With all the headlines concerning a “Mortgage Meltdown”, “The Credit Crisis”, the “Liquidity Crunch” as well as overwhelming statistics about foreclosure activity, here are some straight forward answers to frequently asked questions.
What is the “meltdown” that I’m reading about in the headlines?
This refers to a culmination of factors that has led to massive tightening in credit standards among mortgage lenders. This tightening is due to an excessive number of mortgages that are both delinquent and in default. As a result of tighter credit standards and the devaluation of mortgage-backed securities, global investors are shying away from purchasing additional pools of loans, causing over 100 lenders to close and leaving many homebuyers and homeowners unable to locate financing alternatives.
How did this happen?
The recent real estate boom was fueled by a period of robust 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. The riskier nature of these mortgages was offset by the underlying appreciation of the homes financed.
Then, in 2006, a slowdown in real estate led to a leveling off and 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 are following in record numbers and a re-valuation of mortgage bonds and other financial instruments is creating the credit/liquidity domino effect we’re now experiencing.
Factors that contribute to the increase in foreclosures of these exotic mortgages (besides the risky underwriting standards) were just plain fraud on the part of borrowers, the loan originators, or both in overstating income to qualify combined with the practice of appraisers, desperate for business, overstating the value of homes—a practice know as “pushing” the appraisal.
Why should a home SELLER be concerned about this?
The pool of potential buyers has shrunk as many find it difficult, if not impossible, to obtain mortgage financing. Experts have speculated that the number of potential buyers will contract anywhere from 15% to 30%. Sellers should also be aware that increased foreclosures can depress community values and result in a glut of local inventories, which could further drive down home prices. Now is not the time to sit and wait for the best possible price. Have a serious talk with your real estate agent. It is more important than ever to make sure potential buyers are PRE-APPROVED and STAY PRE-APPROVED throughout the entire transaction.
Why should a home BUYER be concerned about this?
Buyers need to get pre-approved before entering the market. 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. What you qualify for today could change tomorrow in this volatile market. This is NOT the time to be slow returning your application documents to your lender or making any changes to your finances that could jeopardize your loan approval. This IS the time to make sure your lender has at least one back up plan, if not two, in case the first option falls through. The two largest mortgage lenders in the country have cut back significantly on the types of loans they extend, so anyone is fair game. If you are dealing with a single bank or credit union, it’s a good idea to get pre-approved at a second place just in case.
What types of loans have been most impacted by credit tightening?
Subprime and Alt-A have suffered the greatest setback because these borrowers are at greater risk for defaulting. Subprime loans are those loans which have typically been taken by borrowers with poor credit. Alt-A type loans are for borrowers that typically have good or excellent credit but are unable or unwilling to provide documentation for income and/or assets.
Also very hard hit have been the Home Equity loan and Jumbo loan sectors. Home Equity loans are used primarily for debt consolidation, remodeling, etc., or for a purchase using both a first and a separate 2nd mortgage—a “piggyback” Home Equity Loan. Jumbo loans refer to first mortgages over $417,000 on a single family residence and a few other larger amounts. Rates on these two types of loans have increased significantly–even for those borrowers with excellent credit.
The common thread here is Subprime, Alt-A, Home Equity, and Jumbo loans do not have government subsidy or securitization. However, loans through Fannie Mae and Freddie Mac have been very safe and rates have in fact dropped recently. These loans are primarily for good credit and loan amounts under $417,000. The same goes for FHA and VA, programs federally insured for poor credit borrowers. Also the State of Wisconsin WHEDA program remains a great option for many first-time homebuyers.
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. While there may be more intervention from the U.S. government and foreign central banks, this correction will, in the long run, be healthy for residential real estate.
By Troy Sainsbury, ChFC
Mortgage Consultant
Waterstone Mortgage Corp.
Written by Jamie Miller, filed under Home Finance, Madison Housing. September 20, 2007
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