The Game Has Changed
by Tom on August 3, 2007
in Uncategorized
This week’s interest rate update is going to be a bit different than most because frankly this week is significantly different than most weeks. It’s going to take a little explaining, so I hope you’ll stick with me and let me lay out a little about how the mortgage industry comes up with the money that we loan to people to buy or build or refinance homes. At the very least, skim through most of this and read the last couple of paragraphs more closely.
How do we (and by we, I’m not referring just to Fifth Third, but to the entire mortgage industry) come up with the money to loan to home buyers? There are a couple of ways:
1. Portfolio Loans – those we do with our own money. A bank like Fifth Third has a LOT of money that people has deposited with us and we use certain portions of it to make loans. These types of mortgages usually have higher rates, aren’t done for as long of a time period, and aren’t fixed rate loans.
2. Fannie Mae and Freddie Mac – (those are the “nicknames” for the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation). I describe these as “quasi governmental” institutions who buy mortgages from banks and mortgage companies by the billions of dollars and sell “shares” in those mortgages as investments. A couple of important details about the loans that they buy:
a. They won’t buy loans that are larger than $417,000 (the current “conforming loan amount”).
b. They set their own underwriting requirements and won’t buy loans that don’t meet those guidelines.
c. They do very very little with interest only loans, no documentation loans, stated income loans, low credit score loans, high debt to income loans, etc. The loans that they will buy are typically borrowers with credit scores in mid 600’s or higher, people who can document their income and assets (and they have some assets) and the loan that they want to get is reasonable for their income.
3. Other private investors – There is quite a market, or at least there WAS, quite a market for loans that didn’t fit Fannie Mae and Freddie Mac’s guidelines. The loans that the other private investors buy typically fall into a couple of “types:”
a. Jumbo loans – loans above $417,000
b. Exotic loans – the pay option ARMS, interest only ARMS with teaser rates, negative amortization loans, no documentation loans (aka liar loans), stated income loans, etc.
c. Alt A loans – I refer to these as the “not quite ready for prime time” loans. They probably meet 80% of Fannie Mae and Freddie Mac’s guidelines, but not all of them.
d. Subprime loans – these are the loans that are made to people who have bad credit, credit scores below 620 etc.
How does the money “flow” through the system? A couple of steps to it:
1. The mortgage lender writes a loan and closes on it with you or one of your clients and comes up with the money from one of two ways:
a. Their own funds if they have the assets to do that.
b. A “warehouse line” from a bank or banks where they borrow the money on a short term line of credit from one or more banks.
2. They then package the loan, after closing, and sell it to either #2 (Fannie or Freddie) or #3 (Private Investors).
3. When they sell the loan, they sell it for more than what they wrote the loan for and that’s where they make the profit.
So, what has gone wrong? A couple of things:
1. The private investors (aka Wall Street) got greedy and was willing to accept higher risk than they should have and was willing to overlook some of the necessary accountability in pursuit of higher returns.
2. Many (but not all) of the mortgage lenders, especially those who wrote a lot of the loans that went to the private investors, got sloppy with their underwriting and wrote loans that, if the borrowers paid as they should, would have earned very nice returns, but the probabilities of that were slim.
3. The historically low interest rates fueled a housing boom that encouraged many people to use some of these “exotic” loans to get into houses that they shouldn’t have.
Now, we’re faced with a couple of things that are happening:
1. Delinquencies are rising, particularly in the loans that are being bought by the private investors (Wall Street). Many of them are experiencing HUGE losses because of rising foreclosures and falling real estate values.
2. Suddenly the private investors that are buying these loans are finding that they either don’t want them or don’t have the cash to buy them any more.
3. The mortgage lenders who wrote the loans on warehouse lines of credit are finding out that they can’t sell the loans and pay off their lines of credit.
4. The banks who have the warehouse lines (and these are HUGE lines – some of them in the billions of dollars….) are starting to realize that they have a big problem on their hands and are starting to cut off or close down those lines. That essentially kills the mortgage companies because without the ability to borrow the money, they can’t write the loans and without the ability to sell the loans, they can’t pay off the lines of credit.
According to information that I’ve read, over 100 major mortgage lenders have shut down at least part of their operations this year because of this squeeze.
You’re probably saying, gee that’s interesting, but how does that affect me? A couple of things from all of this that probably will affect a good number of the people who are in the home buying/building/refinancing market….
1. Jumbo loans (those over $417,000) are getting a lot more expensive. It used to be that there was maybe .25% difference between loans under $417,000 and loans between $417,000 and $1 million. Take a look at today’s rate sheet to see how that has changed. For those who want to borrow between $417,000 and $700,000, it might make more sense to do a first and second mortgage rather than a jumbo loan because of the interest rate differential.
2. The instability of mortgage lenders – if you have a deal going on that is contingent on someone else’s financing, make sure they are working with a reputable mortgage lender (like me at Fifth Third!) because there is a lot of instability in the mortgage lending business right now and many sources of mortgage funding are drying up. American Home Mortgage (formerly the 3rd largest mortgage company in the country, as of this morning, out of business) had closings scheduled on Monday and Tuesday of this week that they weren’t able to fund because of their problems. How many closings? $800,000,000 on Monday and $500,000,000 on Tuesday. That’s a lot of buyers and sellers who got a phone call the day of closing that wasn’t very nice to get. In today’s market, you need to know you’re working with reputable financial sources.
3. Expect that the day of significantly reduced documentation on mortgages is going to go away very soon. I can’t say for a fact, but my read on it is that the markets are realizing that the stated income programs, which were designed to give people some added convenience turned into “liars loans” and got abused. I don’t expect we’ll see much in terms of stated income loans any time soon.
4. The Subprime and the “not quite ready for prime time” loans are going to require a higher downpayment, higher interest rates, and significantly higher documentation than previously required.
5. The trickle down effect from this tightening of credit is going to work it’s way into the housing market sales numbers and the overall economy. My personal opinion is that the tightening of the credit requirements in the mortgage arena is going to push the overall economy into a recession.
So where does all of this gloom and doom leave us?
1. If we do head into a recession, as I expect, I also expect that we’ll see the Fed lowering rates later this year.
2. If you are involved in a transaction with someone who needs an Alt A or subprime loan, get it closed ve
ry very soon because the rules on that part of the game are changing and are changing very rapidly.
3. Expect more mortgage lenders to go out of business. The business is changing and consolidating quite rapidly. If someone
4. Expect that the amount of documentation you are asked for when you get a mortgage is probably going to increase.
In light of these changes, in my opinion, it makes more sense than ever to work with someone who has a lot of experience and works for an established bank who has been around for a long time.
Any idea who I might be thinking of? 
Have a good day and let me know if I can help.
Tom Vanderwell
Mortgage Officer
Office (616) 653-5375
Cell (616) 292-7559
Fax (616) 825-6085
111 Lyon St. NW
Grand Rapids, MI 49503
thomas.vanderwell@53.com
For some straight talk about mortgages, check out www.straighttalkaboutmortgages.blogspot.com.
Quote of the week: “American Home has ceased taking mortgage applications and has notified all of its production employees that they will be separated effective tomorrow, August 3, 2007. Accordingly, the Company employee base will be reduced from over 7,000 to approximately 750. The Company currently is maintaining its thrift and servicing businesses.” American Home Mortgage Press Release, August 2, 2007
