When using the label “subprime” the typical stigma is one of a bad credit customer who couldn’t get a loan at the bank so they went to a lender who charged higher interest rates to make the loan. (insert loan shark jokes here…) The main issue this raises is this: while subprime lenders did make some bad loans, the graph used shows something different.

The graph shows that people were being allowed to buy more home on the same income they had in the past. Subprime lending did allow a higher debt level than prime lending had in the past, and this required customers to live on a much tighter budget than previous generations had.

Another and perhaps worse trend occuring in the market was the main stream introduction of ‘pick-a-payment’ loans which allowed customers to choose loans that had an adjustable interest rate, a teaser rate below the actual rate allowing customers to pay less than the monthly payment, and the unpaid interest was added to the loan balance, and this rate could adjust monthly.

These loans had historically been granted to sophisticated customers who understood all the dynamics of the loan, and who could well afford it. The loan qualifications became looser and looser as time went on eventually allowing no down payments, stated income, and finally allowing the borrowers to qualify on the teaser rate vs. the actual interest rate.

These loans went main stream and the volume of these loans rivaled if not exceeded the volume of subprime loans.

Just one more example of how crazy the world had become at the height of the housing bubble!

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What I found interesting was they method they used to define sub-prime, it was based on the interest rate spread vs. the loan qualifications. There is a lot of interesting information available on the web site, however I would like to see default rates as well when blame is being placed for the housing crisis.

Another interesting section of their site has graphs showing the following:

Increasing percentage of income goes to housing.

Total financing of Mortgage-Backed Securities.

Political Contiributions by Securities and Investment Companies.

Political Contributions by Real Estate Companies.

Top Recipients of Securities and Investment Company Contributions.

Top Recipients of Real Estate Company Contributions.

Top Recipients of AIG Contributions in the 2008 Election Cycle.

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As anyone who has been in the mortgage business for at least 10 years knows, when rates go up, you shift your focus to different mortgage products. I.e. Jumbo loans, stated income loans (that make sense), non-prime loans, etc. These loans are typically not available through Fannie Mae, Freddie Mac, and FHA.

In normal markets there are plenty of investors willing to make these loans given that they typically generate higher than average returns, however in today’s market, there is such a shortage of available investors that it appears the entire space is vacant.

This could be due to the vilifying of any lender associated with non-prime mortgage lending, or it could be that entities that normally engaged in this type of activity are worried about the increased scrutiny and regulation coming to the industry. One thing that hasn’t changed is the desire to make money, and once rates increase, the ability to make money from mortgage loans will return.

An increase in players in the mortgage market will bring back competition. Competition typically brings new products, and as long as those products are based on performance and repayment, it will bring returns.

This is what will really bring a recovery to the housing market, not low rates that only a select group qualify for.

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During the hey-day, the split between GSE and Private financing was estimated at 50/50. Granted it got out of control, but there should be a more even split….

As I sit here speculating, I can’t wonder if part of the lack of outside financing is the record low rates that won’t allow investors to make the returns they would like? As housing has supposedly stabilized, would we see more investors return to mortgage backed securities if the Fed raised rates?

There is a lot more that goes into this, but ROI is a primary concern. If there are better returns elsewhere with less perceived risk, it makes sense that the market would chase returns elsewhere!

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We used to get 2-4 letters a week in our neighborhood from Realtors letting us know that they had customers wanting to move in. Then for the past 2 years……. (imagine the sound of crickets here…)

Then last week, we received a letter from an unknown real estate agent, and when we opened it (imagine audio from Handel’s Messiah here) it was one of the aforementioned letters!

Not that we are looking to move, but it got me thinking – Have property values really started to go up? I decided to do a little digging to find out.  The criteria I am looking for to decide if appreciation will occur, is driven by market demand, not by artificial factors, i.e. artificially low mortgage rates.

The items I believe we will need to see to build and sustain a lasting recovery are:

Reasonable unemployment. When people are in fear about losing their jobs, they don’t make big decisions. They won’t be upgrading their homes.

Multiple financing options – Right now there is only one underwriting standard… The Government! Fannie Mae, Freddie Mac, and FHA are the predominant players. Historically there have been non-prime lending options that accounted for up to 50% of the available financing which created a market in which competition played a part. Not anymore. Until other sources of financing open up, we will not have a full recovery.

Real buyers of mortgage backed securities and an open market to trade them – until more entities are willing to buy mortgage backed securities and feel that they will be honestly rated, this could be an issue. BUT as rates increase and good returns are available, these will make a return.

Supply & Demand – in most markets, a 3-6 months supply of homes on the MLS would be considered normal. In many markets there is currently a 12-24 month supply currently, and that does not include many bank-owned homes that are not currently listed. As banks unload these homes, this could cause dips in values in some markets.

Bottom line – we are not out of the woods yet, but I think we can see the edge of the tree line. There are some good deals to be had for real estate investors right now, but investments should be made warily as things could still turn down in some markets. For the overall economy though it appears we are headed in the right direction.

Some resources to check to see how your market could fare:

Click here for a recent Fortune article detailing how markets across the nation are forecasted to perform in 2010 and 2011.

Click here to go to Yahoo’s Real Estate page and look at the National Real Estate Market Snapshot.

Click here to go to Zillow.com and research property values. While not exact, they give good trending information.

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Most of these appraisals are not transferable to new lenders. If the bank denies the loan due to guidelines specific to their bank, the appraisal cannot be submitted to another lender. The borrower would have to pay for a new appraisal to submit the loan to the new lender.

The way the appraisal system has been set up requires a referral service. While the cost of the appraisal has not increased too much, it puts a third party in the mix which means that appraisers get paid less.

These challenges may not be an issue to getting your loan approved, but make sure that you understand the process before you order your appraisal!

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I heard an ‘expert’ the other day talking on one of the news shows about real estate being as affordable today as it was in the 1970′s. (my parents bought a nice house in the 70′s for around $20,000 in Idaho… I don’t see that yet)

Other people say that the smart people today should all be renting houses because real estate will not recover for a decade.

History has shown that in the short term real estate has experienced bubbles, it typically gains value over the long term. This will not be the case everywhere, real estate will typically gain value in markets that have demand for increased housing, and will lose value in markets that do not have demand. While housing is a necessary commodity, it is subject to the same cycles of supply and demand as other items. In  markets with tight land constraints with limited land to build on, as long as there is employment to support the cost of living, prices should increase over the long term, however in areas where there is an abundance of build-able land and/or declining job markets, prices will stay flat or decline.

Bottom line here: If you are looking at real estate as an investment, make sure you look at all the factors before you buy. Don’t buy into the media hype, or take the word of someone who makes money from your transaction. If you are buying a home for yourself, understand that if you plan to move in the next 5 years, you may not have enough appreciation to make money when you sell. However if you find the right deal (and they are out there right now) you could come out ahead – if you do it right.

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From the way the phrase is used, it appears that when obtaining a home loan, the person who is borrowing the money walks into a bank and fills out an application. Then the loan officer must simply hand it over to an underwriter who then tells the loan officer and the borrower how much they qualify for, and how much they must borrow.

It appears that from the media’s perspective, the borrower has no choice in the matter…. No thought enters their mind of affordability, budget, etc. The person who was taken advantage of had no idea that they couldn’t afford a $3,000/month payment, they only make $4,000 a month, and the Loan officer wrote down on the application that they made $7000 a month.

What everyone fails to acknowledge is that in the loan process there are multiple points at which the borrower discloses, and then acknowledges the information. Unless someone is truly not looking at the paperwork, they see all the details of the loan. (the exception possibly being the ‘pick-a-payment loans, an entirely different conversation)

At the point of applying for the loan, they complete a loan application. This application includes their income, and all their monthly debts. The loan officer then is required to send out disclosures showing the terms of the loan, which include the monthly payment they are applying for.

In the case of mortgage brokers, when the loan is submitted to underwriting, the consumer receives a second set of disclosures from the lender showing the terms of the loan.

If the interest rate that was quoted at the time of application changes, the borrower will receive a subsequent set of disclosures telling them the new rate, and payments.

At closing the borrower signs a ‘final’ application, once again disclosing income, and this one must be initialed on every page. The terms of the loan are all there, and payments are disclosed on the ‘final application’, the ‘Truth-in-lending’ disclosure, and the mortgage note. There is typically also a payment stub included in the package showing the payment amount.

This is not to say that there aren’t unscupulous lenders and loan officers - there are. It is simply saying that the consumer should read the documents they are signing, and use common sense when getting a loan. If you don’t think you can afford the loan, you probably can’t.

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When the average consumer is building their lifestyle, they usually start out small (relative to the terms of their upbringing, whether it be smaller house, used car, apartment, etc) and build from there. They typical consumer will rent an apartment, or buy a smaller home, and then at intervals in their life, the will upgrade.

Many consumers also will go through cycles of difficulty, at which times they will either lose a job, leave a job, or their job will disappear as has happened to so many people during this difficult time in the economy.

During these cycles of difficulty, the average consumer will live on their savings first, then possibly credit cards, and then they will either adjust their lifestyle to their current living standards, or they go bankrupt and are forced to change their standard of living. The only way to get back to their previous lifestyle, is to earn more money.

Businesses go through similar cycles. They grow, they contract, they want to expand quickly so they borrow money, if they don’t spend the money on things that generate more money, they either have to make major cutbacks, or they become bankrupt.

While the economy can be much more complicated, and there are many ways to hide or mask true issues, the foundation is pretty simple. You can’t spend more than you make forever. At some point you have to repay the debt, and repaying debt is much harder than living within your means. Once the debt is there, you still have to pay your normal daily living expenditures, but you also have to pay your debt payments……

Bottom line – if we don’t spend our country’s money wisely, we will not only not fix the problem we are facing, we will make it worse.

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Well, we all know the answer to that….. we get higher taxes once things come back around…. Someone has to pay for all the spending. Even if it isn’t a direct tax, it gets passed through in most cases.

So to offset the amount we have to pay back, why not implement something that recaptures some of this federal ‘bail-out’ money that we will be making payments on for years.

Here is my proposal: If someone has their interest rate or mortgage balance reduced, that amount is reported to the government. If the bank taking the loss received federal bail out funds, then that consumer will not get a tax refund check until the amount the bank lost is recovered.

This will still allow people who need the help to get it, but will prevent those who are simply taking advantage of the situation from doing so without thinking about it….

Just a thought.

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