Last week, a real estate broker I have tremendous respect for, sent me an email that said, "What in the heck is going on with the lending business and how do we adjust our business?" He asked me to come speak with the agents in his office about it this week. Here is what I will tell them....
What's happening in lending is that the biggest banks in the world, like American Home Mortgage (AHM), one of the nation's top 15 lenders, are suffering tremendous losses caused by foreclosures and a soft real estate market. They are all concerned for survival and they are adjusting their business model. AHM couldn't move quickly enough and stopped funding loans in early August.
To understand where we are you need to understand how we got here.
In recent years, Wall Street investors got heavily involved in the mortgage business through asset-backed securities, made up of pools of assets, that investors can invest in.
Let's say Countrywide puts together $700 million of mortgage debt from 2000 different homeowners. They then move it to Wall Street who packages that into a mortgage-backed security. So investors invest in this package and when the borrowers make their payments, the investors collect their dividends. Wall Street takes a cut for doing it and Countrywide gets a nice price for their package of loans. Not a bad deal for everyone, huh?
So keeping in mind that these investors get paid as borrowers make their payments on their mortgage, when people don't make their payments, and let their home go into foreclosure, the mortgage-backed security loses its value, investors lose money, they panic and then bail out on them.
This brings us to today where we have near record foreclosures in many areas and many more are coming due to resetting adjustable rate mortgages.
Of all of the subprime loans done last year, 75% have ARMs that will adjust next year. Talk about the tip of the iceberg. Combine this with depreciating home values and the mortgage-backed security has become a very risky investment. These securities have become impossible to sell unless they are priced in such a way to be considered worth the "risk" to investors.
So let's say you were an investor in mortgage-backed securities and you have been losing your shirt. If you were an aggressive investor, you would tell Wall Street "don't bring me anymore of that garbage unless the interest I can make is substantial. I am willing to take the risk, but I want the reward." That means high rates and bigger down payments.
If you were a conservative investor, you would simply say "no, thank you." That means less programs choices and limited credit.
The investor market for mortgage-backed securities is frightened right now. They are afraid to put their money behind it. I recently heard a story about a firm that was out shopping $90 million of seven-year interest-only ARMs all at loan-to-values of 80% or less and could not find a single investor. Not one.
When American Home Mortgage closed, their CEO said, ""Unfortunately, the market conditions in both the secondary mortgage market as well as the national real estate market have deteriorated to the point that we have no realistic alternative." This sums it all up.
The biggest banks in the world have nowhere to sell the loans they are making and they don't have the money to keep these loans themselves.
With nowhere to sell these loans huge companies, like New Century, American Home Mortgage, and Fremont, and scores of other smaller lenders have already gone out of business. Many more are going to follow.
One of our biggest local lenders, Silver State Mortgage, closed its doors earlier in the year, and last week, I understand, another giant in our market, Meridias Capital, stopped funding ALT-A loans on their banking line and are brokering those loans only.
Businesses of all kinds rely on the credit market to loan them money to run their companies. In the mortgage business, while a bank waits to sell its loans, those loans primarily sit on their lines of credit. Once that line is full, if they can't get the loans sold, and they can't get more credit, they are out of business.
The CFO of Bear Stearns came out last week and said the credit market, primarily because of the fears in the housing and mortgage market, is the worst it has been in over 20 years. This means that the large banks are finding it difficult to secure the credit lines necessary to keep funding mortgages and running their businesses successfully.
So, with nowhere to go, and limited resources, they are considerably limiting the credit they will extend to people who don't have money for a down payment and don't have excellent credit. They are raising interest rates when they do make a loan for them. They need to create sellable loans.
If you need an "ALT-A" loan or "alternative" loan and this means like stated income or low doc loan, or you want an interest-only loan, or you are buying a condo that doesn't have a Fannie Mae approval, your rate is going to be much higher or your down payment requirement will. ALT-A loans make up a huge segment of loans in our market here in Las Vegas.
Nationally, last year, over 40% of the loans issued were either ALT-A or subprime. You can imagine what the elimination of these products means to the amount of potential buyers in the market. It severely limits them.
It doesn't even matter if your credit score is 800. If you need 100% financing and you have to state your income and you want an interest only, plan on your rate being nearly 4-6% higher than someone who can prove income and wants a fully amortized loan (not interest only).
I just priced out a 100% loan on a $400,000 sales price, stated income, with a 780 score. The rate was over 10.000%. One investor quoted me 14.125%. If you need a jumbo loan, over $417,000, plan on it being even worse. For all intents and purposes, stated income loans at 100% are very close to being a thing of the past.
Rates are going to be much higher for those who provide less documentation of income and who have less money for a down payment. These rates are going to vary dramatically between lenders. I priced two second homes today at 90%. One was for a guy with a 750 credit score and full doc. Another for a 760 credit score and stated income. The rate for the full doc loan was more than two points less.
What is 9.375% at one bank may be 11.625% at another for the exact same loan. This is because if the bank doesn't have an investor at the other end to sell the loan and they have to service it and hold it themselves, they are going to price it far differently.
Many astute borrowers watch the bond market and follow economic news closely to help them see what interest rates are doing. They can forget that for now as banks are pricing in all of the risk factors, like stated income, high loan to value loans, etc. more heavily into the rate.
This means it's more important than ever for the client to have an experienced lender, shop the banks himself (like Wells Fargo, Bank of America, etc.), or make sure his broker or banker shops all options for him.
This is going way beyond subprime loans, which is where it started at the beginning of the year. The lack of investors to which to sell loans are forcing lenders to go back to the more-conservative lending matrices of pre-2003.
If you can document your income, your credit is good, and you can make a 5% down payment or more, you will be rewarded with a variety of loan options and a very competitive interest rate. In the low to mid 6.000's.
If you can't, you are going to pay a lot for it and it will be more challenging to get.
Many analysts are predicting that more than half of all of the loan products available today for borrowers who want limited documentation of their income (stated, no doc, no ratio, etc.) will be eliminated in the next few months, if not the next few weeks. Many banks, like National City, have already gotten rid of them.
The lending guidelines are becoming stricter each week and they are rapidly changing all of the time.
This reduction in credit and rising of rates on the ALT-A product is going to put even more pressure on the residential real estate market, where things have already been pretty flat. These lending changes are likely going to lessen the amount of qualified buyers, which will lower the demand for housing, and bring down prices further.
In my opinion, these banks are making a mistake and are overreacting. Sure, there needs to be a restructuring of the way things have been done in the past. However, the more credit people have access to, the more they spend on houses, the more homes appreciate, and the better chance the market has for a faster recovery.
Overreacting and restricting credit is simply going to lessen the amount of potential buyers, worsen the housing market, cause housing prices to plummet, and create even more foreclosures when people can't refinance out of their recasting ARM. Therefore, these banks are trading one set of problems (liquidity) for another set of problems (profitability).
However, all is not lost. Let's use an example from our market. Let's say you have a client who is a tipped employee at a popular Las Vegas casino and needs 100% financing. Now, let's say that although he claimed $45,000, he actually made a bit closer to $60,000. Last year you would take him out shopping for a home in the $380,000 range, he would state his income and get his approval.
Today, this may not be as available. He will have to find a home where he can qualify with his income that can be documented. This may mean the sale price needs to be closer to $300,000 or so. Sure, it's a bit less commission, but it's still a possible sale.
SO WHAT DOES THIS MEAN YOU AS A REAL ESTATE AGENT AND AS A NEW HOME BUYER?
o1) It is more important than ever to have your clients pre-qualified with an experienced lender with every loan option available in the market. If you care about your business, the days of letting someone use their "cousin," are over. If that cousin cannot prove to you that he is experienced and knowledgeable, have someone else take a look.
o2) Make sure one of your preferred lenders is FHA-approved. Many loan brokers cannot do FHA loans. Ask them. Subprime is dead unless you have a decent down payment. But FHA will likely never die.
o3) Don't pre-qualify without a lender. When you talk to your potential client, please don't try and make a lending determination yourself. For example, if a prospect tells you he makes $10 per hour and his credit isn't very good, don't walk away just because you think he won't qualify. Let your lender still try. We can sometimes get full doc loans approved with a 65% debt to income ratio. This means someone who grosses $2000 per month may be able to qualify for a new home payment of $1300 per month with no other debt and only average credit.
o4) Understand the loan limits. If the loan is $417,000, and under, the loans are much easier today. A jumbo loan is one that is higher and may require more documentation and come with a higher rate. Know the FHA loan limit in your area. In Las Vegas, its $304,000. If you don't know it, go to this link: https://entp.hud.gov/idapp/html/hicostlook.cfm
o5) Think full doc first. When you meet with your prospect and you start to talk a little about his qualifications, if he is putting very little down, don't let him just say, "I am going stated income or no doc." Let him know that this should be a discussion with his lender and he should still be prepared to provide income documentation.
o6) Move fast. Once you have an accepted offer, get your client in for a loan application, and get their programs and loans locked immediately. Do not delay or think you have "plenty of time" for that. In today's climate, the pre-approval letter you get may only be for that day only. In today's market, the program may not be available tomorrow.
o7) Stay educated. Talk to your lender. Ask him "what's new?" and if there is anything you need to know for your business. Make sure he communicates with you throughout the process.
o8) Be patient. With lending guidelines changing all of the time, it may take a bit longer to process and underwrite the files. Everyone is being very cautious today, especially underwriters.
o9) Understand the timelines. Ask your lender at the very beginning of the loan process how long underwriting times are running at his bank. Keep in mind scores of banks are no longer with us. That has put additional pressures on the remaining banks. I understand some banks have underwriting times of three weeks right now. It's important for you to know this and communicate it to everyone in the transaction.
o10) Mortgage insurance is back. Remember private mortgage insurance (PMI)? It was replaced by the 80/20, 80/15, and 80/10. With the Wall Street fears, one of the first products to get hit was the second mortgage. Although it's still around, be prepared that it may not be available to some of your clients and they may have to have mortgage insurance.
We live in a different real estate world today. In my opinion, it's not bad, it's just different. The past four years we lived in paradise. We got drunk on endless supplies of buyers and an infinite amount of creative loan programs to assist them. Ten million more households own their own homes today than they did 10 years ago. But then it caught up to us. We still live in paradise however we are now in the hangover period.
Things have changed in the market and in lending. It's important for your business, like in life, to live in the present and not the past.
This is a crucial time in our business and everyone needs to understand these changes.
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