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Subprime Market and "No Doc" Loans are Still Good for Housing

While the current news cycle is full of commentary on the current subprime mortgage fallout, over the long term the subprime market and “no doc” loans that are offered to borrowers are critical to maintaining our high level of home ownership in the USA and maintaining opportunities for those with less than perfect credit to obtain financing.

As Ben Bernanke testified this morning on Capitol Hill, lenders offering loans to subprime borrowers and loans that use stated income versus documented income (“no doc” loans) have been tightening their underwriting standards and doing more thorough reviews of those applicants.  These measures will dramatically improve the quality of these loans in the future.

In many cases the bad loans that were underwritten in the last couple years were done by unscrupulous loan officers that did not follow the guidelines that were already in place and in many cases committed outright fraud against the lenders.  In other cases, the loans were on a 1 year adjustable rate, interest only (no reducting in principal owed), or negative amortization where the math simply didn’t add up.  These borrowers were being set up to fail without either a dramatic increase in their income or the continued meteoric rise in housing prices.

Mortgage lenders need to make money to survive.  While we’re going through turmoil right now, many lenders have already taken the steps necessary to limit these problems in the future, which suggests this will only be a problem for the next year or two.  I know this seems like a long time but you must also realize that this problem developed over several years too, so it makes sense that something that took several years to fester may take a similar amount of time to heal.

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9 comments
Aaron Dickinson
Aaron Dickinson

I haven't had a chance to review the entire law but the part that stuck out on me is that the new restrictions on stated income loans only apply to mortgage brokers and not mortgage bankers. The difference between the two is who is funding the loan. A mortgage broker does not fund the loan, but rather "brokers" the loan out to a bank. A mortgage banker underwrites their own loans. This means that mortgage brokers will have a distinct disadvantage in the loan products they can provide. As Edina Realty Mortgage is a joint venture with Wells Fargo, it is considered a mortgage banker and consequently can still write stated income loans.

DAL
DAL

Well, what do you think of the new MN laws for mortgage brokers???

Aaron Dickinson
Aaron Dickinson

Yes, the 30-somethings and younger are the "screwed generation." My as well just give up now :-) After looking at all the comments I think we all agree that more stringent measures for qualification do need to be enacted.

Real Estate Guru
Real Estate Guru

Can you substantiate your claim that “in many cases the bad loans that were underwritten by unscrupulous loan officers that did not follow the guidelines that were already in place and in many cases committed outright fraud against the lenders”? This is a very vague statement that should be supported by facts. The vast majority of loans that are failing (and which the tax payer is going to have to pick up the cost in the end) were written within the proper guidelines and underwritten correctly (this is why there are underwriters). The majority of media coverage seems to focus on particular loans such as “no-doc” loans that are supposedly going away which is not the case. The loan standards are being tightened as you mentioned which overall in the long term is good for the real estate market. The current market is being heavily affected by the foreclosures from property owners who were not responsible with their loans. This is definitely not a case of predatory lending as some would lead you to believe, these loans were originally sold to the market as a means to allow people to improve their credit. It allowed low credit score individuals the chance to own a property, pay on time and within their means, increase their credit score, and then refinance into a traditional loan program once their credit scores had increased. All of these loans were disclosed up front to clients that they were adjustable, or option pay, and that the payment would increase dramatically within a set period of time. Now the responsible home owners and public will hold the bag on cleaning this up from many standpoints. The banks will not eat these costs, they will be passed on as usual. The current market is being affected by the foreclosures that are currently in process and the many that are to follow. And some of the “insurance” costs will be picked up by the government which is the tax payers. The belief that the LOSS of these loans will affect the responsible home owner is false because responsible home owners will own more homes. People need a place to live and if they are not able to purchase they will rent. That same property that the irresponsible person did not have the down payment for will be owned by a responsible home owner who will have the ability to make sure that the rent and payments are made on time, it’s the case of an irresponsible person having someone put them in check. The bottom line on owning property is that history has proven that if an individual is financially responsible and able to hold a major % stake in the property they will take care of the property and make payments. The “no-doc” loans are not going away, nor the low down payment loans, they are just going to be offered to the responsible individuals that deserve them. Letting someone purchase a property with zero down, no-documented income, and a bad credit score does not logically make sense. It is a bad investment that has a high percentage of failure and someone has to pay for them when they go bad.

DAL
DAL

Well, you mention 66.2% ownership in 2000, Kasriel says the peak was 69% in 2004, and NPR shows the percentage of subprimes starting to increase in 2004 and beyond. So, not really convinced the graphs all track as you mention. Seems we should be at the peak about now with the logic presented. The "fix" is to underwrite the loans based on the ability to pay over the term of the loan given the best data available at the time of underwriting. I don't think that is so hard or abstract. Is it really home ownership if the debt exceeds the value of the home? Great, I can own a home that really someone else owns, the bank. American dream?? Really just convoluted. ARMS work much better in a declining interest rate market rather than a rising rate market. Or, if the buyer is solid enough to refinance, which apparently many were not. Possibly something that should be considered in underwriting subprimes is the ability to finance as a 30 year fixed. Create a scale that says the buyer needs to be within a certain range in order to be approved for the subprime ARM taking into account how close they are to qualifying for an FHA fixed mortgage. In a rising rate market, ARMs create the ability to over-reach on the amount of home a buyer truly can afford over a longer period of time. We don't need to create another ticking time bomb for our younger citizens. Social Security, Medicare, Pensions, and now their homes, too??? We're going to need to rename this generation, "The Screwed Generation."

Aaron Dickinson
Aaron Dickinson

Here's commentary from both sides: Warren Reports writes about a report from the Center for Responsible Lending showing subprime loans decrease homeownership. Paul L. Kasriel, Director of Economic Research for Northern Trust Company, hypothesizes that subprime mortgages have increased homeownership but can't make that conclusion because he does not have the data on the number of subprime mortgages issued. NPR has a post that shows the dramatic increase in subprime lending as a percentage of all loans, which does seem to track with Paul L. Kasriel's graphs. What's the right answer?  We're probably not going to have that definitively figured out for several years to come and by then we will have executed actions to "fix" the problem, which may or may not actually be the right solution.  It'll be an interesting read when it is all said and done!

DAL
DAL

Mortgage insurance has been around a number of decades. And actually, in rural areas banks many times use to require 25% down payments or possibly more because they kept the loans and didn't sell them. Just ask an old banker. The packaging of loan products is the capital that greatly improved home ownership. Higher down payments make those packages potentially better risk adjusted opportunities and may provide more liquidity, price stability and new homeowner opportunities to the real estate markets. The FHA added assistance to the viability of the packages through insurance. I don't think your comments provide cause and effect that racier mortgage products have greatly improved home ownership. These products were possibly the result of a fat industry milking the last few dollars near the end of a good run, hoping no significant problems would surface later and/or that housing values would not fall. They may have viewed them as lower risk than reasonable given what they had achieved over the previous good years. OR more likely, just numb to the real risks because business was so good. Another factor to consider is that as home ownership grew, there was this perception and reality that real estate would just continue to climb in value. When excesses are created, that feeling can go away, creating an illiquid or less liquid market. A perception of economic concern may take over, and recessionary thoughts may enter the mind. People can be very fickle, living on the edge, and adjustments at the margin can affect all of us. A lack of moderation and supervision can play a large role in the results. Other factors may have played a roll in home ownership availability. Equity market factors, employment, technology, etc. The FHA may very well change their requirements to take some business from the subprime people based on a recent Kiplinger article I read. If you find some facts that can actually prove the subprime people have materially increased home ownership, I would be interested. Especially, if the data is adjusted for the fall out. I would guess that data is not available yet. We may still have more facts pointing to the problems of subprime and no doc loans than we have documented evidence of the benefits. Customers may be entering these loan programs without a clue what they are about. Lack of moderation has been the problem on the "loose" side of the equation. The pain of the excess is now being felt. When a small minority can mess up the rest of us, it very well can be time for some intervention so those of us wise in the long term don't have to also pay the price again next time for the short vision folks.

Aaron Dickinson
Aaron Dickinson

At one point you HAD to have 20% down to purchase a home. When loan products from the FHA and the private sector came out offering consumers options to finance larger portions of a home, homeownership rose. In 2000, the nationwide homeownership rate stood at an all-time high, 66.2%. Yes, things have been tight and loose the last few years, but it is just as easy to tighten the rules too far and help bring about a new crisis. Moderation is the key to any action or reaction.

DAL
DAL

These poor underwriting processes may have been directly related to the run up in real estate prices and the uncertainty we currently seem to be facing in the real estate market as buyers were allowed to carry multiple mortgages in speculating on mutliple properties. Excessive liquidity can create excessive prices, which makes home ownership MORE difficult for lower income buyers. The poorly constructed gimick loans you describe are really only suitable for wealthy individuals who can withstand the unhealthy financial nuances of these products. These loans are not the solution to expanding home ownership. Solid financial management by homeowners and potential homeowners is more key to long term consistency and affordability in housing. Building a financial house of cards through mortgage products also can have the ability to create homeless people following the date sixth months after the sheriff's sale. Fraud is an unfortunate fact of life. Regulation is important and the MN Attorney General is looking to make progress in this area. The standards of assisting mortage customers must be adjusted to assure some mortgage companies are not inappropriately providing financial advice to clients.

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This website is a service of Aaron Dickinson of Edina Realty, a broker Participant of the Regional Multiple Listing Service of Minnesota, Inc.