Foreclosure and Real Estate Blogs

“Mortgage delinquency and foreclosure rates have increased substantially over the past year and a half,” Mr. Bernanke said during a speech in Washington. “Behind these disturbing statistics are families facing personal and financial hardship and neighborhoods that may be destabilized by clusters of foreclosures.”
From the NY Times

Well, duh.

Of more interest is the comment that 1.5 million homes entered foreclosure last year and there are another 1.5 million subprime loans that will have their rates reset this year.  There’s a lot more pain to come, and not just for homeowners.  Bear Stearns, one of the big players in the subprime mortgage market is now looking for a bailout from JPMorgan.

When this is all over, and I guarantee the Fed won’t be the architect of it’s resolution, many homeowners might be battered, but they’ll carry on.  Some of the big lenders that facilitated the credit bubble won’t be carrying on, they’ll be absorbed or shut down, which is the way things should be.

There’s been a lot written about home loans and securities lately with the emphasis on increasing foreclosure rates and the losses incurred by the holders of sub-prime securities.  That begs the question “What the hell is Fannie Mae and Freddie Mac, and why do I care?”

U.S. residential lending was far different in the fifties, rather than what we’ve got today.  Local banks, savings and loans, thrifts were all sources of financing, and although the loan terms weren’t too bad, it did require a 20% down payment to purchase a home.  Housing, and residential construction were subject to boom and bust periods often influenced by the availability of credit.

Fannie Mae was restructured in 1968 as a federally chartered corporation, Freddie Mac was created in 1970 to “compete” with Fannie Mae.  Both corporations are private, but are government sponsored and have lending advantages that aren’t available to non-sponsored lenders.  The explanation for what these organizations do isn’t hugely simple, but it is understandable.  They create CMOs or Collateralized Mortgage Obligations which entails combining a group of mortgages into a “pool”, then separating the future payments into “strips” with different risks and maturity dates.  Those strips are then sold as securities.

Many mortgage loans originated in recent times won’t be owned by a “lender”, they are originated to Fannie Mae or Freddie Mac guidelines, then sold into the secondary market.  The entity servicing(collecting payments) the loan may, or may not have an interest in the loan.

The use of CMOs in the past certainly helped stabilize housing markets and increased overall homeownership rates.  Where things went bad, IMHO, was when the demand for high returns led to the creation of CMOs for pools based on artificial or non-existent original loan documentation.  It was musical chairs with ever increasingly easy credit, the big problem being there were an awful lot of players and not too many chairs.

Everyone’s aware of the issues with California’s housing markets, today’s question is whether current prices make sense given a more realistic loan underwriting requirement. Conventional loan underwriting requires a home loan payment, including property tax and hazard insurance, to be less than 33% of a borrower’s pre-tax income. That’s not cast in stone, but it’s a good number for determining housing affordability.

Let’s take a house listed for sale at $600,000. Yes, some areas will be lower priced, some will be higher priced, adjust the numbers to reflect your local area.
$600,000 Purchase Price
-$60,000 Down Payment (10% down based on the $600,000 purchase price)
$540,000 Loan Amount

What will the payments look like?
$3,413 Principal and Interest ($540,000 loan @ 6.5% for 30 years)
$ 625 Property Tax ( 1.25% of $600,000/12 ) - might be significantly higher
$ 250 Hazard Insurance - Probably a bit on the high side, this will vary
Total Monthly Payment - $4,288 - Does not include the possibility/probability of PMI or Association dues

What income is required to purchase this home affordably?
$12,994 a month, or $155,928 a year.

2006 California median income for a 4 person family was $74,801. Half of the families were making more than that number, half were making less. Census Median Income
Now, we can use the argument that some California counties are affluent, and some California counties are more rural and less affluent. That’s reasonable. Orange County had a 2004 median household income of $58,605. Marin County had a 2004 median household income of $67,731.  Maybe there are more affluent counties?

There’s also the argument that only people earning significantly more than the median average were buying homes over the past few years.  It sounds reasonable, but if the qualifying threshold is roughly three times the median income, the buyer pool becomes really, really small.  The most likely answer to why prices reached levels unaffordable for many lies with the Option Arm loans with qualifying based on teaser rates or stated income.

It allowed many people to purchase homes, but will it allow them to keep those homes?

The recent changes in how lenders underwrite loans became very obvious to me over the past few days.  We were looking at an SFR to use as income property, but trying to use 10% as a down payment rather than the historical “norm” of 25-30%, we also wanted to go with stated income rather than full documentation.  Surprise, surprise, the loans available half a year ago to anyone with a pulse aren’t currently available.  I have one broker pushing a 90% loan that needs to be a full doc through Chase, another broker wants to do a 75/15/10 using stated income.

So why not take the 75/15/10 ?  I was sent a preliminary HUD-1 that showed a roughly 2% Yield Spread Premium on top of the quoted 1% origination fee.  For those not in the lending business, a YSP is an amount paid from the lender to the originating broker for delivering a loan with a higher interest rate than the best available rates.
In other words, I was being charged 3% for a loan that really wasn’t too complicated.  We have the credit history, funds in the bank, income to carry any potential problems, what’s so difficult about the loan decision?

If anyone believes the issues created by the subprime lending meltdown aren’t bleeding into conventional lending, I’ve got news for them, the bleed-over is real, and I think it’s going to get a lot more significant over the next year or so.  At a guess, I think we might be looking at the rebirth of the creative real estate financing techniques.

Here’s a quick primer on residential lending, and why someone should or shouldn’t qualify for a loan.

There are three main facets to a good underwriting decision.  One is credit history, the second is employment/income, the third is down payment/assets.

Credit History
Credit is scored on an alphabetical grade scale with A credit being very good with maybe a late payment or two over the past few years, with those late payments being explained by a written letter.  B + C credit will have multiple credit dings, maybe some collections, but no real huge credit issues.  D credit is going to have major lates, including possible mortgage lates.  A credit gets the prime, advertised interest rates, B+C have to pay a premium in interest rates, D is what is consider sub-prime.  Credit factors can be compensated for/overcome in residential lending if income is high, or there is a large downpayment or equity in a home.
Many lenders will use a FICO credit score to determine creditworthiness, in a FICO score ,720 or more is good, 620 or below is getting in the sub-prime category.

Employment/Income
The last two years of employment is the most important in a lending decision.  Two years with the same company, or in similar industries, with a steadily rising income can predict a probability that the borrower will continue with steady employment, allowing them to make their housing payment on time.  The general rule of thumb is that a borrower shouldn’t be paying more than 33% of their gross (before taxes) income on housing, including their principal and interest on the loan, property taxes, and hazard insurance on the home.

Down Payment/Assets
The traditional standard is a borrower should be putting 20% down payment on a home.  Homeownership rates have increased by relaxing those standards, mortgage insurance(MI) protecting the lender for losses they may suffer above that 80% Loan To Value point started the ball rolling, lender programs offering both a first and second loan totalling sometimes more than the value of the property continued the low down payment phenomenon.  Typically, a borrower should have at least two or three months worth of housing payments in cash at a bank or somewhere it can be quickly obtained if there is an emergency requiring those funds to keep a home loan current.

A solid borrower should have good credit, stable employment/work history and a little bit of financial cushion in case of life issues.
A slightly more risky borrower will have issues with one of those three, but have other strong characteristics.
A risky borrower is one that doesn’t really have any strength in any of those facets.