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Archives for July 2009

Feds To CIT – “Your Loan Application Has Been Denied”

July 16, 2009 by Leave a Comment

CIT Solution Is Bankruptcy – Not Bailout

A CIT spokesman said late today that “There is no appreciable likelihood of additional government support being provided over the near term”.   Taxpayers had previously supplied a massive $2.3 billion dollars in loans under the TARP program late last year.  The large TARP infusion did little to turn around CIT which has reported losses for the past two years of over $3.4 billion.

CIT has $60 billion in finance loans and leases outstanding, an amount that is a mere rounding error in a $14 trillion US economy.  CIT does not represent a systemic risk to the US financial system.  The large amount of losses reported by CIT over the past two years suggest that loan approvals were given to risky enterprises.  CIT would not be losing money and on the verge of bankruptcy if their lending policies had properly accounted for risk.

The weak economy certainly contributed to CIT’s losses, but they could have been mitigated by better risk management.   As a private lender, CIT has the right to lend based on whatever standards they chose.  As a private lender, they also bear the responsibility of loss.

The American taxpayer should not be stuck with the cost of bailing out every failed business enterprise.  There already is a solution for poorly run companies – the solution is known as bankruptcy.  The US Treasury can join other creditors in bankruptcy court – cutting your losses is often the best option.

CIT aggressively expanded its loan portfolio over the past fives years by almost 100% to $60 billion.   CIT attempted to rein in its lending as the recession deepened, but the losses continued.  Increased losses resulted in a dramatic reduction of new lending activity over the past year.  CIT has effectively shut down new lending to small businesses for over a year now.  Customers that qualify for financing have gone elsewhere.

CIT -courtesy WSJ

CIT -courtesy WSJ


For small businesses, CIT is already failing.

“In order to service its debt and meet obligations, [CIT] has been cutting back on new originations,” explains David Chiaverini, research analyst at BMO Capital Markets.

CIT CEO Jeffrey Peek said in November that his company was “the bridge between Wall Street and Main Street,” and “one of the few significant sources of liquidity for small and mid-sized businesses who are struggling to survive.” But by then, CIT was already burning down its bridge, turning away many of the small businesses that had come to rely on the company.

BMO Capital Markets’ Chiaverini sees bankruptcy as CIT’s most likely next step.

“The best case for CIT is to get its liquidity issues resolved — bankruptcy could actually get things back to normal on the lending front,” he says. “If it does go into bankruptcy, I think what will happen is unsecured debt holders will convert their debt into equity and it will emerge stronger without the overhang of debt coming due. Then, it can start lending again.”

CIT’s role in small business financing will be hard to fill, but for many companies, the damage is already happening. Saving CIT would only help Main Street businesses if the company became healthy enough to resume making loans.

FDIC Rejects CIT Loan Guarantee Request

Sheila Bair, FDIC Chairman, had previously expressed deep reservations about allowing CIT to access the Temporary Loan Guarantee Program (TLGP) due to CIT’s weak financial condition.   Due to the financial crisis, the FDIC was called upon to provide guarantees to bank issued debt under the TLGP.  This type of massive “mission creep” imperils the primary purpose of the FDIC which is to protect depositor funds.  The FDIC Deposit Insurance Fund (DIF) is nearly depleted.  Sheila Bair made the right call and so did the Federal Government.  Let the owners and creditors of CIT assume the risk of loss – not the US taxpayer.

“Cutting Your Losses”

cit-chart

Disclosures: No positions

More on this topic: Treasury Bets U.S. Financial System Can Weather CIT Collapse

Filed Under: Bailout, CIT, Deleveraging, FDIC, Problem banks Tagged With: ,

Payday Lenders – Predators or Saviors?

July 14, 2009 by 2 Comments

Payday Lenders Serve The Financially Inept

One of the fastest growing lending businesses in the country has been “payday lending”.  Without the hassle of a credit check or application, a payday lender will give an employee a cash advance to carry him over to his next paycheck.  There has been huge consumer demand for payday loans as reflected by the growth of  payday storefronts to 25,000 today from zero in 1990.  Convenient locations and quick easy cash entice consumers to take a one week loan on a $300 paycheck for a $50 fee.

Payday lenders argue that the credit losses, overhead costs and the complexity of  administering millions of small loans require them to charge high fees to stay in business.   When Pennsylvania capped interest based fees on payday loans, the payday lenders disappeared from the State.

Responsible Lending.org has characterized payday lending as predatory and forcing borrowers into a vicious cycle where each loan is paid off with another loan resulting in huge fees to the borrower.  Effective annual interest rates can exceed 800%.

A full three quarters of loan volume of the payday lending industry is generated by borrowers who, after meeting the short-term due date of the loan, must re-borrow before their next pay period

Repeat borrowing of what is marketed as a short-term loan of a few hundred dollars has long been documented, but this report verifies for the first time how quickly most payday lending customers must turn around and re-borrow after paying off their previous loan.

Payday lenders generate loan volume by making a payday loan due in full on payday and charging a sizeable fee—now nearly $60 for an average $350 loan. This virtually guarantees that low-income customers will experience a shortfall before their next paycheck and need to come right back in the store to take a new loan. This churning accounts for 76 percent of total loan volume, and for $20 billion of the industry’s $27 billion in annual loan originations.

Payday lenders argue that they are lenders of last resort and provide vital credit that cannot be obtained elsewhere.  If payday lenders cease operating, how would those who had relied on the payday loan get by?

North Carolina provides an example of how consumers fared after payday lending was closed in 2006.   Here are the results of a study done by the Center for Community Capital:

Researchers concluded that the absence of storefront payday lending had no significant impact on the availability of credit for households in North Carolina.  The vast majority of households surveyed reported being unaffected by the end of payday lending.  Households reported using an array of options to manage financial shortfalls, and few are impacted by the absence of a single option  – in this case, payday lending.

More than twice as many former payday borrowers reported that the absence of payday lending has had a positive rather than negative effect on their household.

Payday borrowers gave first-hand accounts of how payday loans are easy to get into but a struggle to get out of.

Nearly nine out of ten households surveyed think that payday lending is a bad thing.

As was the case with aggressive no income and sub prime mortgage lending, many people will borrow money despite onerous fees and high rates.   Financially desperate consumers giving up 15% of their next paycheck to have money a week early are clearly not helping their financial situation.  The government cannot prevent people from making foolish financial decisions, but in the case of payday lending,  tougher regulation seems necessary to protect the financially inept.

Ironically, despite the high fees charged by payday lenders,  it turns out that investors fared no better than the payday borrowers.  Earnings have generally been trending downwards and stock prices have declined significantly.  New State or Federal fee restrictions on the payday lending industry would crush loan growth and profits.  Investors in QCCO and AEA are likely to face continued disappointing returns.

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Disclosures:  No positions.

Filed Under: Interest Rates, Payday lenders, Regulatory Reform, Saving Money Tagged With: ,

High Risk Mortgage Lending Still Being Promoted By GSEs

July 13, 2009 by Leave a Comment

Sufficient Income Key To Sound Home Ownership

In an effort to prevent delinquent home owners from losing their homes to foreclosure, the Department of the Treasury recently issued guidelines to lenders.  Under the Making Home Affordable mortgage modification program, the Treasury stated that the mortgage loans for at risk home owners should be modified to result in a front end debt ratio of 31%.   A front end debt ratio is the percentage of gross monthly income that is spent on housing costs, typically principal, interest, taxes and insurance.

Historically, a front end debt ratio of around 31% was considered to be an affordable portion of a borrowers gross income to allocate to housing.   A housing debt ratio in this range allowed the borrower sufficient remaining income to cover other living costs and debt payments.

DEPARTMENT OF THE TREASURY
Office of the Comptroller of the Currency, Joint Statement of June 23, 2009

On March 4, 2009, Treasury announced guidelines under the Program to promote sustainable loan modifications for homeowners at risk of losing their homes due to foreclosure.

Under the Program, Treasury will partner with lenders and loan servicers to offer at-risk homeowners loan modifications under which the homeowners may obtain more affordable monthly mortgage payments.

The Program guidelines require the lender to first reduce payments on eligible first-lien loans to an amount representing no greater than a 38 percent initial front-end debt-to-income ratio.6 Treasury then will match further reductions in monthly payments with the lender dollar-for-dollar to achieve a 31 percent front-end debt-to-income ratio. Borrowers whose back-end debt-to-income ratio exceeds 55 percent must agree to work with a foreclosure prevention counselor approved by the Department of Housing and Urban Development.

The OCC guidelines corresponded to comments by the Secretary of HUD, Shaun Donovan, who had previously supported lowering the debt ratios of at risk homeowners to 31%.  In response to the question as to why so many home owners re default after having a mortgaged modified, Mr. Donovan stated the obvious – if a mortgage payment was excessive compared to income, default was much more likely.

What it showed was that where there’s actually a reduction in payments, there’s long-term success for those homeowners. People do much better when you lower payments and make them affordable than these other so-called modifications, which actually keep payments the same or increase them.

So I saw it, and in fact, if you look at the report, some of the language in it directly supports the way that we’re setting up our plan to create a standard that is truly affordable for borrowers. 31 percent debt-to-income ratio is the right standard. It’s widely accepted, and if we can get to that level, as we do in our plan, we believe that that sets us up, based on the results of the study, for long-term success for homeowners.

Someone Should Tell The GSEs

The HUD Secretary’s comments make sense and reflect previous sound underwriting guidelines that existing prior to the housing lending mania of the bubble years.  If mortgage lenders had not abandoned traditional income requirements, borrowers would not have been approved at debt ratios that virtually guaranteed future defaults.   The Treasury and HUD are promoting sound lending policies when they recommend a conservative debt ratio.

The problem is that some one forgot to tell Fannie Mae (FNM), Freddie Mac (FRE) and especially the FHA what HUD and the OCC have proposed as a safe debt ratio.  (See Why Does The FHA Approve Loans That Borrowers Cannot Afford.)   We now have the absurdity of lenders being required (at taxpayer expense) to modify mortgages to a 31% debt ratio while it is extremely common to see new mortgages being approved at debt ratios of  50% or higher.   When a borrower is paying out half of pre tax income for housing expenses, there is usually barely enough left for other debt payments, living expenses, home repairs, etc.   A reduction in income, a major unexpected home repair bill or any other unexpected expense can be enough to tip the borrower into default.   Yet, the automated underwriting systems of Fannie, Freddie and the FHA are routinely approving  risky mortgage loans at debt ratios far in excess of 31%.

The government’s obsession with increasing housing sales and refinances has resulted in a bizarro world situation.    Mortgages are being approved with unaffordable payments, the borrower falls behind and then the payments are modified lower under the Making Home Affordable program.  It’s not surprising that the Federal Reserve has had to become the buyer of last resort of mortgage backed securities – who else would want to buy them?

Disclosures: No positions.

Filed Under: FHA, Housing, loan modification, Making Home Very Affordable, Mortgage Basics Tagged With: ,

FDIC Tells Banks California IOU’s Good As Gold

July 8, 2009 by 5 Comments

Bank Have Enough Bad Assets

Yesterday, a group of major banks, including Bank of America, Citigroup, JP Morgan and Wells Fargo,  said that they would stop accepting California IOU’s.  The State of California, virtually out of cash, has been issuing IOU’s, known officially as “individual registered warrants” to creditors in lieu of cash.  The State has promised to pay IOU holders 3.75% interest when the warrants mature on October 2.

With Fitch Ratings dropping California’s debt rating to BBB junk status, it is understandable that the banks do not want to cash the IOU’s.  Allowing warrant holders to cash in their IOU’s would effectively transfer the credit risk of the IOU’s to the banks.  Most major banks already have a mountain of non performing assets and, understandably, do not wish to add California IOUs to the list.

The reality of the situation is that California has already defaulted since they have reneged on their obligations to creditors.   I wonder what the State of California’s reaction will be when their citizens adopt the State’s method of bill payment and start sending in IOU’s instead of cash for tax payments due?  Many of California’s citizen have been placed in a horrendous financial situation by California’s “spend and borrow until we are bankrupt” policies.  If the banks won’t cash in the IOU’s, why would an average citizen or business want the IOU’s?   The IOU’s won’t pay for your groceries or rent and they can’t be converted to cash – what does that say about faith in California’s “promises to pay tomorrow what is due today”?

FDIC Issues Statement On California IOU’s

The FDIC today issued the following statement to its member banks regarding the credit worthiness of California’s IOU’s.

California Registered Warrants
Interagency Statement

Summary: The federal financial institution regulatory agencies are jointly issuing the attached supervisory guidance for financial institutions regarding the regulatory capital treatment for registered warrants issued by the State of California as payment for certain obligations.

Highlights:

  • The Attorney General of the State of California has opined that the registered warrants that the State is issuing as a form of payment for certain of its obligations are valid and binding obligations of the State.
  • The banking agencies’ risk-based capital standards permit a banking organization to risk weight general obligation claims on a state at 20 percent. These warrants, which are general obligations of the State, would, therefore, be eligible for the 20 percent risk weight for risk-based capital purposes.
  • Banks should exercise the same prudent judgment and sound risk management practices with respect to the registered warrants as they would with any other obligation of a state.

It would guess that the FDIC’s statement on the soundness of California’s IOU’s was more politically motivated than financially inspired.  If this is all the support that California is going to get from the Federal Government, the citizens of California have much to be concerned about.

The FDIC is telling the banks that the risk of the  California’s warrants is the same as any other state issued general obligation debt.  Nice try, but apparently, the biggest banks in the country, as well as the credit rating agencies, are not buying this line.  If the banks won’t cash the IOU’s and you can’t spend them, they are effectively worthless today.  Those stuck with California IOU’s may be in for a long wait before they can be cashed in.

Disclosures: None

Filed Under: California, Confidence, FDIC Tagged With: , ,

The Contradiction Of Empty Homes And Rising Apartment Vacancies

July 8, 2009 by 1 Comment

A Housing Surplus

Huge increases in foreclosures have resulted in millions of homes sitting vacant as bank REO managers struggle to sell the empty homes.  Theoretically, people who have been evicted or lost their homes to foreclosures would be new renters.  Consider, however, the increase in apartment vacancies to a 22 year high:

U.S. apartment vacancies rose to their highest in 22 years in the second quarter as job losses cut tenant demand and more units came to market. Vacancies climbed to 7.5 percent from 6.1 percent a year earlier, New York-based real estate research firm Reis Inc. said today. The last time landlords had so much empty space was in 1987,

“Vacancies continued to rise despite what has traditionally been a strong leasing period for apartment properties,” said Victor Calanog, director of research at Reis.

Job losses and falling wages are shrinking the pool of potential renters, defying forecasts that prospective homebuyers would rent rather that purchase as house prices decline. The U.S. unemployment rate rose to a 26-year high in June and U.S. payrolls dropped more than forecast in June, the government said last week.

Rents paid by tenants, also known as effective rents, fell 0.9 percent from the previous quarter to $975, said Reis. Effective rents were 1.9 percent lower than a year earlier.

“New buildings coming online over 2009 and 2010 will face higher initial vacancy levels, and will work to increase the pressure on leasing managers,” Calanog said.

The brutal economic fact is that those losing their homes cannot afford to rent.  In many cases dispossessed adults are now sharing homes with children, friends or relatives.  In addition, USA Today reports  children are moving back into their parents’ homes:

Matthew Costigan is young, single and a recent college graduate.

So what does he do? He gives up his nice pad in the trendy Shadyside neighborhood of Pittsburgh and moves in with mom and dad. To his boyhood home. In the suburbs.

Costigan and many others in the most educated generation of young adults are seeking refuge under their parents’ roofs from skyrocketing housing prices, mounting college debts and a tight job market.

A survey of 2004 college graduates shows that 57% planned to move back in with their parents. MonsterTRAK, an online job site for college students and young alumni that conducted the survey, found that 50% of 2003 graduates are still living at home and 35% are still looking for work.

The Families and Work Institute for the first time asked 3,504 employed adults whether they have grown children living at home. The findings were surprising, says Ellen Galinsky, president of the New York research group. “Fully 25% of employed parents have children from 18 through 29 years of age living at home at least half of the time,” she says.

Forced by economic hardship, children are moving back in with parents and parents are moving in with their children.   Meanwhile, apartments and homes sit vacant, causing bank losses on homes and commercial loans.

Foreclosed empty homes and increasing rental vacancies are just one more sign of an over leveraged, cash poor consumer.  Forecasts predicting an economic recovery based on increased consumer spending are certain to be wrong.  Major job losses and wealth destruction of the past two years are forcing consumer to do what they must to survive.  With job losses increasing and unemployment reaching depression levels, an economic recovery remains a fantasy at this point.

Filed Under: Deleveraging, Economy, Have Nots, Housing Tagged With: , ,

Geithner’s Pump And Dump Scheme

July 8, 2009 by Leave a Comment

Pump and Dump

According to the SEC website, a pump and dump scheme is one of the most common investment frauds and works as follows:

First, there’s the glowing press release about a company, usually on its  financial health or some new product or innovation.  Then, newsletters that purport to offer unbiased recommendations may suddenly tout the company as the latest “hot” stock.  Messages in chat rooms and bulletin board postings may urge you to buy the stock quickly or to sell before the price goes down. Or you may even hear the company mentioned by a radio or TV analyst.

Unsuspecting investors then purchase the stock in droves, pumping up the price. But when the fraudsters behind the scheme sell their shares at the peak and stop hyping the stock, the price plummets, and innocent investors lose their money.

If all of this sounds familiar it should, since we have probably just witnessed one of the biggest pump and dump schemes ever perpetrated at the expense of witless bank share investors.

Consider the scenario: The Pump

Early this year, the financial system is in a panic as banks announce ever greater losses and talk of nationalizing the banking system is rampant.  Public officials fear a full blown banking collapse if worried depositors start a run on the banks.  Public opposition to bank bailouts is intense.

To stop the growing banking panic, the Fed and Treasury announce that the major banks are too large to fail and will not be allowed to collapse.

An easy to pass “stress test” of the biggest banks is announced to prove to the public that the banking industry is sound.

After a cursory examination of the largest banks, they all pass and are told to raise additional capital just to be on the safe side.

Investors start to buy the bank stocks en masse causing many bank stock shares to double and triple in price.

Over $200 billion in new capital is obtained from investors eager to get in at depressed prices.

Treasury Secretary Geithner states that “this transparent, conservatively designed test should result in a more efficient, stronger banking system”.

Witless commentators at CNBC pile on with predictions that the banks will soon be earning billions in profits.

No less a luminary than Warren Buffet adds to the buying panic by stating that he would put his entire net worth into Wells Fargo.

Potentially catastrophic losses on derivatives, commercial real estate, mortgages, off balance sheet assets and credit cards are swept under the rug as frenzied investors pile into a sure thing.

The Dump

Now, however, Geithner’s brilliant scheme seems to be entering the “dump” phase where “prices plummet and innocent investors lose their money”.  Consider the recent price action in major bank stocks:

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Most of the bank stocks peaked during May and have already declined substantially or appear to be in a distribution phase.  Nervous investors are considering the latest horrendous employment numbers and increasing defaults in virtually every major loan category.   There’s no harm in jumping into a pump and dump scheme early on for some quick gains.  It just might now be the time to jump back out.

Disclosures:  None

Filed Under: Banking Industry, Geithner, Pump and dump - Geithner version, Wells Fargo Tagged With: , , , , , , , ,

Wells Fargo’s New Zero Down Payment Mortgage Program

July 7, 2009 by 4 Comments

Risk Of No Down Payment Mortgages

There is  longstanding and overwhelming statistical proof that zero down payment home buyers default on mortgages at a far higher rate compared to home buyers who make a down payment.   This matter has lately received more attention than in the past due to the large number of foreclosures related to zero down payment purchases during the housing bubble years.  In 2005, for example, nearly half of all home purchasers were made with zero down payment mortgages.

Zero Down Payments = Foreclosures

FHA Delinquency Crisis

Could FHA’s rising delinquency rate be due to FHA incorporating risky practices that have become standard in the mortgage industry? Since industry experts often cite 100% financing as being a major factor in the mortgage meltdown, let’s take a look at borrower down payment sources:

The delinquency rate clearly rises in tandem with the increase in non-profit funded down payments.

In 2005, HUD commissioned a study entitled “An Examination of Downpayment Gift Programs Administered By Non-Profit Organizations”. Later that year, another report titled “Mortgage Financing: Additional Action Needed to Manage Risks of FHA-Insured Loans with Down Payment Assistance” was completed by the U.S. Government Accountability Office. Both studies concluded that seller funded down payment assistance increased the cost of homeownership and real estate prices in addition to maintaining a substantially higher delinquency and default rate.

No Skin In The Game
The analysis indicates that, by far, the most important factor related to foreclosures is the extent to which the homeowner now has or ever had positive equity in a home.

Instead, the important factor is whether or not the homeowner currently has or ever had an important financial stake in the house. Yet merely because an individual has a home with negative equity does not imply that he or she cannot make mortgage payments so much as it implies that the borrower is more willing to walk away from the loan.

Rather, stronger underwriting standards are needed — especially a requirement for relatively high down payments. If substantial down payments had been required, the housing price bubble would certainly have been smaller, if it occurred at all, and the incidence of negative equity would have been much smaller even as home prices fell.

No Down Payment

No Down Payment

Courtesy: WSJ

Wells Fargo Initiates Down Payment Assistance Program

Ignoring the overwhelming evidence of high default rates on zero down payment purchases, Wells Fargo (WFC) this week announced a major nationwide down payment assistance program (DAP) to be used for down payment and/or closing costs on FHA, VA and conforming loans.  Incredibly, the program is being advertised as a means of helping low to moderate income applicants achieve the “American dream” of home ownership.

Based on the historical evidence, Wells Fargo is sowing the seeds for the next major crop of foreclosures.  Incredibly, this is being done even as the current foreclosure crisis grows in intensity.  Approving mortgages that immediately put new homeowners at a high risk of default is financial lunacy and a  disservice not only to the homeowner but to a nation already in financial chaos due to defaulting homeowners.

Down Payment Assistance Programs (DAPs)

Help More Low- and Moderate-Income Borrowers Achieve Home Ownership.

Refer your low- to moderate-income applicants to local housing agency contacts and help them achieve home ownership by using one of these Downpayment Assistance Programs (DAPs) approved for use with a Wells Fargo Wholesale Lending first mortgage. DAPs provide financial assistance for qualified borrowers and, depending on the program, may be used for debt reduction, down payment and/or closing costs on FHA, VA and Conforming Conventional loans.

Disclosures: None

Filed Under: FHA Defaults, Housing, Mortgages, Wells Fargo Tagged With: , ,

Profile Of A “Making Home Affordable” Homeowner – Everyone Should Do It

July 7, 2009 by Leave a Comment

Overburdened  Homeowner Subsidized

Home Sweet Home?

Home Sweet Home?

Loan modification programs have been seen as the answer to preventing foreclosures and allowing the housing market to stabilize.  The programs have become progressively more aggressive as foreclosures continue to mount and housing prices continue to slide.  The current government program, Making Home Affordable, has a dual approach whereby a homeowner not eligible for refinancing (at loan to values up to 125%) can then attempt to have the mortgage modified to lower payments.  Eligibility requirements are quite simple – if the borrower has suffered a hardship (such as reduced income), is having trouble making the payment or simply bought more house than he could afford during the exuberance of the housing mania, relief in the form of lower payments may be available.

Here’s an actual example of a borrower granted mortgage concessions under the US Government’s Making Home Affordable program.

Home owner purchase the home in 2005 for $153,000 with a stated income mortgage, 100% financing.

Home owner refinanced a year later and received $30,000 cash with a stated income $190,000 mortgage at 7.125%.   The home is now worth about $165,000.

Home owner works at a grocery chain and earns $43,000 with limited prospects for increased income.  Credit card debt amounts to $22,000 with monthly payments of $315.

Home owner’s current housing expense and other debt payments result in front end and back end debt ratios of 46/55.   A back end debt ratio is calculated by dividing borrower’s total mortgage payment, taxes, insurance and all other minimum monthly debt payments divided by gross income.  After debt payments and payroll taxes, home owner is left with about $950 per month to cover all other expenses.  Home owner is 45 years old, has minimal savings and a negative net worth of around $50,000.

Home owner is not eligible for the Making Home Affordable refinance program since the debt ratios would still be too high even with a rate reduction to the current prevailing mid 5% mortgage rate.

Homeowner therefore applies for a mortgage modification.  The basic requirements are that you are having trouble paying your mortgage and your front end debt ratio exceeds 31%.   The front end debt ratio is the monthly mortgage payment, taxes and insurance divided by gross monthly income.  Homeowner is approved for a mortgage modification that lowers the rate to 2% fixed for two years, with an increase to 3% in year three, 4% in year four and then fixed in year five at the prevailing conforming rate.   No principal reduction of the loan was granted.   The initial rate reduction lower the home owners debt ratios to 31/40, a ratio that should allow debt payments to be handled without undue stress.

Comments – Who Won and Who Lost?

If the homeowner decides to sell the home, $30,000 cash would be required at closing due to negative equity, commissions due, etc.  Since the homeowner has no cash, a sale of the home would have to be a short sale, with the mortgage holder (or taxpayer) taking the loss.

The homeowner in this case received a mortgage rate that is unavailable to the best A+ borrower.  In addition, there were no closing costs to receive the 2% rate.  The average homeowner pays thousands in closing costs on a refinance.

The taxpayer winds up paying, one way or the other,  for the cost of the mortgage subsidy.

The subsidized 31% debt ratio puts the loan modification  homeowner in a vastly better off position than millions of other homeowners with much higher housing debt ratios who are unable to get a loan modification or a refinance.

The homeowner cited would never have been a homeowner if not for the 100% financing, no income verification programs that prevailed during the housing/mortgage bubble years.

Not everyone was victimized by the liar loans and sub prime lenders.  The homeowner in this example has nothing to complain about.   Besides the $30,000 cash received on the refinance and a zero investment in the property, the homeowner also has a super low 2% government subsidized mortgage rate .

As property values continue to decline, expect ever more costly, aggressive and futile  government efforts to reflate the burst Humpty/Dumpty housing bubble.

Filed Under: Bailout, Have Nots, Housing, loan modification, Making Home Very Affordable, Mortgages, Uncategorized Tagged With: , ,

Elderly Americans Last Refinance – Reverse Mortgages

July 6, 2009 by 1 Comment

Reverse Mortgages – More Easy Lending

As originally conceived, reverse mortgages were designed to fulfill a legitimate borrowing need.  Reverse mortgages were developed for elderly Americans who had a mortgage free home with substantial equity and wanted to cash out their home equity to supplement their retirement income without having to sell the house or face large mortgage payments.

Almost all reverse mortgages are purchased by HUD and insured by the Federal Housing Administration (FHA).  FHA insured reverse mortgages are known as “home equity conversion mortgages” (HECM) and they provide the following advantages to elderly homeowners:

  • Provides supplemental cash income to elderly homeowners.
  • Does not require a monthly payment.
  • Allows the homeowner to remain in his residence until death or sale of the property.
  • Should the borrower decide to sell and move, the  amount of the loan repayment cannot exceed the value of the house.
  • HECM allows the borrower either a monthly lifetime payment (based on value of the home and age at time of mortgage closing) , a lump sum payment, a line of credit or a combination of the above choices.

In theory, the HECM made sense by allowing homeowners to remain in their homes and monetize their equity.  The lifetime HECM payment, along with other retirement income and savings would allow for a more comfortable lifestyle.  The only theoretical loser on the HECM program would be the FHA if property values dropped.

HECM Program – Theory VS Reality

The disadvantages for a borrower of a reverse mortgage are as follows:

HECM rules require a borrower to make a full draw at closing to obtain a fixed rate mortgage.  Most borrowers take the adjustable rate option and a line of credit.  The adjustable rate HECM presently has a low borrower rate of around 3.1% based on a lending margin of 2.75% and a LIBOR index of only .32%.  At some point rates will rise again and rates on the HECM could rise dramatically – the lifetime cap on the loan is over 13%.  Borrowers could see their credit lines reduced and their equity vanish quickly with higher interest rates.

Borrowing money without having to make a loan payment equates to compounding interest working against the borrower since the loan balance increases each month along with interest charges.  Borrowers who later decide to pay off the HECM and sell their homes may find that most of their equity has been lost due to accrued interest.

The HECM is a very complex product.  Despite the fact that HUD requires a potential borrower to receive financial counseling, it is unlikely that most borrowers fully understand the type of mortgage they are taking out.

The HECM is available to all those 62 or older who have sufficient equity in their homes.  HECM program lends without regard to credit or income and is strictly  asset based lending.  Do these lending criteria remind anyone of  past  disastrous mortgage programs, such as  sub prime, ALT A or Pay Option ARMs??

The fees on a HECM are very high and include an upfront and monthly mortgage insurance payment to the FHA, loan origination fees and other closing fees.  Total fees over the life of the loan can reach 12%.

A HECM does not require that the homeowner escrow for taxes  or homeowners insurance.  A known risk factor for default is a non escrowed loan.  The homeowner can face foreclosure  for not properly maintaining the property or for non payment of taxes or insurance.

The most striking feature regarding the use of reverse mortgages by elderly Americans is the large amount of equity that is being extracted upfront, leaving them with only a small future monthly cash payment as can be seen in Exhibit 3 below.

HECM CASH PAY BY YEAR

HECM CASH PAY BY YEAR

Courtesy: HUD.GOV

The reason why borrowers are taking most of their available cash out upfront is because they are using the proceeds to pay off mortgages, consumer debt, medical bills, credit cards, etc.   Borrowers run up large amounts of debt when spending exceeds income, a situation likely to continue  after the borrower taps the last dime of equity from his home.  Since the HECM was the last option available, what happens in a couple of years when the borrower is again overwhelmed by debt?

HECM – Loan Of Last Resort

The number of reverse mortgages has increased tremendously as other borrowing sources have disappeared.  Many of the reverse mortgage borrowers are retirees with limited income who would not qualify for a traditional mortgage loan under current underwriting guidelines.  In the past, many of these borrowers would have taken out a stated or no income verification mortgage.   The  large increase of HECMs starting in 2005 correlates to the time period during which no income verification loans were being discontinued.

Reverse Mortgage Volume

Reverse Mortgage Volume

Here’s an actual example of a HUD approved HECM.  Borrower has a home worth $525,000 and owes $290,000 in mortgages and other debt which will be paid off with a $350,000 HECM.  Homeowner is left with about $60,000 at closing.  Borrower has an abysmal credit score of 510 and  is 90 days past due on his current mortgage.  Income is unknown since HUD doesn’t care about the borrowers income.

Based on the credit profile and debt levels incurred prior to his approval of a HECM, what are the odds that the borrower’s finances turn around after his refinance?  My guess is that within a few short years, borrower is in heavy debt again, unable to pay the property taxes or maintenance on the property and thus facing a potential foreclosure.  Since HUD will not be throwing senior citizens out of their homes, expect a mortgage modification program for reverse mortgages and further losses to the taxpayer on another mortgage program gone bad.

More on this topic

Smarter planning would probably eliminate the need to borrow when retiring.   Bob Adams writes an informative and thoughtful blog on the challenges of successful retirement – a site worth bookmarking.

Filed Under: FHA, FHA Defaults, Housing, loan modification, Mortgages, refinance, Reverse Mortgages Tagged With: , , ,