August 31, 2006 at 11:23 AM #7394powaysellerParticipant
“To head off potential problems, Countrywide Loans, the largest mortgage originator in the U.S., has started sending out letters to thousands of its borrowers who have been making only the minimum payments on the company’s pay-option ARMs. The letters are framed as “an early message” to alert homeowners that based on their current payment trends and potential future interest rate changes, they should prepare themselves for significant increases in monthly payments.
The letters contain hypothetical examples of what lay ahead. One is a California homeowner making only minimum payments on a $402,000 loan. The current full interest rate on the loan is 7.6 percent, but the borrower has been paying just $1,348.47, far less than what’s needed to fully amortize the mortgage over its 30-year term. If the loan reset at today’s rates, the full payment required would be $2,887.50 — more than double what the homeowner is currently paying.
Countrywide does offer advice to customers who want to prepare for resets in the coming year: They should either switch from the minimum and move to either a 15-year or 30-year standard amortization plan, switch to an interest-only option if full payments are not feasible to fend off still-higher principal debt balances, or explore alternative refinancing options sooner than later.
Don’t be an ostrich
But some financial experts don’t see a doomsday scenario and say that due to frequent turnover in the housing market, exotic mortgages are here to stay.
“The average life of a loan is less than five years, so why get a 30-year fixed-rate loan which locks you into higher payments?” says Teresa O’Dette, owner of O’Dette Mortgage Group in Tahoe City, Calif. “People are not buying homes to stay in them forever.” – MSNBC
Exotic Mortgages Lose their Allure
Ok, Ms. O’Dette, I’ll answer your question.
First, people don’t move every 5 years. From SD inventory and population, we see that each homeowner moves only every 13 years. (40K inventory, 1.1 mil homeowners). I don’t know where she got the 5-year number; she’s from Lake Tahoe. Did you ever consider that someone might want to stay in their house forever?
Second, with a loan where you pay off principal, you are building equity, instead of debt.
Third, when your loan resets, and your payment doubles, how will you pay it? So what if you were planning to move in another year, you are still faced with a higher, unaffordable payment today.
Fourth, if your plan was to sell the house after the rate adjusts, what is your contingency plan if home values have dropped below your mortgage amount, and you are upside down? What if at that time, demand is low and rices are falling? You would essentially be forced to sell at the worst time.
Fifth, how many of your borrowers understood the loans they obtained from you? Did you just tell them they will move anyway before the 5 year into period is up? Well, did you disclose the payment could double, interest rates could be higher, and the market could be falling, making it likely impossible to qualify for a refinance, and possible to sell at a loss? Ms. O’Dette, if you are like most loan officers, I doubt it.
Nice try, Ms. O’Dette, but I don’t buy what you’re selling.August 31, 2006 at 11:28 AM #34105waiting hawkParticipant
hhmmmmm, “O’Dette Mortgage Group ” or should it be named “O’ Debt Mortgage Group”?August 31, 2006 at 1:03 PM #34115PerryChaseParticipant
Just for the fun of it, i’d love to see a sample letter. Anyone have one?August 31, 2006 at 1:26 PM #34116
Other bloggers also try to get a copy:
This journalist may have a copy of the “form letter”
Separately, yesterday’s WSJ has this interesting article on the credit market — basically, the melt-down is starting to happen, we just don’t know how severe it will be.
Mortgage Market Begins to See Cracks
As Subprime-Loan Problems Emerge
August 30, 2006; Page C1
First the housing bubble deflates. Then come the credit problems.
As homes sales have fallen and borrowing costs have edged higher, the mortgage business has slowed down. The big question is whether credit-quality deteriorates. While customers have been able to pay off loans in high numbers for years, the markets are seeing the first glimmerings of problems among customers with poor credit.
That’s to be expected. But there are signs that problems will emerge among higher-quality borrowers over the next several months.
Almost as if they are following a script, the mortgage companies that cater to those with poor credit — so-called subprime customers — see trouble first, and they’re already warning about emerging credit troubles.
Last week, H&R Block, the big tax preparer, alerted Wall Street that its Option One Mortgage unit, which focuses on the subprime market, would have to set aside about $60 million, or 19 cents a share, because borrowers were falling behind on their payments.
Customers of Countrywide Financial, which has products across the credit-quality spectrum, are paying loans off more slowly, as are those at subprime companies Impac Mortgage and Accredited Home Lenders. Mortgage companies, such as regional bank Fremont General, have begun putting money aside to account for loans going bad.
So far, late payments and defaults are relatively low. But the housing downturn is just in its early stages. In one of the first signs of concern in the market for credit-worthy customers, First Horizon National said yesterday that mortgage volume was falling so rapidly that it would miss earnings estimates for the current quarter. Less than 5% of First Horizon’s loans are to customers with poor credit.
Marty Mosby, the bank’s chief financial officer, says he’s not worried about credit problems, which have been low as a percentage of loans. “We don’t see any trends that say it’s going to swing very dramatically,” he says.
Here’s what’s been happening: Mortgage originators make loans and then sell them to investment banks, which mash them together with other loans and slice them up like sopressata for sale to institutional investors.
The worry has been that in the rush to gain customers during the housing boom, mortgage-makers lowered their lending standards. During the boom times, investment banks overlooked these concerns because they had no problem finding buyers for their mortgage and debt products.
Now, with the mortgage market slowing and the secondary market for mortgage-related securities faring modestly worse than in the past, investment banks are scrutinizing the loans that come into their sausage factories more carefully.
The investment banks have been sending mortgages back to the lenders if they find slip-ups, such as inaccurate paperwork or poor performance. The most common trigger is a so-called early payment default, where the mortgage holder has missed the deadline for the first payment.
Lenders complain that the investment banks are taking advantage of a contractual loophole to push the mortgages back. Customers often miss first payments, they say, for reasons that have nothing to do with credit worthiness. Sometimes it’s just an indication of an administrative delay.
But that’s probably wishful thinking.
If the problems spread beyond customers with poor credit, they’ll infect the world of exotic mortgages for supposedly credit-worthy customers first. Along with the companies that offered mortgages to customers who didn’t produce much documentation of their income and assets, the more vulnerable will be banks that sold huge numbers of option adjustable-rate mortgages.
Option ARMs give borrowers choices to minimize their mortgage payments, including the ability to make a minimum payment that is lower than the interest due that month. When a customer chooses that option, the mortgage balance goes up. After a certain period, often just a year, the rate can move up sharply.
Skeptics have wondered whether customers understood the full costs of these loans and whether lenders correctly estimated how likely it was they’d be paid back.
In an indication that there was reason to worry, Washington Mutual, one of the country’s biggest mortgage lenders and a big option ARM player, slipped in a rather stunning confession in its annual filing with the Securities and Exchange Commission.
In the filing, WaMu confessed it had bungled the underwriting for option ARMs, improperly measuring some of its customer’s debt-to-income ratios for 2004 and most of 2005. As short-term interest rates rose in those years, the company disclosed, the interest rate at which lenders qualified for loans “was not adjusted upward, which resulted in loans being made to borrowers who were qualified based on debt-to-income ratios calculated using an interest rate below” the prevailing interest rate.
In other words, the applicants looked more credit-worthy than they really were. Talk about violating Rule No. 1 in lending.
Of $43 billion of such loans, WaMu discloses, the unpaid balance for borrowers who were qualified at below the market rates totaled $30 billion.
The bank says it fixed the problem in October. It disclosed the problem in its annual filing this spring, but outside American Banker, few in the media or Wall Street picked it up.
A WaMu spokesman emails that the company expects that “the credit performance of these loans will not differ materially from the expected performance of option ARMs [customers] qualified” at the correct interest rates. WaMu, which says it has more than 20 years experience writing option ARMs through all economic cycles, says that the customers’ credit scores and the ratio of the size of the loan to the value of the property were high and that these measures are more important gauges of loan quality.
Option ARMs have been among the most scrutinized exotic mortgage products over the past year. That such an error could creep into WaMu’s lending should worry investors not only about the bank’s balance sheet but the industry’s lending standards as a whole.
Option ARMs didn’t go to subprime customers. That’s precisely why the coming mortgage problems may not be isolated to customers with poor credit.
Write to Jesse Eisinger at [email protected]August 31, 2006 at 1:40 PM #34117lendingbubblecontinuesParticipant
I think the letter went something like this:
When we handed you the loaded pistol, we had know idea you might try and actually blow your brains out. Please return the bullets if you can find them. If not, please just don’t tell anybody about this.
Your friend and partner in financial success,
CountryF*ked MortgageAugust 31, 2006 at 3:09 PM #34118PerryChaseParticipant
lendingbubble, I love it when it’s put in plain language, ha.ha. The vernacular is always so descriptive. 🙂August 31, 2006 at 3:30 PM #34120PDParticipant
Great letter!August 31, 2006 at 4:03 PM #34121vcguy_10Participant
ybc: Do you have access to the Case & Shiller Op-Ed piece in yesterday’s (Aug 30) WSJ?August 31, 2006 at 4:31 PM #34124waiting hawkParticipant
lol lending.. That is my kind of post!August 31, 2006 at 4:34 PM #34125
By KARL E. CASE and ROBERT J. SHILLER
August 30, 2006; Page A10
Looking back at past housing booms, the first sign of the end is when a goodly share of buyers stop making offers and eventually stop looking, seeming to just disappear. In the spring of 1987, during another U.S. housing-market boom that was starting to lose speed, Nora Moran, president of the Greater Boston real estate board, said “someone blew a whistle that only dogs and buyers heard.”
Across America today, it is as if the whistle has again been blown. New home sales in July are 22% below July 2005. The decrease is 43% for the Northeast over that same period, and the inventory of unsold new homes is up 22%. Existing home sales are down to 6.33 million in July from over seven million at the end of 2005. Older boomers are cashing out of valuable suburban homes and heading for condos in the city, or out of high-priced regions altogether.
Why is this happening so suddenly? It can’t be interest rates alone. The 30-year mortgage rate is up less than one percentage point since this time last year, and is no higher than it was a few years ago when this boom was roaring along.
The market spoiler was in place some two years ago. At that time, we felt that the spectacular price increases could not be justified. The psychology of that time could not continue indefinitely, and indeed it has not.
In the summer of 2004, the annual rate of increase for home prices in major U.S. cities reached its peak. According to the Standard & Poor’s/Case-Shiller Composite Home Price Index, based on 10 major metro areas, housing inflation reached 20.4% in the 12 months ending in July 2004. Now, the latest numbers announced yesterday show only an 8.2% increase in the 12 months ending June 2006, and most of that increase was in 2005. Six of the 10 cities actually fell between May and June. By simple extrapolation, if housing price changes continue to decline as they have, inflation will turn into deflation, and 12-month price changes might be squarely in negative territory by some time in 2007.
Talk is part of what changes the mood and actions of buyers, and the air is now full of talk of a bust. The covers of the New Yorker, the Economist, The Wall Street Journal and virtually every news magazine and newspaper in America has heralded the bursting of the “housing bubble.”
Part of what has focused the spotlight on the housing market has been the sheer size of the boom. Ten years ago, U.S. household holdings of real estate were valued at just under $8 trillion, about 40% as large as household financial wealth. At the end of 2005, real-estate holdings were $21.6 trillion, 56% as large as financial wealth. Just in the last five years, the total market value of residential real estate alone has increased by nearly $10 trillion.
New construction, initiated in response to high home prices, has reached unprecedented levels, and new houses are still hitting the market just as demand is dropping. Between 2000 and 2005, housing starts were over two million per year, existing home sales were over six million per year, and home-improvement spending hit $162 billion in 2005. All of this generated income for millions of brokers, builders, bankers, appliance dealers and construction workers, and kept the economy growing at a strong clip. But the housing construction boom can’t go on forever.
This incredible boom has been fueled in part by favorable demographics, low interest rates, a very liquid mortgage market with low down payments and borrower-friendly underwriting (option arms, interest-only, stated-income, etc.), a baby boomer generation with a special taste for housing, a substantial volume of foreign demand, and the poor overall performance of the stock market.
But beyond all these factors there is the simple psychology of expectations that is part of any speculative boom. These expectations can turn suddenly when alert home buyers get the sense that something might be amiss. Among respondents to our questionnaire survey of home buyers in April and May of this year, the median expected 12-month home price increase in Los Angeles was only 5%, compared to 10% in early 2005. In Boston, the median expectation was down to 2% from 5% last year.
Long-term expectations for home price appreciation have fallen much less. Americans haven’t changed their basic views on housing as a great long-term investment. Not yet, at least. That won’t happen unless there is a protracted housing price decline.
While our surveys indicate that relatively few expect prices to actually fall, buyers do not want to pay prices that are significantly higher than a year ago. Buyers are waiting and low-balling. Sellers want to get a price increase of the kind they’ve observed in the recent past. The result is that fewer agreements are reached, and sales fall. If the housing market were like the bond market and all houses for sale were auctioned every day, prices would indeed fall precipitously. But they are not. The aggregate indexes based on repeat sales have decelerated markedly but are not yet falling.
The U.S. now has a futures market based on home prices. The market that opened in May at the Chicago Mercantile Exchange is now showing backwardation in all 10 metropolitan areas trading. The backwardation can be expressed as implying a rate of decline of 5% a year for the S&P/Case-Shiller Composite Index by May 2007. Since the margin requirement is only about 2.5%, an investor who is sure that prices cannot actually fall by next May has, on that assumption, a sure return of at least 200% from buying a futures contract, and even more if prices rise at all. But there can’t really be so much “money on the table.” It must be that people really no longer see it as a sure thing that prices won’t start falling across the metro areas.
As always, the future is uncertain. Many of the underpinnings of the boom are still strong, and the soft-landing scenario so widely promoted by economists and industry leaders is a possibility if the U.S. can avoid a generalized inflation, if long rates don’t rise a lot, and if the rest of the economy stays strong. But that possibility is not enough to give great comfort to all those who worry today about the housing market.
Unfortunately, there is significant risk of a very bad period, with slow sales, slim commissions, falling prices, rising default and foreclosures, serious trouble in financial markets, and a possible recession sooner than most of us expected. Deterioration in that intangible housing market psychology is the most uncertain factor in the outlook today. Listen hard and watch out.
Mr. Case is professor of economics at Wellesley. Mr. Shiller is professor of economics at Yale and chief economist at MacroMarkets LLC.August 31, 2006 at 4:35 PM #34126vcguy_10Participant
Thanks ybc!August 31, 2006 at 4:46 PM #34127August 31, 2006 at 9:44 PM #34150
Begins to Pinch
Slower Demand for New Loans
May Hit String of Strong Profits;
Few Default Concerns — So Far
By ROBIN SIDEL
September 1, 2006; Page C1
The cooling housing market is starting to pinch the nation’s banks, which are more exposed to real estate than ever — and it comes at a time when some of their other key businesses already are being squeezed.
Although real-estate downturns typically trigger concerns about rising delinquencies and defaults on existing mortgages, the more pressing worry in the industry right now is that a slowdown in demand for new loans will cut into earnings that have been exceptionally strong.
That is significant because financial institutions already are grappling with several issues. They include a difficult interest-rate environment, competition for traditional banking customers, a saturated credit-card market and expectations that strong consumer-credit quality will soon show signs of weakening.
“Any wiggle in the real-estate business has a significant impact on banking because that’s where the growth has been coming from,” says Richard Bove, an analyst at Punk, Ziegel & Co.
The Commerce Department last week reported that sales of new single-family homes fell 4.3% in July to a seasonally adjusted annual rate of 1.1 million. The National Association of Realtors, meanwhile, said that existing-home sales fell in July to the lowest level since January 2004.
Indeed, banks have begun to warn investors that the housing slowdown is starting to hurt their business. FirstFed Financial Corp., a Santa Monica, Calif., bank with a large mortgage business, said in a securities filing Monday that its mortgage originations were down 47% in July from year-earlier levels. The next day, First Horizon National Corp., a Memphis, Tenn., bank that sells home loans across the country, said it expects mortgage originations to fall by $1 billion in the third quarter due to a falloff in applications. And Punk Ziegel’s Mr. Bove last week cut his rating on Salt Lake City-based Zions Bancorp to a “hold” from a “buy” due to views that the bank, which provides loans to home builders, will experience lower volumes as construction slows and land values decline.
Banks have ridden the real-estate boom over the past five years by pitching traditional loans, newfangled mortgages and home-equity loans that can be used to pay off credit-card bills or fund a new plasma-screen television.
While the banks reduce their exposure to these loans by selling some of them into secondary markets, real estate still amounts to a chunk of their assets.
As a result, real estate, including mortgages, home-equity loans and commercial loans, represented a record 33.5% of the U.S. banking industry’s $9.298 trillion in assets in July, according to the Federal Reserve. The numbers represent the highest level in the Fed’s database going back to 1973.
Although the nation’s biggest banks have sprawling operations, their share of the mortgage market also has grown during the boom, whether through acquisitions or internal expansion. At J.P. Morgan Chase & Co., the nation’s third-largest bank as measured by assets and market value, real estate represents about 13% of the bank’s assets. That is a slight increase from 2003, when real estate was less than 10% of Bank One Corp.’s assets and about 11% of J.P. Morgan’s assets. J.P. Morgan acquired Bank One in 2004.
At Bank of America Corp., the nation’s second-largest bank, behind Citigroup Inc., home-equity loans represented 5% of assets as of June 30, up from 4% at the end of 2001.
“Five years ago, you would have said that mortgage risk was pretty [small] for the banking industry as a whole, and for the large banks in particular, but it is hard to say that today,” says Frederick Cannon, an analyst at Keefe, Bruyette & Woods Inc., which specializes in the financial-services industry.
So far, bank executives and Wall Street analysts are expressing little concern about the prospects for a big increase in mortgage delinquencies or defaults, particularly if unemployment stays low and the economy shows signs of strength despite high gasoline prices. They say that credit-scoring models are far more sophisticated today than they were in previous housing cycles. Delinquencies stood at 4.41% in the first three months of the year, up from 4.31% in the year-earlier period, according to data released by the Mortgage Bankers Association, a trade group, in June.
Still, the mortgage market is filled with new types of loans that were far less prevalent — or didn’t exist at all — in previous housing downturns. These products, such as interest-only loans or adjustable-rate mortgages in which the borrower can choose from multiple payment options, are viewed as more risky than traditional fixed-rate mortgages. The trade association says that fewer than 25% of all mortgages are adjustable-rate loans.
“The oldest saw in banking is that bad loans are made in good times,” Keefe’s Mr. Cannon says. “We have never really faced a weakening housing market with the structure of the mortgage market as it is today.”
Write to Robin Sidel at [email protected]
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