There’s been a price to pay for toxic mortgages. You’re paying in the form of lower home values, fewer jobs, falling stock prices, massive deficits and a government that is printing money at an unprecedented rate — a rate that could result in substantial levels of inflation if we’re not careful.
The situation is even more severe if you want to finance or refinance real estate. Here again you’ll pay, even if you have terrific credit and a mound of bullion in the basement.
Why is it that good people with good credit and cash in their pocket are having so much trouble getting home loans? There are five key reasons which explain why the credit crunch is crunching even the best of us.
1. It’s Not You
I recently got a letter for my newspaper column from a loan officer who was fairly steamed. She had a borrower with a credit score well above 800 and a down payment equal to more than half the purchase price of a home he’s trying to buy. Despite such facts, the lender still wanted the borrower to fully document his loan application.
The loan officer argues that her client was being treated unfairly, that he represents no risk to any lender and that he should be able to complete a short and sweet stated-income loan application.
Truth is, on a one-to-one basis, she’s right.
The problem is that the world is not operating on a one-to-one basis. Instead, there’s a vast system in place to originate loans and to then sell them. The money made from selling mortgages is used by lenders to create new loans — with lenders getting fees, charges and interest along the way.
The people who buy loans, investors, are none too pleased with the U.S. mortgage system right now — and who can blame them? The result is that the only way investors are going to buy U.S. mortgages and mortgage-backed securities is if loan applications are fully documented and verified. All loan applications, even from terrific borrowers with lots of equity and great credit.
It’s nothing personal, but without verifications and full documentation those great interest rates now hovering at about 5 percent are effectively off limits. If you don’t have great credit and lots of paperwork today’s interest rates are an illusion, pots of gold at the end of a financial rainbow that can never be reached.
2. Where’s My Security?
As much as lenders want borrowers with solid credit and documented income and employment, they also want something else: strong security for their loans. The logic is that if the borrower can’t pay the lender gets the property to settle the debt so the property has to be worth a certain amount.
This system worked well when home values were rising, but now many homes are worth less than the debt they secure. As an example of a home with a falling value, Zillow estimates that the value of the White House is now $308 million — that’s a lot of money, but down $23 million in the past year.
If you bought with little or nothing down — or if you have an “affordability” loan that allows for negative amortization (meaning the principal amount can grow because those low monthly payments are not even covering interest costs) — when it comes time to refinance you’re asking lenders to give you a loan that is worth more than the house. No prudent lender would do that and with good reason: If the property is foreclosed it will not generate enough revenue to pay off the loan.
Unfortunately, it’s not just borrowers with toxic loans. When neighborhood values go down, they go down for all local homes. Thus if you have a fixed-rate loan or even a property that’s mortgage-free the sale price of your home can still drop, which means you can only borrow less — or not at all.
3. The Flight To Credit Quality
The Federal Reserve reports that banks have been tightening their credit standards during the past quarter. This, of course, is in addition to previous efforts to raise credit standards.
“The issue here is one of extremes,” says Jim Saccacio, Chairman and CEO at RealtyTrac.com, the country’s largest online marketplace for foreclosure properties. “We have gone from a few years where loans could be obtained by just about anyone to a system where any credit glitch can be used to justify a mortgage rejection. What it means is that in too many cases individuals with minor credit dings who could once navigate the traditional underwriting process are now sunk.”
The result is that a large number of people who would like to finance and refinance can’t take advantage of today’s low mortgage rates. Like Moses at Mount Nebo, borrowers can see the Promised Land of less interest and better loans but they’ll never get there because of today’s credit extremism.
4. Where The Money Went
Despite hundreds of billions of dollars given to banks in late 2008 and early 2009, they’re plainly not lending as much as they could. Instead, much of the money has gone to build up capital, acquire other companies and make sure that no executive misses a fat paycheck for the leadership efforts that created the mortgage meltdown in the first place.
As an example, the New York state comptroller’s office says that in 2008 “the bonus pool paid by the securities industry to its employees in New York City totaled $18.4 billion in 2008 based on personal income tax collections and other factors, including industry revenue and expense trends. This represents a decline of 44 percent compared with the $32.9 billion paid in 2007. The decline is the largest on record in absolute dollars and the largest percentage decline in more than 30 years, but the size of the bonus pool is still the sixth largest on record.”
It was Adam Smith who said we are each guided by the “invisible hand of self-interest.” In the case of the nation’s banking system there’s nothing invisible about it. Money from the U.S. government that was plainly intended to restore the lending process has instead been diverted into lender vaults and executive accounts. Having been spent for other purposes, that money is simply unavailable to mortgage borrowers, regardless of their credit standing or the value of their homes.
5. A Contract Is A Contract
During the past five years millions of so-called “affordability” mortgage products have been originated. Such loans are routinely distinguished by low monthly payments up front as well as growing loan balances. The result is that once “start” periods end after two, three or five years, the borrower owes more than the original loan balance and faces vastly larger monthly payments.
A savvy borrower, of course, would refinance the loan before higher monthly costs kick in, but now such changes are impossible for most borrowers. Why? Three reasons: First, while the mortgage balance has been growing in many cases the underlying value of the home has been declining. Second, higher monthly costs have resulted in late payments and no payments, meaning substantial credit issues have arisen. Third, toxic loans routinely include substantial prepayment penalties.
With some loans there is justification for prepayment penalties, such as when a lender pays up-front settlement costs that lower the amount of cash required from the borrower to close the loan. The lender in such circumstances should have a fair shot at getting back its investment.
In other cases, prepayment penalties are little more than financial scalpings, something purposely designed to assure that borrowers are stuck with woeful terms and high costs for the longest possible time. This means that even borrowers who have never missed a payment and have properties that are worth more than the loan balance still cannot refinance without great additional cost.
Imagine that a home has a $300,000 mortgage with a 7 percent interest rate. The borrower wants to refinance and get a 5 percent mortgage. However, if the loan is refinanced during the first five years of the mortgage term the borrower must pay a prepayment penalty equal to six months’ interest, a total of roughly $10,500 in this example.
The result is that even borrowers who have great credit and sufficient equity to refinance can’t get a new loan unless they can also pay off the prepayment penalty. For many, a better mortgage with lower costs and better rates is as distant as the moon.
Peter G. Miller is syndicated in more than 100 newspapers and operates the consumer real estate site, OurBroker.com.