The Game of Mortgage Lending

In my free time, I play apocalyptic war games, because they provide a vivid diversion from life. In the real world, I, along with my father, run a mortgage company in Orange County, California. We have been in the business for nearly 30 years. Orange County is the ravaged and troubled birthplace of some of the most egregious real estate excesses that prefaced the financial collapse of 2008. Mortgage lending isn't a game, but it certainly feels like war these days. Financial destruction has cut a wide swath across our landscape. “For sale” signs for short sale and foreclosed homes have exploded in previously booming new developments, while long established brokerage firms are closing their doors and vacating the industry. Compounding the problem of falling home values and increased inventory due to distressed sales, every loan application we send to the banks for financing is required to navigate a minefield of new lending laws and regulations that seem engineered to destroy any chance our borrowers have of reaching the goal of home ownership. In short, we have serious long term problems in the real estate market in this country, which thus far, remain largely unacknowledged by the industry leadership, government officials and even the financial media. The prevailing opinion seems to be that the market will stabilize then begin to recover and within the next few years. In a press release by the National Association of Realtors, Ron Peltier, chairman and CEO of HomeServices of America, Inc., the second largest independent residential real estate brokerage firm in the country, is quoted as saying that the nation is in the seventh inning of the housing market correction and that that today's real estate market resembles that in the year 2000. (REALTORS® Cautiously Optimistic about Future of Housing Market) In truth however, current conditions are grim and all market indicators suggest that we are in for a long hard slog, of six to eight years, before the market is to rid of all the toxic assets on bank books and the number of qualified borrowers comes close to matching the available inventory. Below I outline the five burning fuses on the hidden grenades of the real estate market that will prevent any immediate recovery. Perhaps most significant problem preventing a real estate recovery is the lack of qualified borrowers. There are several factors which are contributing to this dearth. First, is the plummeting credit scores of the average American consumer. Over twenty five percent of the people in the country have a FICO score under 600 identifying them as poor risks for lenders. (See this here). An A+ loan rate from any of the national banks requires a FICO score of at least 720. A FICO score of 620 and under disqualifies buyers from nearly all loan products. As the recession drags on, more and more people will fall into that “poor risk” category. The pool of potential buyers is therefore shrinking despite the historically low interest rates. And while the currently low interest rates are an incentive to purchase for those with good credit, these low rates are not expected to last. The May 2010 Economic Outlook published by Fannie Mae's Economics and Mortgage Market Analysis Group projects a steady increase in mortgage rates over the next several years reaching 5.8 percent by the end of 2011. While still low compared to the typical mortgage rates of the 1970s and 80s, in an already troubled market the increase rates can do nothing but shrink the pool of interested and qualified buyers. Another factor which is influencing the number of home buyer in the market place is the limited financing options available. Even “credit worthy” borrowers today have far fewer choices in terms of the types of loan products available. In the period between 2000 and 2007, many homes were purchased or refinanced with loan products that no longer exist. My personal experience was that during this period many borrowers did not want 30 year fixed loans. While I did not promote the 100% interest only, 10% down Option ARM or subprime products to my borrowers, these products were extremely popular with borrowers who wanted to get into the housing market but did not have large cash reserves for a down payment. Most of these “creative” products are now gone -- THANK FULLY GONE and I hope to never see most of them ever again. The fact remains however that potential new borrowers have far fewer financing options. If they cannot meet the down payment and monthly payment requirements of the few products now available, those buyers too are effectively removed from marketplace. The end result is that we will have far fewer but more qualified buyers -- which in turn means more time will be needed to clear the excess inventory from the market. The so called “shadow inventory” problem is the third issue that is extending the timeline for market recovery. The problem of the banks Shadow inventory is growing, and growing. The amount of homes sales needed to take these homes off the market in 3 years amount to someone getting a golden ticket in a Wonka Bar. The Banks are just getting drowned with foreclosures. Also, the Horrific time it takes for a short sale home to close just makes this problem drags it out. Again getting back to my original point Time. So the great call by Jim Cramer on the bottom of housing Jim Cramer's Housing Bottom Call Revisited (VIDEO) just a tad early. If you want the true pricing of homes in the country make it law to put all the shadow inventory homes on the market and see how these Vampire sucking Demons show you a bottom of the market. In essence the banks are artificially keeping the housing price high so they have more time to recapitalize their books. The solution to the shadow inventory problem is time, time, time. 4. Strategic defaults. When a borrower has the ability to pay and they walk away from their homes We have seen a rise from last year on People who can pay their Mortgage but are walking away from their homes. I believe this is going to shock people the most when it's all said and done on the amount of home owners who just simply say.... Forget about it. At issue here is that these borrowers see people get 4.25% refinanced loans because they are going though trouble and they feel left out. Because they make their payments but can't refinance because of their negative equity they say the long term benefits of owning their home at the rate they are paying with so much negative Equity doesn't make sense to them. The Longer problem here is that these people make money and it can take them 3-7 years depending on how they walk about from their debt to buy another home. Again time.. and less economic soldier out there fighting the war against the real estate decline 5. We thought the above components were the most difficult battle to face. But, a fresh horror has appeared on the horizon. We are now seeing another round of 30 date late mortgages, something which we hadn't seen in a while. Just as in my imaginary war games, when I have finished off the last errant enemy, seeing a fresh army headed over the hills tells me the battle is about to become fierce again. We will soon see a new round of fresh foreclosures, from people who walk away,zombie like, from their homes, leaving a wake of short sales, foreclosures and bankrupticies behind them. More collateral damage that needs to be undone.. In short, the housing bubble created an oversupply of homes which will now sit, unused and unneeded, until there are enough qualified borrowers to absorb them. It will take 8-9 years to clear this glut. Financiers and economists could delve into this issue in much greater depth than I have here, but my objective is to bring this to light in the simplest and shortest way. So, WHAT is the solution? TIME. TIME, the old “healer of all things.” We cannot and should not bring back the lax lending standards of the past in order to qualify buyers, and then when rates begin rising, those that qualify now will become even fewer, so this entire real estate problem will drag on for years and years. There is only one idea which I can see should be put into place, and would help the “healthy” borrowers and homeowners, and thereby slow down or halt some of the coming foreclosures and short sales. Wouldn't it be prudent to enlist Freddie and Fannie to do an entire refinance for all borrowers who would like to lower their rate, and who have been making their payments on time? Let these people go through the credit, income and asset underwriting and if they are qualified in all those ways, then allow them to refinance. In order to do this, the appraisal process would have to be abolished for these people. For now, the appraisal requirement limits their ability to refinance, because their home is often too undervalued to qualify. And, yet, if these borrowers have been credit worthy, want to stay in their home, and simply lower their payment, why should they be punished for the prices of real estate having dropped? Or, allow the house to be appraised, but don't allow the appraisal price to kill the borrowers ability to refinance a loan on which he's always made good. We cannot ask the privately funded mortgage holders to agree to this, but why not Fannie and Freddie? Isn't this something good and logical they can do? The risk of default would be low because we are only helping borrowers who are making their payments now and they would just go through the underwriting process to make certain they qualify for a refinance. Taking the home value out of the equation would be like bringing fresh water to the troops who have fought the longest, hardest and most courageous and for the finest cause. I have to get back to my video game. Where's my gun?