The End of the Gravy Train???

You may have noticed that there has been a good deal of interest in what is going on with the lending industry lately. For years the industry has been trying to figure out how to make mortgage lending available to the broadest segment of the market. After all homeownership is the American dream, right? And if that is going to be accomplished to its highest degree then mortgage funds have to be made available.

Generally speaking, the three most significant roadblocks to mortgage approval and subsequent homeownership are insufficient funds to purchase, inadequate income and poor credit. Over the years the industry has tried to address these issues and have successfully managed to develop products that enable these groups of aspiring homeowners to realize their dream.

FHA and VA mortgages have been around for generations, making homeownership possible for folks with little or no cash for a down payment and for all those years have adequately served that piece of the pie. Even though a borrower had to qualify for income and credit, delinquency and foreclosure rates were still high, but within acceptable parameters. One would have to figure that if a family had a cash flow problem to begin with, a financial crisis could throw them over the edge. Nonetheless, these programs have served the purpose for years, successfully overall.

However, the mortgage gurus, not being satisfied to serve only a portion of this market, developed additional, and what I believe to be, dangerous products, to reach a much larger group of these borrowers. Through "no documentation” and “sub-prime” mortgages this order was filled. The “no doc” allowed people with difficulty verifying their incomes to obtain financing. Initially, these were only available for those with sterling credit and who were using the product as a convenience to avoid the hassle and intrusion of the typical mortgage application. As the years went by “no doc” standards became watered down to the point where so-so credit was accepted and rather than using the product to avoid the hassle, the product was used because income couldn’t be verified. This swung the door wide open to the possibility of mortgage fraud, both on the part of the consumer and the mortgage loan officer anxious to write another loan. These practices were not undetectable by any means: the borrower was required to execute IRS form 4506, which gives the mortgage lender the right to order a copy of the borrower’s tax return; however, by practice, the form was not utilized unless the loan went delinquent. Somebody say, “close the barn door first.”

“Sub-prime” loans allow folks with “less than perfect credit” (read that as poor credit) to obtain financing. This is just downright dangerous, contrary to the laws of common sense. Let’s take this to the most basic level. Your brother-in-law borrowed $100 from you and never paid it back, or only paid you half, or paid you five years later. The next time he wanted to borrow money you probably wouldn’t be anxious to take his call.

Well, this is what “sub-prime” lenders are doing. History of bankruptcy – that’s OK. Foreclosure, that's no problem. Delinquent payments, that’s OK too. The trade-off is usually a relatively high rate of interest. Little consolation if the borrower stops making payments.

Roll this all together with lenders making loans that are over 100% of value and you might begin to wonder how all these lunatics had escaped and found their way into the same vocation.

On a personal level you would never do these things: lending money to people with a proven history of not repaying debt, lending to someone who you were not sure had the ability to repay or lending significantly more than the security is worth (here’s my Timex, now lend me $1,000).

It is due to these lending practices that we are now experiencing the highest foreclosure rates in decades and as a result we are seeing serious efforts to reverse this. These fringe loans are already getting more difficult to find and when found, more effort is being used to assure that they have some chance of working out. Large lenders are cutting back on these kinds of products and small brokers who were specializing in this area are finding it harder to continue. Many have, in fact, failed.

So what is the future? Here is an absolute – mortgage lenders don’t lose, I mean the guys with the money. Sure their distributors may crash and burn, but they will be just fine. Remember, in the vast majority of these foreclosure cases the lenders are insured against loss, so don’t worry about them. As you can see, for the balance of the mortgage market, money is readily available and the rates are still in the mid-six percent range, so get out there and borrow some money: it’s good for the economy.

Gary Straub is an independent real estate consultant and real estate professional for 36 years.