Mortgage Meltdown- The Beginning Part 2

The information I am giving is of course in my words only and my experience related work. I have not referenced a lot because I was working through all of these years and while I may be leaving out some of the particulars or details, this is a synopsis of what occurred during the Mortgage Meltdown…

Fannie and Freddie by no means caused the meltdown either…they were simple a part of it because they did join in with the buying of these loans later on in the process. The total meltdown process was caused by the Subprime Loan Market…I have no reservations about that. Fannie and Freddie never allowed “bad” credit loans but some were less than perfect. Usually they were decent in some aspects but these loans did allow more homeownership in our Country. Congress pushed this aspect of Fannie and Freddie allowing more risky loan purchases.

What makes up a “risky loan?”

A risky loan goes something like this: 100% financing, no money in the transaction, all closing cost paid by the seller, no reserves, credit report which shows excess delinquency, credit scores below 640+-. A client who has a history of late payments, collections and judgments and their debts are 50 % of their total gross income. A client who get one loan of 80% and then has a 2^nd, mortgage for 20%. A client who is over extended on their credit, meaning they have lots of credit lines on their credit report; even before he/she closes on their mortgage loan, which occurred quite frequently. A client who has not paid their rent within 30 days for the past 12 months is also a client that is a risk. An investor loan, meaning someone who is buying up property to rent is also a risky loan, especially if they have more than 10 properties, unless they have a net worth of a substantial amount.

There were hundreds of Subprime Lenders…some to mention and some of the first to go were First Magnus, Indy Mac Bank, Decision One, Franklin American Mortgage and Hometown Mortgage to name only a minute few. I know these people because in 2005 I went to work for a Broker and we delivered loans to some of these people. Wells Fargo also took a lot of the less than perfect stuff.

I read an article which stated that a decline in rules and regulations and underwriting guidelines did not cause the delinquencies. I dare to disagree and here is why. If Fannie and Freddie had not started allowing loans to be delivered to them with higher loan to values, credit scores down to 620 and sometimes below, and higher DTIs (debt to income ratios) with no money in the transaction they might have had less lose. Fannie started allowing approved Mortgagees, who sold their loans to them, to make the 80% of loans where there was a second mortgage for 20%. These loans were made so that the mortgagor did not have to buy Mortgage Insurance because it was an 80% loan. Yet they were strapped down with a second mortgage payment also at a much higher rate usually.

When the Subprime Lenders began to get the first time homebuyer’s market because they could get a better deal; not a better rate or lending practice but a better deal, is when Fannie and Freddie decided they had to do something to get their business back and make some of the money that went with the less than perfect loans. There were a lot of loans made in the Subprime Market that were not bad loans, they could get higher loan to values, at some points, all of the closing cost paid by the seller and higher debt to income ratios. What Fannie and Freddie did not realize I think, is that when the ARM loans started to reset; the borrowers were not going to be able to make the payments, not just the Arms’ but some of the fixed payments as well. With the CRA loans, the borrower could not make but a certain medium income which was associate with each state so this was eliminated with the Subprime loan and even some had excellent credit. They could get the higher loan to value and no money out of pocket and a Sales Price over and above their ability to pay so much of the time.

The Subprime Lenders were handing out the 2/28 ARM loan, the Option ARMs’, and Interest Only loan products, left and right. These loans had quirky guidelines and were suited to borrower’s who were educated. They did not educate the borrowers to the products so therefore they did not understand that if they obtained the Option ARM and only made the minimum payment, they would have negative amortization which would have to be added back to the principal of the loan. The Option ARM had three choices of payments. One fully amortized payment of principal and interest. One interest only payment and one minimum payment. Of course when you need to pay the utilities, you are going to pay the lowest payment on you housing if you are allowed to…human nature. The interest only loan of course was nothing but making the interest payment up to five years (5) and ten years (10). Therefore at the end of the initial interest only payments; the loan had to be re-amortized over the remaining life of the loan. The payments of course were going to be much higher to pay the loan out in the remaining term.

This is my perception and what I know from being in Underwriting, Originations and Management. Before the appraisal request was ever sent by the Mortgage Company to the Appraiser, the Realtor had added in the Real Estate Fee for selling the house plus they knew the borrower did not have money to put into the transaction so they added in another 3 to 6% for closing cost. This eliminated the seller from having to pay anything out of the profit of selling their home. Risky business to say the least and this practice elevated the values over and above the true value of the home; from day one. It is normal to add in the Real Estate Free but if you think about, it also makes the true value less than it would be if it were not added in. When the appraiser could not get the value to match the sales price; the Realtor and everybody else was ticked off.

Most of us who are in mortgage know that an appraiser must look within the subject properties immediate area to find comparables. If the other dwelling in the immediate subdivision do not measure up to the sales price of the subject, he has to search near by to find comparables so that he can get the value that he Real Estate Agent and the Mortgage Loan Officer wants. He if doesn’t, his name is mud….This became harder and harder to do on the last. In rural areas and the country, it was impossible. The values are now declining because the “sales prices” were inflated to begin with.