Subprime meltdown : Rooftop Views

Rooftop Views

Subprime meltdown

Our friend and super mortgage guy, Ty Mann of Visionary Lending Corp, sent us this explanation of what is going on with the Subprime Market. We thought we should share it with you.

In recent months there have been a number of negative stories in the media regarding the rising foreclosure rates around the country as a result of some significant changes in the “sub-prime” mortgage industry. Since the media seems to report negative views, such as the housing market is going to crash because of the “sub-prime” problems, I thought it appropriate to offer a different perspective on what exactly is going on in the mortgage market.

The “Sub-prime” Market

“Sub-prime” mortgages by definition are loan programs that were designed to cater to higher-risk borrowers that do not fall into “prime” lending guidelines, usually due to credit issues or lower credit scores. When used responsibly “sub-prime” loans are a very effective way to help deserving consumers qualify for a home, while working to reestablish a stronger credit rating.

What Drives the “Sub-prime” Market?

Greed drives the Sub-prime market. Investors make money by investing money in mortgage backed securities. For example, history shows that the “prime” market has a lower risk of default on a loan, so the mortgage-backed security will produce a return of 5.25%, while the “sub-prime” market tends to be a higher risk and might produce a return of 9%. As you read through this keep in mind that less restricted guidelines mean the loans are a higher risk for the investor, therefore the investor charges a higher rate, which will net a higher return on Wall Street.

Why was it Working & What Happened?

A great housing market covers up many problems associated with real estate. When the market is thriving the strength of it creates equity in homes. If a home owner cannot refinance, the rate adjust or they become overwhelmed with the payment, they will can put the house on the market, walk away with a profit and the investor gets their money back with no harm done.

When the housing market goes flat, like it is now, the problems become visible especially when 100% financing was done. Consumers in the “sub-prime” market end up upside down or maxed out in their house because there is no equity to refinance. The home owner cannot sell their home because by the time they pay realtor commissions and closing fees they have to bring money to the closing. Since there is no incentive to protect a down payment and no equity in the home, the owner walks away and the investor has a house they will have a very hard time selling.

History Repeats Itself

As we know, history has a tendency to repeat itself and the real estate industry is no different. In the late 1980’s the housing market was on fire and consumers were upset with how long it was taking to get loan approval. With all the pressure to get things moving quicker, the banks decided to loosen qualification standards for a loan to speed up the process. In 1990 & 1991 the housing market took a tumble, investors lost money when the higher risk loans went into foreclosure causing lenders to create stricter qualification standards. The same cycle happened through the 90’s and this decade. The qualification standard for a loan is loosened while the market is thriving and gets stricter when the market slows because of a higher foreclosure rate.

The Impact

According to the Mortgage Market Guide, “In the short term, home loan rates are benefiting, as the stock market is taking a beating, causing money to flow into Bonds and Mortgage Backed Securities, which benefits home loan rates. But the long term picture may spell higher interest rates ahead, as lenders have to absorb the cost of the loans that went belly-up, combined with the cost of increased compliance and accountability standards.” The overall housing market should not be affected too much because “sub-prime” loans are a very low percentage of purchase business.