Subprime Loans Coming Home to Roost

Home ownership is the “American Dream”. It creates stable neighborhoods and families, and help build wealth. It’s a good thing for most people to own a home. But for some, it’s a bad idea. Get ready to start seeing a lot more news, like the CNN article I’ve posted below, about the fallout heading our way as a result of too many subprime loans being given to home purchasers who, just several years ago, would have had to remain renters.

American Dream or not, for many Americans, renting a home is a much better option than owning. It use to be that one had to save at least 5% for downpayment. The downpayment represented somewhat of an “entry fee” into home ownership. Those unable to save a 5% downpayment could not become home owners, and I think that’s the way it should be. Too many young couples with small kids receive a door flyer or postcard from a Realtor or Mortgage company promising that they too can own a home, “for “Zero Down”. If you are a renter – even one with marginal credit – you’ve no doubt received these offers.

As stated in the CNN article below, “One watchdog group, the Center for Responsible Lending, forecast recently that 19 percent of subprime mortgages originated during the past two years will end in foreclosure. This rate … exceeds the worst foreclosure experience in the modern mortgage market, which occurred during the ‘Oil Patch’ disaster of the 1980s”.

The other 80% of borrows may avoid foreclosure, but many have homes they can’t afford to maintain, and have other financial consequences resulting from buying a home before they were financially prepared to do so.

Read below to see the cumulative result of this practice and the effect it may have on our economy.

Subprime woes: How far, how wide?
Problems loans to home buyers with less than top credit has become a big threat to the markets – and the economy.
CNNMoney.com March 5 2007

NEW YORK (CNNMoney.com) — Lending to homeowners and buyers without good credit has suddenly become a very bad business – and possibly a very big problem for the U.S. economy as a whole.

The sector is known as subprime mortgages, which pumped $640 billion into the economy through facilitating home purchases and refinancings in 2006, according to trade publication Inside B&C Lending. That’s nearly twice the level of this kind of lending seen as recently as 2003.

But now, with delinquencies and defaults by borrowers rising, experts in the field see more lenders filing for bankruptcy and a sharp pullback in subprime lending. In addition, banking regulators are proposing tougher lending standards and regulations in the sector. All that sent shares of some major financial firms sharply lower Monday.

“Everyone in the subprime sector this year is going to lose money,” said Bose George, analyst with Keefe, Bruyette & Woods, a Wall Street firm specializing in banking and finance. “They’re getting squeezed on all sides. Going into the year, we were lookingfor a decline of 15 percent [in subprime lending],but clearly now that is far too low. It’s now looking like a 25 to 30 [percent] decline.”

On Wall Street, the biggest loser Monday was New Century Financial, the No. 2 subprime lender according to Inside B&C Lending. Its shares plunged nearly 70 percent in midafternoon trading Monday after the company said in a filing late Friday that it was facing a criminal probe of its practices by the Justice Department and that its outside auditor, KPMG, said it now believed there was substantial doubt about New Century’s ability to function as a going concern.

But other lenders in the sector also got hit. For example, Fremont General Corp. lost a third of its value after it announced it would exit the subprime sector because of the demands of regulators and market conditions.

While it’s the smaller subprime lenders whose shares have taken a beating, many of the nation’s biggest financial services firms are also leading subprime lenders.

Some economists say that choking off more than $100 billion in home financing will cause problems for real estate and home prices overall by keeping some buyers out of the market and by forcing some current homeowners to sell or face foreclosure.

“People who a year ago could have purchased a house with a subprime mortgage aren’t going to be able to purchase,” said Paul Kasriel, chief economist with Northern Trust in Chicago. “Increased foreclosures will mean more inventory on a market that already has a glut of homes for sale.”

Kasriel said the additional hit to real estate from the subprime meltdown is likely to mean serious problems for the economy overall.

“Housing has played a very large role in this expansion and one of the reasons it’s played that role is there has been a change in the mortgage market,” he said. “This has been a credit-induced housing boom that lifted other sectors of the economy and it’s all in reverse now.”

One watchdog group, the Center for Responsible Lending, forecast recently that 19 percent of subprime mortgages originated during the past two years will end in foreclosure.

“This rate … exceeds the worst foreclosure experience in the modern mortgage market, which occurred during the ‘Oil Patch’ disaster of the 1980s,” the group said in a report issued in December.

The group praised a call from federal regulators Friday for much tougher standards for lenders making subprime loans. But the tougher standards will mean many borrowers will be cut off from financing, according to requests for public comment on the proposal.

The proposed new rules come aftermortgage financing firm Freddie Mac said it would no longer buy subprime loans on the secondary market that have a high likelihood of excessive payment shock and possible foreclosure. Freddie Mac’s new guidelines, and the proposed federal rules, would require that a borrower qualify at the highest rate possible under adjustable-rate loans, a move that would leave many not able to qualify.

The proposed rules on new standards and the action by Freddie Mac are important since most subprime lenders package their loans into securities to sell in the secondary market in order to get additional funds to make further loans.

In the new, tougher financing environment for subprime lenders, ACC Capital Holdings, the closely held owner of Ameriquest, the No. 7 subprime lender, said last week it secured additional working capital from Citigroup. In return, Citi got an option to buy ACC’s wholesale mortgage business as well as its mortgage servicing operations. CitiMortgage is already the nation’s No. 4 subprime lender.

“This relationship is a result of ACC Capital Holding’s thorough review of the current market and the different strategic alternatives currently available to an independent mortgage lender,” it said in a statement.

Citi is not the only major financial services firm in the subprime sector. Last Thursday, Countrywide Financial, one of the nation’s largest mortgage lenders, warned that 19 percent of the nonprime loans it collects payments for are delinquent. Its shares slid another 3 percent Monday on concerns about the sector.

Other leaders in subprime mortgage lending in the United States are units of some of the nation’s biggest financial services firms, including HSBC, the No. 1 subprime lender, whichtook a $10.6 billion charge for bad loans, as well as General Electric, Wells Fargo and Washington Mutual.

And some businesses that aren’t generally thought of as subprime mortgage lenders, such as H&R Block and General Motors, also have subsidiaries in that business.

One cause of GM’s delay in reporting fourth-quarter results is the attempt to look at how changes in the real estate loan market affect the value of GMAC, the financing subsidiary that GM sold a 51 percent stake in during the quarter.

Posted by Steve
9 years ago
Steve

Steve is a Real Estate Blogger, Husband and Dad, UT Austin Grad, Runner, Real Estate Broker and owner of Crossland Team and Crossland Real Estate in Austin TX.

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David Reed - 9 years ago

Nice article, but I would have to disagree with the minimum down payment being a requirement. The VA, as an entitlement for example, issues zero down VA loans every day while also allowing for relaxed debt ratios. FHA loans, a HUD invention since 1934, has been a champion of little or no down for years and has helped countless millions of borrowers over the years buy a home.

The problem that sub prime lending is experiencing the is multiple layers of risk they keep adding to make more loans. The primary risk culprits are “stated” income/assets with marginal or poor credit.

Zero down, in my opinion, is not the issue but zero down with any of these: marginal or poor credit, non-verified income or assets is the issue. And these loans were in fact not available just a few short years ago, but were “invented” by these sub prime lenders in attempt to sell more loans.

That’s my two cents. 🙂

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Tree - 9 years ago

What’s worse then zero down loans are the zero downs/pay only the interest loans. Then the bank takes your house and you have no equity. Lovely.

When do you think the foreclosures will start here?

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Barbara Thompson - 8 years ago

The article is ok .But often people with bd credit are no different then others. It goes back to the saying rich get richer because often bad credit is due to low income . And they have to have a place to live as well as the ones with more money. And a home is something they would maybe try to hang on to longer then someone that may feel ,”oh well we can always get another loan.”Rich or poor why should only the people with higher incomes and good credit get the homes.,we all deserve the right to a decent place to live. And by not giving someone with bad credit a home you are just helping someone with more money pay there bills , it’s call rent , sommething the poor have to pay.

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