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Mortgage Market Crisis
Current State of Mortgage Financing and What You Can Do  Anyone watching or reading the financial news over the last few weeks has seen a lot of angst and fear over the state of the mortgage industry. In fact, one of the larger lenders in the US, American Home Mortgage, was forced to shut down operations recently. But why? What is happening, what does all this mean to you and most importantly... what should you be doing do right now to make sure you are protected? How Did This Happen? Over the last five years, with the global financial markets awash in money seeking any investment with a decent return, investment dollars flooded into the US financial markets. With the increase in available funds, loans were being issued with reduced requirements. This situation included lower credit scores, higher loan-to-value ratios, interest-only and even negatively amortizing loans. At the same time, the premiums required by investors to accept this risk, in the form of higher rates and fees, got skinnier and skinnier and eventually anyone with a pulse could qualify for a big loan with great terms and tiny payments. These non-traditional or "non-conforming" loans, that do not fit within the traditional "box" for home loans are often called "Sub-Prime" or "Alt-A". This meaning that they were somewhat riskier in nature than A credit, prime, or traditional loans. Another type of "non-conforming" home loan is one where the credit and income might be perfectly fine, but the loan amount is higher than $417K, which is the current maximum loan that can be funded using pools of money from mortgage giants Fannie Mae (FNMA) and Freddie Mac (FHLMC). If the loan amount is higher, it can certainly be done - it's called a "jumbo loan" - but the end money comes from private institutions, not from the large government sponsored entities of Fannie and Freddie. The end result is that most non-conforming loan product rates have significantly increased. Here’s Why That Happened The end investor for Subprime or Alt-A loans will charge a premium for taking on a pool of these loans, because they know that traditionally, they might have a higher rate of default and delinquent payments within that risky pool. But lately, default and foreclosure has been on the rise - partly due to the fact that with credit tightening and a soft real estate market, many troubled homeowners are unable to refinance or sell in order to get out of trouble. So now, these end institutions are demanding a much higher "risk premium" for taking on these pools of loans, as they see the rates of default are climbing higher. But since these institutions are purchasing these pools of loans sometimes months after the borrower has actually closed at a given rate, this increase to the risk premium means that instead of paying $101K for a $100K loan that will bear interest, they may only be willing to pay $95K for that $100K mortgage to account for the risk. Multiply that times thousands upon thousands of loans...and you have millions upon millions of dollars in loss for the company trying to sell the pool at a much lower price than they were expecting. This is called a "liquidity crisis", and is exactly what happened to American Home Mortgage - there was no mismanagement, but they simply got caught holding too many "hot potato" loans, forced to sell them at massive losses...and eventually they had to make the decision to close the doors and stop the bleeding. Further, even when a lender is able to take some losses, they may be subject to a "margin call". This means that as their losses and risk premiums increase, the value of their loan portfolio decreases. As the value decreases, the credit lines that are secured by those portfolios begin to issue margin calls as the value of the asset that they are secured on is now diminished. This is exactly like margin calls in the Stock market. If you have a loan against a Stock that is losing value, you will get a "margin call" and need to pay down the loan, as the underlying Stock is losing too much value to be considered adequate collateral any longer. So for the big lenders, as their portfolio is losing value due to increased risk premiums and losses...the margin calls start coming in, and they are required to pay down their balances. In turn, this means that they have less availability to fund their new loans, which then exacerbates the problem. In response to seeing this situation play out in the demise of American Home Mortgage, lenders of other non-conforming loan products increased their interest rates dramatically almost overnight to be better prepared - and likely over-prepared - for increased risk premiums down the road. Even though loans above $417K are not presently suffering from increased delinquencies like the Subprime and Alt-A loans are, these rates popped higher as well, because they are being purchased by smaller private entities that can't afford to take on any margin of risk. What Happens Next? The major damage is probably already done, and the present situation will likely settle out over the coming year. Lenders will stop pulling products off the shelf, and the rates on products that have moved so significantly higher now should trend lower down the road as delinquency rates stabilize. What Can You Do To Protect Yourself? ONE: Even if you are not presently in the market for a home loan of any type, make sure that your credit standing is as solid as possible. Many people in the market for a home loan didn't expect they would have a need, and didn't plan in advance to ensure their credit would qualify them for the best possible financing. Plan now; time is on your side. TWO: Now is the time to be working with a real qualified professional who can keep you informed of changes in the market and get your loan funded quickly. Your home and your financing are just too important, and times have changed. |
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