George's Blog

Current State of Mortgage Financing...What's Going On?

Anyone watching or reading the financial news over the last few weeks has seen a lot of angst and consternation over the state of the mortgage industry. In fact, one of the larger lenders in the US, American Home Mortgage, was forced to shut down operations recently. But why? What is happening, what does all this mean to you and most importantly... what should you be doing do right now to make sure you are protected?

Here's the scoop.

Over the past several years, many loans were made to homeowners with somewhat nontraditional or "nonconforming" situations, be it a poor credit history, inability to document income, or any number of factors that do not fit within the traditional "box" for home loans. These loans are often called "Sub-Prime", or "Alt-A", meaning that they were somewhat riskier in nature than A credit, prime, or traditional loans. Another type of "nonconforming" home loan is one where the credit and income might be perfectly fine, but the loan amount is higher than $417K, which is the current maximum loan that can be done using pools of money from mortgage giants Fannie Mae (FNMA) and Freddie Mac (FHLMC). If the loan amount is higher, it can certainly be done - it's called a "jumbo loan" - but the end money comes from private institutions, not from the large government sponsored entities of Fannie and Freddie.

Most nonconforming loan product rates popped significantly higher recently. Here's what happened.

The end investor for Subprime or Alt-A loans will charge a premium for taking on a pool of these loans, because they know that traditionally, they might have a higher rate of default and delinquent payments within that risky pool. But lately, default and foreclosure has been on the rise - partly due to the fact that with credit tightening and a soft real estate market, many troubled homeowners are unable to refinance or sell in order to get out of trouble. So now, these end institutions are demanding a much higher "risk premium" for taking on these pools of loans, as they see the rates of default are climbing higher.

But since these institutions are purchasing these pools of loans sometimes months after the borrower has actually closed at a given rate, this increase to the risk premium means that instead of paying $101K for a $100K loan that will bear interest, they may only be willing to pay $95K for that $100K mortgage to account for the risk. Multiply that times thousands upon thousands of loans...and you have millions upon millions of dollars in loss for the company trying to sell the pool at a much lower price than they were expecting. This is called a "liquidity crisis", and is exactly what happened to American Home Mortgage - there was no mismanagement, but they simply got caught holding too many "hot potato" loans, forced to sell them at massive losses...and eventually they had to make the decision to close the doors and stop the bleeding.

Further, even when a lender is able to take some losses, they may be subject to a "margin call". This means that as their losses and risk premiums increase, the value of their loan portfolio decreases. As the value decreases, the credit lines that are secured by those portfolios begin to issue margin calls as the value of the asset that they are secured on is now diminished. This is exactly like margin calls in the Stock market. If you have a loan against a Stock that is losing value, you will get a "margin call" and need to pay down the loan, as the underlying Stock is losing too much value to be considered adequate collateral any longer. So for the big lenders, as their portfolio is losing value due to increased risk premiums and losses...the margin calls start coming in, and they are required to pay down their balances. In turn, this means that they have less availability to fund their new loans, which then exacerbates the problem.

In response to seeing this situation play out in the demise of American Home Mortgage, lenders of other nonconforming loan products increased their interest rates dramatically almost overnight to be better prepared - and likely over-prepared - for increased risk premiums down the road. Even though loans above $417K are not presently suffering from increased delinquencies like the Subprime and Alt-A loans are, these rates popped higher as well, because they are being purchased by smaller private entities that can't afford to take on any margin of risk.

What happens next? The major damage is probably already done, and the present situation will likely settle out over the coming year. Lenders will stop pulling products off the shelf, and the rates on products that have moved so significantly higher now should trend lower down the road as delinquency rates stabilize.

But here are a few important things you should DO RIGHT NOW:

ONE: Even if you are not presently in the market for a home loan of any type, make sure that your credit standing is as solid as possible. Many people in the market for a home loan didn't expect they would have a need, and didn't plan in advance to ensure their credit would qualify them for the best possible financing. With no immediate need for a home loan, time is on your side... why don't we take a few minutes together and just make sure you are prepared, should a need arise down the road? Call or email me right away.

TWO: If you are in the market for a home loan, or know someone who is - understand that now is the time to be working with a real qualified professional who can keep you informed of changes in the market and get your loan funded quickly. Now is NOT the time to be playing the risky game of trying to scour the entire nation to find someone who promises to save you a paltry amount on costs, or deliver a rate that seems too good to be true.

Your home and your financing are just too important, and times have changed. I am here to help and advise during these volatile times - and would welcome calls from you, your friends, family, neighbors or coworkers.

George Duarte

the "Real Deal" Guy (sm)

House Passes Housing Stimulus Bill HR3221 CONFORMING LOAN LIMITS GO DOWN

BAD NEWS FOR CALIFORNIANS AND OTHER HIGH COST AREAS!

This bill is over 700 pages, very comprehensive and very complex. I won’t go into all the details now, except the most important one, that is the current temporary conforming loan limit of $729,750 which is due to expire on Dec. 30, 2008, will be replaced with a LOWER limit of $625,500. That’s great, huh? The conforming loan limit is the maximum loan amount that Fannie Mae and Freddie Mac will buy, and FHA will insure, and is very important because even with all the recent financial turmoil that they have had, they are still the most dependable source of mortgage loan funds available right now.

The temporary loan limit increase to $729,750 occurred earlier this year in emergency economic stimulus package. Because it was only temporary, it is actually a two tiered pricing system- the regular conforming loans up to $417,000 (the old conforming limit), and "conforming jumbo” loans from $417,001-729,750. A whole new secondary market had to be established for the new confumbo loans, with new mbs (mortgage backed securities) instruments created, and whole new set of underwriting guidelines, as well, resulting in a lot of confusion and limited utility to the consumers it was meant to help.

The new loan limit was the result of intense negotiation between the House and Senate. Representative Barney Frank, the Chairman of the House Financial Services Committee, was a very strong advocate for making the temporary limits permanent, but ultimately lost to powerful Republican members of the Senate Banking Committee, who originally wanted only a $550,000 limit, but settled on $625,500. The California Congressional Delegation, lead by Senators Boxer and Feinstein, and Members Gary Miller, Ellen Tauscher, Maxine Waters and Brad Sherman fought valiantly on behalf of California consumers, with Representatives from other high cost areas, but lost out to powerful conservatives from the Midwest on this issue.

WHAT THIS MEANS TO CALIFORNIANS-

If you currently have a loan over $625,500, and have been considering refinancing it, then DO IT NOW. You have until Dec. 30^th to get the loan closed at the lower rates, then you are in Jumbo territory, and the rates are in the high 7’s range, with much stricter underwriting guidelines, and less choices. Also, all the rates have been going up in the last 2 weeks, under fears of inflation, the longer you wait, the worse the rates could get.

If you are thinking about purchasing a home, now is a great time because values have dropped, but that benefit could be negated by the higher rates. Like Bobby Weir said “can’t win for losin”.

The window is closing!!

George Duarte

The “Real Deal Guy” (sm)