A colleage of mine forwarded me an article entitled “Mortgage Hot Potatoes” from the Wall Street Journal that discussed how banks like Merrill Lynch, J.P. Morgan Chase, and HSBC Holdings are excercising clauses in their purchases of sub-prime loans from mortgage originators to make the originators take them back.
These clauses apparently state that if a borrow defaults early in the repayment period or if the loan had underwriting defects, such as bad appraisals, that the originator must buy back the loan. Needless to say that this allows the big banks to keep the good loans and kick back a large portion of the bad loans back to the people that shouldn’t have lended the money in the first place.
While this process will prevent the big banks from hemmoraging too much profit margin, it will put some (or possibly a large number) of the subprime lenders/originators out of business. Many of these lenders/originators have limited assets and use corporate lines of credit to finance the loans they close until they can resell them to the bigger banks.
When these banks send these loans back (for failure to pay), this means that the subprime originator has to borrow against their line of credit, reducing their ability to make new loans. If enough of these loans get sent back, the mortgage originator may consume all their credit line with these bad loans and may not be able to fund closings on their new ones.
Enter the headache for buyers and sellers: Imagine sitting at the closing table waiting for a wire transfer of the buyer’s funds and come to find out that the buyer has no funds because the originator has no money! This scenario will come true, it is just a question of how many originators will have the problem.
In the last few years lenders really softened up their lending requirements, allowing a lot of low credit score borrows to go “stated income” or “no doc” loans which basically paired up risky borrowers with risky loans. In the rush to make as much money as possible, some mortgage brokers/originators went one step further and either omitted or falsified information on the applications to get buyers approved that shouldn’t have.
Because we are still in a rising interest rate market and we haven’t exited the housing slowdown, there’s still a long time for these loans to go into default and come to the attention of the big banks that bought them. As more of these loans come under scrutiny, I think we’re going to see much larger problem than many expect.
If you’re buying or selling a home, it is eminently important that you know where the money is coming from and that the lender will still be in business at closing!
