I would like nothing more than to get my hands on accurate default rates on Option ARMs. Cagan’s admission that these loans are at risk is a huge admission. He’s the one who published a paper showing that most homeowners have plenty of equity and ride out any housing downturn. I found his change in sentiment significant.
The per capita income in San Diego is nowhere near $70K – $100K. I think less than 20% of families in San Diego make in that income range. So the income premise does not hold.
Most important is this: lenders qualify borrowers at 40% – 55% DTI, based on today’s teaser rate. It doesn’t matter how much money you earn, if you are already maxed out on your mortgage payment and it goes up 50% – 100%, you’re at risk of default. In my opinion, most of the people whose mortgage adjusts up by at least 50% will end up in foreclosure. My reasoning is that they are already maxed out on their mortgage payments.
IF the lenders used traditional underwriting guidelines, and they qualified the borrower on 33% DTI, then your mortgage is max. 28% of your gross income and your total debt payments are a max of 33% of gross income. So the general formula is that you could borrow 3 – 3.5x your salary for a mortgage. If the lenders used the traditional guidelines, they would make sure the maximum interest rate under the loan AFTER the teaser period ends, falls within the 33% guideline.
But that is not happening. This revelation was a surprise to us on this forum when we mutually discovered it earlier this year. We were astonished, “What, the borrower is qualified based on the teaser rate only? Then how does the lender expect the borrower to make the mortgage payment when it jumps 50% or even doubles?” Answer: the lender doesn’t give a damn, ‘cuz he sold the loan to the MBS investor.
So the money is lent w/ a double whammy of risk: at the teaser rate and at up to 55% of income. So the borrower is already at a high debt load in the initial teaser period. He’s basically screwed if he can’t refinance when the teaser period ends.
It’s the lax lending guidelines that are to blame for the wave of defaults we will see.
Remember Casy Serin who got $2.2 mil in loans? This kid barely had a job.
To understand why I am so bearish on housing, you’ve got to understand the lending environment, and how loose it is. Low FICO, one day out of bankruptcy, no problem. Brokers are lying about borrower income, stated income, 0% down, qualifying borrowers on the teaser rate only without regard to whether the borrower can afford the payment after the loan resets….
The lenders have abandoned prudent lending guidelines. It’s all about getting the commission today, and no longer about making sure the loan actually gets repaid. The lender could care less if the damn loan gets repaid. They have the profits today!
Get this: the subprime hybrid ARM has very low payments for 2 years, and then jumps in year 3, with a payment shock of 40% – 50%. Even if the interest rate goes down by 200 basis points, the payment shock is 25%!!!! (Center for Responsible Lending). The panel member at the Senate Hearing said there are 3 main problems with the subprime loans:
1) high debt ratio (50% – 55% of gross income for principal and interest).
2) underwriting to initial payment, so the borrower is qualified based on his ability to pay the temporary low intro rate. When the payment goes up, the FINAL PAYMENTS EXCEED HIS GROSS INCOME!!!!!!
3) borrower’s ability to pay is on principal and interest only. They don’t even include the taxes, insurance, HOA! If you include all that, you could be over 55% – 60% of gross income. That is on the initial teaser rate only.
This degradation of lending is criminal. We’ve got lenders who are selling products for the sake of commission, without a care whether people can stay in their homes.
So don’t waste your time getting mad at me. Get mad at the lenders who have perpetrated the greatest homeowner disaster in our history, basically ensuring that millions of Americans have loans with payments they soon cannot afford. Will not afford. So I will be very clear: in my opinion, millions of Americans will lose their homes in foreclosure because lenders put them in products they simply cannot afford.
If you disagree with me, start your own thread. What do YOU know about the lending environment, and what will be its consequences?