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.
