Mortgage Industry

[Sonny]

Hopefully those home owners among us are locked into a set rate they can handle. The mortgage industry is headed for some deep doo-doo and tons of home owners are overextended:
http://today.reuters.com/news/articlenews.aspx?type=domesticNews&storyid=2007-03-29T184850Z_01_N28302234_RTRUKOC_0_US-USA-SUBPRIME-FORECLOSURE.xml&src=rss&rpc=22

[StrykerFSU]

If you have access to a copy, there is a great article in the latest issue of The Economist on this. I've got my fingers crossed that my property value doesn't tank on account of a glut in the housing market.

When will we learn to live within our means?

[shrekjr]

I love my fixed 5.0%, will be paid off in six years!!!

[Kyle Berggren]

This is a sensitive, but very interesting subject. Just like anything else, someone's financial misfortune means profit for others. Many HedgeFunds have been making money due to these foreclosures, & quite frankly I believe we overvalue/misuse our homes as investments. This is a tough place to get into that, but I'll gladly try if you guys are interested.

That article doesn't exactly paint the picture of why there's a problem, or even why it thinks there's a problem. The media doesn't take any responsibility, but in general, everyone thinks homes are great investments... Rarely do people think about the fact that it can go down in value, or even look at the fact there could quite possibly be a market correction. In the Stock market, a 10% down turn isn't looked at as complete horror, the spin is it's a correction. It's what happens when prices are over-inflated & too many people are on the band wagon. Did anyone else notice the real estate bandwagon?

[LaxRef]

A home is a good investment because you get to deduct mortgage interest and because, hey, you've got to live somewhere anyway and it beats paying rent or living in a refigerator box. But investing in real estate to try to make money as you would with stocks carries risks of which many people are either not aware of or not sufficiently wary of.

The key with real estate is that a house is only worth what someone is willing to pay for it when you're trying to sell it. Many people get caught up in, "Well I paid $X for it 5 years ago, so I should be able to sell it for $(X+Y) now" (Y>0). A lot of people who fixate on that end up with houses on the market for two years.

I'm on my fourth house. The first two we sold for big profits. In the third, we faced a glut, priced the house at a loss and sold it relatively quickly. It was a bitter pill, but we needed to move and it beat carrying two mortgages. We lost about $15,000, but in the grand scheme of things it wasn't too bad because we'd done well on our other two home sales and we're very happy where we are now.

[Kyle Berggren]

A home is a good investment because you get to deduct mortgage interest and because, hey, you've got to live somewhere anyway and it beats paying rent or living in a refigerator box.

Okay, I'm not on my office computer & I'm far too lazy to do the calculation by hand, but here's the just of it. Owning a house doesn't necessarily beat paying rent... I'm not saying this is or isn't the right situation for each person, but the conventional wisdom to own a house isn't exactly flawless. The going concern should be revolving primarily around cashflow, & it typically isn't. It isn't necessarily a great investment, hell it isn't exactly a good investment. You can't control the market, which is why quite often people will have to take a loss. The major advantage in owning a home comes in the leverage it takes to finance the home. Tax write offs are offset by maintenance & repairs. Quite often people choose the wrong loan for themselves anyway, taking away many of the advantages they could have had.

For instance, if you could own a home & pay $3k/month in 30 year mortgage or pay $2k/month in an interest only, what would you? Often our clients have been surprised when we say take the $2k payment. If you're not going to be in the home over 10 years, take the lower payment. Sure you can afford the $3k, but the majority of that payment is front loaded interest, very little is going to equity. What if you took that extra $1k/month ($3k-$2k) and invested it? even left it in a money market? You'd have $120k in principle (also liquid funds, an emergency fund that many families are lacking), plus the interest, the compounding, & capital appreciation over 10 years... 10 years is right about the crossover point with interest only vs. 30 year fixed loans. If you stay over 10 years, the equity built into your home compounds at a faster rate than the alternative.

There are some interesting books on why you should rent forever vs. owning a home. They're pretty interesting, but I can't simplify well enough to make a decent argument. A quick example would be the price difference between renting & buying... $3k/month for a mortgage, or $1.2k for renting? What happens when you invest the difference?

I haven't made this argument in a while, but I hope I got it on paper well enough for this discussion.

Oh, & for the record, I do believe housing prices will continue to go up in the long term... inflation dictates it so, but liquidity in the housing market can be a nightmare.... Don't keep all of your eggs in one basket...

[Jana]

Since I'm in the industry...to expound on Kyle's post - when choosing the program with a lower payment -- an IO loan, or a 40 year, or an ARM or a hybrid, or even buying down a fixed, the cost savings really only work if you have financial discipline to save the difference and invest it into something with some liquidity that you can access in emergencies.

Most people in subprime loans are in them because they didn't have fiscal discipline to begin with, so their FICO scores are below 600. They are unlikely to save or invest the difference. Their income is usually not very high anyway, so the potential IRS income tax savings may or may not be large enough to offset the difference between rent and PITI [Principal + Interest + (property) Taxes + Insurance].

Fast forward 2 years into a subprime loan, they have not been disciplined - no savings, no investing, or they got into ARMs and didn't realize the ramifications of the yearly rate adjustment - and now they are in a real bind: their interest rates have been increasing, but their lack of fiscal discipline means they have no liquid investments and continue to have lousy FICO scores. In the meantime, the underwriting guidelines for subprime loans and refi's are tightening up - so it's harder for them to refinance. AND many of them have taken out HELOCs, so they just keep digging into more debt.

On top of all this - add criminal behavior from loan professionals. Yes, criminal, and more of them should be wearing orange jumpsuits at the county jails. They misuse stated income loans for subprime borrowers who rarely generate the income listed - or have a chance of earning that income in the future. They promise rates and then they can't get them, so to make the loan fly, they slip in 5 year pre-pay penalties into docs to get the rate down to what they promised (I have at least 1 person each week drop into our office asking me if I can get the pre-pay "waived" - they signed paperwork without understanding it with some loan ranger broker, and now it's tough to break it and the loan ranger broker is long gone).

Unlike other industries where you get paid on residuals, loan officers get paid up front, so it is to their own best interest to pressure people into loan programs that provide the highest commissions to the loan officers and may not be the best loans for the borrowers.

Another factor is the gung ho willingness of investors to buy mortgage bonds for the subprime market. The high interest rates were very attractive to foreign and domestic funds looking for that sexy return. So the industry kept creating more creative loan programs, because the market would buy them.

The market is now correcting - at the retail sales level and also in the mortgage bond market, in a few places the market is overbuilt with condos and new homes (Atlanta, Las Vegas, etc). Puget Sound Biz Journal just reported home values went up 7% from last year, so some areas continue to grow (but at a slower pace).

In a better world, becoming a loan officer (or a loan originator to use the industry term) should be as difficult as becoming an attorney or a CPA. The tests should be far more stringent, with much tighter oversight. Granted, there are still unscrupulous attorneys and CPAs, MD's, and many other professions, but creating more obstacles to entry and higher standards of knowledge requirements are truly necessary for the mortgage profession.

For most people, this is the biggest ticket item they ever buy, they deserve to work with ethical advisors - even people who are willing to say "rent for 2 more years and save some money - this is truly in your best interest".

Why do people choose a cheesy commercial or a stupid cartoon character when they choose their mortgage companies, and then why are they surprised that the loans are terrible for their situations? I mean, if your wife has cancer, do you choose her oncologist based on a stupid jingle on the radio or cheesy cartoon on the internet? I hate all the radio / internet / TV ads that are flooding the market right now - they are so cheesy and do nothing to educate the public or improve the industry's integrity.

[StrykerFSU]

Why do people choose a cheesy commercial or a stupid cartoon character when they choose their mortgage companies, and then why are they surprised that the loans are terrible for their situations?

Amen. I also read about folks getting mortgages without having to show any proof of income...and how is this not a sign you are in a shady deal??? I was warned about the dangers of the Ditech.com's of the world when I bought my house but as the son of a real estate attorney, I had good guidance.

On the brighter side, the rising number of foreclosures will only create a small blip in our debt economy so we may get lucky and this problem will only affect the few and not create a wide scale recession. Obviously bad for the few but as has been said, those few probably shouldn't have been buying homes anyway.

[Sonny]

Unlike other industries where you get paid on residuals, loan officers get paid up front, so it is to their own best interest to pressure people into loan programs that provide the highest commissions to the loan officers and may not be the best loans for the borrowers.

That is the biggest problem, IMHO. Loan officers (& the closing attorneys) don't care one iota when the mortgage fails 2 months down the road or 2 years down the road.

[Sonny]

Unlike other industries where you get paid on residuals, loan officers get paid up front, so it is to their own best interest to pressure people into loan programs that provide the highest commissions to the loan officers and may not be the best loans for the borrowers.

That is the biggest problem, IMHO. Loan officers (& the closing attorneys & the property appraisers) don't care one iota when the mortgage fails 2 months down the road or 2 years down the road.

[Kyle Berggren]

Amen. I also read about folks getting mortgages without having to show any proof of income...and how is this not a sign you are in a shady deal???

It's been a while since I've looked at these, but their intention is more for folks that are self-employed.... Now is that how they're used? I'd bet not, I've worked with a few folks in sub-prime that use the stated income to get the loan done. "Sure it's 1% higher, but they can refinance in 6 months when their credit is cleared up."

People simply aren't savvy enough to make an informed decision... we're too trusting... & we're simply too greedy. Even the Fortune 500 not-4-profit financial institution I very recently left has salespeople. They're motivated by income/greed... When you find a salesperson that says, "I'm sorry, I can't help you," They're turning away commission, that's probably someone you shouldn't automatically hate.

[Jana]

It's been a while since I've looked at these, but their intention is more for folks that are self-employed.... .

They are meant for self employed and people in sales positions, or with quarterly bonuses.

They are definitely being misused.

I know the "official line" of my industry is that all the creative loan options made homeownership possible for more people. And that is true to a certain extent. But it also drove up the price of housing, because more people were now qualified to bid on homes, because they had access to all of these creative financing mortgages, often 100% financing with stated income loans that were essentially "liar loans".

The unexamined factor is the easy access to unsecured credit card debt. This is a big reason for the low FICO scores, they are used to living beyond their means, and our society simply doesn't have the culture of savings that we need to have.

It would serve our country better to have tighter underwriting guidelines and tell people they need to save up at least 5% plus closing costs before even thinking of owning their own homes. My parents, and many of the parents of my friends have similar stories - they spent the first 2 years of their marriage living on 1 income, while they saved the 2nd income to purchase their first homes. They ate at restaurants only for their birthdays and their anniverary, and that was it. All other nights they ate at home and they packed brown bag lunches.

[LaxRef]

The unexamined factor is the easy access to unsecured credit card debt. This is a big reason for the low FICO scores, they are used to living beyond their means, and our society simply doesn't have the culture of savings that we need to have.

Boy, is this the truth. I think a lot of us have married friends with two good incomes, no savings, huge credit card debt, and every toy you can imagine (multiple big-screen TVs, iPods, computers, jet skis, etc.). Meanwhile my wife and I—while not living like paupers—are saving well beyond the maxed-out employee retirement plan on a full-time and a part-time income.