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Chicken Little Meets the Mortgage Market:
The Implications of the Market Correction
By G. Steven Bray,
Texas Lone Star Lending
, LLC
If you listen to some of the noise in the media and on Capitol Hill, you would think the mortgage industry was melting down like Chernobyl. (Or the sky is falling - I'm not sure which). As has become common in our 24-7 news world, exaggeration and hysterics attract publicity. You've probably seen headlines like "Soaring Foreclosures" (ABC News), "Mortgage Morass" (San Jose Mercury News), and "Crisis Looms in Mortgages" (NY Times). Are they true?
Let's look at the facts. The mortgage market has seen the demise of several lenders in the last few months. The most commonly cited reason for their demise was the forced buy-backs of delinquent loans. Mortgage delinquencies (payment more than 30 days late) are up slightly, rising from 4.67% of mortgages in Q3 2006 to 4.95% in Q4. Delinquencies stood at 4.70% a year ago. Delinquencies for subprime mortgages rose to 13.33% and for FHA mortgages rose to 13.46%. While delinquencies have risen, the Mortgage Bankers Association (MBA) reports that foreclosure rates are within normal ranges, and while the subprime delinquency rate is high, it has been higher in the recent past (Q3 2002).
So, what has caused the rise in delinquencies, and is it a cause for concern? Foreclosures are driven primarily by life events: loss of employment, illness, divorce. This creates a background of foreclosure activity that always will exist. Against this background, market events can cause delinquencies to rise and fall.
The market event du jour is the correction in the housing market. It's no secret that housing prices in many markets were rising much faster than buyers' incomes. In order to meet the needs of buyers in these high-cost markets, lenders began offering non-traditional mortgage products (such interest-only and payment option mortgages) with lower initial mortgage payments that allowed more borrowers to qualify. Borrowers and lenders alike anticipated that rising incomes and price appreciation would allow borrowers to absorb payment increases. In hindsight, these may have been poor assumptions.
Non-traditional mortgage products also include subprime mortgages. The subprime mortgage market is for borrowers with lower credit scores typically caused by failure to pay bills on time or at all. Subprime lenders have been very aggressive in creating loan programs to fit the needs of borrowers, including programs that require no down payment and no income documentation. These loans typically are adjustable rate mortgages (ARMs), meaning the mortgage payment may change (higher or lower) at the end of an introductory period.
While non-traditional mortgage products have introduced more risk into the market, they have helped more people qualify to purchase homes than at any time in history.
It's not just home buyers who have used these aggressive loan programs. With rising home prices, many consumers have been treating their homes like piggy banks. They're using these same non-traditional and high leverage loan programs to tap into their homes' increased equity for a variety of needs including home improvements, paying off credit cards, and education and healthcare needs. If they hit a bump in the road, they just tapped into their homes' equity. But home prices no longer are rising, and life still happens.
Who's to blame? Well, the government has encouraged more homeownership, consumers have demanded flexible mortgage products, lenders have created the products and approved the loans, and investors have purchased the loans as investment instruments.
The media and the politicians want a scapegoat, and a favorite choice of late seems to be mortgage brokers. This is pure silliness. Mortgage brokers don't set loan programs, and they don't make lending decisions. Lenders do. Brokers also don't force people to take out mortgages. Those are choices consumers make. A good broker helps consumers choose loan programs that meet their needs.
That's not to say there aren't some unscrupulous loan originators that prey on poorly informed consumers. Like every profession, the mortgage industry has a few bad apples. Industry associations and government regulators are working together to try to get rid of them.
Lone Star Lending
is at the forefront of this effort designing a comprehensive compliance and anti-fraud program to protect its customers.
So, is the sky falling? Unlikely. Ninety-six percent of mortgagees are making their payments on time. The largest players in the mortgage market, Fannie Mae and Freddie Mac, claim to have little exposure to subprime loans. A few high risk companies will fail, and other companies will purchase their portfolios at a discount. The market will correct. According to HUD Deputy Secretary Roy Bernardi, the news media have "overreacted" to the correction in the subprime market, and the mortgage market will settle down soon.
That said, there may be a greater risk to the economy as a whole. Tighter standards for subprime borrowers mean some no longer will qualify for mortgages. Estimates of the number of affected homebuyers range from 80,000 to 500,000 this year. It's also possible that tighter standards will trickle over to prime borrowers, but any effect likely will be short-lived. Mortgage-backed securities are attractive investments, and investors aren't likely to sit on the sidelines long. Finally, given the increase in delinquencies, foreclosures are likely to rise. This means more housing inventory, inventory likely to be selling at a discount. The combination of fewer buyers and more housing inventory may delay the housing recovery.
But this risk may be overstated. The economy still has good growth (projected growth of 2.6% this year), and it continues to add new jobs. Most of those who took out subprime loans, those with the highest delinquency rate, tend to be less-affluent consumers who make up a relatively small share of consumer spending.
The question is what effect will the market correction have on you?
If you're one of those at risk of foreclosure, the effect is tragic, and I am very sorry. The subprime mortgage market still offers hope for these people, but unfortunately, financing options are disappearing for those with damaged credit.
Those free of financial difficulty may notice no effect. Lenders are still making loans, lots of them. Lenders are looking a little harder when qualifying borrowers, but non-traditional mortgage products, payment option ARMs and stated income loans, still exist.
For more information about mortgage products and changes to the mortgage market, please give Steve or Stacy Bray a call at (512) 261-1542 or drop them an email at
info@lonestarlending.com
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