Tuesday, April 29, 2014

The Good Credit Foreclosure Crisis

Two or three years ago, all anyone could talk about was the housing market. It was booming. Builders were building, buyers were buying, and lenders were lending. Everybody was making money hand over fist, and everybody loved it.

It didn't last. The market started to lag in 2006 and has only gotten worse in the first half of 2007. Some experts maintain that the market is just returning to normal after a strong surge and that there's nothing to worry about. Others, believing that the housing market is an indicator of the future of the rest of the market, are beginning to utter the unutterable word that starts with r: recession.

One thing is clear. This is not just a slight dip in the housing market. When slight dips occur, contractors are the first to be hurt, then the lenders, and buyers sometimes suffer a little bit. This time, current owners are getting into the mix. Foreclosures are at an all-time high, and it seems to be affecting everyone in the market. Whether you're an owner with bad credit, an investor, or an owner with good credit, the national figures have you at risk of foreclosure. Nationally, there is currently one foreclosure for every 134 households, which represents an increase of over 55% from the same time last year.

It isn't surprising or particularly unnerving that borrowers with bad credit are late on their payments or have already gone to foreclosure. They are, of course, the first borrowers who can be expected to have difficulties. Bad credit borrowers are the perfect prey for predatory lenders using aggressive lending tactics. They hooked borrowers looking to get in on the housing boom a few years ago when those same borrowers never had a chance at a mortgage earlier in their lives. During the housing boom they were able to borrow at subprime rates and the lenders got rich.

Although subprime rates and strong-arm tactics have been around for decades, the extreme slowdown in the housing market seems to have increasingly magnified the problem of late. Legislators are taking action to cut down on the practice. Congresswoman Deborah Price (R-Columbus, Ohio) has cosponsored a bill to help protect homebuyers from fraud in the mortgage market. She says that "Ohio's foreclosure rate is now three times the national average, one in six subprime loans is delinquent, and the problem is expected to worsen." Ohio is definitely at the center of the housing crisis, but states from coast to coast and in all different types of economies are suffering as well.

Real estate investors have greatly contributed to the current situation. Although this is to be expected during difficulties in housing markets, hundreds of thousands of homes and condos now stand empty because these investors got caught and were unable to flip their newly acquired properties. These investors bought property during the tail end of the housing boom at prices and rates that were much higher than in recent past. As prices eased, and in some areas began to fall, these investors are now forced to sell property for less than they bought it, causing them to lose money and some are defaulting on their mortgage payments because they can no longer afford to make them.

What really has a lot of industry experts nervous is the number of home owners with good credit who are foreclosing on their properties. At the epicenter of the housing industry's downturn is Countrywide Financial, one of the largest lenders in the country, who on July 24th, 2007, issued some of the worst news for the housing market in recent memory. While they confirmed the bad news that subprime borrowers were delinquent at record rates, they also surprised many in the financial sector when they announced that 5.4% of their loans to borrowers with good credit were past due. Countrywide was forced to reduce the value of their loans and assets by almost $1 billion. Their stock plummeted, dropping almost 10% in a single day.

Countrywide's announcement has a lot of people scrambling. The words of Chairman and CEO Angelo Mozillo may be the most troubling. On the day of the announcement he said that home sale prices were dropping "almost like never before, with the exception of the Great Depression." Investors shook their heads as they knew any mention of the Great Depression from a high-ranking CEO of a financial company was going to send the Dow plummeting by triple digits.

While many in the market are scratching their heads and asking why borrowers with good credit are defaulting on their payments, Ron Borg, CEO of Mortgage123.com says the reasons are simple. "There are 3 simple reasons for the tremendous increase in defaults on "good credit" mortgages", says Mr. Borg. "One reason has been the popularity of the Pay Option ARM. While the loan itself is not necessarily a bad loan, three particular features of the loan greatly contribute to defaults on this type of loan".

Mr. Borg continues, "See, the borrower's interest rate adjusts monthly and the rate is determined by adding a "margin" to a specified "index". The "index" is typically a short term bond such as the rate on the U.S. 1 year treasury-bill or other index such as the London inter-bank offered rate, which also based on short term interest rates. Over the past year and a half, short term interest rates have risen approximately 4%! That's a tremendous increase for most people.

Mr. Borg says that the second factor affecting Option ARM defaults is that mortgage lenders and brokers compensation is directly tied to the margin. The margin is the amount of interest that is added to the index which in turn, determines the borrower's actual interest rate. "Most borrowers have absolutely no idea that margins are negotiable" Mr. Borg states. He says that "Margins can vary from 2 ½% to as high as 6 ½%. Most indexes today hover around 5%, so you can easily see why so many borrowers are hurting."

The third feature of the loan is that it is improperly marketed, says Ron Borg. "Companies advertise that it comes with a very low rate, under 2%. This is completely misleading consumers", he says. "The fact is, that "interest rate" lasts for one whole month. After that it becomes nothing more than a calculation to figure a borrower's minimum monthly payment. Unfortunately, that minimum monthly payment isn't enough to even pay the monthly interest on the loan and negative amortization occurs." he says. That is when the balance of the loan actually goes up instead of down. "While this may be a valid short term strategy, thousands of borrowers got sucked in because of that low payment without regard to the consequences. Now they're hurting.

Another part of the foreclosure story is the proliferation of mortgage lead companies.. These companies created websites, spent millions of dollars to drive Internet users to their sites, promised better rates because lenders would compete for their business. "Consumers really don't understand how these companies operate", says Mr. Borg. He says that lenders pay huge advertising dollars to be part of these website companies.

"They receive so many leads from these lead companies, and they pay so much for those leads, that they cannot afford to hire experienced mortgage loan officers. Most hire sales or customer reps rather than actual loan officers. Some companies even outsource these jobs overseas!" he said. These reps are there to sell mortgages, not to provide any level of advice or consultation. Mr. Borg continued. They just want to sell loans. They don't worry about building a client base that can refer more business to them because each and every day they get new batch of leads, provided by the lead generating website company. Experienced loan officers work much differently - they provide consultation and a true desire to provide the best financing package for their borrower's particular needs."

While a large portion of borrowers that apply through lead generation websites have sub-prime credit, many are not borrowing on subprime loans and for the most part they don't have other properties to pay off or lose money on. Common sense would dictate that an individual with good credit would know to stay away from unscrupulous lenders. However, many borrowers with good credit have been lured by the promises of super low interest rates and the competitive environment offered by lead generators when they were looking for a mortgage during the housing boom of the past few years.

The nation had never before seen such a great housing boom in the era of the internet. The internet did not create any new lenders, but it did create a plethora of new lead generators. These are basically websites that get paid by lenders to find possible borrowers and direct them to the lenders. However, the tactics they use and the way these lead generators market themselves may have had an adverse effect even on borrowers with good credit, contributing to the current poor housing market.

LendingTree.com is a perfect example. Potential borrowers go to their website, provide their personal financial information and then are contacted by a variety of lenders. Their slogan is that "When Banks Compete, You Win." One glaring problem with this business model is that your online application is forwarded to multiple lenders within their network and then each lender makes a credit inquiry on the borrowers", says Mr. Borg.

The problem is that multiple credit inquiries in a short period of time hurt the borrower's credit score. This can sometimes result in less optimal mortgage rates, especially if a quick decision is not made. Furthermore, such sites can be very secretive about what they're doing. They claim that multiple credit inquiries is not a problem and simply push the borrower to make a decision, good or bad; after all, they get paid when customers choose any lender from their site.

Recently, some companies are looking to provide borrowers with similar services as these lead generators but without the risk. Mortgage123.com is a good example. They offer multiple lender quotes but without the multiple credit inquiries. Instead of submitting credit inquiries to the lenders, they pull the borrower's credit score themselves and manually calculate each rate quote. The borrower gets more accurate quotes and their credit only gets accessed once.

The third reason for the rising foreclosure rate, of course, is the market itself. Mr. Borg had this to say - "While all the politicians are now grandstanding about predatory lending and looking to regulate the problem away, the fact is, if real estate continued to appreciate, most of the problems of today simply wouldn't exist. But when you combine increasing mortgage balances with declining home values, well, let just say, you're going to see some problems."

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