The Game of Mortgage Lending
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 must 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 and then begin to recover 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 rid of all the toxic assets currently on bank books and the number of qualified borrowers comes close to matching the available inventory.
Below I outline the five hidden grenades that will prevent any immediate recovery in the real estate market.
Few qualified buyers. Perhaps most significant problem preventing a real estate recovery is the lack of qualified borrowers. There are several factors 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 mortgage 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 rate increases can do nothing but shrink the pool of interested and qualified buyers.
Limited loan options. Another factor influencing the number of home buyers 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. Between 2000 and 2007, many homes were purchased or refinanced with loan products that no longer exist. My personal experience during this period was that many borrowers did not want 30 year-fixed loans. While I did not promote the 100% interest only, 10% down Option ARM or other 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 — THANKFULLY 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 today. 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.
Shadow inventory. 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. Simply put, the banks are drowning in foreclosures, and are keeping many of those properties off the market in hopes of a recovery. They are, in essence, artificially keeping housing prices high so they have more time to recapitalize their books. At this point, the amount of home sales needed to take these homes off the market in 3 years amount to someone getting a golden ticket in a Wonka Bar. Also, the amount of timeline required to close a short sale is horrific, and just makes this problem drag out even further. So the great call by Jim Cramer on the bottom of housing (Jim Cramer’s Housing Bottom Call Revisited) was more than just a tad early. If you want the true pricing of homes in this country, the government should require banks to put all the shadow inventory on the market. This will show you a true bottom of the market. Barring this, the only solution to the shadow inventory problem is time, time and more time.
Strategic defaults. When a borrower has the ability to pay, and yet they walk away from their homes and mortgages, they are strategically defaulting. We have seen a significant increase in the last year in the number of people who can pay their mortgage but are simply walking away from their homes.
I believe this is going to shock people the most when it’s all said and done. They make their payments but can’t refinance because of their negative equity, and they say conclude that the long term benefits of owning their home at the rate they are paying, on a house that often is worth only a fraction of what they owe, doesn’t make sense to them. In addition to adding to the glut of foreclosures, these strategic defaulters will be out of the market for 3 to 7 years, depending on how they walk away from their debt. That means even fewer buyers will be ready and/or able to purchase real estate, furthering the market’s decline.
New wave of foreclosures. We are now seeing another round of 30-day-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 from their homes, leaving a wake of short sales, foreclosures and bankruptcies behind them…just more collateral damage that will need 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. All of the issues outlined above will combine to stall the market. My prediction: It will take 8 to 9 years to clear this glut.
In our rush to address these problems, one thing is certain: We cannot, and should not, bring back the lax lending standards of the past in order to qualify buyers. This will simply exacerbate the problem.
There is only one idea that I think 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 have been making their payments on time and would like to lower their rate? Let these people go through the credit, income and asset underwriting, and if they are qualified in all those ways, 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 homes are often too undervalued to qualify. 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 worthy borrowers who are making their payments and meet the underwriting requirements currently in place. Taking the appraised 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?