Tag Archives: subprime

What should a loan modification look like?

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I just wrote this long comment on Jillayne’s post, and decided it needed to be a post of its own.  This loan mod returns the risk premium that was not effective at controlling risk.  It didn’t work…give it back. It also makes the lender partly responsible for approving short term income on a long term basis.  It does not involve ANY loss to the lender below the face amount of the notes, and gives them some interest, and saves the homestead.  I think it includes all aspects of consideration for a loan mod, but finding staff competent to come up with loan mods in a short period of time, is not realistic.

What we do know is that the higher risk premium rates, did not cover the risk.

Let’s take an example and see how it plays out, and propose a loan mod.

Family qualified for their current home based on $80,000 a year. $60,000 was salary and $20,000 was two years of consistent bonus or overtime. That was considered conservative lending guidelines “two years of proven history on bonus or overtime

Joe Sixpack and the Subprime Crisis

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The Subprime Crisis is a broken promise to Joe “Sixpack”.

One Day in early 2006, Joe was feeling pretty darned good about himself. He was making $65,000 a year at a job he held for over 6 years. He had $30,000 saved up in the bank. He had no credit card debt. He owned his car free and clear. He looked at his pregnant wife and his 2 year old son about to outgrow the two bedroom apartment they were renting and said, heck…time for us to buy a house.

He didn’t need no granite counters or stainless steel appliances.  He just wanted a decent neighborhood and decent schools for his kids.  He needed a small yard for a dog and to throw a ball back & forth in with his son and to have a barbecue and a beer in with his buds once in a while.  His American Dream seemed within reach.  He read everywhere that mortgages were pretty easy to get, and interest rates were near all time lows at 5.5%.

Mrs. Joe picked the School District she wanted to live in, and Mr. and Mrs. Joe walked into a real estate office and said, “We’d like to buy a house in this School District”. Ms. Realtor pulled out a big questionnaire asking them to fill in all the things they wanted, while she left to figure out what they could afford.  She did a quick qualification in the back room of the office.  $65,000 a year divided by twelve times 33% equals a payment of $1,787.50 a month and at 5.5% interest rate that equaled a loan of $315,000.  She added the $30,000 they had saved, and came to $345,000. She wondered if that was a little high, but it was certainly the lowest price she could hope to find, so she found them a little old rambler in Kenmore asking $350,000.  They all went out to see it.  It had an old kitchen and needed some work but the couple hugged and said, “We can make this ‘home’ with a little hard work and some paint and curtains”.  Everyone smiled and went back to the real estate office to make an offer of $345,000, with the seller paying the closings costs.

The real estate agent called her favorite lender and put Joe on the phone with the lender while she typed the offer.  The lender faxed over a pre-approval letter for a purchase price of $345,000 to submit with the offer.  Joe’s agent called the Listing Agent of the little rambler who said, “We already have 3 offers, and we’re presenting offers at 7 o’clock tonight”.  It was 4:30 p.m.

Joe’s agent called the lender who shot over a new pre-approval letter for $375,000.  Joe’s agent added an Escalation Clause for $1,000 more than any one else’s offer up to $375,000.  She took out the seller paying the Closing Costs explaining that with multiple offers, that wasn’t going to fly. She took out the home inspection clause explaining that would strenghten the offer. She told them to up their Earnest Money Deposit from $5,000 to $10,000 to make the offer really solid. Mr. and Mrs. Joe  signed it, and the agent faxed the offer to the Listing Agent.  That night Joe’s family got the call that they got the house for ONLY $364,000!  WOO-HOOS and High Fives all around.  They WON!

Joe went to the lender’s office a couple of days later and made a full loan application.  He got a Good Faith Estimate saying his payment was going to be $2,646.47 a month. $1,937.36 on the first mortgage of $291,200 at 7% +$459.11 on the 15% second mortgage of $54,600 at 9.5% + $200 a month for real estate taxes and $50 a month for homeowner’s insurance.  Total payment $2,646.47 a month.  Joe started sweating profusely.  He called his agent and said, can we cancel this?  She said not without losing your $10,000 Earnest Money.  There was no home inspection contingency and the Finance Contingency didn’t have a little blank space to put in a rate cap.  There was no “legal out” for “OMG the payment is $1,000 more than I thought it was going to be”.

The agent called the lender and he switched the loan to an interest only on the first with a fully amortized 40 year second and added a two year pre-payment penalty.  That brought the payment on the first mortgage down from $1,937.36 to $1,698.67.  The fully amortized 2nd at 40 years vs. 30 years dropped that payment from $459.11 to $442.29. Total payment $1,698.67 + $442.29 + $200 + $50 is $2,390.96.

Joe scratched his head and asked, “Where’s the 5.5% lowest interest rate in years?”.  The lender explained that rate was only for people with credit scores of 660 or better, and Joe’s score was 640.  Also, that rate was for people whose ratios were 33/40 and Joe’s payment, even at the reduced rate of $2,390.96, was just over 44% of his gross income of $5,416.67 a month.  His ratios were “out” which made him SUB-PRIME.  BUT, here’s the good news! IF you can stick this out for 12 months…24 tops…and make your mortgage payment on time, you can RE-FI at the lower rates! The value of your house will grow so that the 5% you put down will be 20%, and you will have ONE mortgage at the low rate instead of TWO mortgages at SUB-PRIME rates.

Joe went home.  He was feeling a little sick in the stomach and he had a massive headache.  He looked at his pregnant wife.  She was packing and making yellow curtains for her new kitchen.  He kissed her on the forehead and went to the corner store and bought a sixpack.  Two weeks later they closed escrow, moved into the house and he and his son went out and bought a new puppy.

Joe worked hard for a year.  He put in overtime and drew down on the little savings he had left.  He was able to make his mortgage payment on time for 12 months.  He called the lender to get that RE-FI he was promised.  The lender said…oh, well…you really should wait another year because of that 2 year pre-payment penalty.  Joe said, I really can’t do this for another year.  The lender said OK, but I’m going to have to add the costs of the re-fi and the pre-payment penalty to the principal of the mortgage.  Joe asked how much the pre-payment penalty was and nearly fell off his chair.  He said, OK…I’ll stick it out for another year.  He went out in the yard where his son was playing with the dog and drank a couple of sixpacks.

6 months later Joe was told that he couldn’t get any overtime.  They were cutting back on expenses.  He opened his mail and there were those multiple offers for credit cards at ZERO INTEREST!  He got himself three of them.  He started charging stuff to make ends meet until he could get to 2 years and RE-FI his mortgage.  He went out with one of his new credit cards, bought his wife a box of chocolates, his son a new football, the dog a new collar and a case of beer for himself.

Finally…TWO YEARS had passed.  No pre-payment penalty!  Time to RE-FI! He called his lender.  Well Joe, I’ve got some bad news for you.  You did improve your credit score with all those on time payments for two years from 640 to 680, but the best rates are now going to people with scores of 700 or better.  The REALLY bad news is that because of your ratios, you were stated income-SUB-Prime…and those loans don’t exist anymore.  There is no re-fi for people with your ratio of payment to income.  Joe hung up the phone and went out in his yard and drank a couple of six-packs.

At first, Joe was only getting behind in his credit card payments.  He opened his statement and the interest rate jumped to 30%! Joe called around and said “Isn’t charging 30% ILLEGAL?”  Well Joe…it used to be…we used to have something called “Usury Laws”, but no more.  Usury Laws were part of RICO to get rid of Loan Sharks but in 1980 Congress elected to “deregulate” and exempted Banks from Usury Laws for the most part.  30% only seems fair, since you breached your promise to pay on time.  Joe wondered why breaching his promise demanded such a penalty, when those who breached their promise to him of getting a RE-FI and reasonable mortgage payments seemed not to matter.  He put his head down, grabbed a couple of six packs and headed out to the garage trying hard not to turn the motor on in the car.

Joe started getting behind in his mortgage payments.  He had the same job making $65,000 a year…in fact he got a raise to $69,000 a year.  Still he was falling further and further behind.  He called his real estate agent and said, I can’t do this anymore.  I have to sell this place.  The agent told him that prices were down, cost of sale was 8% or more, and there were those payments he was behind getting penalties and interest.  He was “upside down” and the new distressed property law scared her and she couldn’t help him. Meanwhile the mortgage company was calling him every day, sometimes 4 times in one hour.  They had no answers.  They just asked if they could post date a check for the $4,000 he owed them to next week.  He said “Do you really think if I can’t make my full payment again this month, that I can write you a fkn check for $4,000 today that is going to be good “next week” you fkn moron!”  Joe slammed the phone down, turned the ringer off and headed out to the garage with his little TV and a couple of sixpacks.

Joe drank his six-packs and watched all the Presidential Debates and Campaign speeches.  He heard someone talking about “Joe Sixpack” and wondered if she knew how “Joe Sixpack” got that nick-name, and what she was going to do about it.  He watched as everyone fought over the $700 Billion Bailout and wondered if that would help him…and hoped it would.  The Bailout passed, but his phone didn’t stop ringing.  The Credit Card Company was still charging him 30%.  The Mortgage Company still didn’t seem to have any answers.  He called his agent and asked again about selling the house.  She agreed to help him do a “short-sale”, but she didn’t quite know how that worked.  He went out to see where he might rent if he sold his house “short”, but no one would give him a rental, because his credit was now fckd…

He went back to the garage, popped open another beer and stared at the car with the motor off.

Reviewing Your Adjustable Rate Mortgage

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RCG’s Jillayne Schlicke was interviewed on King 5 last night…I wish her spot would have been longer.  Check her out here!  The piece is about resetting subprime adjustable rate mortgages.   King 5’s, Chris Daniels reports that locally, we’ll see around 12,000 subprime mortgages reset over the next 6 months.  Combined with lower home values and tougher underwriting guidelines, if home owners are not able to swing their new payment or refinance, may be in a tough situation. 

I thought this would be a good opportunity to go over how to determine what your new mortgage payment may be in the event you have an adjustable rate mortgage.  This does not only apply to borrowers with subprime mortgages–this is for anyone with an adjustable rate.  

First, drag out your Note for your mortgage.  

In your Note, you will find the following information that you will need in order to determine what your payment may be once your mortgage adjusts:

  • Index/Indice — this is what your rate is based on.  Most common are LIBOR, Treasury, MTA, etc.   It can vary so you need to determine this.  The index is a variable and not a fixed figure.
  • Margin — the margin is added to the index to determine what your new rate will be.
  • CAPS — caps limit how much your rate can adjust at the first adjustment, every adjustment following and provides a lifetime limit on how high or low the rate can adjust.
  • Start Date — when you started paying your mortgage.
  • Fixed period term — is your ARM fixed for 2, 3, 5… years (etc).
  • Amortization — Does your mortgage offer an interest only feature?  Do you have negative amortization? 

If your mortgage is set to adjust within the next 6 months, I especially recommend that you go through the following exercise.   I’ve been sending letters to my clients with adjustables that are set to adjust with this information:

Start Date:  May 1, 2003

Start Interest Rate:  4.125%

CAPS (first/after first/lifetime):  5/2/5 (Lifetime CAP: 9.125%)

Margin/Index:  2.75%/1 Year LIBOR – 3.16 as of June 1, 2008 (currently 3.22)

Start loan amount:  $131,500

Fixed Period:  60 Months

First Adjustment Date:  June 1, 2008 and adjusting annually on June 1 for the remaining life of the loan.

This is not a subprime loan.  Many subprime loans have much higher CAPS and margins.   This is a classic 5/1 LIBOR ARM.   This home owner has not refinanced nor do they need to.  Their rate is attractive compared to current market. 

Based on their estimated balance (assuming they did not pay additional towards principal over the last 5 years) of approx. $118,500; their rate for the next 12 months will be 6.00%.  (Index from when the mortgage reset: 3.16 plus the margin of 2.75 = 5.91.  This is rounded up to the nearest 0.125%).   6.00% is a pretty good rate for not having to pay closing costs to refinance as long as you can tolerate the annual adjustments (which may work in your favor or not).   Their pricipal and interest payment will be approx. $763.50. (balance at adjustment/projected interest rate/remaining term of 25 years).

On June 2009, the highest this rate can be is 8% since there is a 2% annual cap.  The lowest the rate can be is 4%.  The most the rate can change on the anniversary of the change date is up or down 2% from the current rate.  It can never go beyond the lifetime cap of 5% plus the Note rate (9.125%) and it can never be lower than the margin of 2.75%.

How will your ARM treat you?  It all depends on the term of your Note and what the Index is when it adjusts.   This reset I’ve reviewed here is prettier than most–especially compared to subprime.   With FHA and Conforming Jumbo loan limits being reduced at the end of this year, I would consider meeting with your Mortgage Professional sooner rather than later if your ARM has you feeling itchy.

The Mortgage Witch Hunt

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Just in time for Halloween, officials from various levels of government are gathering together over the [photopress:salemexamof.jpg,thumb,alignright]frightful happenings going on in the mortgage industry. Home values were going down, mortgage payments were on the rise and consumers did not contact their mortgage professional for advice. Some were provided opportunities to own homes by using “non-traditional

I am a Mortgage Dispenser

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Over the past month, I’ve been combing through my database of my closed clients who have either adjustable rate or balloon mortgages.   I’m sending each and every [photopress:july55ad.jpg,full,alignright]one of them a letter reminding them of the terms of their mortgage.   Regardless of how much time I spend explaining how their mortgage program functions, as soon as someone has moved into their new home and they’re unpacking boxes—they’ve forgotten the fine details to the financing that made buying a home possible! 

The letters restate what is disclosed on the Federal Truth in Lending and their Note, including what their margin and caps are.    It also addresses when their first adjustment will take place and what the worse case rate and payment may be.   Worse case payments are currently not disclosed on the Truth in Lending.   

I began my mortgage career on April 1, 2000.   So far, 20% of my closed transactions have been adjustable or balloon mortgages and 3% of my total closed business would be classified as “subprime

What is your Mortgage Exit Strategy?

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Unless you have a long term fixed rate mortgage, you should develop an exit strategy.   An exit strategy is a well thought plan on how you’re [photopress:airplaneexit.jpg,thumb,alignright]going to leave your current mortgage.  Every time you board an airplane, the Stewardess reviews the “exit strategy”.   They’re not planning on an actual emergency landing, they are simply preparing you for a worse case scenario and informing you where the exits are and what you need to do in that event.  

You should have a plan if your current mortgage is:

Having a plan (being prepared) does not mean waiting until you receive a notice from your mortgage company that your mortgage payment is hiking because your fixed period on your ARM is over.   You need an exit strategy because once fixed period is over and your mortgage adjusts, odds are that your new mortgage payment will not be desirable or affordable.  

You need to start developing your plan well in advance.    Here’s what I recommend:

  1. Find the Note for your mortgage (deed of trust) and determine what your new rate may be using the worse case scenario.   If you have an ARM, you can figure this out by adding the first cap to your interest rate.   For example, if you currently have a 5/1 ARM with a note rate of 5% and the first adjustment rate cap is 5% (5/2/5 is a common cap structure), your new rate could be 10%.   If the first adjustment cap is 2% (2/2/6 is another possibility); your new rate could be 7%.   If your ARM has an interest only feature and will also be converting to amortized payments (some have longer interest only terms beyond the fixed rate period), you’re in for a double whammo if you’re keeping the mortgage.
  2. Determine what your worse case payment may be.  Your new payment will be amortized over the remaining term of the mortgage.   Use an amortization schedule to see what your mortgage balance will be at 60 months (using the 5/1 ARM scenario) and figure your payment based on the maximum possible rate amortized for 300 months.   This new payment does not include taxes and insurance.  In fact, anyone with an adjustable rate mortgage, regardless how long the remaining fixed term is, should contact their LO to determine what their “worse case payment

This Just In: Zero Interest Loans, at a Cost of Zero, with a Monthly Payment of Zero (APR 0%)*

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This is part three of a four-part series of blog articles about the subprime mortgage problems facing the real estate industry. In part one I sketched the rise and fall of subprime loan products and their relation to predatory lending practices within a capitalist system. In part two, I examined the structural relationship between a professional and his or her client. In today’s blog article, I will compare the subprime problems with a classic business ethics case study.

The space shuttle Challenger accident has frequently been used as a case study in the study of engineering safety, the ethics of whistleblowing, communications, and group decision-making.  With Challenger, an O-ring eroded on earlier shuttle launches. Morton Thiokol (MT) managers believed that because it had not previously eroded by more than 30%, that this was not a hazard. During a pre-[photopress:morning_1_2_3.gif,thumb,alignleft]launch conference call with NASA, the MT engineer most experienced with the O-rings, Roger Boisjoly, pleaded with management repeatedly to cancel or reschedule the launch. He raised concerns that the unusually cold temperatures would stiffen the O-rings, preventing a complete seal. MT senior managers overruled him and allowed the launch to proceed. Challenger’s O-rings eroded completely as predicted by Boisjoly resulting in the disintegration of Challenger and the loss of all seven astronauts. Boisjoly concluded that the caucus called by managers who decided to launch, was an unethical decision-making forum which came about because of intense customer intimidation. “Roger Boisjoly and the Challenger Disaster: The Ethical Dimensions

Zero Down Loan? You Better Have a 620 Credit Score or Higher

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Update 11/11/2008:  This is post is more of a reflection of the times.  Zero down loans are not available with convetional financing at this time.  Private or hard money may have zero down loans available.   FHA with a loan from family members is the closest to 100% financing that I’m aware of.   As with any posts about mortgage guidelines, be mindful of when they were written as guidelines have (and will continue to) change.

I’ve been working on a zero down rate quote for Jillayne, since she requested that two weeks ago when I did my posted my first Friday rate’s on RCG.   She was curious how 100% loan to value mortgages compare based on different credit scores.   At the company I work for, we have around 80 (woops…make that 78 now) lenders we work with.   A majority of our business is handled in our credit line (Mortgage Master is a Correspondent Lender) and some business is “brokered”.  Typically this is subprime or unique loans with added risk.   As a Loan Originator, you wind up selecting 3-5 of your favorite “a money” sources, a few “alt a” lenders and of course, and I like to have around 3-5 sub-prime lenders.   These are the lenders and representatives you rely on, get to know their products and trust their underwriting.   

Back to Jillayne’s request, last night I called my three preferred subprime resources for my rate quotes…what’s the lowest credit score they will lend to at 100% ltv and is the rate and program?  Thanks to RCG’s Tim, I’ve just learned that one of those resources I’ve relied on, New Century…and the only one that I work with who did quote yesterday an 80/20 with a 600 mid-score is facing troubling times to say the least.

“New Century Financial Corp. said it’s the subject of a criminal probe and Fremont General Corp. agreed to a cease-and-desist order with bank regulators in the biggest regulatory actions to emerge from the subprime mortgage meltdown.”   To read the entire article on Bloomberg, click here.

Every day I’m receiving memos from various subprime lenders with details of (much needed) tightening guidelines.  If you currently have clients shopping for a new home and they are using subprime financing (you might know this if they’ve told you their credit is not great, if the mortgage is a 80/20 with a prepayment penalty, etc.) you just might want to contact the Loan Originator to make sure the preapproval is still valid.  If that client has a credit score below 620, they may (1) not be approved any longer or (2) be approved for an entirely different rate (much higher). 

Subprime lenders are either eliminating their zero down products all together or are raising the credit score requirements.  Previously, a 580 – 600 mid-credit score was no problem for 100% financing.   They were beating down our doors to do these loans!  Now, the new standards for mid-score (with the lenders I work with) seems to be 620.  This is a significant jump that will delay some rentsers from buying homes until they improve their credit.   Which again, I think this is good.

I’ve mentioned this before, but this is so important.  If you have clients who have used subprime financing who have purchased homes in the past 1-2 years, this could be a good reason to pick up the phone and call them.   Hopefully they received good counseling from their Mortgage Planner AND they took the advice to heart…working on cleaning up their credit usage, managing their spending, etc.  With the subprime market tightening, if those subprime borrowers have credit scores below 620 when their prepayement penalty is up and their fixed payment is adjusting towards the sky, they may be are in a very tough situation.

Jillayne, this post is all ready a bit long… I promise I’ll have your zero down rates posted soon!

There's No Love for the Subprime Borrower

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It’s all over the news, we’re hearing about major subprime lenders having to restate their losses and every day, lenders are coming into my office to inform us of changes to their guidelines.   This is all good, right?    It will be tougher to provide loans for home buyers who maybe should be spending more time to learn about budgeting and using their credit cards.    What about the people who are all ready in these programs?

First, allow me to explain the basic dynamics of these loans.  Many of these mortgages are zero down, 80/20s (80% of the loan to value for the first mortgage/20% of the value for the second mortgage).   The first mortgage is typically offers a fixed rate for 2-3 years with a prepayment penalty (the standard is six months interest) that matches the fixed rate period.   In addition, the mortgages may be interest only or amortized at 30, 40 or 50 years.    The rates on these mortgages are completely dependent on credit score. 

When I meet with Mr. and Mrs. Subprime, I advise them of their options of buying now using this type of subprime mortgage or that they can work on their credit, job history, etc. and buy later with a better mortgage program.   Because there are no guarantee of what rates will be (or maybe because they know there’s not guaranteed they’ll clean up their act) and because they want to buy a house now, they often opt for the subprime mortgage.   Once this happens, I heavily stress (or Jillayne would say, I lecture 🙂 —which I’m sure I do) to Mr. and Mrs. Subprime that they have 2-3 years to change their spending habits because once their fixed period rate is over, their mortgage is going to adjust and do so big time.    I let them know that I want them to be in the best position for a refinance into permanent financing (or to have a better mortgage should they decide to sell the home assuming they have any equity) and that the subprime mortgage they are using to obtain their home is temporary financing.  

Many of my clients in these mortgages have done very well and I’m proud of them.   They have taken the responsibility of owning a home and having a mortgage to heart.  I’m able to restructure the original mortgage and improve their situation greatly.   The concern is for Mr. and Mrs. Subprime who just didn’t get the hang of it.   They continued to charge up their credit cards, they bought or leased a new car to go in their new driveway and maybe a new TV, too.   They’ve been sliding ever since the holidays and are now having a tough time paying their mortgages on time.   Maybe they just have one mortgage late.   Their credit is rough at best.   Their fixed period (and prepayment penalty) is over and now they really need to refinance fast because their mortgage has adjusted for the first time—their rate is now 2% higher.  Their situation has gone from bad to worse.    With all the tightening in the subprime market, even if their credit scores and scenarios are the same as when they bought, there may not be a program for them to refinance out of now.   They will be forced to sell (hopefully they have enough equity to pay commissions and other closing costs) or to somehow manage to choke down their increased payments.

I guess this post is a plea of sorts.  If you currently have a subprime loan (especially the type I described) please contact your Mortgage Planner to have your credit reviewed to make sure you’re on the right track to be able to refinance (or have a better loan for when you sell) when the time is due.   Do not assume there will be a program for you if you have not made significant changes to your spending and use of credit cards.   If you’re a real estate agent or loan originator, check in on your subprime clients to let them know of the changes in the industry…see if they need guidance to stay or get on track so they don’t wind up stuck with a higher mortgage payment, being forced to sell or foreclosure.