Mortgage crisis. Credit crunch. Predatory lending. Foreclosure. Subprime fallout. Even those who are unfamiliar with the real estate and lending industries are tossing around this terminology these days. The media continually reports failed subprime lending practices that, for many homeowners across the country, are turning the American Dream into a nightmare. As an agent, you need not only to understand the current credit crunch, but also be able to explain it to your buyers in a way that soothes their fears and hesitations. By K.K. Snyder
The current state of the mortgage industry is showing repercussions across the board, from the homeowner to the international investor, as an estimated 10 percent to 15 percent of subprime loans issued in the past five years are going unpaid, the borrowers having to admit they can no longer meet the payments.
As a Realtor, you’ve undoubtedly had to field questions regarding the mortgage crisis and resulting credit crunch. In addition, you’re likely getting questions from clients that you may or may not feel qualified to answer. <i>Chicago Agent</i> has consulted top players in the mortgage industry in hopes of bringing those answers to you in terms you can absorb and relay to peers and clients.
HOW THINGS WENT WRONG
About 10 years ago, the emergence of subprime loans helped level the paying field for people with credit scores of 650 or lower, and, until recently, the practice was successful. But during the last few years, the average credit score under subprime loans decreased further, causing it to become even more of a risky business.
The finance market makes the mortgage loans, a high percentage of which are packaged into securities and sold, therefore the appetite of investors determines the price and availability of home mortgage credit, says Carl Tannenbaum, chief economist with LaSalle Bank and 24-year veteran of the industry
“Once the subprime loans started getting into trouble, investors began facing significant losses,” he says. “All of a sudden, nobody wanted to be the owner of anything to do with subprime loans. A couple investment funds closed their doors because subprime assets had fallen so much in value…and we began finding out who was holding the hot pot. It looked like a single sector of finance spread to others.”
The tendency to point fingers when a situation like this occurs is typical, so everyone is looking to those companies whose bottom lines are dependant upon subprime lending or predatory lending practices. But the current crisis is actually the result of a confluence of events, says Howard Ackerman, president of the Illinois Mortgage Brokers Association and senior VP/mortgage division head for Fifth Third Bank in Chicago. The first was irresponsible subprime lending practices, followed by adjustable rate mortgages coming into first payment reset and, finally, the softening real estate market.
As interest rates rise, more pressure is put on home values and prices are pressured down, says Ackerman. Then the bottom falls out because interest rates go up, oversupply is not being lowered by demand, and builders and developers are stuck with partially completed projects. Now enter the investors in those projects who are looking to get out of the industry because they can’t hang on, so they start selling, which drives prices down.
“Now values are going down, you have people in homes that can’t afford the adjusted payment,” says Ackerman. Under ordinary circumstances, the troubled homeowners might escape by selling their homes, and maybe even pocketing a profit along the way. But because the market is soft, these home owners are stuck in a house they probably can’t sell.
Even if they are able to sell it, the home owners stand the risk of losing their equity or not even making enough on the sale to pay off the lender, and soon the foreclosure process begins.
Granted, more than 80 percent of nearly 3 million borrowers of subprime loans make their payments and enjoy homeownership without threat of foreclosure or bankruptcy. It’s the 10 percent to 15 percent of loans written to people who can’t pay them back that have the entire industry in turmoil.
So how did this happen? Let’s say a young couple with a less-than-stellar credit rating begins the process of buying their first home. While they can’t qualify for a traditional home loan because of their level of risk as borrowers, they will qualify for subprime loans with much higher interest rates and adjustable rate terms, even if it takes a shoehorn (or less-than-ethical practices) to get them there.
Because the borrowers have not educated themselves as to the agreement for repaying the loan, and the lender does not do his part to explain the loan product and terms of repayment, everything looks good on paper. The only thing on the borrowers’ minds is moving into their new home. The payment? They’ll worry about that later.
In the meantime, the couple buys the home, moves in and is barely makes the initial payments. Their income is undocumented or overall debt is not considered during the application process. A few years down the road, financial troubles increase, or they come into the first payment reset of their adjustable rate loan. The payments become even more unmanageable, and the foreclosure process begins.
WHAT HAPPENS NOW?
One of the big questions now is whether the federal government will step in to assist homeowners, investors and lenders. Some don’t believe the mortgage situation the Federal Reserve’s responsibility. Others think the Fed should get out in front of it. To date, the Fed has taken a careful approach to the issue.
“Some believe the problem was created by Wall Street and should be solved by Wall Street,” says Tannenbaum. “These are big boys and girls with a lot of money. The Fed is very sensitive about being in a position to bail out portfolio managers who made bad bets.”
One highly anticipated decision is whether the Federal Reserve will adjust the interest rate and, if so, how much? Bloomburg reports 17 consecutive rate hikes between June 2004 and June 2006, says David Hurst, executive VP and midwest division manager for Countrywide Home Loans.
“Historically, lower rates are good for the industry,” says Hurst. “So if the Fed decides to take action that would give us some relief on rates which, historically, are still attractive, it could stimulate and help regain some confidence in the housing industry.”
Of course, investors aren’t the only people in our country who have been affected by this current market situation; international investors are hurting as well, says Ackerman.
“Securities made up of these loans are significantly not as valuable as they once were and have impacted international and national investors,” says Ackerman. “We’re seeing not only the failure of many subprime mortgage lenders, but also seeing an overall contraction in the mortgage industry. And many investors are now saying this industry is a much higher risk than they care to take. We’re seeing less liquidity and fewer investors who are interested in investing in loans, even if they aren’t subprime loans.”
While all this commotion continues to brew, Realtors are still trying to stay afloat in what many refer to as a “soft market.” Kelly Rizzo, VP of Rizzo Realty Group, makes a concerted effort to keep abreast of the situation by educating herself, her agents and her clients about the state of the industry and what everyone can do to ensure successful transactions.
“It’s a matter of knowing the loan products and knowing that not everybody should be in the buyer’s market right now, unlike in past times when everybody was in the buyer’s market,” says Rizzo, who oversees four offices and 75 agents.
She tries to avoid dwelling on negative media reports regarding the state of the real estate industry and, instead, focuses on assuring that she and her agents have a solid grasp of the facts.
“It always helps you have an edge on the market, and you are better able to help educate your buyer,” she says. “You have to change your approach sometimes, but I never feel like it’s a bad market, just more challenging. Sometimes, you have to look for different ways to do things.”
Lenders will have to find different ways to do things as well. Unfortunately, some mortgage lenders are already closing their doors, having seen the writing on the wall.
“It’s a matter of there being only so much business to support the infrastructure, and right now there is less business to compete for,” says Michael Lefevre, CEO of the newly established National Association of Mortgage Professionals. “Some companies don’t have the wherewithal or the finances to hang in during these bad times.”
Obviously, the practice of lending consumers money to purchase homes isn’t going away. So what can your clients do to protect themselves from biting off more than they can chew or signing their names to mortgages that they may one day find themselves unable to repay?
It’s all about knowledge, says Lefevre, who is always amazed by consumers who might spend four weeks researching which plasma television to purchase, or three weeks deciding which laptop is they best buy, but will spend no time researching a mortgage product or lender.
“The consumer needs to take a more serious, vested interest in what’s happening,” says Lefevre. “Ask questions. You need an ethical and educated person from the mortgage industry talking to borrowers. You can’t have someone off the street making a half-million-dollar transaction.”
Even amidst all the turmoil, it’s business as usual for most companies. Funds are still available and loans are being made, including subprime, but the terms are just a little different now. For example, many in the industry are looking at using private mortgage insurance (PMI) again as a security blanket of sorts, a practice that many had abandoned in recent years.
“We’ve seen, across the country, lower home sales and higher inventories and, in some markets, we’ve actually seen some average home prices decline,” says Hurst, whose company recently announced the planned layoff of at least 10,000 employees — maybe as many as 12,000 — in anticipation of a 25 percent drop in loan-origination volume during the upcoming calendar year. “In Chicago, we’ve been relatively fortunate that the average sale prices have held up pretty darn well.”
Lefevre believes both the consumer and the subprime lender share the responsibility. “The guy at the point of sale is taking them [to a lower interest rate] and giving them a sizeable amount of cash, but not explaining the adjustable rate mortgage and what they can expect to happen down the road,” adds Lefevre. “The consumer needs to think about what’s happening and engage the lender. On the mortgage side, you need someone who knows what’s happening and will be up front about the product.”
The state of Illinois is working diligently to hold predatory lenders accountable for their actions, contends Ackerman. “It is a challenge, but there is a severe and deliberate approach to strengthen predatory lending laws and enforcement of those laws in the state of Illinois. I think individuals who are operating in a manner that would be considered predatory lending practices are either feeling the heat or have already moved on to some other business.”
At the end of the day, plenty of attractively priced mortgage products remain on the market, but dealing with someone established in the industry has never been more important. The ideal picture, says Lefevre, would be a mortgage professional who is ethical, educated and licensed — a person of good moral judgment, dealing with a consumer who is informed and engaged.
Consumers will do well to deal with a company that has a local presence, loan officers and staff in the community, a stellar reputation in the industry and employees who are willing to go the extra mile to educate their clients and be proactive when and if first signs of repayment trouble begin to surface.
Ackerman sums it up, “I think the focus is clearly on maintaining the integrity of the industry so the companies and people that work in this business can continue to offer our services to the buying public with the confidence that they’ll be well-advised, offered products best suited to their needs and understand all the risks of what the transaction entails.” C.A.
President, Illinois Mortgage Bankers Association
Senior VP/Mortgage Division Head
Fifth Third Bank, Chicago
Countrywide Home Loans
of Mortgage Professionals
Rizzo Realty Group