June 26, 2007

Mortgages 101: Rule #1, Read your Mortgage! Riding the Mortgage Default Wave.

News flash. No summer jump for housing. I’ll give you a minute to recover from the shock of this surprising update. And in other news, people don’t read their mortgage applications before signing the dotted line. In this weekend’s LA Times and another article from the Washington Post, some startling data is released regarding mortgage borrowing. A Federal Trade Commission study took a sample of 819 prime and sub-prime mortgages borrowers in 12 locations around the country and found:

· 90% of borrowers could not identify the correct upfront cost associated with their mortgage.

· Two-thirds didn’t realize they would get hit with penalties if they refinanced within two years.

· 80% had a hard time understanding why the APR was different from the loan note interest rate.

This is absolutely startling because the data gathered came from prime and sub-prime borrowers. The sample size is also significant because it shows a decent representation of what is occurring in the current marketplace. I find it fascinating that those in the housing industry seem to take no issue with the above numbers. The line in the sand is being drawn. On one side, you have resolute bears that will refuse to pay current prices and are waiting for prices to reflect market income and rental rates. On the other end, you have housing bulls crying “personal responsibility” regarding buyers and echoing a continued growth in real estate appreciation. I can see both sides of the argument. However, when you have housing bulls saying a buyer knew what they were getting into and therefore are directly to blame (the above data shows they did not know what they were getting into), this pretty much shakes the foundation of their argument. After all, now that we factually know the vast majority of buyers do not know even minor details of their mortgages, do we continue turning a blind eye to this financial negligence?

What about personal responsibility for the mortgage industry? I guess they see it as a one way road. We have the mortgage industry committing outright consumer fraud and malfeasance by placing borrowers into homes they know that sometime down the line, they will be unable to afford. In some cases we are actually having lenders taking borrowers out of fixed conventional loans and placing unknowing buyers (aka see aforementioned borrower stats) into risky interest-only or other exotic mortgage products. Somehow this seems okay. And we wonder why foreclosures are rocketing up to the moon? Some would like you to believe that a trillion dollar mortgage industry should be held to the same standard as a financially irresponsible buyer making $25,000 a year getting into a $500,000 Real Home of Genius. You’ll never hear the real estate syndicate talk about a fiduciary responsibility because they have thrown that concept out of their lexicon. The consequence for the borrower? They lose their home and are financially screwed for many years. The consequences for the mortgage industry? Only time will tell but last year “bail-out” talk was being thrown about in the Senate. Guess who will pay this bill? The tax payer. Do you pay taxes? Unless your name is Wesley Snipes, you probably do. So in essence, the ridiculous irresponsibility of Wonderland lending will come home to roost with you regardless of whether you played into this housing bubble or not. The mortgage industry’s shenanigans will bring a collective cloud on the entire public.

The Elephant in the Room: Lending has become a Pure Sales Industry.

Local banks used to have a stake in the lending that occurred in their neighborhood. You actually had to go to your bank (physically) and meet with a representative to go over your financial statements. They would look at your income, W2s, bills, and financial statements to ensure you were a qualified buyer. And if all else failed, underwriting was more restrictive because you actually had to have a down payment. During this bubble, you literally could make up your income to jump into a home. Make up your income? Stated income baby! No interest-zero-down cash-back-loans amigos! Taking a page out of 2nd Life, you literally could reinvent yourself in a pseudo-reality made up by your own definitions. Anyone that has a sense of finance only could stand back as a spectator and wonder what the hell was going on. And a major problem is local banks passed the buck all the way to Wall Street and decentralized mortgage buyers. No longer did the local bank have to fit the bill if you went MIA on your housing payments. What do they care if you foreclose since your mortgage is now chopped up like hamburger meat and floating around in some hedge fund in China yielding 8%. At least that is until the market came to a screeching halt.

Companies such as New Century Financial bit the dust because of first and early payment defaults and were forced by Wall Street to eat some of their own crap. What happened when they got these notes back? An implosion. Mortgage insiders and even speaking to a few acquaintances in the know, sub-prime outlets operated as boiler rooms. A white board was on the wall for all to see and literally a competition of who could sell the most loans ensued. The riskier the loan the bigger the commission. And all this could be done via the phone and over the net. You can electronically sign and send statements to some lender operating half way around the country. I’m sure an Orange County lender knows market conditions in Oklahoma City. What do real estate agents say? Oh yeah, location, location, location. Apparently the industry didn’t take note of one of their key rules.

Wall Street hungry for these loans devoured anything that was sent to them. The pressure spread from aggressive outlets and affected the bottom line including your local bank. So instead of putting pressure on regulators to enforce basic financial laws, they decided to join the ongoing credit orgy. Now, you can go to your local bank for a mortgage, a credit card, mutual funds, and open up a savings account all under one roof. Although savings account are pointless since America as a whole is in a negative savings range. Why save when savings rates are at 1%? So bank representatives suddenly became sales folks trying to sell you on multiple products. A Jack of all trades, but a master to none. At least previously, there was some implicit understanding that your bank representative needed to evaluate the risk you posed to the bank. If you foreclosed, your home was an REO and you look like a retard for lending $400,000 to a person making $20,000 a year. You probably lost your job for being so incredibly irresponsible. Now, the mortgage has been sliced and diced so many times that no one really knows who holds your actual note (chances are no one fully since it is morphed into a derivative and is essentially a collateralized debt obligation). Fancy words for spreading the crap so thin that it eventually smells like roses.

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Mr Vincent said...

My, uh "friend", who works in the lending business for a very large bank, said the following to me:

"Most borrowers over the last few years told me that they don't care how we do it, just get us the lowest payment possible."

The lunacy ran both ways.

Dr Housing Bubble said...

mr vincent,

I want $10 million dollars but doesn't mean I'll get it. The scary thing in the last few years people were able to get $500,000 regardless of their financial situation. You are right, the craziness runs both ways.

I'm not sure anyone knows exactly how all this will play out. Obviously we know the buyer will get hammered and foreclosed upon. But once the market hits and news spreads, then what? Now standards for loans aren't so lax. It actually has become harder to get a loan even from early this year. Does the market crash or progressively trickle down? I've looked at previous real estate cycles and the market decline has been sticky. Yet the magnitude of the current housing market has no parallel in history.

I still think that we'll see some wacky behavior throughout the summer because people still believe the summer bounce will hit so you'll see a split market. Those in the industry that are seeing actual numbers may have a different perspective than a would-be seller looking at sales data from 2005/2006.

Bob from Brooklyn said...

Take a look at Minyanville, TheBigPicture, etc. for a "map" of the states affected by subprime...

Funny and not so...

Socalwatcher said...

You hit an interesting point:

The execs knew that these junk mortgages woud be sliced into confetti and as long as it stays in effect long enough (which from first payment default to actual REO status is long enough) it winds up in so many different places as CDO's and other derivatives, the track back of the fold up is not going to pose much consequence. The problem is that these sub-slime lenders took so many that the became drunk on their own profits. The wave that hit China's stock market really rippled this entire market. Interesting to see how this unfolds when large funds like Beart Stearns is crying Uncle from the half nelson that Morgan Stanley is inflicting right now.

Brian B said...

I love your analogies. Wesley Snipes and Second Life in the same blog? Great stuff. I have to say that this rubbed off on me. I was in the middle of reading your blog when a friend called to tell me how he almost screwed up really bad with his girlfriend and broke up. I said, "You almost went from hitting home runs in the ballpark to selling beer in the grandstand." I had to laugh because this was truly spontaneous and only happened b/c I was reading your blog. Ha.

A serious question now. I was in a real estate seminar and the speaker said that a big problem with some loans is finding the person to sign off on the sale. Since the mortgages have been chopped up so much that finding the current lender can be tough. They almost had a deal fall through and then at the last minute the lender from India called and signed off on clearing the seller's loan. Is this legit? I know my house loan was immediately sold to Wells Fargo. But they are in the US and I know where the check goes. People in the US aren't sending mortgage payments to China or India, so how does that work when China and India invest in CDOs in the US? If the deal falls through is Wells Fargo responsible or does the investor in China take the hit?

I might be able say witty stuff at the drop of a hat now, but some of this other stuff still confuses me.

Anonymous said...

Heya Brian B. I did a refinance in 2004 and my loan was "resold" to Citibank. Although I actually assume Citibank is the owner of my loan I have recently found out this may not be the case.

If, for example, you were starting your own hedge fund and wanted to invest $100 million in mortgages, you can go out and buy those loans. However, you wouldn't want to be the person that thousands of people sent their loan payments to (in addition to handling late payments, etc.). This is called "loan servicing."

I recently read that Countrywide was making a lot of revenue in loan servicing meaning, although Countrywide doesn't hold the paper, they provide all the billing and management of mortgages.

So, there is my long winded comment on your comment. I would love a second opinion from the Doctor though.

Greg (Mighty Mortgages) said...

Very sound advice. I hope the home buying public takes a minute to really absorb what you have written and that is doesn't fall on deaf ears.

Anonymous said...

Hate to say it, but earlier this year, I was one of those borrowers telling my mortgage broker, "Here's the payment...just make it work." I completely understood concepts like teaser rates and interest-only periods, but I was assuming that the house would continue to appreciate. The idea of ending up underwater never even occurred to me. Listening to the realtors and MSM, is it any wonder? Luckily the deal fell through and I found this blog!

Anonymous said...

The older I get the more I realize that we are surrounded by idiots, rich, poor, educated, uneducated, it doesn't matter. Stupidity runs to all walks of life especially when it comes to money. One of my neighbors was actually PRE-paying his INTEREST on his mortgage every month. He paid his mortgage and instead adding some extra money to the payment to pay down the PRINCIPAL of the mortgage, and so shorting the duration of the mortgage and interest paid overall, he added $200 a month to the payment and prepaid the interest! When he told me first I thought he used the wrong word and I tried to correct him, saying you certainly mean paying down the principal, like I do, meaning with every extra dollar I pay towards the principal of my mortgage, this extra dollar lowers the mortgage principal and doesn't generate interest for the bank the next time around. What good would it do if you pay down the interest?
Nope he was exactly doing as he told me and started arguing with me and I gave up trying to save him from himself.
Nevertheless, here is an idea why the home prices are not going down right now and I don't know to what extend it applies to the general home owner population. I know several people who are sitting on huge housing appreciations, they bought the house 5-6 years ago for around 290-340k and now they are selling for 650-780k in the same neighborhoods, (they are actually selling there) but here is the kicker, these people DO NOT have to sell and several I know DONT WANT to sell. They don't care about whatever value, realistic or not, their houses have. They are no desperate, have the right mortgage and love where they are living. Just a thought.

Myself, I am still a home owner! For some reason whenever I rented I ended up with a piece of shit landlord, who never did anything, cried to me when the 40 year old furnace broke and ripped my security deposit off, even after I left the place in better condition then when I moved in. I always bought the cheapest house in the best neighborhood, sounds like a cliché, but it's still out there. Location, location, location and not overpaid in the first place.
Right now I am living in a wonderful house with pool which I bought for over $100,000 less then my neighbor, who closed 2 months before me. For the 100k less I got a pool and hardwood floors and other great upgrades. It was just a matter of negotiation, if you don't ask you don't know. For me, not to have a landlord counts for a lot, I bought the pool for myself not expecting to get any money out for this when I sell. Bad investment? Not for me, my wife and I are living in a cash economy, no debt and 20% of our income goes to retirement savings. I am not a “home debtor”, I have a comfortable mortgage, fixed and similar to rent. Frugal is the motto, not cheap.
Most “home owners” nowadays are not “home owners”, they are gamblers, even if they did not intent to flip or make a killing in the first place.
It is the instant gratification, consumer mentality which creeper into our daily life. It's no longer the shiny rims and idiotic cars they buy on credit, now it's houses they cannot afford and most of all it is these amateur “investors” (really stupid Las Vegas gamblers) and fly by night mortgage brokers who should be prosecuted for their fraudulent behavior. Let me give you an example:
Single woman, 3 house, zero down. First house 775k, second house 820k, third house 36k. All three are in foreclosure. I wrote HUD, I called my representative, I called the Attorney General. Nobody is doing anything against this fraud! This is only one example, I have many more. Disgusting.

Anonymous said...

"The pressure spread from aggressive outlets and affected the bottom line including your local bank. So instead of putting pressure on regulators to enforce basic financial laws, they decided to join the ongoing credit orgy."

So true. I offer the following anecdote as illustration.

My wife and I prefer to do our banking with credit unions, since (we assumed) they make member needs a high priority and offer more attractive rates and terms than the commercial banks.

But when we talked to the mortgage department of our current credit union (a Portland, Ore.-area one that has historically served teachers) to see if they could finance our recent house purchase, they only offered adjustable-rate products. Same with another large local credit union we were eligible to join. They claimed these were in the best interest of first-time buyers in a still-hot Portland market. We were skeptical, since ARM rates were not as good of a deal compared to fixed rates anymore.

But we chalked it up to some sort of regulatory or capitalization issue that prevented them from offering fixed-rate products. We actually got a better deal from a large commercial bank (30-year fixed with an attractive rate) than our "member-driven" credit union.

Come to find out in December that our credit union formed a joint venture with Countrywide Financial to sell and manage its mortgages. I question both their timing--the subprime implosion was just getting underway, and Countrywide does have a large chunk of subprime business--and their motivation in aligning themselves with a sketchy player in the mortgage industry. True, less sketchy than others, but sketchy nonetheless (given the rumors about a federal investigation into their subprime business).

"Member-driven" indeed.

Anonymous said...

I'm renting in Rancho Cucamonga and my landlord really doesn't show up much nor do anything for me even though I respect his property and I have a housekeeper keeping the place really clean.

However, it still makes financial sense right now to rent. Even if I spent several hundred dollars per year fixing/replacing the broken stuff on my own, I'm still WAY ahead financially than if I would buy an albatross (ie house in Rancho Cucamonga) right now.

I agree some sellers are not desparate but I would guess that the vast majority of people who put their houses on the market actually DO want to sell them. At some point prices will go down because of inventory being so high with oodles of houses that are on the market (regardless of weather or not the sellers really want to sell). It is interesting how many listings have "motivated seller" and "bring all offers" and "seller willing to consider all offers."

Why not "seller selling" or "this house really for sale" on the listing... those words are about as useful...

If you believe the listing comments, pretty must there are lots of people who really want to sell.

Oh, by the way, maybe houses are still closing where you live, but in the IE, houses in the range you stated 650-780K really have come to a standstill in the IE. I hope the standstill continues for many many more months until home sellers figure out that their massive greed will fail them. If they want their houses to sell, lower the price!

Anonymous said...

...After all, now that we factually know the vast majority of buyers do not know even minor details of their mortgages, do we continue turning a blind eye to this financial negligence?...
I have a major issue with your post here and how you look at this issue.
I am a LEGAL immigrant and now citizen. I came to this country 15 years ago, barely speaking English and almost no money, virtually.
Anybody telling me that people did not know what they where signing is utter BS for me and they are getting what they have coming to them.
I have little sympathy for these people, I learned English on my own dime, stopped speaking my mother language completely for years so I could be successful in this great country, worked my ass off for minimum wage, never cheated on my taxes and paid them and finally was able to get a professional job paying top dollar. Looking back the last 15 years, this country has become a country of whiners, head in the sand morons who feel great about themselves voting on American Idol by the millions and cant get their obese ass out the door to vote in elections. Common courtesy is completely gone and any fringe perversion is suddenly acceptable everywhere in our society.

Anonymous said...

I like your blog - it is part of the list on housing that I look at almost everyday. I also think you are right about the correction that is starting. I don't, however, believe that all these people did not know. From my own experience people have very selective memories about this kind of thing. When it goes well they are brilliant - when it doesn't they were duped. Of course many people are going to plead ignorance. Its a way of life - avoid accepting responsibility at any cost.

I have done many mortgages over the years - all repeat and referral. Almost all my borrowers are set with good mortgages. I've been telling everybody for the past few years that this is coming. No rocket science in that.

Two notable exceptions come to mind:
Started with a couple approx 7 years ago - put them in subprime - paid off all debt - gave them instructions not to run up debt again etc. worked them up to a 5.something 30 yr fixed when rates were good like that - they then divorced and one of them wanted to keep the house and the other wanted cash - explained that the only way to do this was to go into a loan that I did not like and up until then never did - person wanted it and had to have it. Now when it is tough I get a call and the person pleads ignorance - "I didn't know this was what I got" - I went back over our discussions and emails - and the person then has to admit that we went over this Very carefully.

The second is a man who uses mortgages to keep the wife's business afloat. Did several mortgages for them - cleared up debt - suggest they scale back. Things get better then he buys a bigger house, not using me and getting into really hot water. Calls me later and needs cash and needs to get out of the really bad loan. I explain what we can do but that he needs to keep the loan for 2 years so we can then get him into something better. Go over everything very carefully. Get a call a year later -he is refinancing with someone else and "Didn't Know." I went back over this with him, reminded him that the plan was to live within the means for two years so we could get him into a 30 yr before the correction - I know he took the new loan, paid the prepay and is probably one of those people claiming ignorance again now that he can't keep doing this. These are my experiences with "I didn't know."

You have a good point to make with your blog - and the reality is bearing it out - you don't need the hyperbole and hysteria - that just hurts your credibility and makes you less interesting to read. Let the lenders and the regulators play the finger pointing game - you don't need that since there is so much substance in what you have to report.

socalwatcher said...

How many of those people who were calling out "bitter renters" who laughed and bought in the last few years are seeing resets that possibly will make them different kind of "bitter renter"?

Anonymous said...

I just love the "Las Vegas" syndrome a lot of borrowers have. They always tell you how much their mother or they them selfs won in Las Vegas, 5k 10k and so on but never talk about the money they loose there, they just forget conviniently.
It's like the guy who makes a million a year but spends 2. After having 6 mortgages in my lifetime I can tell you that I always knew what I signed, always. Come on, give me a break, I like your blog but it is time to point the finger in the right direction and stop making excuses for these idiots.

Anonymous said...

I think one lesson here is the read what you sign, despite what the salesperson (aka loan broker, home builder, real estate agent, etc.) is telling you. Buying a home is an emotional event and it's difficult for the average person to really be objective about the whole process. Blame whomever you want, but most people are going be negatively affected by this mess. Even though I sold at the peak and have been waiting and saving, I know I will have to pay a much higher interest rate to as the amount of credit shrinks over the next few years. Two-thirds of our economy is driven by the consumer so I'm sure our economy will take a huge hit now that the ATM/house is tapped out.

bear cave said...

@ anon 6:56PM:

While I agree that these people should have read their loan, I am going to hammer home once again that loan agents, RE brokers, and others in the financial services industry have, by definition and by law, a fiduciary duty. An example of this would be Anon 6:24 PM: he says that he carefully explained the terms of loans to his clients. If, after in his judgment he has made an adequate attempt to elaborate in understandible terms what the loan does and possible pitfalls, then he has cleared his fiduciary duty. His clients decided, with full cognizance, to make what he explained were not good choices.

If you hire a lawyer to go over a contract, hhe may not use language you understand in the contract, but if he doesn't explain it to you, he's a shit lawyer. These people are highly paid not just because they understand the terms and skills of the industry, but also because they operate as their clients' representative and have a professional responsibility to explain to their clients.

By the same token, i generally think the abandonment on this part of professional responsiblity and fiduciary duty is really just a part of a larger phenomenon socially. We just don't care about social impacts any more (not to be a lefty necessarily, consider the impact of, e.g., section 8 housing and other poorly-thought-out welfare programs)... the idea of operating in one's "enlightened self-interest" has degenerated into "immediate self-interest": Buy a house NOW. Close that mortgage that'll fail next week TODAY. Etc. Wall Street has been good at using CDOs and other derivatives to simultaneously profit from these things while minimizing the larger impact, but it's catching up with us.

I wouldn't be surprised if in the next twenty years we see a social change as big as the one that followed the great depression. Get out your surfboard and get ready for the K-Wave, yo.

Anonymous said...

Interesting blog, but you can't save people from themselves.

Some people are too ignorant to increase their net wealth.

You've got people who can't make a nickle, those that can't save a nickle no matter how much they make, and those that save / increase their net wealth no matter how little or how much they make.

So to all those who screwed up on the housing bonanza of 2002-2006, your just blew your retirement, but on the bright side you would have blown it anyway, eventually.

In a few decades you'll be greeting me as I walk into Wal-Mart and watching me pay for everything with interest from my investments.

Dr Housing Bubble said...


Loan servicing is a big industry. That is a topic I will cover in a later post. I have an acquaintance that works for a sub-prime outlet that was recently bought out. You know what most sub-prime lenders are now saying? “I’m going to jump into the foreclosure industry, that’ll be the next big thing.” Little do they understand that when credit tightens, most investors come in either with cash or solid credit. Plus, you have to possess strong intestinal fortitude to buy a home in a market hemorrhaging with foreclosures. And the market has a lot of trimming to do because in down markets, there are less sales. Less sales equals less loans. Less loans equals less work. Somehow, they forget to connect the dots.

I may have been a bit unclear on this post. In no shape or form am I saying a buyer is not responsible for signing a note. They signed the bottom line therefore, they will live with the repercussions of over paying for a home. As someone commented, they were the one’s pushing for a riskier loan product and not the bank/lender. And I appreciate the comments from both sides here. Yet the reality does show that we are facing another $500 billion in loan resets this year alone. The mortgage backed securities industry is enormous and will have an impact on the overall economy. The largest contributors to both political parties are part of the housing syndicate. Let us not forget to connect the dots here either:

Top Political Action Committee Contributors:

National Assn of Realtors $3,752,005
National Beer Wholesalers Assn $2,946,500
National Assn of Home Builders $2,900,000
National Auto Dealers Assn $2,821,600
Intl Brotherhood of Electrical Workers $2,796,875
Operating Engineers Union $2,784,435
American Bankers Assn $2,748,299
Laborers Union $2,687,150
American Assn for Justice $2,558,000
Credit Union National Assn $2,412,853

Funny how we also have a beer association here but that is a different topic altogether. Personal accountability is a hot topic. The punishment for a buyer getting into an over priced home? Foreclosure and ruined credit. Punishment for irresponsible mortgage lending? I would only hope that we let the system of capitalism let the irresponsible sub-prime outlets be flushed out of the system. The standard should be the same at both ends.

Anonymous said...

You forgot to mention that Hillary and Libermann and the rest of the democratic and liberal bunch are the top takers of these organizations...

Anonymous said...

"Loan Originators Needed. No Experience Needed!"

Haven't seen this mentioned, but oftentimes, it's the blind leading the blind into these ditches.

Yeah, right.

1) Go over the compensation plan.
2) Fill out your new hire paperwork.
3) Go over the compensation plan.
4) Meet your new fellow employees.
5) Go over the compensation plan.
6) Get on the phones and sell yourself.

If you've got the time, call around and ask a few loan officers about basic mortgage terminology and see what you get.

Dr Housing Bubble said...

anon 1:10,

I didn't forget to state anything. Check your facts. The NAR and NAHB are the largest contributors to the Republican party. Either way, both parties are guilty of taking massive contributions. They eat from the same buffet. We need a legitimate 3rd party to contend with these folks. And really, what do you mean by "liberal bunch"? Specifically, what defines a liberal and a conservative in your eyes?

anon 7:36,

This is what happens when their are low barriers to entry and high rewards. It'll bring the good, the bad, and the ugly. On a few deals, I was working with brokers that didn't realize the title company needed to check certain documents before closing. Other states aren't so kick back as California and they were confused as what to do. "This is where you ask me for my income statements such as W2s, 1099, etc." I had to tell them.

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