The "Sub-Prime" Mortgage Crunch in the U.S.

Factual Questions
21

[QUOTE=Atomicktom]

Another huge factor in defaults (at least here in Florida) has been property taxes and insurance rates. While Florida limits tax increases on homesteaded property, that property is re-appraised by the tax collector whenever it is sold. So, people ended up with tax bills much bigger then what the previous owner had paid, something many people didn’t properly consider. Similarly, a rash of hurricanes in recent years has sent home insurance rates skyrocketing, causing huge increases in the monthly payments that many borrowers have had to pay.
[/QUOTE]

Interesting. California has the same issue, thanks to Prop. 13, but I haven’t ever heard of mentioned as a problem, even with the big jump in home values. We pay a lot more in property taxes than the people we bought the house from, and when we sell the buyers will pay a lot more than us.

Do the loans you deal with have prepayment penalties? That seems to be an issue here.

22

How much of this were people thinking they could get rich quick in real estate by buying properties as investments? I was listening to a financial show, and one caller had SIX (!) homes in addition to her primary residence that she couldn’t pay for and couldn’t get renters for.

I’m sure that’s an extreme example, but still! Bottom line is, 10% minimum down payment is good, fixed interest is good, 15 year loan (if you can swing it) is very very good.

If you don’t qualify for the above, you have no business buying a house.

23

[QUOTE=ivylass]
How much of this were people thinking they could get rich quick in real estate by buying properties as investments? I was listening to a financial show, and one caller had SIX (!) homes in addition to her primary residence that she couldn’t pay for and couldn’t get renters for.
[/QUOTE]

A good deal of it, because people interested in flipping houses often did so using the teaser rate ARMs because their plan was to sell it for profit before the teaser rate period expired (why lock into a 30 year if you are going to sell it a year later?). But when these people couldn’t find buyers they’re stuck with a huge mortgage nut they can’t afford.

24

I remember distinctly when I purchased my home in the summer of 2002. I knew what my income was, I knew what my wife’s income was, had a substantial amount of money set aside for a down payment, and calculated myself exactly how much I could afford to have a fixed loan with 20% down.
I calculated out and decided I could afford a $190K home.
When I went to get approved for a loan they ran our credit and insisted over and over that we should be looking at homes over 300K because our credit said we could and they could make it happen easily for us. They told us all the benefits of ARMs, not needing 20% down, your house will appreciate, yada-yada.
I declined and stuck with the $190K home.
I can imagine the folks out there who went into house hunting blindly relying on the banks to tell them what they could afford.

25

Don’t forget all the home builders out there. They’re part of this too. The developers have been building huge ‘master planned’ communities, filled with ‘McMansions’, and pricing them for maximum profit. They’re now at the point where they’ve over-built, and there are more homes available than people to buy them.

For some time, the only way they’ve filled these homes is through ‘creative’ financing, with balloon payments, adjustable rates, and all sorts of banking tricks. It was kind of a pyramid scheme, and only worked as long as they could keep qualifying people for the homes. Now they have run out of people who can qualify, and not only because the ‘creative’ financing had run out.

26

I see all the foreclosures, and I feel sorry for those who are uneducated and got taken for a ride, but I DON’T feel sorry for those who should know better. My wife and I make a relatively standard middle-class income, and we purchased our first home this year, for $139,000. Our maximum budget: $140,000. We knew we couldn’t afford more than that, so we purchased within our budget, and consequently, I know I’ll afford my house payment until I move or pay it off (30 year fixed).

I’m sorry…if you have any math skills, you should know that you can’t afford a $500,000 house on $60,000 a year. I mean, come on…that’s $16,000 a year with ZERO interest, and ZERO property taxes. It doesn’t take a genius to figure out that you’re in over your head, and yet THOUSANDS of loans were made to people like this.

Of course, the banks are mostly to blame…why on earth would you make loans of that amount to people with income like that? What’s amazing to me is the sheer size of the problem. I have to say…I’m glad I am not planning on selling my house for another 6-7 years, when hopefully the market has recovered and I can make a tidy profit on my house.

27

But how much of the crisis can be attributed to predatory lending practices and how much can be attributed to the aforementioned inability to determine risk in the secondary market?

I am reminded of the S&L crisis in which there were a bunch of headline-grabbing assholes whose chicanery cost billions, but the bulk of the problem was caused by honest bankers who were forced to invest in high risk loans in order to pay the kind of interest on deposits that the market demanded combined with fairly low fractional reserve requirements.

Thanks,
Rob

28

[QUOTE=sweeteviljesus]
But how much of the crisis can be attributed to predatory lending practices and how much can be attributed to the aforementioned inability to determine risk in the secondary market?
[/QUOTE]

The problem was caused by subprime loans, but the crisis was caused by the widespread use of structured products.

29

[QUOTE=Voyager]
Do loans you deal with have prepayment penalties? That seems to be an issue here.
[/QUOTE]

I do see a lot of loans with prepayment penalties, but I’m not sure how much that figures into the default. Typically, when the loan is “accelerated” by the lender (that is, the lender calls it due in full because the borrower has failed to make payments), they can’t use that acceleration to claim a pre-payment. So, no penalty accrues as a result of the foreclosure.

Having said that, I’m sure that many people are unable to re-finance out of their loan because a prepayment penalty would create a huge hit against them. That, after all, is the point of a prepayment - it creates a disincentive to get out of the loan during its initial stages.

Again, this underscores the point that people got into loans they couldn’t really afford. If you can’t afford the loan, don’t assume that market forces will make up for your shortfall.

I once saw a family getting into a loan that had a $100,000.00 balloon payment in 20 years; this was the only way the broker could get their initial payments low enough that they could afford them. The assumption was that they would refinance out of the loan well before that balloon payment came due. IMHO, however, this is a bad way to budget: it may work for the government to put off paying today’s bills until tomorrow, but that strategy is a recipe for disaster in one’s personal life.

30

[QUOTE=SmartAleq]
Buyer buys house, no down payment, buys house for say 300K. Payment is oh, 1500/month but it’s all interest. Creative financing avoids PMI which protects lender in case of default–but it’s cool because houses always appreciate, right?

Buyer gets past prepayment penalty time, wants to refi to something more reasonable. Lender says sorry, we’ve lost a whole buncha money in the last little while on loans like yours and you’ll have to come up with 10%–who has 30K just laying around?

Let’s just say for S&Gs that borrower scrumps up 30K so it’s a go–but oops! Foreclosures in neighborhood have reduced value of house to 250K! Uh oh! Borrower now has to come up with the extra 50K as well as the downpayment because he HAS to borrow enough to service the original loan, but the house ain’t worth that anymore. Lender will only loan against 90% of the new value of 250K. Borrower says no can do, decides to wait. After all, payment hasn’t changed, right?

More time passes, values are not going up, only down due to many other people who got their great ARM deals before our borrower did defaulting. House is worth less but borrower’s still paying 1500/month to service the original loan, still interest only. ARM term ends. Interest rate jumps 2, 3, 5, however many points. Borrower is now paying say 2500/month to service original loan but now house is only worth say 225K. Borrower will still have to come up with the 75K difference + 10% of appraised value to get out of the bad 2500/month deal.

Borrower says fuckit and goes into foreclosure. Borrower will probably not be able to buy another house for years, if ever, so the pool of available home buyers is smaller but there are lots of houses available to buy. Bank now owns 225K value house they loaned 300K on and short sells it for 200K to anyone who’ll take it off their hands.
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Post snipped.

That situation basically describes how I bought my new house. I closed a couple weeks ago and I got the house for ~110,000 below the original sale price. The house was built in 2006, the previous owner had it for less than a year then it was foreclosed. The original sale price for the house was at ~155 a sq foot. I got it at ~103 a sq ft.

There is another issue that I didn’t see mentioned and that is pulling out equity. I know a couple people who pulled out equity from their houses by refianancing the house. All those people are now screwed because they owe way more on the house than it is worth.

Slee

31

Doesn’t the federal gov’t have to accept some blame here? Lawmakers were screeching about how hard it was to get a mortgage and enjoy the American dream, so mortgage companies were pressured into maybe making loans they shouldn’t have?

Keep in mind…despite all the hype, the subprime “crisis” is only a small percentage of the overall mortage market. Most people are fine. But, squeaky wheel gets the lead story on the evening news…

32

[QUOTE=sleestak]
Post snipped.

That situation basically describes how I bought my new house. I closed a couple weeks ago and I got the house for ~110,000 below the original sale price. The house was built in 2006, the previous owner had it for less than a year then it was foreclosed. The original sale price for the house was at ~155 a sq foot. I got it at ~103 a sq ft.

[/QUOTE]

My situation was a bit different. I bought my house during the summer of 2006, for $320,000. We got a good fixed rate mortgage, which put our monthly payment at right around $2400- a bit higher than I would’ve liked, but completely doable with our income.

Then this last summer, I had to transfer to another studio (same company, just in a different town). We looked into renting the house out- but because so many people had bought houses as investments, the rental market was glutted (five rental houses on our street alone)- *if *we’d managed to rent it, we would’ve been lucky to get $900/month… but as it was, we never even got a nibble. In our new area, rental houses are rare- we’ve now living in a smaller, older house for $1700/month.

1700-900 (if we were lucky, which we weren’t) +2400= too much for our income. We’re currently going through a short sale. We just got an offer on the house- for around $100,000 less than what we bought the house for, a year-and-a-half ago.

33

I think part of the problem was all the people who were buying properties to flip them. I knew several people who bought a new condo stating that they would live there and then a month or two after closing would sell the place and pocket the change. One guy timed the market beautifully, selling his last place in 2006 for about what he paid for it and took the hint to get out.

This kind of behavior had the negative effect of inflating condo prices which now are deflating and people are stuck with negative equity.

34

[QUOTE=fiddlesticks]
A good deal of it, because people interested in flipping houses often did so using the teaser rate ARMs because their plan was to sell it for profit before the teaser rate period expired (why lock into a 30 year if you are going to sell it a year later?). But when these people couldn’t find buyers they’re stuck with a huge mortgage nut they can’t afford.
[/QUOTE]

Do you have any information on the extent of this. It certainly happened, but my impression was that these guys are a very small part of the problem - and don’t qualify for the bailout, since they are not occupying the house.

Their whole business model - ARM or not - was that in an appreciating market an improved house would sell for more than the combined renovation and financing costs. ARMs helped, but the difference between a teaser rate and the regular rate wouldn’t matter - assuming the market was hot enough to unload the house quickly. I think very few of these people held onto the houses long enough for the reset - they got screwed by the slowdown, not by an increase in interest rates.

35

[QUOTE=ivylass]
Doesn’t the federal gov’t have to accept some blame here? Lawmakers were screeching about how hard it was to get a mortgage and enjoy the American dream, so mortgage companies were pressured into maybe making loans they shouldn’t have?

Keep in mind…despite all the hype, the subprime “crisis” is only a small percentage of the overall mortage market. Most people are fine. But, squeaky wheel gets the lead story on the evening news…
[/QUOTE]

The government supported the mortgage market with Fannie Mae, etc., which to the best of my knowledge was not making subprime loans. I think the profit motive for the mortgage companies is plenty of explanation without government involvement - unless you count the Fed lowering interest rates and thus encouraging the bubble.

If only subprime borrowers were affected, the problem would be bad but not a crisis. The massive losses were causing a crunch even in regular jumbo loans, and the foreclosures are pulling down property values for everyone. I believe I read in the Times yesterday that a 10% across the board price decrease is over a trillion dollars of lost equity. That’s not a problem if you’re not selling, but it is for those people who’ve been depending on taking equity out of their homes to support a lifestyle unaffordable on their salaries. Scoff at them if you wish, but they’ve been the ones keeping the economy afloat for the past couple of years.

36

[QUOTE=Voyager]
Scoff at them if you wish, but they’ve been the ones keeping the economy afloat for the past couple of years.
[/QUOTE]

If they were the ones keeping the economy afloat, they were doing it on borrowed money. From the federal gov’t on down, Americans have gotten in the habit of spending more than they make.

If it takes a little bit of pain now to wake people up to their folly, I’ll take it. In the long run it will be better for the economy.

37

[QUOTE=ultrafilter]
If it really were that simple, all the big banks could just declare their exposure and we’d all be on our merry way, if maybe a little poorer. The issue at the heart of the credit crunch is that, due to everything being wrapped up in complex structured products, no one was able to say quickly how much money they stood to lose. That’s what caused all the markets to gum up.
[/QUOTE]

The root cause is specifically what I mentioned. It doesn’t matter what gummed up what and created bigger market issues, the simplest and most time-honored debt-to-income ratios were not enforced, and the credit histories were given much less relevance.

The complexities of the loans are secondary. People can’t afford the loans they were given, and even goofy loans that float up can be managed by people who have the debt-to-income ratio to deal with fluctuations in the debt. Further, people who have outstanding credit histories find ways to pay their bills when their bills increase monthly. This isn’t news – this is the rock on which credit was built.

Mortgage companies also had nothing in hand to counter the new risk THEY assumed. People have been protected by risk models that are a century old, and while they are ultimately responsible, you can’t blame them for letting their guards down.

I know very astute money people, and a well honed rule has always been, “If they are going to lend you the money, and the money is cheap, take whatever they will lend you.” That whole premise is based on the century old notion that the bank knows the risk, enforces the rules and wouldn’t lend itself into dust. And it has been true for a long time.

38

Another subset of victims of the subprime collapse are older people who are getting into “reverse mortgages” to supplement their retirement income. In this type of deal the owner of a paid off house takes reverse payments of equity out on a monthly basis and ideally they die the month before the last equity payment is disbursed. If neighborhood foreclosures have forced house values down, we have old people essentially losing hundreds of thousands of dollars in potential retirement income. This is gonna be a burden on someone… These are people who didn’t do a single thing wrong, worked hard, paid off their mortgages–but now they’re penalized for the foolishness and overoptimism of others. If these same people had investments that bought into subprime loan bundles they’re getting assfucked TWICE by the same crisis! Yay!

39

Well, even Joe Public who has a 200k mortgage and a 200k home equity loan on his home that now is only worth 350k is hurting, too. His escape plan – sell the house if it gets hard to pay the loans – is out the proverbial window.

And chances are that a good chunk of these folks who owe much more than their house is worth are going to struggle to pay those loans back…so they would love to revert to their escape plan.

When your home suddenly isn’t collatoral on your home loan, that is a big frigging problem for you and the bank.

Everyone should work with their bank, because they don’t want your home. Not now they don’t.

40

[QUOTE=ivylass]
… the subprime “crisis” is only a small percentage of the overall mortgage market. Most people are fine.
[/QUOTE]
Unless you’re trying to sell your house! Every extra month it takes to sell is a couple of thousand more dollars out of pocket.