This is part one of a series of blog articles on the subprime mortgage market correction. In today’s article, I will briefly sketch the rise and fall of subprime loan products and their relation to predatory lending practices within a capitalist system.
When I first entered the industry in 1985, Conventional loans were the cream of the crop. There was no risk-based pricing. Everyone received the same interest rate on their conventional loan whether they had great credit or a few late payments. Homeowners with very poor credit, lack of job stability, zero cash reserves, and unverified source of funds to close, were not approved for a mortgage. It was a very big deal to decline a loan. As a mortgage loan underwriter, I was told our job was to make loans, not decline loans. We had to try our very best to help our company figure out a way to help the homebuyer. Declining a loan was serious. We had to state rational, good reasons why a homebuyer did not qualify. That all changed with the introduction of risk-based pricing into the mortgage lending market.
5% down use to be considered very risky.
3% down buyers were directed to FHA loans
0 down use to only be available to veterans
0 down seller contributions to closing costs is currently the norm for first-time homebuyers.
0 down seller contributions, pay-option ARMS, interest-only, negative amortization use to be available only to the most savvy and credit-worthy of homebuyers.
Hard money which was re-named subprime lending moved in the same direction. Subprime started out years ago with high interest rates and a very large down payment required. In our capitalist economy competition heated up and we saw a relax of credit standards in the same direction; from high down payment to 0 down, which coincided with the introduction of risk based pricing. The more risk, the higher the price.
This ended up pushing a huge amount of homebuyers into the market, and infused the industry with a tremendous amount of job growth in the lending, banking, title, escrow, appraisal, and real estate agent arena. Corporations must earn a profit (within the bounds of the law) so corporations continued to push for profit growth. We live in a democracy (although my econ professor believes we live in a system where corporations control our political system.) It doesn’t matter which political party holds power: Democrats or Republicans. BOTH parties push homeownership onto the American public as the dream every person in America ought to be able to achieve. Government-sponsored, low down payment homeownership programs sprung up all over the country. On a side note, it might be an interesting topic for a longer post to see how those homeowners are doing default-wise.
About four to five years ago I started seeing a lot of real estate agents structure offers for 0 down clients + seller contributions to closing costs. The mortgage products were out there being marketed by wholesale lenders to street-level loan originators.
In the classes I teach, I continued to bring up the question: “What happens if the house doesn’t appraise?” The agents answer, “The house will always appraise; we’re in a rising appreciation market.” My follow up question is, “When you create a new Comparative Market Analysis (CMA) a couple of months later on a similar home just down the street, don’t you want to know if that sales price included seller contributions?” Everyone answers “yes,” but at that time, there was no way of obtaining that information short of calling the former real estate agent. Some agents return phone calls of this nature, some do not.
With little regulatory oversight in existence for mortgage brokers and consumer loan companies, (although they argue that they are HEAVILY regulated) the mortgage brokers, consumer loan companies, and the wholesale lenders have had a field day with profits. ALL the real estate agents I talk to, and I meet thousands of real estate agents every year, with regards to predatory lending considered this a problem of the mortgage lending industry, acknowledging that there “could” be effects on the real estate market, but without actually feeling any of those effects it was always someone else’s problem.
Our state regulators DO have money set aside to go after the most egregious cases of predatory lending and mortgage fraud. However, government was never intended to police every single deal written by mortgage brokers and consumer finance companies. There is just not enough government re$ources available to do this, and there never will be. In Part Two of this series, I will outline possible solutions that go beyond harsher government regulations.
Every one of us in the industry WILL feel the effects of the subprime collapse. We might feel it in more or less intense ways, some of us sooner, some of us later, but this will affect us all. From Rhonda having to make those difficult calls to homebuyers to real estate agent’s homebuyers who were approved last week and now those loan products are now no longer available.
On the up side, the industry might experience a rush in homeowners seeking to refinance into fixed rate mortgage loans which will lead to an increase in business for title, escrow, appraisal, and lenders this year. Mortgage brokers and consumer finance companies that blatantly ripped off consumers will not see repeat business. Those customers will go elsewhere, as they should. Mortgage brokers who have ONLY done subprime will find it challenging to become approved as an FHA lender as FHA has many rules to follow including the requirement for loan originators to be W-2 employees and many brokers pay their originators as contract workers. Consumers are sick and tired of bait and switch advertising and hopefully won’t fall for it this time around. Those companies will go down, their loan originators finding jobs scarce since their only training has been hard-core, script-memorizing, pressure-laden sales tactics. They have specifically chosen to be in subprime for the money and only the money. They will exit the industry and find another unregulated industry.
Treating home buyers (and refinancing homeowners) only as a tool to maximize profits is one business model that is no longer growing profits at previous rates. These companies are refi machines built on marginally to blatantly deceptive direct mail or email campaigns and they exist in every market in the United States. The market now sees a decline in profitability and in a capitalist system, profit drives morality: what’s profitable is good, what’s not profitable is bad.
Brokers, lenders, and banks that have always operated their business with a foundation of treating consumers with respect will survive and thrive. By respect, that means declining some loans because sometimes this is the most respectful thing to do, and yes, real estate agents, this WILL affect you, no matter what price range or neighborhood you’re in.
It is way past time for a mortgage market correction and I am hopeful that our current subprime crisis will lead us to a better place in the mortgage lending industry. I for one welcome the winds of change.
Part 2 of this blog article will examine the deeper relational-structural issue at the foundation of our current mortgage market correction and propose possible solutions.