May 25, 2022

Why Won’t My Loan Officer Answer the Phone?

Anyone trying to refinance or get a mortgage to buy a house may wonder why it is so hard to reach their loan officer.  Numerous emails and voicemails ignored and cell phone numbers not in service are annoying to any customer but at least the missing loan officer probably has a really good excuse – he just got fired!

The mortgage industry has always been a boom and bust business but the current environment is more brutal than anything ever seen.  According to the Mortgage Bankers Association (MBA), both purchase and refinance mortgage activity have seen a stunning decline from a year ago.

The Refinance Index decreased 8 percent from the previous week and was 68 percent lower than the same week one year ago. The seasonally adjusted Purchase Index decreased 3 percent from one week earlier. The unadjusted Purchase Index decreased 2 percent compared with the previous week and was 14 percent lower than the same week one year ago.

For the average loan officer working strictly on a commission basis and doing mostly refinances, driving to the office costs more in gas than what he gets paid.  The response from the nonbank mortgage companies has been swift and brutal.

Why you shouldn't close your business to carry out a stocktake | Stocktaking.ie

Better.com, a major mortgage banker, which clumsily fired 900 people in December via a Zoom meeting and a further 3,000 employees in March, announced that another round of cuts will eliminate an undisclosed further number of employees.

Will things get better soon?  Not soon enough for those loan officers who were abruptly fired and even the MBA which usually spins optimism, seems to have a bleak outlook going forward.

The 30-year rate has increased 70 basis points over the past month and is 2 full percentage points higher than a year ago. The recent surge in mortgage rates has shut most borrowers out of rate/term refinances, causing the refinance index to fall for the sixth consecutive week. In a housing market facing affordability challenges and low inventory, higher rates are causing a pullback or delay in home purchase demand as well. Home purchase activity has been volatile in recent weeks and has yet to see the typical pick up for this time of the year.

Many mortgage companies facing a drastic drop in revenue from their only source of revenue face a serious risk of having to close their doors.  It may be time to approach your local FDIC insured bank for a mortgage going forward instead of a nonbank mortgage lender.  Banks are strictly regulated in terms of capital requirements whereas the regulations on “nonbank mortgage” companies are much more lenient.

Mortgage Rates At 10% a Real Possibility If Inflation Can’t Be Reduced

Mortgage Rates Explode to 12 Year High

This year has seen one of the most explosive mortgage rates increases in history.  In a matter of a few short months the 30-year fixed rate mortgage has almost doubled from the high 2’s to over 5%. There have been previous periods of time during which rates rose substantially but 2022 has been a vertical move up that is rarely seen.

30-year fixed mortgage

Why rates have risen so quickly is no mystery.  After months of Federal Reserve talk of “transitory inflation” it has become clear that inflation is here to stay and likely to get worse before it gets better. The Fed must increase rates significantly to have any chance of reducing the inflation rate since current rates are far below the rate of inflation.

This from the WSJ:

During the 1980s, when Paul Volcker’s Fed was desperate to avoid a repeat of the inflation of the 1970s, interest rates were on average more than 4 percentage points higher than inflation. Leave aside the fact that at the moment the Fed Funds target rate is an extraordinary 7 percentage points below inflation; markets aren’t bracing for the Fed to be truly hawkish in the long run. Investors still think there’s no need, since in the long run inflation pressures will abate.

This is probably a mistake. The inflationary pressures from Covid and war will surely go away eventually. But self-fulfilling consumer and business expectations of inflation are rising, and a bunch of longer-term inflationary pressures are on the way. These include the retreat of globalization, massive spending to shift away from fossil fuels, more military spending, governments willing to run loose fiscal policy, and a starting point of an overheated economy and supercheap money.

If interest rates continue to rise, we may be looking at another housing bust similar to what we saw in 2018.

FHA Mortgages and Student Loans Are a Risky Combination

First time home buyers have traditionally faced a variety of obstacles including the high cost of housing, stagnant wages, and the difficulty involved in saving for a down payment.

 

If that wasn’t bad enough, recent changes by the Federal Housing Administration (FHA) now raise another potential barrier to home ownership due to the manner in which student loan debt must be evaluated.

 

For a variety of reasons many potential home buyers with a large load of student debt are able to obtain payment deferments of various durations.   Since there was no formal payment due under the payment deferments, some of which can last for years, the FHA had for the most part simply ignored the looming certainty of future monthly payments.  By not factoring in an estimated loan payment for deferred student loans, borrowers were able to lower their debt ratios for purposes of loan eligibility.

With the new FHA requirement to account for future payments on deferred student loans, many applicants may wind up with a back end debt ratio in excess of the 43 per cent currently allowed under FHA regulations.  Potential home buyers who were close to the maximum for monthly debt payments may now find themselves ineligible for any type of mortgage loan.

Are the new FHA regulations fair to first time home buyers?

One could make the argument that the new rules make sense since at some point the borrower is going to be required to start making payments on the student loan debt and if the payment is large enough it could cause enough financial stress to put the borrower at risk of defaulting on the mortgage.   According to a HUD spokesman,  “Will that borrower actually be able to afford their loan and the student loan payment? It’s a legitimate issue to consider.  Deferred student debt is debt all the same and really must be considered when determining a borrower’s ability to sustain both student debt payments and a mortgage long term.  Our primary interest is to make certain that a first-time home buyer is put on a path of sustainable home ownership rather than being placed into a financial situation they can no longer tolerate once their student debt deferment expires.”

It’s difficult to dispute the logic of HUD’s position but it seems to fail to take into account the prospect of a borrower’s future income increasing enough to compensate for the additional student debt payment.

The problem with considering future income, however, is that incomes have been increasing at a very slow pace in the post financial crisis period.  The prospects of higher incomes for the average worker remains speculative while the certainty of having to make payments on a student loan at some point are not.  Nonetheless, the increase in the amount of student loans being handed out have been increasing at a staggering rate as students furiously borrow on the dubious prospect of obtaining a job after college that pays enough to buy a house and car, raise a family, and payoff student loans.

Those expecting an increase in the rate of home ownership are likely to be disappointed as more and more young people remain at home with their parents unable to take on the financial responsibilities of home ownership.

The excessively easy lending of a decade ago temporarily raised the rate of home ownership as totally unqualified borrowers bought houses on the theory that home values could only continue to skyrocket.  The subsequent default of these weak and unqualified borrowers resulted in millions of foreclosures which burst the housing and mortgage lending bubble which resulted in the rate of home ownership falling right back to the long term historical average of about 65 per cent.

The Zero Sum Game Of Lower Interest Rates And Why Mortgage Rates Will Rise

The Federal Reserve has forced long term interest rates to historic lows in a desperate attempt to “stimulate” both the housing market and the economy in general.  The results have been mixed but the benefits of lower rates to borrowers are undeniable.  Lower rates reduce the cost of large debt burdens carried by many Americans and increases the spending power of those able to refinance.

Exactly how much lower the Fed intends to repress mortgage rates is anyone’s guess but as interest continue to decline, the overall benefits diminish.  Here’s three reasons why the Fed may wind up discovering that the economic benefits of further rate cuts will be muted at best, self defeating at worst.

1.  Lower rates are becoming a zero sum game for the economy as lower rates for borrowers translates into lower income for savers.  Every loan is also an asset of someone else and lower interest rates have merely been a mechanism for transferring wealth from savers to debtors.  Every retiree who prudently saved with the expectation of receiving interest income on their savings have been brutalized by the Fed’s financial repression. Even more infuriating to some savers is the fact that many debtors who took on irresponsible amounts of debt are now actually profiting from various government programs (see Foreclosure Settlement Q&A – A Victory For The Irresponsible).

A significant number of retirees that I know have been forced to drastically curtail their spending in order to make ends meet while others have been forced to draw down their savings.  The increased spending power of borrowers has been negated by the reduced spending power of savers.  This fact seems to elude Professor Bernanke who hasn’t been able to figure out why lower rates have not ignited the economy.

2.  Many consumer who would like to incur more debt are often turned down by the banks since their debt levels are already too high.  Those who can borrow often times chose to deleverage instead, considering the fragile state of the economy.  Anyone saving for a future financial goal (college tuition, home down payment, retirement, etc) is forced to reduce consumption and increase savings due to  near zero interest rates.  The Federal Reserve has destroyed Americans most powerful wealth building technique – the power of compound interest.  A 5% yield on savings will double your money in about 14.4 years while a 1% yield will double your money in 72 years – and that’s before taxes and inflation.

3.  As mortgage rates decline into uncharted territory, the mathematical benefit of lower rates diminishes.  As can be seen in the chart below the absolute dollar amount of monthly savings as well as the percentage decrease in the monthly payment diminish as rates race to zero.

Benefits of a refinance on a $200,000 mortgage diminish as rates decline

% Rate Mo Payment Mo Savings % Reduction Yearly Savings
6.00% $1,199.00
3.00%    $843.00 $356.00 29.70% $4,272.00
1.50%    $690.00 $153.00 18.10% $1,836.00
0.75%    $621.00  $69.00 10.00%    $828.00

Closing costs at lower rates also become problematic, making it impossible to recapture fees within a reasonable period of time.  With closing costs of $8,000 on a $200,000 mortgage refinance, it would take a decade to recoup closing costs.

Many astute analysts have made elaborate and compelling arguments that interest rates can only go lower.  From a contrary point of view, I believe that a future rise in interest rates is a high probability event.  This is the opposite of my prediction in March 2009 when I surmised that mortgage rates would decline to 3.5% – see 30 Year Fixed Rate of 3.5% Likely.

The Chart of the Day has a long term chart of the 10 year treasury and notes that the recent sharp decline in interest rates “has brought the 10-year Treasury bond yield right up against resistance of its 26-year downtrend channel.”

 

The Risk Of Higher Mortgage Rates

Mortgage rates again ticked higher Friday as the treasury market continued its sell off.  Most of the good news may already be priced into the treasury market that mortgage rates are based on.

Reasons why mortgage rates may increase:

1.  As the Fed’s efforts to stabilize the credit markets succeed, frightened money is moving out on the risk curve, selling treasuries and purchasing much higher yields on corporate debt, preferred and common stock and municipals.  To the extent that the Fed is calming the credit markets, their actions are  counterproductive to lower mortgage rates.

2.  The Fed’s announcement in late November of their intention to buy half a trillion dollars of mortgage backed securities is what kicked the mortgage rate decline into high gear.  Most of this may now be fully discounted.  The actual announcement of the purchase schedule of the MBS’s did nothing to lower rates.

3.  Without the backing of conventional mortgages by the government, mortgage rates would be much higher.   This can be seen from pricing in the jumbo fixed rate mortgage market where rates are as much as 2 to 3% higher since Fannie and Freddie do not purchase or guarantee these mortgages.  Many banks effectively do not offer jumbo mortgages since there is no secondary market for them.

4.  Continued massive government support of the mortgage market will be necessary since investor demand for mortgage securities is likely to remain low due to collapsing housing prices and the risk of mortgage debt being discharged by bankruptcy and loan modifications. How can an investor properly price a mortgage security where the asset value underlying the security is declining and also face the risk that the principal investment may be impaired by court decree?

5.  The question of how much financial support the government is able to continue to provide to subsidize mortgage rates becomes important, especially as bailout demands escalate.  There are reports today that the State governors are seeking $1 trillion in bailout support as their deficits grow.  Unless the funding ability of the US Treasury is infinite, price support for mortgages may be reduced.  The Fed is now expected to absorb virtually all of the new mortgage backed securities this year.  Meanwhile, the debt of the US Government continues to explode, possibly beyond the point where the debt can ever be repaid.  This scenario implies higher rates on all government backed debt.

Many investors expect the eventual outcome of the Fed’s quantitative easing campaign to result in much higher inflation.  Some very astute investment managers, who had correctly predicted the financial meltdown now view the treasury market as overpriced.

  • Jeremy Grantham of GMO describes the 30 year treasury bond as “ridiculously” overpriced and effectively forecasting only a 1% annual rate for the next three decades.  Mr Grantham sees the scenario where there could easily be a large surge in inflation.
  • Bob Rodriquez who runs the FPA New Income Fund and was up on the year in 2008 also sees a “massive bubble in treasurys”.  He is not buying treasurys since “We will not lend long term money to a borrower that capriciously erodes its balance sheet.”
  • Peter Schiff of EuroPacific Capital also sees a substantial risk of massive inflation and sharply higher interest rates at some point.   Eventually foreign investors will refuse to buy US Government debt based on concerns about the US ability to repay its debts.

The above scenarios may not be imminent but they do become more probable as the US Government depletes the Treasury with endless bailouts, guarantees and borrowing.

Debate On Loan Modification Continues: Free Enterprise Vs Free Government

The debate seems to intensify on a daily basis regarding the merits and legitimacy of for profit loan modification companies.  Officials of HUD, Hope and the banking industry continue their criticisms of the loan modification industry by noting that they offer for free the service that many borrowers are now paying for.

Consider some recent comments from both sides debating the merits of for profit loan modification.  Daily Herald

“You don’t need to go out and hire someone to help you,” said Michael Gross, managing director of mortgage servicing for Bank of America. “It is very, at times, frustrating to find a homeowner who has paid a for-profit company $3,000 to $5,000 in an upfront fee, when they could have gotten the same or better assistance free.”

“Nonprofits are not as efficient as the regular market,” said Moose Scheib, head of Michigan-based LoanMod.com, a loan modification firm that charges homeowners $1,500 to help renegotiate their mortgages. “I think the difference is probably more attention you get from us.”

“Once a borrower pays an unscrupulous loss-mitigation consultant and time is wasted, the damage has been done,” said Sarah Bloom Raskin, Maryland’s commissioner of financial regulation. “While we may be able to recover fees, we can never recover the lost time — time that the borrower could have used to work out a bona fide loan modification.”

“We are extremely concerned about the huge proliferation of for-profit companies making a buck on these people,” said Laurie Maggiano, senior policy adviser at HUD’s Office of Housing.

Clayton Sampson, founder of U.S. Housing Assist of Nevada, which launched in July, said nonprofits provide a great service, but added, “We have a lot of clients that need us.”

Sampson said he spent five years at a mortgage brokerage and his contacts have enabled him to customize workout plans for a homeowner’s lender. His firm charges a minimum of $2,500, but he said he would return the money if he was unable to help the homeowner.

Some developments that I foresee in 2009 include the following:

As the number of mortgage delinquencies and foreclosures increase, the loan modification business will receive more scrutiny from state and federal regulators.  I would expect that many more states will introduce tough licensing and bonding requirements for any firm engaging in the loan mod business.

Companies involved in the loan mod business may be required by regulatory decree to provide full disclosure to a potential customer that loan mod services are offered for free by various agencies.

If the number of complaints about loan mod companies grows dramatically, strict federal regulations may be passed.  For example, it is possible that HUD would  require that banks and loan service providers deal only with third parties approved by HUD on any loan modification.

The loan mod companies that remain in business will have to give potential customers a compelling reason to deal with them, especially as consumers become aware of the free loan mod services available.

World’s worst borrowers given astonishing concessions

Bank of America agreed with the state attorneys general to offer astonishing concessions to 390,000 subprime and pay option arm borrowers that will cost upwards of $9 billion, as reported on by the Wall Street Journal.

Summary terms of the settlement with borrowers for loans made by Countrywide Financial include the following:

Mandatory loan modifications are required due to “unfair and deceptive” practices.

Supposedly this action will keep borrowers in their homes, support local communities and the general economy.  Some background here: loan modifications, still off the mainstream press, have over the past year grown into a sizable cottage industry, manned mostly by ex loan officers and former lenders, who for a fee, will negotiate with the borrowers bank to try and obtain a reduction in either or both the interest rate and the principal balance.

Many lenders are now and have been proactively contacting borrowers and offering them a loan modification where it was obvious that the borrower was in over his head.  The biggest impetus to loan mods was by Indy Mac after being taken over by the FDIC where 38,000 borrowers were sent letters offering to reduce their payments by either rate and/or principal reductions.

Loan mod results to date have been uneven, and each lender has been individually offering concessions where they see it to be in their best interest.  To date, most of the loan mods have been an interest rate reduction since the mortgage investors are hoping that eventually property values recover and their write downs will be limited.  In cases where only an interest rate reduction was offered, initial stats suggest that only 20% of borrowers are still current six months later  thus necessitating either a foreclosure, recovery, or another loan mod.

I recently spoke to a woman in Massachusetts who had a subprime mortgage with Chase at 12%; after months of phone calls and sending paperwork to Chase, she was given a fixed rate of 1% for 5 years, with the rate to rise in steps to 6.25% at the end of 10 years.   The lender did not, however, adjust the loan principal and she has negative equity of around $80,000.  Whether or not this loan mod works out for both parties is subject to debate.

In an excellent post by Mr Mortgage, a very compelling argument is made that negative equity is one of the prime motivators for payment default by the borrower, regardless of the rate.  Apparently the attorney generals read Mr Mortgage, since the loan mod mandate settlement requires that changes be made to the borrowers loan so the that loan payment is “affordable and sustainable”; thereby necessitating in most cases both a rate and principal reduction.

A Credit Suisse study of subprime loan mods, however,  indicated that over 20% of subprime mortgages in which a principal reduction was granted were 60 days delinquent on their mortgages within eight months of the loan mod, so the success rate is not much different were only a rate reduction was granted.  Keep in mind that all the statistics on loan mods are preliminary and based on small sample numbers over short periods of time since there have not been a great number of loan mods done to date.

Borrowers’ monthly PITI (principal, interest, insurance and property taxes) should not exceed a 34% front end debt ratio.

This means the PITI should not exceed 34% of the borrowers’ monthly gross income.  See my post on Mortgages still being approved for unqualified borrowers) and Unsound lending policy.

For borrowers who took out pay option ARMs, Bofa will reduce the loan amount so that borrowers have as much equity, if not more, than when they took out the loan.

Borrowers will not be charged for the loan mod and any prepayment penalties will be waived.

The mandate that no fee be imposed on the borrower for modifying the loan will make it very questionable from an ethics and business standpoint for the nascent loan mod industry to try and attempt to charge a Countrywide mortgagor a fee to modify their loan, since Bofa will be contacting all the Countrywide customers with no cost offers to modify their loans.

In those cases where the loan is serviced by Countrywide but owned by an investor, Bofa will work with the loan servicer to get the necessary approval for a loan mod.

BofA will send offers of a loan mod to qualified borrowers by December 1 and stay any foreclosure action until a borrower’s eligibility has been determined.

Bofa will provide $150 million to refund some closing cost on the original loan if the borrower is in foreclosure and also provide $70 million of “key money”, cash payouts to help with moving costs.

It is only logical to conclude that since one of the largest banks in the country has agreed to this type of settlement that virtually every other lender and loan servicer will also be required to participate, either by invitation or legislative decree.  Indeed, banking regulators are now calling on every subprime loan servicer “in the strongest possible terms” to adopt a similar loan mod program as possible.

In the rush to “do something”  to address the foreclosure problem, it appears that there is a collective rush to judgment that loan mods are the best manner in which to address the problem.   Superficially, it appears to be a compelling solution to the problem; make the payments low enough so that the homeowners can easily make their mortgage payments.  Every easy solution, however, seems to create unanticipated adverse consequences.

Specifically, the following issues may cause adverse consequences that outweigh the presumed advantages:

1. Moral hazard may be a significant factor.  I talk to many people who would like to refinance but cannot due to insufficient or negative equity in their homes.  Most of these people have good credit and sufficient income to pay their mortgage but many of them (especially with negative equity) bring up the question of whether or not they should stop paying their mortgage and mail the keys back to the bank and to what extent this would impact their credit.

As publicity about the loan mods programs grow, the flood gates could open here especially since there are around 12 million households that now owe more than their house is worth according to Moody’s Economy.com.  Modifying a loan may sound like an easy solution, but the reduction of a loan amount equates to a loss for someone else – a bank, pension fund, insurance company etc.   A reduction of only $25,000 on 12 million homes means another bailout of $300 billion – someone gets burned by this loss and our government does not have an unlimited ability to borrow money.

2. The social backlash and resentment from the 40 million households who have a mortgage but still have equity, as well as from the 24 million households that have no mortgage is going to be tremendous; the consequences will not be positive.

3. Every borrower who has a subprime or pay option arm loan was not a victim; I am sure some did not understand the terms of their loans and there were abuses, not to mention that many of these borrowers should never have been granted a mortgage approval in the first place.  However, most people of reasonable intelligence normally ask about the terms and details of their mortgage and are given numerous disclosures during the loan process and at the closing table.

Why should someone else pay for another’s carelessness with their financial affairs and failure to properly evaluate their actions?   There is plenty of blame to go around here, both on the borrowers part and certainly on the part of the lenders who knowingly made loans that they knew could not be repaid.

4. For a nation that has a tremendous debt burden on every level, loan mods could encourage debt repudiation on a massive level which will cause a further destruction of asset values on a scale too large to contain, which is what is already happening.   Every loan represents an asset to someone else; debt destruction and asset price destruction reinforce each other; the evaporation of wealth (assets) on a massive scale will not help anyone.

5. Many of the buyers of properties in the past 4 years purchased with 100% financing.  To the extent that they now have negative equity, what have they really lost?  They received a free call option on future price appreciation of the property that they bought. Now that the property didn’t go up in value, they are entitled to walk away from their loan obligation or simply default and then be given huge concessions?   I have seen many people that purchased a home with 100% financing come back a year or two later and then take out as much cash as possible with a new first or  second mortgage. My math puts these people way ahead of the game.

6. I have also seen many people do 100% cash out refinances in the past four years, often times using the money for trips,  new cars, consumer goods etc.  Many of these refinances occurred at the peak of the market meaning that they effectively sold their properties at peak prices.  For those now walking away or getting their loan balance reduced, it is their gain and the banks’ loss.

7. To modify the loan so that the borrower has a 34% front end debt ratio is extremely generous.  Most of the new first time homebuyers and mortgage refinances that I see approved have debt ratios above 34%, but the borrowers work hard, struggle and pay.  How is this equitable to them??

8. To reduce the principal on a pay option arm borrower back to his original principal or lower is equally inequitable to those borrowers who borrowed in a more conservative manner with a 30 year fixed rate loan.  Many of the pay option arms had initial payment rates based on a rate of  1% or 2% for a period of years; the real rate fully indexed was typically 6 or 7%,  but the borrower was allowed to pay a very low payment based on 1% and the balance of the interest that was due was added to his loan balance.  The pay option arm borrowers reap a windfall here since they effectively were given a 1% rate compared to the conservative borrower who took out a 30 year fixed rate and paid the full payment on a 6% mortgage.  Obviously, the pay option arm customer had a lot more cash left in his pocket at the end of each month; by my math they came out way ahead.

9. Many of the loan mods proposed will probably not work out since a significant number of the subprime and pay option arm loans were done with inflated stated income (liar loans).  Many of these types of loans would have to have a massive reduction in the loan balance for the borrower to have a comfortable payment since his income was never even close to what was needed to service the loan from day one.  The result would be a ridiculous situation whereby we are rewarding those who falsified their income to qualify for a loan.  How inequitable would this be for the financially responsible borrower who bought a home for $250,000 with a $50,000 down payment next door to the guy who also buys a $250,000 home, “states” his income to receive a 100% loan and now receives a loan reduction down to $150,000??

10. The impact of loan mods on future mortgage lending in this country will be incredible negative.  The government can subsidize rates and we can all pay for this, but investors who previously bought the loans or mortgage backed securities (which support the mortgage market) will either have no interest in this type of investment going forward or require a properly risk adjusted rate which is obviously going to be very high.  No one is going to lend out money when they face a substantial risk of large losses by having their original loan amount and interest rate reduced by a loan mod every time there is a price pullback in housing.  Mortgages have become and will remain an asset class of “extremely dubious value” (see 7. above).

11. Not Everyone Should Own a Home, Wall Street Journal, Janet Albrechtsen. In an excellent article that explains why Australian banks are not bankrupt entities as in America, the author points out the weaknesses in our banking system and the lack of responsible behavior by borrowers and lenders which helped propel us into the banking, housing and credit crisis.

Instead of prolonging our property market declines with constant costly bailouts, it may be wiser to follow the RTC example in the 90’s when the market was cleared by selling foreclosed properties for whatever bid was offered.  Anything will sell quickly at the right price.

Mortgages Still Being Approved For Unqualified Borrowers

With foreclosures at record highs and the banking system in collapse, why would the banks still in business be making loans with reckless disregard to the borrower’s ability to repay? As explained in my post “Unsound Lending Policy“, any mortgage borrower with a high debt ratio (large percentage of income devoted to debt repayment) is usually a candidate for default. The borrower may be unsophisticated or simply over optimistic but it should be the responsibility of the lender to ascertain, using sound underwriting policies, that the borrower has a reasonably probability of being able to repay his mortgage debt.

I am still seeing loans being approved by automated underwriting systems for borrowers with total debt ratios in the high 50’s and just this week another loan approved with a 62% debt ratio. The odds of these loans defaulting are astronomically high since the borrower simply does not have enough income to pay his loans and living expenses. These loans are being approved by “desktop underwriting”, a system where the loan is approved by a computer based on input values. Obviously the software underlying the desktop underwriting that determines whether a loan will be approved has not been updated from several years ago when little regard was given to income, credit or loan to value, since it was assumed that the borrower would simply refinance again or sell the home in an eternally rising property market.

The loans being approved today with super high debt ratios are technically not “subprime” loans since that industry no longer exists; these are loans that will be sold to Fannie Mae in most cases, thus assuring that Fannie Mae will continue to have future foreclosures and a need for eternal government support and bailouts.

The really dark question here is, have the automated underwriting systems simply not caught up with the times or is this an effort to keep home sales up, support otherwise starving realtors and mortgage companies and hope that future rising home prices will keep the high debt ratio mortgages from defaulting? If one chooses not to accept the dark theory, the only other answer seems to be that reckless mortgage lending is still alive and well.

Unsound Lending Policy

Where have these guys been?

This email came across my desk last week from a mortgage lender looking for business.

“More bad news yesterday from the agencies with reduced LTV’s and increased fico’s for cash-out. How can you avoid this latest problem? With a Dream House “combo loan”!

85% cltv with a 650 fico (won’t get there now without a 700!)

No MI required!
DTI to 55%

AVOID LOAN LIMITS and get easier approval with lower LTV 1st mortgage

Call me today for more details!”

Please note that this lender is allowing a debt to income (DTI) ratio of up to 55%. This means that they are offering to lend mortgage money to someone who ultimately will never be able to make the payments on his mortgage, for the following reasons. Calculation of debt to income ratios are a routine part of the underwriting process in determining loan approval, along with credit and collateral review. The front end DTI is the ratio of an applicant’s monthly payment of principal and interest on the mortgage, plus the monthly amount due for property taxes and home owners insurance divided by his gross monthly income. Thus, if the PITI (principal, interest, taxes, and insurance) is $2,000 per month and the applicants gross income (before taxes) is $5,000 per month, the front end DTI will be 40%. The back end debt to income ratio includes the PITI and all other recurring payments for installment and revolving debt, such as credit cards, car loans, personal loans, etc. If the PITI is $2,000 per month and other debt payments total $750 per month, and gross income is $5,000 per month, the total back end debt ratio would be 55%.

If a loan applicant accurately reports his income and has a debt ratio of 55%, he faces almost a certain future of defaulting on the mortgage.

Debt ratios are computed using “gross” income before any deductions for payroll taxes, etc. In this example, the borrower with a gross income of $5,000 will be lucky to take home $4,000 of spendable income after deductions for social security, Medicare and federal income tax deductions. This would leave him with only $1,250 per month for everything else in life such as food, dining, gas, car repairs, home repairs, tuition, medical expenses, life insurance premiums, gifts, clothing, entertainment, etc. etc., you get the idea. If the borrower has no savings, as is frequently the case, one large home or car repair could easily result in a missed mortgage payment. Typically, one missed mortgage payment will easily lead to another until the borrower is in default.

Question???? Why would anyone make a mortgage loan to a borrower with such a high debt ratio? The time tested banking limits on the back end DTI of 32-35% were used for a reason – it prevented the borrower from overextending himself and falling into default. Theoretically, lenders should be able to lend to whomever they wish to using whatever underwriting standards they chose to use. In addition, some borrowers have additional income that they cannot provide documentation for and thus are not able to use this type of income when applying for a mortgage. Therefore, they may have debt ratios that are in reality better than what appears in the formal debt calculation.

The only problem with this rationale is that allowing very high debt ratios is what has led us as a nation into a financial crisis based on easy lending to borrowers who really never had a realistic chance (absent eternal home price appreciation) of paying back the money that they were approved to borrow. Also, it was not a great leap, once you allowed high debt ratios, to also allow approvals of mortgages by applicants with low credit scores and minimal down payments, which totally guaranteed foreclosures for this type of borrower profile.

Given the the large number of mortgage defaults that we already have, I believe that lenders should be constrained in their enthusiasm to make aggressive loans to borrowers who may not fully realize their financial limitations.  In fact, in many ways, lending to a borrower with a verified high debt ratio is worse behavior than the approvals previously given to subprime and altA stated income borrowers since in those cases, at least the lender could look with two blind eyes at the income the borrower stated that they made and say, “ok approved”.  However, approving a loan where you have verified the income and know that the borrower’s income is insufficient is simply irresponsible .