Your Mortgage Matters Blog

As rates began to fall at the beginning our our last real estatate boom many homeowners were scrambling to find a lender who could refinace their home.  Backlogs were substantial and homeowners found themselves having to wait to find a mortgage counsultant to help them.

Although those days are long gone, the remnants of those times still remain.  If you don't believe me just take a look in your local newspaper in the real estate foreclosure section.  You will find countless numbers of homes in foreclosure. 

Most folks would assume that the forclosures are just the result of folks who lost their jobs and can no longer afford to make their payments.  While that is partly true, the majority of the foreclosures are the result of folks who got in to a mortgage that they did not fully understand.

Now, several year later, their payments are balooning and they are no longer able to make their payments. Was this a poor loan choice on the part of the buyer.  Most likely not.  The probable reason is their loan officer did not fully disclose the the type and term of the loan they were getting -- and many of those were adjustable rate mortgages, also known as ARMS.   

As a result, many homeowners now find themselves with a monthly payment spiraling upward, far beyond their means of repayment.

This is not the result of a loan officer who mistakenly placed the client in a product that was not suitable for them.  Most likely, this was the result of a loan officer who was desperate to close a loan and earn a commission, and therefore placed their own self interest before the interest of their client. 

Unfortunately, most of these loan officers, having collected their commission, are long gone, and the client-victim is now left to deal with this matter on their own.  For some, they will be able to refinance into a fixed rate product, although at a higher interest rate, but fixed none the less.  For others, there is no way out, so they will simple lose their home to foreclosure. 

Working with a competent professional who can help you make wise decisions is priceless.  And the value of their services far outweigh the costs they charge.  Remember, the cheapest initial rate may not always be the best product.

We’ve all seen news reports regarding the fallout from the recent meltdown in the sub-prime market, but will this spill over into the conforming market as well? While there is certainly the potential for increased delinquencies, the fundamental differences in borrowers will prevent a crash in the conforming market. Let’s take a look at these differences.

Credit Scores

One of the largest differences between conforming and non-conforming borrowers is credit scores. The credit score is a primary factor in determining the borrower’s credit worthiness. Credit scores are calculated based on five different characteristics of the borrowers’ credit habits. Below is a summary of these five factors:

1. Payment History – This accounts for 35% of the borrowers total score, and is based on you payment habits – that is, whether you pay your debts on time.
2. Amounts Owed – This accounts for 30% of the total score, and is based on the amount of the borrower’s available credit to total credit. Credit scores drop when a borrower is close to being maxed out on a particular credit line.
3. Length of Credit History – This account for 15% of the total score and is based on the length of the borrowers credit history.
4. New Credit – This accounts for 10% of the total score and is affected by the number of recently opened credit account
5. Types of Credit In Use – This accounts for 10% of the total score and is based on the mix of the various types of credit in use.

As you might assume, borrowers in the non-conforming market have lower credit scores and are therefore a greater credit risk for lenders. Additionally, as sub-prime lenders have relaxed their guidelines and lowered the minimum score required for 100% financing, they have assumed much greater risks – the effects of which are rapidly surfacing.

While mortgage delinquencies have risen slightly in the conforming market, they are nowhere near the staggering delinquency rates currently being experienced in the sub-prime market.

Products

Another significant difference between the conforming and non-conforming market is products. Many sub-prime borrowers end up in a 2 or 3 year adjustable rate mortgage, with the hope of improving their credit so they can refinance into a fixed rate product by time their rate resets.  While even the initial rate on these ARMs can be quite high, the maximum interest rate cap can be staggering.

The sad reality is most sub-prime borrowers have great intentions, but they lack the ability to execute their plan, and therefore never improve their credit scores. When their rate resets, their new payment becomes so large that they can only manage it for a short period of time.  Many of these borrowers eventually fall behind in their payments and ultimately end up in forclosure.

Reserves

Reserves is the term used to describe liquid assets such as savings accounts, stocks, bonds, or other investments that can be liquidated in the event the borrower needs funds to cover their mortgage payment. Reserves are stated in number of months. For example, if a borrower’s monthly mortgage payment is $1,200, and the borrower has $6,000 in a money market account, they would have 5 months of reserves (5 x $1,200 = $6,000).

Historically, conforming borrowers typically have larger reserves than most sub-prime borrowers, and therefore have the ability to continue to make their monthly mortgage payments during the times they experience financial challenges. Unlike conforming borrowers, sub-prime clients generally have smaller, if any, reserves, and do not have the ability to weather financial challenges for extended periods of time.

Certainly there are other factors to be considered, but credit history,  product, and reserves are key elements in determining a borrower's ability to keep their mortgage current.  The fact that conforming borrowers are well positioned to weather most financial challenges will mitigate any risks of a crash in the conforming market. 

As the meltdown in the subprime market continues to grow, SouthStar Funding, an Atlanta based non-conforming lender, announced the closing of their company.  On Friday, March 30th, SouthStar contacted their settlement agents and informed them that they were shutting down their operation. 

Settlement agents were instructed not to close any SouthStar loans they currently had inhouse, and to wire any SouthStar funds currently being held in their escrow accounts back to SouthStar.  Although they had experienced problems earlier in the year, many thought the brunt of their troubles were over.

Their recent troubles stemmed from purchase commitments that their investors failed to honor.  SouthStar had recently negotiated purchase agreements with a new investor and was in the process of tendering the loans to the new investor when they unexpectedly backed out.

Although SouthStar had hope to resolve this issue through ongoing negotiations, they were unable to reach an agreement, and their existing warehouse lines were frozen.

Over the last few weeks as subprime lenders have been unable to find investors for their loans, many thought these were isolated incidences.  The continued closing announcements indicate this is actually a much larger problem that originally thought, and the worst is certainly not over yet. 

For consumers, this is even more troubling.  Many non-conforming borrowers who once could have purchased a home with 100% financing, are now finding their dreams of home ownership vanishing before their eyes. 

Likewise, lower end home builders will also feel the brunt of the fallout.  Many are sitting on a large inventory of completed homes, with little prospect of seeing them sell soon, and new construction of these homes have all but come to a halt.

As if all this is not enough, consider the plight of homeowner's in this market who are wanting to "move up" to a larger home.  With new home sales suffering, and builders offering substantial purchase incentives, the market for resales has all but dried up.

Finally, let's not forget the "flip-that-house" crowd.  With housing prices somewhere from flat to declining, the value of these homes is falling and investors are watching hopelessly as their equity continues to decline.  Not only that, but when you consider the additional interest expense for several  months, some investors will be lucky to squeeze even a slight profit.