The Truth About the Mortgage Market

Denver, CO – Subprime mortgages have now been credited for bankrupting well over 110 lenders and seriously damaging operations at many major mortgage firms. They've reportedly wiped out 5 hedge funds, tens of thousands of jobs, and have led to millions of foreclosures with millions more on the way. And, as if that weren't enough, subprime mortgages are also blamed for massive volatility in the stock, bond, credit, futures, and real estate markets here in the US and around the globe. Some say losses in the mortgage securities market alone could reach hundreds of billions of dollars this year.

This means that, for any Americans looking to buy, sell, or refinance a home, they are confronting a very different market from the one that existed just 6-12 months ago.

How did this happen?
The recent real estate boom was fueled by a period of record home appreciation and historically low interest rates. Banks, in order to compete, loosened guidelines and began offering more funding to more borrowers through riskier, non-conforming or "exotic" mortgages.

These ideal lending conditions persisted for several years, supported by high demand, historical real estate data, home prices, and massive trading volume/profits on mortgage-backed securities and other financial instruments on Wall Street.

Then, in 2006, a slowdown in real estate led to a deterioration of home values, an increase in inventories, and ultimately to today's tightening of credit guidelines, leaving many investors unable to sell or refinance out of their existing positions. Many Americans who had tapped into their equity were suddenly tapped-out and overextended as home values fell. Foreclosures followed in record numbers and a re-valuation of mortgage bonds and other financial instruments created the credit/liquidity domino effect we're now experiencing.

Unfortunately, it's going to get a lot worse before it gets better. According to the latest estimates, over 2 million subprime and Alt-A adjustable rate mortgage (ARM) holders will face payment increases of up to 30%-100% when their loans reset in the next 2 to 18 months. These loans make up less than 40% of the total mortgage market, but the negative effects, as we have seen, of increased foreclosure activity can have a ripple effect throughout the industry and around the globe.

What does this mean to you and your mortgage?

Sellers: If you're planning on selling your home, be prepared for an even smaller pool of qualified buyers. While some experts predict a settling of this credit crisis over the coming year, tightened credit guidelines and diminishing mortgage products could knock out as many as 15%-30% of potential qualified buyers. Now is not the time to sit and wait for the best possible price. Have a serious talk with your real estate agent. Having experienced buying/selling transactions in your area, he or she can help you price your home accordingly. He or she can also help ensure that your buyers are pre-approved and stay pre-approved throughout the entire transaction.

Buyers: Get pre-approved by your mortgage professional. While there are a lot of great deals out there, getting credit is becoming tougher and tougher, and it's taking longer and longer to complete a transaction. Remember, what you qualify for today could change tomorrow in a volatile market. For those looking to refinance, keep this in mind. There is no time to delay! Communicate with your lender. Don't do anything that could negatively affect your credit, and make sure you get all your documentation in on time.

ARMs Borrowers: If your ARM is scheduled to reset in the next 2-18 months, you need to schedule an appointment with a mortgage professional right away. Whether your ARM is subprime, Alt-A, or even if you have a pre-payment penalty, don't let a default or foreclosure situation sneak up on you. Did you know that your monthly payments can increase anywhere from 30% to 100% once your loan resets? At the very least, give yourself the peace of mind of knowing what your adjusted payment will be.

Borrowers with less-than-perfect credit: Each week it seems lenders are shedding more and more mortgage products. Many lenders have stopped offering No-Doc loans and are reducing all forms of Stated-Income loans. While it might be challenging, borrowers with credit issues need to see a loan expert. Often they have credit repair resources and other strategies to help you reach your financial goals.

Finally, there's an important concept to embrace: all markets, while cyclical in nature, are self-correcting, be it credit, real estate, stocks, or bonds. For the last 6 or 7 years, real estate was booming and riding high. The correction we're experiencing now – while it seems harsh and could get much worse – is, in a sense, "natural" and directly related to the extremely loose guidelines and perhaps overzealous lending and leveraging during the boom cycle.

Homeowners facing resets on their adjustable-rate mortgages or hoping to refinance into less-burdensome loans may be the biggest beneficiaries of the Federal Reserve's surprise rate cut this week as mortgages continue to get cheaper.

As many as 2 million homeowners face ARM resets this year and declining interest rates hold out the promise of at least limiting the sticker shock of higher payments on loans linked to Treasury indexes used to calculate many adjustments.

Lower rates also will make it easier for homeowners to qualify for refinanced loans, mortgage professionals say.

 

"For anyone on the margin, this will provide some relief," said Richard Musci, vice president of Charles Schwab Bank. But he warned that for those already struggling or already behind on credit payments "the die has been cast."

The Federal Reserve's emergency interest-rate reduction of three-quarters of a percentage point brought the central bank's key lending rate down to 3.5% from 4.25%. It was the most aggressive one-time cut in more than two decades, and its bombshell nature underscored the Fed's worries that credit conditions for consumers and businesses are at a breaking point.

"Whenever you lower rates, it can't hurt the consumer," said Bernard Baumohl, managing director of the Economic Outlook Group. "The Fed never promised it could change things dramatically overnight. There's a certain timeline with a cut in rates of nine months to 18 months when the economy feels the benefits."

'Consumers should be able to afford more'

While mortgage rates are not specifically tied to the rates the Fed controls, they have dropped significantly in the last three weeks and may be drop further.

"Mortgage rates already have fallen and they still are falling," said Dave Loyst, vice president of retail lending at Stearns Financial in San Diego. "Every deal is a struggle, but we're still doing loans. I think this rate cut absolutely is going to help the real-estate market."

"This definitely will help the mortgage situation," Loyst said. "With rates falling, more people are able to qualify for refinancing and more people who were left out from buying homes before will be able to do so now."

Consider what's happened since September's rate cut for creditworthy Schwab borrowers. On Oct. 7, a 5-1 adjustable-rate mortgage of $350,000 carried a 6.52% interest rate, assuming a 20% down payment. (A 5-1 ARM gives borrowers a fixed interest rate for the first five years and then converts to a loan that adjusts annually after that.)

The rate this week for that same loan was 5.04%. That translates into an annual mortgage payment that's $5,100 cheaper, Musci said.

"This is the affordability piece," he said. "Consumers should be able to afford more (of their living and discretionary expenses) at these lower interest rates."

Get the paperwork started

Richard DeKaser, chief economist at National City Bank, encourages consumers to go for it now. "This doesn't apply to all cases, but for those who have an adjustable-rate mortgage and good credit this is probably a very good time to lock in some fixed rates for the long term."

But he warns that credit-lending standards are much tighter than they were two or three years ago when many borrowers took out their current loans, with full documentation of income required on nearly all loans.

"Don't go out and borrow money for the sake of borrowing money. But if consumers can consolidate and lower some credit-card debt, it probably makes sense to do so," he added.

Musci said those who want to refinance should get the paperwork started and look for lenders that offer a "float down" option that gives the borrower a one-time chance to lock in a lower rate should mortgage rates continue to fall in the wake of any additional Fed cuts.

"Even though it costs money to refinance, rates have gone down so much that you're probably locking in rates at the bottom or close to the bottom," Musci said.

Even though mortgage rates may be low, some homeowners may have trouble refinancing if the value of their house has fallen, as has been the case in many parts of the country. But home-price patterns vary by locale.

In Boston, for example, home prices are starting to inch up again after falling sharply, but in Bakersfield, Calif., more fallout is expected. So borrowers will need to monitor their property appraisals.