The mortgage Industry has been grabbing the media spotlight in recent weeks and much of the news appears alarming. Wall Street has watched anxiously as mortgage investments have tumbled to record lows. It has been reported that borrowers are defaulting on home loans at a higher rate than ever before. Home values are flat or falling which has resulted in a glut of abandoned properties in many markets. What does this all mean for the average person seeking a new home loan or seeking to refinance?
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To understand the seemingly tumultuous environment we have today, it's important to understand a few key facts. The reported troubles in the mortgage market stem from the subprime mortgage market and other aggressive lending practices. Subprime or non-prime loans are those that are targeted to borrowers who are unable to qualify under stricter, traditional lending guidelines. In other words, the loans are issued to borrowers who would be considered a poor credit risk under traditional terms. Because of the increased risk, lenders charge these borrowers higher interest rates. Other aggressive lending practices include low or no down payment, interest only and no proof of income loans.
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For many years housing prices soared fueled by easy money. This housing boom resulted in lenders expanding their lending guidelines to include a greater number of borrowers. Homeownership became a possibility for many more Americans. People once denied because of low credit scores or minimal savings now had lenders clamoring for their attention. The subprime mortgage market grew from $150 billion in 2000 to $650 billion in 2005. The subprime market has been great for those borrowers who deserved a mortgage loan but could not qualify in the prime market. However, aggressive lending practices also gave rise to predatory practices which pushed many borrowers into loans that they simply could not afford.
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The subprime industry grew and thrived until the summer of 2005 when the Federal Reserve began what would be a string of 17 rate hikes in the short term interest rate. Since many subprime loans carried variable or floating interest rates, this sector was greatly impacted by increases. Some homeowners saw their monthly payments increase by 30% to 50% which led them to fall behind.
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Many subprime loans also carry prepayment penalties. Thus when borrowers tried to refinance to a conventional loan with a lower interest rate they could not afford the penalties. Even if the penalties were affordable, with housing prices falling many were not able to get a new loan large enough to cover the balance on the old one.
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The result: a larger number of defaults and delinquencies. In late 2006, approximately 12.6% of the subprime market was in foreclosure or 90 days past due on their payments. There may be even greater damage when many borrowers experience their first rate adjustment in 2007. According to the Mortgage Bankers Association between $1.1 trillion and $1.5 trillion in floating rate mortgages will adjust in 2007.
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Adding to the market woes, 15 subprime lenders have either gone bankrupt, shut down, sold or are up for sale. Making matters graver, Federal Reserve Chairman, Ben Bernanke is urging Congress to tighten the reins on Fannie Mae and Freddie Mac, the two largest buyers of home mortgages. Investors' fears about risky mortgages contributed to the recent gut wrenching 416 point plunge in the Dow Jones Industrials.
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These market conditions have resulted in Freddie Mac announcing that it would no longer buy certain risky, subprime mortgages. Many banks, investors and mortgage bankers have decided to eliminate 100% financing loan options.
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What lies ahead for the average consumer? The news is not all bad. The subprime mortgage market will continue to exist and the best lenders will survive the ups and downs of the market. Borrowers with bruised credit will still have an opportunity to become homeowners and with the housing prices in their favor, it's still a good time to buy. However, those borrowers who can manage a mortgage but lack funds for a down payment need to act fast. The no down program is the one benefit that is here today but will be gone tomorrow.
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