It’s been all over the news for months: mortgage lenders across the country are going out of business and a massive credit crunch is sweeping the nation.
American Brokers Conduit, one of the largest wholesale lenders in the nation, bit the dust several weeks ago, and on Monday, Greenpoint (owned by Capital One, and another large wholesale player) announced they too are closing their doors and filing for bankruptcy.
Making matters worse, we can now see that what’s taking place in the States is starting to affect other countries as well. In the past few weeks alone, over $2 trillion has been lost in the global market!
How did this happen? And what does it mean for the average consumer? Let’s take a quick look back and see where things went wrong.
Lending like there’s no tomorrow
Over the past few years the US has been in a real estate boom. Homes were appreciating at record levels creating a feeding frenzy of buying and selling. Many lenders and investors who wanted to cash in on this opportunity loosened their guidelines and made mortgages available to people who previously were unable to receive financing.
Subprime and alt-a loans allowed more and more people with bad credit, no verification of income, and no down payment to obtain home loans. These are statistically high risk mortgages, but with the rampant real estate boom, lenders and their investors were willing to take that chance.
The people who received these loans were banking on the fact that their homes would continue to appreciate, and obtained short term ARMs or option-ARMs with the plan of refinancing after a couple of years. Others simply planned on selling the home after a few months to a year and cashing in on the appreciation.
But during the third and fourth quarters of 2006, mortgage delinquencies started to mount. The real estate boom was over and many people had stopped paying their mortgage. And just like a line of dominoes, this kicked off a scary chain of events.
How mortgage loans work
Most loans are not kept by the lender or investor that funds them. Instead they’re pooled into packages which are then sold to investors as mortgage-backed securities. These are traded as any other bond, and a yield is created by the homeowner paying their monthly mortgage.
When investors started noticing that these types of bonds weren’t performing, they stopped buying, and lenders who had banked on being able to sell their newly funded loans were left holding the bill. Unable to sell, they were forced to file for bankruptcy and shut their doors.
In December this happened to Own-It Mortgage, a large subprime/alt-a lender, just one of the first in a group of 120 lenders to unexpectedly call it quits. (You can see a list of all the lenders who have gone under at ml-implode.com.)
As more lenders went bankrupt, fear of poor returns continued to scare investors away from buying these loans. Compounded with a slow real estate market we have, in a sense, achieved the perfect storm.
The future of home loans
So what’s next for borrowers? Well, those that fit into the “vanilla” category will be all right. (A vanilla borrower is someone with great credit, good income, low debt, and strong assets.)
Those that fit into the alt-a or subprime categories will have a tougher time than they used to. An alt-a borrower is someone with good credit but without any assets, no down-payment, or difficult to document income. A subprime borrower has bad credit usually coupled with collections, bankruptcy, or foreclosure.
Reduced documentation loans and stated income loans will become more difficult to obtain and will require higher down payments and carry a higher rate. Second mortgages are going away and those of us in the mortgage business are seeing the return of one loan with private mortgage insurance.
We’re also seeing an increase in FHA/VA loans for non-vanilla borrowers—and any loan not backed and guaranteed by government agencies Fannie Mae or Freddie Mac will be more expensive and less common.
I fear for those borrowers that were banking on their appreciation and who received short term ARMs or option-ARMs, because in the next 12-18 months, over 2 million ARMs are set to recast.
When they do, these homeowners will be faced with a 30-100% increase in their minimum payment, and many of them will be unable to refinance due to less than expected equity and stricter loan guidelines. Those that are unable to refinance and try to sell are going to have a tough time with the already flooded market.
Although no one in the mortgage industry has ever seen anything like the drastic correction we’re now dealing with, we all know the cyclical nature of the market—eventually the pendulum will swing back the other way.
The question is; how bad is it going to get before that happens?
Check back for more articles and predictions to come.
Chelsea Collier is a licensed home mortgage specialist in both Oregon and Washington, as well as a frequent contributing writer for OHM. Please don't hesitate to contact her with any questions you may have about financing (or refinancing) your home.
Or by the same author » Chelsea Collier