Earthquakes in the Mortgage Markets

As summer has worn on, and with very little fanfare, a crisis has been developing in the mortgage industry that will CHANGE THE REAL ESTATE INDUSTRY FOREVER. This is far more than simply “the summer of discontent” for loan officers. It is imperative that all of us understand these developments and what they mean to our business and the United States economy as a whole. Here is a synopsis, along with how I expect this to play out.

What is Happening?

With few exceptions, the mortgage market has evolved to become almost entirely dependent on the salability of loans through secondary markets comprised of Wall Street based securitization pools. As a result of rising rates and declining values, it has become clear to Wall Street and the rating agencies themselves, that the pricing models which allowed secondary market purchasers to effectively price loans, have grossly UNDERESTIMATED the risk associated with loans, especially SUBPRIME loans (guidelines were way too aggressive and rates too low). This phenomenon was widely believed to be contained to the subprime arena early on.

The cat is now out of the bag, and ALT A loans (most commonly used for 100% financing) are now included in this toxic category, leading to a complete shutdown of the secondary market for the time being (Wall Street refuses to buy these loans).

How is this Affecting Mortgage Lending?

Products are being eliminated. Guidelines are being scaled back. Rates are increasing. Pricing volatility is at an all time high. Here are some observations:

1. The demise of mortgage companies (American Home, New Century and others) will continue as these companies are unable to unload billions of dollars in loans to Wall Street. Large deep pocket lenders and banks will survive, but in the meantime, are financing the entire US mortgage market. This cannot continue indefinitely.
2. Rate volatility Even the most solvent lenders are building in an “uncertainty premium” into their rates. Expect wild rate differentials from one lender to the next as banks struggle to become comfortable with price models that may require them to hold all loans in their portfolio until the secondary market returns. Forget about tracking the 10 year treasury yield or listening to the jobs report. Developments in the secondary markets will have a much greater impact on rates with this new risk/reward profile.
3. Different underwriting approaches Expect continued cuts in loan to value, heavy appraisal review requirements, strong movement in the direction of fully documented income loans (versus stated income) higher FICO requirements and more reliance on automated underwriting. Guidelines, in general, will be more generic.

How this will play out Because these are unprecedented developments in the mortgage business, no one knows for sure how this will play out or how long it will take for things to return to normal. Here are some strong possibilities:

1. Either the great minds of Wall Street and/or the Fed will step in and take measures to stabilize the market. One potential measure would be to raise the rate on conforming loan limits.
2. Hopefully, lower rates will be a component of the stabilization which will be a precursor to a potential refi boom as homeowners seek to refinance OUT of adjusting ARMS and into more stable loans such as fixed rate and lower rate hybrids.
3. Regardless of whether #1 or #2 happen, subprime and ALT A loans will never return in their previous form Expect more restrictive guidelines to become a permanent fixture.

Courtesy of Robert Bartolomea, Strategic Home Loans 818.865.2500 ext. 210.

Robert is part of the Powell & Powell Network of Professionals dedicated to getting you into your new home without any surprises. Today more than ever your REALTOR and your Mortgage Broker matter. Choose wisely.