Mortgage changes from out of left field!David Brown and Don McMahonrefinance boom, negatively amortizing loan, appreciated value, federal funds rate In baseball, you never know the outcome until the final out. Today's mortgage industry with its turmoil may be the same. Some of the game's details include the pre-game show, ejected players, a squeeze play, relief pitchers and extra innings. Whether you're a player or spectator in the game, see who wins and how to manage the mortgage team. Pre-game warm up Rewind to the refinance boom that ended in 2004. The federal funds rate was one percent, and the appreciation rate of local real estate was more than 15 percent annually. At that time, if you had financed a property that went up in value (e.g., $24,000) for the year and a loan balance that grew (e.g., $12,000) over the same period because of a negatively amortizing loan, you still made money and had a viable exit plan of refinance or sale at the appreciated value. Squeeze play Since June 2004, the Federal Reserve raised the federal funds rate 17 times, bringing the rate to 5.25 percent, where it remained for nearly one year and three months, before a slight pullback to 4.75 percent. Since June 2004, real estate has declined in value by nearly 10 percent. Borrowers' mortgage loans are adjusting to current rates influenced by the federal funds rate, which is up more than four percent from when the mortgages were originated. Further, those loans are being recast to their current balances, which are probably higher, and re-amortized for the balance of the loans' terms. In many situations, borrowers may see their minimum payment go up more than 200 percent. So why not refinance to a lower payment? The borrower may be blocked from this option. As the balance of the debt grows and the value of the home declines, the borrower is being squeezed as his equity is less than when he purchased or refinanced last and the loan to value is now outside of lender guidelines. To refinance, the borrower must come in with more cash/equity that he does not have. He is now forced to either make the new payments or, if alternative financing is unavailable, sell. Ejected players Within the past year, more than 100 national lenders have closed their doors, either voluntarily or due to pressure from creditors. The issue is no longer limited to sub-prime or alt-A lending. How does this happen to good companies, and how deep is the problem? Just like crime or politics, follow the money! When your mortgage is funded at escrow, the cash comes from the bank as a line of credit (warehouse line) issued to the mortgage company. The mortgage company then packages your mortgage with hundreds of other mortgages into a pool and sells that pool to investors, such as pension funds or hedge funds in the secondary market. This allows the mortgage company to pay down its warehouse line and start over, funding new mortgages. Before we go too far, I need to also tell you the difference between conforming and jumbo mortgages. Most all conforming mortgages are purchased on the secondary market by Fannie Mae or Freddie Mac, which are government-sponsored enterprises, and the risk grade is well known. Jumbo mortgage pools sold on the secondary market are not as homogeneous, as to the risk and property type, and each investor will underwrite the pool based upon its perceived risk. What happened to American Home Mortgage was the pools it went to sell were discounted by the investors in the secondary market, creating a loss to American Home Mortgage. With the change in the value of the mortgage pools, the banks served American Home Mortgage with margin calls on their warehouse lines of credit. This created a liquidity noose that choked American Home Mortgage into its current position, Chapter 11 bankruptcy. While conforming loans have enjoyed a modest decline in rates, jumbo mortgages have spiked up more than 0.5 percent just on the news of American Home Mortgage. The difference between conforming rates and jumbo rates are near an all-time high, with an almost one-percent spread. Spitball The media and politicians want you to blame Mortgage Brokers as the catalyst and scapegoat for the credit debacle. We saw stockbrokers take their lumps as the scapegoat after the stock market correction in 2000, if they advised any client to purchase a dotcom stock. While every industry has a bad apple or two, you should not stereotype the whole barrel. Previously, I have illustrated that market forces and economics are the reasons for the present mortgage turmoil and not misrepresentation by a whole industry. To place the blame on professional standards, and mortgage planners and brokers of integrity, is just misplaced anger. As a sidebar, had there been a continued appreciation of real estate nationwide of only four percent over the past three years, we would not have had any of these credit issues. Relief pitcher Lenders are modifying their guidelines, even as you read this. They are shoring up their products and underwriting to enhance the appetite of the secondary market for their loans. Most will adjust their products by modifying the loan to value, credit score and, of course, price. Stated-income programs, if still available, will become much more difficult to come by, particularly if you are salaried. Credit scores across the board will have a higher threshold. As a borrower, you will be providing much more documentation of assets, income and job history to make the lender's file bulletproof if ever there were a future default. Appraisals will require more comparables and analysis of sales versus listed property. Marketing time for homes will also become a focal point that was glanced over in the past. While exotic loans, as they are called, will still be available, they will be much more expensive and difficult to come by. Extra innings How can borrowers now position themselves to win when they are behind with few outs left? •Don't hesitate! Like a batter's 3-1 count, if you see a good pitch, knock it out of the park. Likewise, waiting in this market is foolish. With decreases in home values and fewer available mortgage options, delaying longer could get significantly more expensive. •If you're presently in the loan process, get all your data in now. Minor delays can result in loan commitments and funds being yanked at the last minute. •Home sellers don't hold out for the record price. Pre-approved buyers may lose that status as lenders tighten parameters, reducing the pool of available buyers. Combining this with an increase in housing inventory means holding out is not the best strategy. •Borrowers who have an adjustment or recast scheduled within the next 12 months should act now, even if there is a pre-payment penalty. There may not be a loan substitute program four months from now that is any better economically. •Make sure your credit is as good as it gets. Fix anything that can reduce your score, such as allocation of debt across your credit cards and inaccurate data or small collections. •Seek out a professional mortgage coach. As the industry contracts, it is possible the lender you once used is no longer in business. Look for a mortgage planner to assist in providing a strategic plan that connects the dots with your other financial goals. The National Association of Mortgage Brokers is a professional trade group whose members adhere to a professional code of ethics and standards that sets the bar for the industry. You can search for a professional near you on their Web site, www.namb.org. •Have your mortgage planner provide an annual review of your mortgage. Keep up to date with trends, rates and personal goals for financial independence by active equity management. Know your batting average. •Steal a base or two. Foreclosures are up and values are attractive compared to two years ago. You may wish to leverage up or cash out some equity and purchase more real estate. The mortgage meltdown is only prevalent in the residential sector. Commercial lenders for income properties are not experiencing the same volatility. Turn the crisis into opportunity. Final score Play to win. The turmoil is that lenders are changing the rules while the game is being played. They have no choice, as investors in the secondary market modify their criteria for risk management and return on investment. Over the play period, you may no longer be eligible as guidelines change. Accordingly, take advantage of the current market and rules, as the next game may be called for bad weather. Accept free agency with your new coach and team. Work with a professional mortgage planner and be both willing and receptive of new concepts and ideas that integrate your mortgage with other wealth-building concepts. Finally, see the signals. If you get the "bunt" sign or "hit and run," do it. The window of opportunity is closing fast. If nothing else, arrest the fall or potential deterioration, by analyzing your present situation with today's mortgage options. Like a batting slump, this too is a cycle that will change over time. The key is to secure a position that you know will get you through the end of the game and into the next. "If you don't know where you are going, you might wind up someplace else." —Yogi Berra David Brown is president of the North Central Coast Chapter of the California Association of Mortgage Brokers and a team member and broker for Residential Mortgage Corporation. He may be reached at (805) 686-2321 or e-mail [email protected]. Don McMahon created Human Resources Financial Solutions and is a team member for Residential Mortgage Corporation. He may be reached at (805) 686-2321.
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