Understanding the Mortgage Industry Crisis

The collapse of American Home Mortgage last week is making all the headlines. Over the past month or so, if you follow any type of financial news you've been hearing about the subprime markets, predatory lending, and the tightening of credit lending standards by State legislatures including Florida. What does all this mean to you? Let's see if we can explain a few of the details so you can understand what actually is happening.

In the past few years quite a few loans were made to folks using a "non-traditional" or a "non-conforming" loan product - this may have been for a poor credit history, unwillingness or inability to document income, or many factors that leave a borrower "outside of the box" for standard loan qualification. Quite a few times these loans may have been referred to as Alt-A, Subprime, or Expanded Criteria. You might have heard of stated income-stated asset, no income-no asset and no ratio loans. And, of course one of the biggest products was the "Option One" ARM loan. The Option One ARM is where many borrowers are into big, big trouble. These loans adjusted at the closing table to a very high interest rate but many borrowers only "heard" that their payment would remain the same. Either they didn't want to "hear" the actual details of their loan product or they truly did not understand how this loan program was administered. Couple those adjusting rates with the slowdown in real estate sales and some loss of appreciation, many homeowners are now "upside down" in value and it's impossible for them to refinance.

In response to what legislators in Minnesota saw as "predatory" lending practices - of which there were many abuses - they passed a law stating that all borrowers must "actually" qualify for all new home loan financing. While their attempt at loan oversight was commendable, the new law had unintended consequences. For instance, under FHA guidelines, if you currently have a FHA mortgage you can refinance to a lower rate without having to qualify again for the loan. Under Minnesota law, this program is no longer available to the borrower as they must "re-qualify" for the "new" loan. Similarly if you are a long time homeowner, have adequate reserves, and wish to use an interest only product because your appreciation has been tremendous over the years, you may no longer have access to these types of programs. Again, what you're seeing is unintended restrictions on qualified and credit worthy borrowers.

Last week, many wholesalers that provide mortgage funds to mortgage bankers and brokers began dropping programs and re-writing their criteria for qualifying borrowers for many loan programs. This was due to a "liquidity crisis" in the market. When a wholesaler pools a packet of loans for sale in the market - let's say for example - the premium on a loan of $100,000 was $101,000 - this is what the buyer of these securities paid for the long term return of interest on the $100,000. Now with default rates rising and a soft value market, that same $100,000 loan may only be able to sell for $95,000. This means the loan can no longer be sold by the "holder" institution at a profit - it will actually sell at a $5,000 loss. And, that's assuming they could find a buyer as end investors for those Subprime or Alt-A loan products have dried up. Therefore, the wholesalers have "dropped" these programs and will no longer be offering them. They include huge wholesalers such as Wells Fargo, National City, TB&W, and many others.

This is what happened to American Home Mortgage. Their creditors "cut them off" and would no longer purchase their loans. American Home Mortgage didn't do anything "wrong" - they just no longer have any funds to deliver to the closing table. And, they're not alone. More than 50 subprime lenders have already gone out of business this year. According to their recent SEC filing, Accredited Home Lenders may be the next subprime mortgage lender to tumble into bankruptcy because of the fire-sale atmosphere in the secondary market for subprime loans.

There is also much talk in the industry about originators that exclusively wrote loans at very high rates of interest to borrowers who did not have a financially feasible way of paying the loan back - hence the increase in defaults. The number of U.S. homes facing foreclosure surged 58 percent in the first six months of this year alone and with many ARM loans set to adjust again, the future doesn't look much better. It's obvious from these numbers; the mortgage industry itself needs to do a better job of policing its own lending policies and procedures.

What should borrowers do now? First, don't panic. There are plenty of loan program options still available. If you need a home mortgage do your best to ensure that your credit is as good as it can be - if you do not have an immediate need for a home loan - then work on that first. If your need is urgent, now is NOT the time to wade through the multiple lenders that promise something too good to be true - because in this market - that may be exactly what you'll get. Your focus should be on finding a reliable and professional lender that will offer guidance to help you evaluate what programs are available at the best possible rate and terms. Knowing you'll have funds available at the closing table is crucial.

Metro Mortgage Company is a full service federally regulated Mortgage Banker specializing in originating Conventional, Jumbo and FHA/VA loans in 20 States including Florida. Contact us and we'll be happy to discuss all your options in today's uncertain marketplace.

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