18.6 Million U.S. Homes are Vacant

Here's a scary statistic for your Tuesday morning: 18.6 million homes in the US were vacant in the first three months of 2008. That's almost 6% higher than the same time last year and the highest rate since since the census bureau started keeping track in 1956.

San Francisco, which is supposed to be immune from real estate downturns, reflects this statistic from the curb. I pass at least four empty apartments each day that have been on the market for more than 6 months. How does it look in your neighborhood?

Emily Davidson – A former TransUnion insider and a member of Credit.com's expert team. Emily writes about credit reports, credit cards, loans and personal finance as the CreditBloggers.com editor.

Suspension of Home Equity Line of Credit Leads to Major Credit Score Damage

Barbara wrote in earlier this week with a shocking story:

The recent "suspension" of our home equity loan is showing up a "major derogatory" on my and my husband's credit reports. Our lender was Citibank.  Our payment record is perfect. I am not disputing Citi's right to suspend the loans (we all know there was some vague fine print in there some where) but their right to trash my credit.  After my complaint to Citi, they changed to loan to zero dollars available which lowered our scores even more.  This started with a "major derogatory" on Trans Union only.  As I have continued my husband has major derogatories on two credit bureaus.

It is WRONG, WRONG, WRONG to trash people's credit score over this.  We are hostages to this system yet there is no reporting accountability.  We are at the end of the long process of building a home and looking for financing.  We have our 20% down and can afford the house... this is making this really hard.

Barbara sent over copies of her credit reports and called with more details. She's been in discussion with representatives at Citibank and TransUnion for days. John Ulzheimer, our FICO expert, and I talked it over yesterday and are continuing the investigation.

Basically, there is no precedence for this home equity account to be reported as a "derogatory" record to the credit bureaus. The account should probably be marked as "suspended," "non-performing" or "closed." These accurate statuses may have a small negative credits score impact, but nothing close to a derogatory.

If the record were to stay marked as a derogatory, the credit score damage (which could be as severe as 200 points) will continue for 7 years. Barbara is in the process of applying for a construction loan and her damaged credit is becoming a major hurdle. With lenders tightening their credit score standards, this inaccurate reporting is particularly damaging. 

This report comes at a point where large banks across the country are suspending HELOCs due to falling home values. CaveatEmptor has a copy of the letter borrowers received from Citibank. Countrywide has shut down 122,000 home equity loans and other banks are following suit.

Is this an isolated incident or a widespread credit reporting error? If your HELOC has been suspended, please share your story with us by email or in the comments section below.

4/11/08 Update: We had Barbara check her FICO scores and it appears that the damage is contained to just her TransUnion report and TransRisk score. It looks like there is a "tagging" problem with the way that bureaus is reading the suspended record. Her FICO scores are undamaged, meaning that the accounts aren't being marked as derogatory on the base credit file.

Emily Davidson – A former TransUnion insider and a member of Credit.com's expert team. Emily writes about credit reports, credit cards, loans and personal finance as the CreditBloggers.com editor.

Lessons in Real Estate Fraud

With all the real estate messes around some tales of woe are starting to filter in.  The most recent one is where some heartless bas*&*^ sold a home in Florida as an investment property to a retired nurse in California. What's wrong?

First, in my humble opinion, people should not by rental property further than a half-hour drive from where they live unless you have someone you know and trust, like a relative, manage it for you. So she unwittingly violated this rule.

Second, she got 100% financing so just had to come up with closing costs. That might be viewed as good but that loan came at a horrible price, like 9% plus PMI. Her payment is gagging. Total mortgage payment and taxes and insurance is more than $3,500 per month.

Third, she can only get $950 per month rent, which probably always was the market rent. That means that she has a negative cash flow of $2,500 per month, $30,000 per year. Rule of thumb is that you want to try to breakeven cash-flow wise, at least a couple of years out. On this property rents may not get to $3,500 per month until the 22nd century.

Fourth, a modest negative is OK if the property is going up in value. But in this case the property has to go up in value at least $30,000 per year for her to break even. Do you think that is happening in Florida, one of the most over-built markets in the country?

Bottom line, she was a victim of fraud, perhaps not legal fraud because I do not know what representations were made to her, but I think that she might have been a straw buyer for some crooks who were trying to unload excess property.  I never thought I would tell someone to walk away from a property but this is an exception to that rule. Sure, it'll mess up her credit but she is a 69 year old lady and really doesn't need credit at this stage in her life.

In another case I am aware of a foolish buyer entered into a lease option agreement with a guy. She gave him $25,000 as an option fee and that and a goodly portion of each monthly payment was to apply toward her down payment when she exercised her option. There is nothing wrong with that kind of a deal and when entered into between two honest people, it can work well for both.

But in this case, the seller did a lot of these transactions, over 100 it is said. What he also did was to refinance each property, probably with fraudulent appraisals, to pull cash out of the property, thus stripping the equity.  This home now has over $575,000 in loans against it. Her option price is $470,000, probably what the home is worth today but the lender who is holding the $575,000 loan isn't going to permit a sale to her unless the entire loan is paid off.

She may get lucky and the seller might approve a "short sale" but I think it is unlikely because the creditors are all lining up against the seller hoping to get whole in Court.

She called me but, frankly, I do not want to be drawn into Court on a deal with this gal who made some dumb decisions in hte past and will probably make more.  Sorry, not with me around.

Bottom line, I wonder about scams. Buying foreclosed property, for example, is a job for professional investors, not the average guy. So I would be really wary about "get rich quick with foreclosed property" seminars. People are going to get burned.

New Loan Limits

Congress has passed and the President is expected to sign the $152 billion economic stimulus package that will give tax rebates to over 100 million people. This priming of the pump action is expected to give a modest jolt to the economy which has slowed to levels that suggest a recession is possible.

Included in the package is a one year increase in the size of loans that FannieMae and FreddieMac can buy.  For single-family homes the new number is $729,750, up substantially from the current $417,000 limit. The question is, "What is this going to do for the housing market?"

First, the limits are also not absolute. They will be keyed to the housing values in particular areas.  The limit is supposed to be 125% of the average home value in the area. In an area where the average home value is $350,000 would then have a limit of $437,500, a slight increase.  Someone living in an area of $500,000 homes would see an increase to $687,500.

How "area" is going to be defined is loose at this point, state or county most likely. So someone in an expensive home with a large mortgage in an area of less expensive homes will not be helped compared with someone in the same home with the same mortgage in an area of expensive homes.

Second, my perception is that most of the foreclosures involve borrowers with loan balances less than $417,000. Thus those people could be "rescued" from their plight under existing rules if they conform to current requirements as to income, assets, and credit. Increasing the limit will not help these people.

So what are the benefits and to whom will they accrue?

Let's remember that the housing market is made up of three main sectors, newly built homes and existing homes, the resale market, where buyers are looking for occupancy as a primary home. Another large group, it might surprise you, are those buying a second home, perhaps a weekend home in the country.

We need also to remember that the market consists of two separate groups of people, the first of which are in the "newly created homebuyer" market, first-time homebuyers. The other group consists of people who are already in a home and who want to sell that one and buy another property.

When you think about this market consider that two ingredients are necessary for success. You need to have buyers at the lower end of the market and you need to have everyone up the chain having the ability to move up a notch.  The first-time homebuyer buys a $300,000 home which allows the seller to buy a $500,000 home which allows that seller to buy a $750,000 home.

When you look at it this way, it seems to me that making more affordable mortgage financing available to that last group of people creates openings all down the chain.  Let me assure you that the Jumbo mortgage market has been ugly for about the last seven months with rate for a 30-year fixed-rate mortgage hovering around 7% compared with 5.5% for Conforming loans.  That's a big difference.

When you look at the market in an area like where I live, there are a lot of people who will be covered by the new limits. Not only that, unless FannieMae and FreddieMac tweak their Automated Underwriting engines to be more conservative, homebuyers are going to find it a lot easier to buy a home with a Conforming loan than had they had to qualify with stricter Jumbo loan standards. This will help both buyers and owners looking to refinance.

My considered opinion is that the housing market problem today is that it is in a static state due largely to people sitting on their hands. People who could perfectly well afford a new home are afraid that they will buy and that values will drop further.

My sincere hope is that this move, while it might not help entry level buyers directly, will create some badly needed energy and confidence in the housing market and get those people into their cars to look for a new home.

Let's hope so.

Randy Johnson – Author of How to Save Thousands of Dollars on your Home Mortgage and Savvy Borrower articles. Randy is a mortgage broker who has financed over $1 billion in properties. He writes about home buying and real estate finance topics for CreditBloggers.com.

Are You Over-Paying for Homeowner's Insurance?

If home values are really tanking where you live, you may be tempted to reduce the amount of coverage on your homeowner's policy. Even when real estate was still going strong, you probably felt you were over-paying. And according to the Consumer Federation of America (CFA), you were!

Along with a dozen other consumer advocacy organizations, CFA just released a white paper on the insurance industry. The report concludes that insurers "continued in 2007 to systematically overcharge consumers and reduce the value of home and automobile insurance policies, leading to profits, reserves, and surplus that are at or near record levels. The study estimates that insurer overcharges over the last four years amount to an average of $870 per household."

I was surprised by the report's findings, which describe record profits in 2004 and 2005, even though there were a lot of hurricanes, as well as unprecedented profits in 2006. Of course, the industry has another point of view! I'll delve into these industry issues in a future blog, but for now, I want to focus on us, and our costs. 

As a new homeowner, I was certainly shocked by how much we had to pay for homeowner's insurance. It'd sure be great to save money on that bill, wouldn't it? But please don't scrimp because you think the value of you home has diminished or your insurer is ripping you off! It's still going to cost the same … or maybe more … to rebuild your home.

We have to think about how much it would cost to replace our homes, not how much we'll get if we sell them.

According to a piece in the February issue of Consumer Reports, most homes are underinsured - on average by 28% - which could cost you between $16,000 to $194,000 if disaster strikes.

You can still save a lot on homeowner's insurance
There are many proven ways to save on homeowner's insurance. Here are some of my favorites that together, can cut your premium in half:

• Shop around. You will be amazed by the difference in the quotes you get.
• Get a "multiple policy" discount by having the same company write your car and home policies.
• Go for the highest deductible you can afford.
• Put smoke and carbon monoxide detectors on every floor.
• Ask about all other possible discounts, which might be available because:
  
  • Your home has additional safety features, was built with fire-resistant and/or state-of-the-art construction materials.
  • You are retired, don't smoke, and/or are eligible for a discount because you belong to AARP, AAA, a labor union, or an alumni group.

For more ideas on how to save on homeowner's insurance, click here. Let us know your tips on cutting these costs ... as well as your horror stories about dealing with the insurers.

Nancy Castleman – Co-author of "Invest in Yourself: Six Secrets to a Rich Life" and founder of Good Advice Press. Nancy has spent the last 23 years teaching people how to get out of debt, save money, and live better on less. She writes on all these subjects for CreditBloggers.com.

Credit.com Cautions Consumers against “Score Suicide”

President Bush announced a plan today to freeze interest rates for up to 1.2 million subprime ARM borrowers in an effort to aid the economy through the housing slump.  To qualify for a five-year rate freeze borrowers must:

• Be no more than 30 days late at the time of the freeze
• Have been no more than 60 days late on the mortgage in the last year
• Have less than 3% equity in their homes
• Have an ARM resetting in 2008 or later
• Be capable of making the lower payments and not capable of making the higher reset payments
• Have a credit score below 660

The credit score maximum included in this plan could incite consumers to commit "score suicide;" voluntarily destroying their credit in order to qualify for the rate freeze. Because credit scores carry negative records for 7+ years, it's possible that worried borrowers may cause lasting damage to their credit.

Credit.com cautions consumers against:

• Closing the oldest accounts on your credit report. This loss of "credit age" could be very hard to recover
• Making 90-day or longer late payments. These late payments will damage credit scores for 7 years
• Applying for credit in excess. You may end up burdened with accounts you don't really want
• Entering the world of collections, judgments or liens. These negative public records cause severe credit score damage for 7 or more years

And consumers shouldn't forget that lowering credit scores could also impact their ability to open new accounts, insurance rates and credit card rates.

What do you think of the ARM freeze program? Do you qualify for a freeze? Would you commit "Score Suicide" to lock in a low rate?  Share your opinions and feedback in the comments section below.

Emily Davidson – Credit.com credit expert and former TransUnion insider. Emily writes about credit reports, credit cards, loans and personal finance as the CreditBloggers.com moderator.

Reader Question: Can I Pay Principal Only?

It's not often that I get a question from a reader that I haven't heard before. The email I received this morning was a real first:

Hi Emily. A friend of mine recently told me something bizarre that she was told by a credit counselor.  He told her that when she made her monthly payments to her accounts, she should write "Apply to Principal Only" on the check.  Is this legal and and correct? If so, what happens to the finance charges that are due? I greatly appreciate your time and response on this matter.

Absolutely not true. Creditors and lenders will not pay any attention to what you write on your check's memo line. They will apply your payment toward the blend of interest and principal set for your debt at that specific time.

Imagine if you wrote "paid in full" on your check. Do you think that the lender would accept your $200 payment to pay off a $2,000 debt just because you wrote it down? Writing a note on your check is meaningless.

This is a good example of why you need to be so careful when working with credit counselors. Remember, these counselors often have little to no training and usually not one whit of experience in the credit industry.

Working with a counselor to come up with a budget or a debt management plan makes sense. But please take their credit advice with a grain of salt. If you have a credit or personal finance question, feel free to email our team of experts for a straight answer.

Emily Davidson – Credit.com's Communication Director and former TransUnion credit expert. Emily writes about credit reports, credit cards, loans and personal finance as the CreditBloggers.com moderator.

HELOC Warning

Millions of Americans have Home Equity Lines of Credit. Properly used they can play a meaningful role in a family's financial life. Many families bought their home using a piggyback loan, getting an 80% Loan-to-Value (LTV) 1st combined with a HELOC to provide the balance of the financing.

They are also frequently used to buy a car in lieu of bank financing or to finance a home improvement like an addition or a re-modeling project. Another good use is to pay off high rate credit card debt and replace it with debt on which the rate is lower and the interest tax deductible.

The rate on virtually all HELOCs is tied to the Prime Rate, just lowered to 7.75%. For the first ten years, typically, the required monthly payment is the interest that accrued during the month. However, on all HELOCs it is equally important to have a repayment plan whereby the principal is re-paid so that the balance is ultimately zero.

If you paid off credit cards with a HELOC, for example, when you just pay the interest, there you are after ten years having paid $6.00 per gallon for gas if you include the interest you paid. Or the cost of that $50 dinner turns into $100.  For that reason, these are not loans for the people who have no discipline.

There is another danger, having you account frozen if you don't make a payment on time. A client of mine got a $75,000 HELOC as part of his financing when he bought his home. Being a diligent person, he had paid it down to $25,000 in the few years he has owned the home. But when his vacation was unexpectedly lengthened due to unforeseen circumstances, he missed making his monthly payment on time. It was made on the 25th of the month, past the 15 day grace period.

He was just expecting to pay a late charge but found that his lender had frozen his account and he was no longer able to take advances, ever. Wow! I talked with other HELOC lenders and they have similar policies. One institutes a soft-freeze after the 15th day. That can be removed when payment is received. But they institute a hard freeze after 30 days and you need to tell a convincing story to a supervisor to get it re-instated. I suppose of they don't like your story, it will be frozen forever.

This is very harsh treatment when you consider that these same institutions were falling all over themselves a few years ago to get everyone in America to get a HELOC. 

With this knowledge if you have a HELOC it is important that you understand the lender's policy.  First check your loan document, sometimes called a Credit Agreement. Then, with that in hand, call your lender's 800 number and talk with Customer Service to find out their policy. Then be sure you don't get cross-wise with them.  It could be painful.

Randy Johnson – Author of How to Save Thousands of Dollars on your Home Mortgage and Savvy Borrower articles. Randy is a mortgage broker who has financed over $1 billion in properties. He writes about home buying and real estate finance topics for CreditBloggers.com.

The First National Decline in Housing Prices Since the Great Depression?

The National Association of Realtors has a reputation for putting a positive spin on housing trends. After all, it's in their interest to promote the real estate market as a strong investment opportunity.

That's why today's NAR forecast news is so surprising. They are estimating drops in home sales and prices for the end of 2007:

"The median resale price probably will slip 1.7 percent to $218,200 this year, the Realtors' said. That would be the first national decline since the Great Depression in the 1930s, according to Yun. The new-home median selling price probably will fall 2.2 percent to $241,100, the report said."

The NAR predictions are still more upbeat that other analysts however, the group still fees that sales and prices will continue to rise in 2008. You can read more about the Realtor forecast and response from the mortgage industry online here.

Emily Davidson – Credit.com's Communication Director and former TransUnion credit expert. Emily writes about credit reports, credit cards, loans and personal finance as the CreditBloggers.com moderator.

Update: Requirements for President's Mortgage Refinance Plan

It's been tricky trying to find details about the FHA insured refinance plan President Bush announced last Friday. All we knew was that the plan could help 80,000 homebuyers who struggled with an ARM reset to refinance into lower terms.

An online Q&A session with HUD Secretary Alphonso Jackson cleared up a few points. The refinance program is being called FHASecure and to qualify a borrower must have:

 1. A history of on-time mortgage payments before the borrower's teaser rates expired and loans reset
2. Interest rates must have or will reset between June 2005 and December 2008
3. Three percent cash or equity in the home
4. A sustained history of employment
5. Sufficient income to make the mortgage payment

Borrowers must also be occupants of the house they are trying to refinance and have a mortgage below the insured loan limit for your area ($362,790 in CA).

Emily Davidson – Credit.com's Communication Director and former TransUnion credit expert. Emily writes about credit reports, credit cards, loans and personal finance as the CreditBloggers.com moderator.

Yet Another Reason to Worry About the Mortgage Market

This job connects me to a lot of interesting people. I get a handful of questions from consumers, reporters and industry insiders each day.  Just yesterday, I had a great conversation with an Attorney General investigator about piggybacking.

The email I opened this morning was more than a little worrisome. It was from a high-level risk management executive from one of the nation's largest mortgage lenders. The question: Tell me more about this FICO score change? When will it take effect?

Uh oh. Consider the danger of a mortgage risk management executive not knowing that FICO is going to stop counting authorized user accounts in their credit scores starting this month. That some 3 million credit scores are set to drop because of this change. Right when we hit the peak of the ARM resets. A change that was announced way back in June.

I guess I should just be glad that they came to us now, right?

Emily Davidson – Credit.com's Communication Director and former TransUnion credit expert. Emily writes about credit reports, credit cards, loans and personal finance as the CreditBloggers.com moderator.

Must-Read: Understanding Mortgage Industry Changes

The current mortgage crisis reflects many larger changes in the way Americans buy and finance their homes. Increased real estate ties to the stock market have made home loans more available and at the same time more volatile.

Explaining exactly how the real estate industry evolved from a private deal with local banks to a multi-national series of loans, securities and hedge funds is challenging. An article in last Sunday's New York Times Magazine called "Subprime Time" does an excellent job of explaining the shift:

"The absence of scrutiny on Wall Street had a profound effect on mortgage origination. As mortgage bankers discovered that investors would buy virtually any loan whatsoever, they naturally lowered their standards. What difference whether a loan was sound if you could flip it in 48 hours? The market thus corrupted, it only wanted for the right circumstances to implode.

"And over the last few years, as Robert Barbera, the chief economist at the investment advisory firm ITG, observed, the Federal Reserve took short-term interest rates from 1 percent to 5 1/4 percent. This raised mortgage rates and put home buyers at risk of being priced out of the market. But bankers lent to them anyway, offering, in effect, “junk mortgages” — risky loans with low teaser rates (and much higher rates later), as well as other deviations from sound finance.

"Lenders and borrowers alike knew that such loans were dicey; they were counting on the borrowers to refinance — which, as long as home prices kept rising, was a cinch. Naturally, when prices stopped rising, the music stopped."

Click here to read the complete article on how the mortgage industry has changed.

Emily Davidson – Credit.com's Communication Director and former TransUnion credit expert. Emily writes about credit reports, credit cards, loans and personal finance as the CreditBloggers.com moderator.

Anomalies

An anomaly is defined as:

"a deviation from the common rule, type, arrangement, or form."

The anomaly in question is the risk premium that the market assigned to the yield on junk mortgages.  Frankly, this wasn't just a problem with the junk mortgage market. It applied all across the spectrum of securities. The world has been awash with money seeking higher yields and the market just assigned the wrong numbers to risk.

Back when junk corporate bonds were all the rage – remember Michael Milkin? – low rated bonds might have had a yield of 13% when the best corporations paid 7% for their money.  The difference was the premium that the market assigned to the higher potential of defaults on the low rated securities.

Mr. Milkin sold those bonds because he said that the real risk was less than the market said it would be.  Although there were some defaults and losses, if an investor bought enough different issues to spread the risk, he would have made out handsomely compared with his more conservative counterparts.

Theoretically, this should have happened with junk mortgages too.  If the best borrowers were paying 6% for their loans, the risky borrowers should have been paying, say, 10% or maybe even higher. That extra 4% was all risk premium. 

But what happened was that the junk lenders were putting people into loans that might eventually yield 8%. You can see that the market was saying that the risk premium didn't have to be 4%. A 2% premium was OK.  That departure from reality was the anomaly I’m discussing.

What was even worse for investors is that the loans carried a lower rate – I prefer the term sucker rate over teaser rate – one substantially less than the final rate, maybe even less than the 6% rate being paid by the best borrowers.  They had to do this because they would have had a tough time selling that 8% yields to borrowers without disguising them in some way.  Note that the investor got a lower initial yield too. The higher return didn't kick in until the loans reset at the end of 2 or 3 years.  That reset issue is one cause of the current problems.

I will tell you bluntly that the lenders or mortgage brokers told the borrowers not to worry, they would just refinance into a new loan just before the loans reset. They wanted to make another commission so they really did plan on doing it, that is until the melt-down.

So if you are following this, it turns out the junk lenders created loan programs that promised the ultimate investor with higher yield, but the structure was such that the investor wasn't ever going to get the promised higher return. They'd get refinanced and paid off before that happened.  The investor would get to keep the loan during the higher yield period only if conditions were such that the borrowers couldn't refinance them, what we're seeing now. This is a Catch 22 involving billions and billions of dollars.

Of course, we know today that the effective yield should have been substantially higher than the yield that was actually being created by the junk lenders.  That's the opposite of what happened in the junk bond market.

And another strange part is that a lot of the investors' early yield was "eaten up" by paying the loan officers high commissions that were largely paid by the investor in the form of Yield Spread Premiums.

You have to admire the cunning salesmanship of the lenders and Wall Street to pull off a scam like this.

Randy Johnson – Author of How to Save Thousands of Dollars on your Home Mortgage and Savvy Borrower articles. Randy is a mortgage broker who has financed over $1 billion in properties. He writes about home buying and real estate finance topics for CreditBloggers.com.

Character Based Lending to Asset Based Lending to ?????????

The mortgages on the first four homes I owned were all provided by local institutions, Pasadena Federal Savings, Idaho First National Bank, Winnetka Bank and Trust, and Security Pacific Bank.  The underwriting was done by a career employee of the institution who met with you, reviewed your job and income, and approved your loan.

This was in the days before the development of the Secondary Market where banks sold loans to outfits like FannieMae, FreddieMac, or Wall Street. The banks kept the loans so they obviously had a real vested interest in only doing good loans.  It was also before credit reports so the loan officer's job was, in large part, sizing you up as an individual and ascertaining if you would be a good customer for the bank.  I will call this Character Based Lending, meaning the decision to lend you the money was based, in large part, on the Loan officer's assessment of your character.

In the late 1980s’s and early 1990’s FannieMae, FreddieMac, and Wall Street firms really took over the mortgage business. If you have not read Michael Lewis's book LIAR'S POKER, you really ought to.  The banks were there and some of the S&Ls were still left, not many, and they originated loans and sold them back East. Of course, there was no way anyone back there could meet you and assess your character. 

What this caused was a transition to Asset Based Lending.  The plain truth is that an asset based lender looks long and hard at the collateral you are providing to them as security for your loan. They know that, ultimately, that while they want you to make the payments, and they know that most people will make payments, they will end up owning some of the homes.  We used to kid about the old Home Savings, saying that if they held a mirror under your nose and could detect a sign of life, they'd do your loan, the one caveat being that they had to like your home.

Truthfully, that's actually not a bad way of lending.  If people have equity in their homes, they will work hard to protect it. And if you are in a market where values go up substantially year after year, people have more and more equity to protect and the default rate stays real low.

But in the last few years with the rise of sub-prime lending – what I call junk lending – there was no basis for doing loans. Oh, they started out talking about "under-served" markets and minority borrowers. Honestly, I think that there were a lot of employees in those lenders who really thought that they were helping people who never would have had a shot at owning a home without them.

They also threw out most of the rules. Bad credit? We don't care: No paycheck stubs or W-2s?  We don't care. No down payment?  We don't care.

They plain truth is that those people at the lenders who were making obscene profits on their customers and the Wall Street companies that were making so much money throwing them at their customers, got hooked on the volume! What they were doing was Volume Based Lending that had little to do with loan quality. It had to do with how much money they were making. As someone once said about these guys: If you want a friend on Wall Street, get a dog.

What happens next?  Hard to tell, but what our industry kindly calls "non-traditional" mortgages are going to be very hard to get for a while. The market for full documentation, good credit, lower LTV loans is alive and well, but for the rest, someone is going to have to find a new formula.  Stay tuned.

Chicken Littles in the Real Estate Market

How humans handle risk has always been an interesting spectator sport.  What is so strange is that people seem to ignore risk until something terrible happens to them. Then everyone stands around asking, "Why didn't we see this coming?"

The current disruption in the credit markets that spilled over into the equity markets last week is no different from tornadoes and earthquakes. If you live in the Midwest, tornadoes are a possibility and if you live in California, earthquakes DO happen. Financial tornadoes and earthquakes happen too.

While I'm on that topic, Lucy Jones, a scientist with the U.S. Geological survey, talked about risk last week. She said that the Coachella Valley area of Southern California – read "Palm Springs," one of the fastest growing areas – was way overdue for a major earthquake. As reported in the Los Angeles Times, she said that:

"the shaking could last more than 100 seconds, kill thousands, destroy homes, collapse the I-10 and I-15 freeways, ignite petroleum pipelines and leave untold thousands homeless in potentially searing desert heat. The long-term effects, she said, could be akin to the economic collapse of New Orleans and the Gulf region following Hurricane Katrina."

Now, how's that for someone laying out a risk scenario? Yet, my guess is that if you went down to Palm Springs this afternoon, you'd find that real estate activity was virtually unchanged from a week ago. Should we actually get such a quake, it will likely that no one will remember Lucy's warning, but they may bring it up again after the fact.

So it goes with sub-prime mortgages.  I sit in the epicenter of the sub-prime meltdown with many of the industry's (formerly) biggest players just a few miles away.  I could see that their business practices were encouraging the development of loan products that were potentially dangerous to borrowers.  I could see that the outrageous commissions being paid to loan officers were encouraging unethical business practices.  I could see that the lack of regulation served to stimulate the growth of the industry.

Finally, I could see that gazillions of borrowers were being sold irrational mortgages that would jeopardize their financial future, the housing values in their neighborhood, and, potentially, impact the entire U.S. real estate market. And I wrote about it.

I think that Lucy Jones and I both must feel like Chicken Little.

Randy Johnson – Author of How to Save Thousands of Dollars on your Home Mortgage and Savvy Borrower articles. Randy is a mortgage broker who has financed over $1 billion in properties. He writes about home buying and real estate finance topics for CreditBloggers.com.

Subprime Lending Reality Check

Even though they call them reality TV shows, you wonder about how close they are to reality. I am also always amazed at how we are so ready to abandon reality when it comes to financial affairs.  There is a reality to financial affairs that is very much rooted on common sense, and it works year after year after year, decade after decade.

Yet there are times when the "irrational exuberance" of people leads them to believe something different than what is reality based. For example, we know that the Price Earnings Ratio, P/E, is normally between 15 and 20.  Growth companies that have an ability to grow faster and produce earnings faster than the economy in general command P/E ratios that are higher than average.

Yet during the dot com boom, even concepts like earnings went out the window.  Valuations, if you can call them that, were based upon website traffic without any reference to how that traffic might be turned into revenue and, ultimately, earnings, at some point in the future.

Of course, we all know that in many cases, the management of those companies were spending a significant portion of their time flying around the world trying to attract the next level of financing as they spent money at a prodigious rate, what a friend of mine referred to as "spending their way to glory."  This process of going through cash without much revenue coming in actually got a name - burn rate.  That was the number of months the company could continue to spend money before they went out of business or attracted the next level of financing.

Of course, we know how that turned out. Stock market losses wiped out investment value. Reality finally asserted itself.

We have had a similar situation with subprime lending. It was obvious to everyone in the business that the subprime lenders had departed from this reality and were operating in a galaxy far, far away. Initially, I think that the parties involved really thought that traditional underwriting practices as developed largely by FannieMae and FreddieMac were out-dated.

There is some evidence to support that contention, should anyone want to make it. For example, when they developed their automated underwriting engines in the late 1990s, we quickly found out that the criteria they were using departed significantly from what their own underwriting guidelines that were being used by human underwriters. The computers were being far more liberal in applying rules.

It doesn't mean they were bad loans, just ones that no human underwriter would have thought prudent.  My guess is, however, that the loans that were approved under the more liberal computer rules had a delinquency and foreclosure rate that was no different than the performance of loans that were underwritten under the old, stricter rules. The new rules were just not as strict, but still reality-based.

What happened with the subprime lenders was that they simply threw out the rule books altogether.  The executives and other employees became so addicted to the massive amounts of money they were making, - two, three, four times or more than what ethical lenders were earning on comparable loans – that they just didn't want to quit. They would approve anything!

Reality appears to be finally rearing its ugly head and we're seeing the consequences.

Randy Johnson – Author of How to Save Thousands of Dollars on your Home Mortgage and Savvy Borrower articles. Randy is a mortgage broker who has financed over $1 billion in properties. He writes about home buying and real estate finance topics for CreditBloggers.com.

The Screws Are Turning

Even those who are not close to the mortgage business can't help but see all the newspaper articles about subprime lending. The various branches of our government are weighing in on the problems that are happening as a result of the lax underwriting. We've seen the posturing statements by the Congress's Committee Chairmen.  However, not much concrete has happened until this week. We are finally seeing some action in the trenches.

FannieMae has announced that it will comply with new guidelines issued by a consortium of agencies. The rest of the industry will likely follow. These guidelines include:

All fixed rate interest-only loans will be underwritten using the fully amortized payment, not just the interest portion. For example an application for a $200,000 6.5% loan would be underwritten with the payment of $1,264, not just the interest portion, $1,083. That's 16.7% higher, which means that qualifying ratios are affected. A borrower who had ratios of 36% before would have ratios of 40% now.

All interest only ARMs will be underwritten using the fully amortized payment at the fully indexed rate. The initial rate on a 5/1 ARM, for example, might be 6%. The initial interest-only payment would be $1,000 but if index plus margin is 7.5%, the borrowers would have to qualify for a payment of $1,398, 40% higher.

Option ARMs, the negative amortizing loans, must be underwritten as above AND the payment has to be based upon a loan balance of 115% of the initial loan. Thus a $200,000 loan would have to be underwritten assuming that it was really a $230,000 loan. Using a figure of index plus margin equal to 7.5%, that means the payment would be $1,608, a full 60% higher than the initial payment.  If some lender is discounting that initial payment rate even further, VERY likely the case, it means that the payment for underwriting purposes might be double the actual obligatory initial payment.

No one knows exactly what the full implications are going to be, but for many borrowers who are at the borderline for qualifying purposes are going to be disappointed. It is likely that the number of Option ARMs that have been originated in the recent past, as many as 50% of all loans in some markets, are going to see drastically reduced volume.

There are going to be further restrictions on stated income loans. Those lenders who told their borrowers who can't qualify to lie about their income will have that option taken off the table except for borrowers with very strong credit.

Finally, there are many lenders whose oversight does not lie with these agencies.  In fact, it's not clear exactly who DOES regulate them, meaning who did let them get away with poor practices?  If they don't sell loans to FannieMae and the investors who buy the loans don't adopt the same rules, there will be little change. Not a good sign.

Randy Johnson – Author of How to Save Thousands of Dollars on your Home Mortgage and Savvy Borrower articles. Randy is a mortgage broker who has financed over $1 billion in properties. He writes about home buying and real estate finance topics for CreditBloggers.com.

It's Mine! Mine! Mine!

Occasionally, I have an opportunity to act as someone's agent in a real estate transaction. As it happens, I'm doing that right now. My clients found a home they liked through a friend of the seller. As they were inspecting the home for about the third time, they were introduced to the seller's agent.

Now I can tell you what happened in the listing agent's mind at the moment he met the potential buyers: the Sugar-Plum Fairy began sprinkling thoughts that danced through his head, like, "I'm going to double-end this deal and get twice as big a commission check."  This feeling persisted even when they told him at the first meeting that he wasn't going to be their agent.

They felt as if they wanted to have someone in their corner, someone they could trust to represent their interests. They didn't want to worry about whether the agent who represented them both might be representing the seller's interest more than their interest.

They called me because I had successfully represented a business partner and was highly recommended.  We prepared an excellent offer and it was submitted.  My next call was from the seller's agent who indicated that he had faxed a counter-offer to me. He also indicated that he was prepared to pay me a one-half percent referral fee instead of half of the 5% that would be paid by the seller. He intended to keep 4.5% as his share.

He said that I hadn't been the "Procuring Cause," meaning I hadn't found them this property. True enough, but he hadn't found them either; a mutual friend had brought them to the property, not anything he had done.  In fact, this agent had an opportunity to convince them to become his clients too, but they rejected him. They have a right to do business with whomever they want.

Then in the "discussion" that followed, the seller's agent actually told me, "You are stealing my commission." Remember the Sugar-Plum Fairy? He had managed to convince himself that the entire commission was his even though there was evidence – the buyer's rejection – making it clear that he was never going to get all the commission.

What ought to be obvious here was that this agent was putting his own commission ahead of the seller's interest.  I guess my client's intuitive judgment about the agent was on the mark. He was actually outraged because he wants the home and perceived that the seller's agent's latest action was putting his commission ahead of his, the buyer's interest, too.

In reality, a realistic solution would be to acknowledge that neither of us had found the property for the buyer and that the selling commission and price should be reduced by 2.5%, but that's not the way the business works. The seller was obligated to pay a 5% commission, and his agent was there to make sure he got most of it.

The next day the agent's heart was still hardened right up until the point in time when the buyer called the seller – remember that they had been introduced by a mutual friend – and said that he wasn't going to go through with the deal unless the commission thing got worked out. Ten minutes later, it got worked out.

Truthfully, buyers and sellers should not have to get involved in squabbles like this, but they shouldn't happen either. 

My point is that, unfortunately, there are a significant number of real estate agents who don't have any problem putting their own commission ahead of a client's welfare when it is in their interests to do so. That is particularly true when times are a little tough, as they are now. Luckily, the majority don't, but you shouldn't assume anything.

I believe that the greed factor is more at work today than at any time in my memory, and others confirm that. The grim reality of this is that buyers and sellers may just not know what to look for. Someone may be doing this to them in one way or another but they don’t know what warning signs to look for.

All the better reason to find someone you can trust. Get referrals and check references and you will not have to deal with this.

Randy Johnson – Author of How to Save Thousands of Dollars on your Home Mortgage and Savvy Borrower articles. Randy is a mortgage broker who has financed over $1 billion in properties. He writes about home buying and real estate finance topics for CreditBloggers.com.

Mortgage Hanky Panky

Someday, someone may sit down and write a long book about the hanky panky that has gone on in the sub-prime mortgage business in the last few years.  It'll be a long book.

At last count the Implode-o-Meter showed 92 companies had imploded or were ailing.  Are there more to follow? Who knows, but the site would make interesting reading if it were not for the amount of suffering that these people caused, not all of which has yet come home to roost.

In the most recent news, a Vice President of a major homebuilder was fired for unauthorized shredding of documents.  Perhaps they would have showed that some of their activities were improper.  I have long suspected that homebuilder owned mortgage companies were particular susceptible to doing loans that "weren’t quite right" when the company had to close more houses to make the end-of-quarter statement look good.

Three now-former employees at Countrywide agreed to plead guilty to insider trading of the company's stock and apparently the FBI has raided a Countrywide office to gather documents as part of an investigation, presumably into lending practices in the sub-prime area.

At New Century, which filed for bankruptcy, the SEC has upgraded their investigation to a more serious level. In addition, there is an investigation into accounting practices at the company.

I heard about a case today where the now-ex employees of a mortgage company were going into closed-loan files and changing the income on them so that when someone submitted a new refinance application on the same borrowers, the income on the new file correlated with what it was on the old file.

Obviously, there has been fraud at everyone connected with the sub-prime business, whether mortgagee broker, lender, or Wall Street firms that sold the mortgage-backed securities. My strongly held belief is that if it is going on at the higher levels of a company, it’s going on at lower levels too. Certainly not all employees are guilty, but there are probably plenty of blame to assign.

I chatted with the head attorney for the Department of Real Estate in California about consumer protection. He said that they are so busy with major fraud cases, they simply do not have enough manpower to look out for the individual consumer these days.  I don't blame him or the legislature that funds them, but if you are a consumer, it does make you want to take extra precautions to protect yourself.

In case you think that you have been taken advantage of by some lender, I'd try Small Claim Court before I would complain to regulators. If, for example, you ended up paying your broker more compensation that was shown on your initial Good Faith Estimate, call the Manager at your lender first and ask for a refund. If you don’t get it, head for Court, and let me know how it turns out.

Finally, for an exhaustingly thorough discussion of what happens to sub-prime loans after they go to Wall Street, check out the article below.

Investment Landfill: How Professionals Dump Their Toxic Waste on You

How the Subprime Market Collapse Impacts You

Upon hearing of the growing rift in subprime lending, responsible borrowers might be inclined to think, "Ah…over-zealous homebuyer…you've gotten yourself in too deep.  Too bad for you."  Unfortunately, the ill effects of the subprime implosion may stretch their ugly arms into the backyards of the financially prudent, too.

To put things in perspective, remember what happened when aggressive lending was at its peak. Looser underwriting guidelines dramatically increased the total number of potential homebuyers. The demand for homes soared, prices rose, residential developers started building, and the housing trades got busy. Industry gurus have released some pretty impressive numbers quantifying this increased activity: According to Inside B&C Lending, the subprime lending sector drove $640 billion into the economy in 2006.

Slip sliding away
Now, turn that logic backwards. When subprime borrowers started sliding into default, lenders' losses began to pile up.  The numbers aren't small potatoes—sources estimate that nearly 20 percent of all subprime mortgages made in the last two years will end in foreclosure. Some lenders shut down their subprime operations, others closed their doors completely. The lenders remaining in the subprime sector are being pressured by secondary market investors and the federal government to overhaul their lending practices.  As a result, underwriting guidelines have tightened up again, loan costs have risen, and the pool of potential homeowners has shrunk.

More restrictive guidelines for all
The subprime implosion hits you the hardest if you need credit, or if you need to sell your home. In the aftermath of subprime losses, lenders are looking more closely at prime lending practices, as well. Even if you have great credit, traditional mortgages and equity lines of credit will cost more. And you may not even be able to get an alternative mortgage, no matter what your income profile and credit history look like.

Harder to sell
Selling your home presents a different problem. Simply put, there aren't enough buyers out there who can obtain financing. Those who do qualify for a mortgage will have to pay more for it, which means they'll spend less money on a house. All of this puts downward pressure on housing demand and housing values. And if you have foreclosures in your neighborhood, the value of your home could suffer because of your proximity. 

Declining stocks
In early 2007, several financial institutions made announcements about mounting losses and high default rates. Freddie Mac subsequently announced that it would no longer purchase risky subprime mortgages on the secondary market.  Following that news, the stock prices of many financial institutions took a beating. At the same time, other companies that are heavily dependent on the strength of the housing industry have also been impacted by the downturn. More than likely, the affected stocks—and maybe parts of your portfolio—will continue to be volatile until the housing and lending markets recover.

What's the bottom line?  Just as we benefited from the strength of subprime lending, we'll now have to suffer through its weakness as well.

By Catherine Brock - MortgageLoan.com   

Regulator- Schmegulator

I never cease to be amazed at the naivete of lawmakers who think that just because they pass a law, that behavior is modified and whatever social purpose they had in mind will be advanced.  This is strange because I think that in politics there is a huge gulf between perception and reality anyway. You think that people who saw this all around them would understand that it happens in the rest of the world too.

The fact is that passing a law is just the first step in a long process.  Someone has to put that law into some kind of bureaucratese, what we would call regulations.  Next, someone has to figure out who is in charge of enforcing the rules and what the penalties are going to be for failure to follow them.

Finally, someone has to be enabled to go out and enforce the regulations, like have an enforcement staff up to the task.  You can already see the problem. There are lots of opportunities for failure between the halls of Congress and Main Street.

A topic of current interest is the ability of consumers to fix mistakes on their credit reports.  The intention of the law that consumers can dispute erroneous items and have them removed quickly and easily.  All of us who work with borrowers who have credit problems realize that this has been a joke for years, not just because Congress wants to hold hearings.

The current hearings on all matter of mortgage and credit related malfeasance have been brought on by this very problem. One Congressman chided the Federal Reserve Board for not having implemented rules that would have "enabled" previously passed legislation.

We'll see how that one turns out, but I'm not holding my breath.  Right now, it looks as if the creditors seem to be taking the position that they have a lot to lose by not including information that may or may not be true. Balance that against the damage to consumers from making it hard to eliminate that same information. Thus it's not really a stand-off. The creditors are holding the cards.

Whatever agency ends up in charge, someone needs to step in and TELL creditors that they don't have a choice on this, that they have to make it easier to remove questionable data and make it painful when they don't.

Mortgage Urgency

A walk-in medical clinic near me has a big sign out front that says URGENT CARE.  I don't think that it is a real substitute for the Emergency Room at our closest hospital, but they are able to provide instant medical assistance for people who can't afford to wait 4 weeks until their regular doctor has an opening.

What I like about it is their name: URGENT CARE.  I am a person who is characterized by what psychologists call "a bias toward action." I like to "do something" as opposed to "sitting around thinking about doing something."

Not all of my clients share my view of life. Those who don't share it need some urging to get them to take action.  I have had many clients who came in to discuss a refinance who should have come in a year before.  They have spent perhaps thousands of dollars in interest because they waited.

In some cases, it is because of ignorance.  Many people, more than you can possibly imagine, just don't know the particulars of their current loan.  Many think that they are paying a lower rate than they actually are. How can they be motivated when they are ignorant of the most important facts of their mortgage?

Others are in denial. They have this nagging suspicion that their rate may be high, but they are afraid to go get out their loan docs and find out the reality. Others make up stories in their minds about how complicated and expensive it is to refinance, so they don't do anything.

Others are just plain procrastinators. They make up excuses so as not to have to take action today, excuses like, "my son's soccer team is in the playoffs and I'm busy with that until next month." It's easy to think that it has no adverse consequence until we have a month when the rates go up one-half percent, as they have just done.

If we ever get around to refinancing his $420,000 mortgage, it's going to cost him an extra $2,100 every year in interest because he didn't jump on it when we first met.  That's $21,000 over the next ten years.

Sure hope those soccer games were worth it.