The appraiser's perspective: After the sub-prime meltdownCharlie W. Elliott Jr., MAI, SRASub-prime meltdown Even though it had been long awaited, most of us probably did not expect to see the sub-prime meltdown that we have experienced recently. After all, we have always had borrowers with less-than-perfect credit, and we have been able to make most of them loans, albeit at higher-than-normal rates. What actually happened? What caused it? Did we learn from it? How will this event affect the future of our mortgage industry? What actually happened? Far too many people with questionable credit were extended loans at high interest rates and with high fees, which they were not in a position to service financially. Many homes were lost to foreclosure. Some of the loans were offered with low teaser rates up front, which escalated to higher rates only a few months after closing. Credit tightened through higher interest rates at about the same time, causing many variable rates to escalate even higher. With the tightening of the credit came a reduction in the number of people who could refinance their way into another loan. Those who could not were stuck with no other option than to walk away from their homes. What caused it? There are undoubtedly varying opinions on this subject, depending upon to whom one talks. There are those who blame the real estate economy going south, taking many marginal people with it. There are those who see the sub-prime part of our industry as being run by predators, charging hefty fees and interest rates to those who can least afford it. Some question the ethics of many in the sub-prime business, claiming that they fudge on the qualifications of the borrower and pressure appraisers to be less than truthful about property values. In addition to all of these potential causes, others see the entire mortgage market as having gone through a wringing out, much like a hangover after a big party. This affected the entire mortgage market; however, the sub-prime borrowers were the most vulnerable and yes, they were hit the hardest. As they say on Fox News, "We report. You decide." Having suggested that you make the decision, I will throw in an opinion to add flavor to the stew. While, perhaps, one or more of these potential causes were the most responsible, it is likely that all of these probable causes contributed to the downfall of the sub-prime market in one way or another. The combination of the above factors created a perfect sub-prime storm, which brought down many homeowners and lenders. Did we learn from it? All of this is sad for those affected and begs the question, "Did we learn from the experience?" Or better still, "Did we learn enough to prevent a similar event from happening again in the future?" I would like to think that we did learn from the experience, and I am sure that some of us did. Whether all or enough of us did, I am not so sure. There is a streak of greed in all of us, and this seems to oftentimes overshadow what might otherwise be 20/20 vision. Let's take the Enron case, for example. Do we believe that such a thing will never happen again? I would like to think that it will not, but the gray hair over my temple tells me that it just might happen again sometime down the road, when everyone has forgotten how bad it really was. This is not to say that the entire sub-prime downfall was caused by unscrupulous people, as in the case of the Enron downfall, but I am of the school of thought that much of the problem arose from aggressive lending practice, if not unethical conduct, on behalf of some. How will this event affect the future of the mortgage industry? Listed below are a few of the changes that I predict we will see, given all that has happened thus far. • There will continue to be a sub-prime market; however, the financial institutions involved in the business will be different. The highly specialized lenders, such New Century and Ameriquest Mortgage Company, will be reduced, if not eliminated. There is simply too much risk. They will be replaced by large financial institutions, such as our larger banks that will offer these high-risk products as a small part of their investment portfolio. This way, the service can be offered and risk can be managed and spread around in such a way as not to place in jeopardy the livelihood of the entire company. • Government regulators will become more aggressive in addressing the problems associated with high-risk loans, both on behalf of the consumer and on behalf of the financial institution. Margins will be smaller—we will see more caps placed on interest rates as well as closing costs. Credit worthiness will be monitored closer and fewer high-risk loans will be made. • Appraisals will be scrutinized more than they were in the past. They will be reviewed more closely on high-risk loans by underwriters. More emphasis will be placed upon appraiser independence than we have experienced in the past. For high-risk loans, don't be surprised if you see more full appraisals with interior inspections and more scrutiny on properties that are located in rural areas. • Mortgage brokers will also be affected more than they were in the past. There will be stricter policies on the source documents on which loan appraisals are made—credit reports, employment verifications, appraisals, financial statements and the like. The ordering of appraisals and the selection of appraisers will be an issue. Right now, as well as in the past, mortgage brokers have not been regulated very much, as far as who selects the appraiser. Expect to see some change here. Some banks will order their own appraisals, some will insist that the brokers order the appraisal from certain management companies and there will be more reviews of appraisals submitted by brokers to the banks funding the loans. In conclusion, the sub-prime market will be very different in the future. It will be regulated more, profit margins will be smaller and there will be fewer loans. It will be harder to get questionable applicants approved, and the big banks will take over more of the process. Brokers will find themselves more regulated, and many potential sub-prime loans will be harder, if not impossible, to make. Perhaps it may just be a good time to focus more on the quality borrower. That does not mean that there will not be a place for the high-risk loan, but if the process is going to be blended into the business of the larger banks, does it not make sense for the originator to spread his risk in a similar way by serving a broader cross section of clients? Charlie W. Elliott Jr., MAI, SRA, is president of Elliott & Company Appraisers, a national appraisal company. He can be reached at (800) 854-5889, [email protected] or through the company's Web site at www.appraisalsanywhere.com. Previous columns he has written for The Mortgage Press can be seen on the Elliott & Company Appraisers Web site.