve accounts. Capital levels in these companies are decreasing drastically because of this.

What's even more astonishing? There are services like one found at www.youwalkaway.com where they charge you $1000 to supposedly help you live in your house mortgage free for 8 months and then fix your credit so that your foreclosure doesn't show- money back guarantee! (My mouth dropped when I saw this website.)

Some predict the loss of investors, decreased risk tolerance, declining home values, and the tightening of underwriting standards will increase mortgage rates, possibly near 8% by the end of 2008. The spread between the 30-year mortgages being traded on Wall Street and the Treasury bonds is almost double the historical average. The bigger the gap the higher the mortgages rates because it is more difficult and costly to hedge the mortgages.

Some Possible Solutions

A lot of people have suggestions on how to help stop the turmoil. Senate Democrats have added to a proposed housing reform bill that would allow bankruptcy judges to modify terms on a troubled borrower's mortgage as another attempt to prevent additional foreclosures. No decision has been made on the bill as a whole or any portion, but there is general concern throughout the industry and among economists and consumer advocates that this will ultimately raise mortgage costs for consumers. It could potentially drive home prices down even further by establishing a “reasonable value” for the home. Lenders would look to offset the potential risk with increased interest rates, higher down payment requirements, and higher closing costs to future borrowers.

On April 17, the House Financial Services Committee Chairman introduced H.R. 5830, the FHA Housing Stabilization and Homeowner Retention Act of 2008. Under this program, the participating mortgage holder must agree to a loan refinancing arrangement that bring the LTV on the new-FHA insured loan to a maximum 90% of the current appraised value. Along with the mortgage holder forgiving this portion of the debt owed, they would also have to pay 3% of the original insured loan amount to FHA and a maximum of 2% would be paid to cover the closing costs, including origination on the new loan. The new loan would be a fixed interest rate and be subject to the FHA loan limit restrictions. FHA would also be required to charge the borrower an annual fee of 1.5% of the remaining insured principal balance. This program also requires that the borrower pay to FHA 3% of the original insured amount or a declining percentage based on net proceeds realized including equity (whichever is greater) upon sale, refinancing, or other disposition. The Congressional Budget Office estimates that only 20-25% of the estimated 40% of affected loans would be eligible for this program. The office's concerns include the willingness of mortgage holders to write down a large percentage of what they are owed with no chance for recovery, the willingness of borrowers to even accept the terms let alone give up the required portion of profit when their house value does appreciate, and how second lien holders will handle their position when a modification is being requested. How many foreclosures will this bill actually prevent and how much will this program cost taxpayers since it is an FHA program? This bill cleared committee on May 1 and is now being brought to the floor for debate. Keep your eye on this one.

The Mortgage Bankers Association (MBA) has a memo outlining an agenda to stabilize the market. On the agenda is supporting a reform of the Federal Housing Administration, the regulation of the Housing GSE's, tax incentives to purchase foreclosed, abandoned or other distressed properties, and creating borrower “rescue” plans. The MBA is also looking at efforts to prevent future problems, such as licensing loan originators, enhancing disclosures, fighting fraud and implementing procedures to ensure accurate appraisals. You can find this memo online by clicking here.

Summary

There is no way to predict what may happen in the coming months, but we can be sure that there is no quick and easy fix to the industry problems right now. Summer of 2010 is the most recent date that experts are predicting a turn around. There are a lot of different ideas coming from all different areas of government, agencies, and associations. The one thing everyone agrees on is that something needs to happen.

Most credit unions are sheltered from the huge effects of these issues because we are generally conservative and know our members. Our institutions might see more of an effect in our Home Equity portfolios rather than our 1st Mortgage portfolios. Credit Unions are GREAT at what we do, including mortgages. We are NOT liars and cheats. This is our time to shine, get the word out that credit unions do mortgages, and develop a lifetime relationship by helping people through the single largest financial transaction that most members will ever have, whether they are in a bind or getting into their first home.

Karen Moran is Director of Lending, Colorado Credit Union and also a member of the CUNA Lending Council Regulatory and Legislative Sub-Committee.