Before: Fraud and Deceit

Many analysts have cited a lack of significant regulation of mortgage brokers as part of the reason why the housing market was able to explode and then collapse a few years ago. With little oversight of mortgage industry workers, many of the following practices were common:

• Broker kickbacks: Some mortgage brokers were reportedly financially awarded for originating more expensive loans. For example, even when a borrower could afford a prime or fixed-rate loan, brokers saw more pay if they issued a subprime or adjustable-rate one.
• Insufficient documentation: Some brokers pushed “stated income” loans (also known as “liars’ loans”), which meant that they could make up any number for a borrower’s income without proof. This allowed borrowers to qualify for more expensive loans than they would have with documentation—because most of these borrowers couldn’t realistically pay for such loans, and eventually defaulted.
• Contract dishonesty: In some instances, brokers reportedly took advantage of non-native English speakers to deceive them about the terms of the mortgage, pushing them to sign when they might not have otherwise.

Of course, many mortgage brokers did their job honestly and well—and the new regulations aim to make sure such brokers become the norm nationwide.

The New Rules

As part of the response to the damage caused by the real estate market’s fallout, Congress passed the Secure and Fair Enforcement for Mortgage Licensing Act (SAFE Act) in 2008. Now, various government entities have released rules for mortgage brokers so they can comply with the regulations outlined in the law.

These rules include the following:

• Mortgage brokers must add their names to a nationwide registry in order to legally work.
• Part of the registration process will include fingerprinting and background checks for everyone interested in registering.
• Mortgage brokers will be required to submit to credit checks, complete education courses and pass both state and federal tests to continue performing their jobs.

The aims of these rules are to eliminate fraudulent practices in the mortgage industry by better regulating those who participate in it. Sources note that as many as 30 percent of brokers who have already taken the government test have failed, suggesting that those who remain will be well-qualified for their work.

Additional Resources

Secure and Fare Enforcement for Mortgage Licensing Act

A recent study shows that approximately 16 percent of triple-A rated subprime-mortgage bonds should not have been rated that high, even with only the information the firms had at the time.

The study cited in the article set up a model to test how a reasonable person, not an expert, would rate the same bonds that lead up to the financial crisis. The model considered only factors that the rating agencies considered: house prices, credit scores, income, debt levels and the amount of documentation borrowers provided.

For the second quarter in 2007, the model found that 71% of the sample portion should have received triple-A bonds, but in reality 84% were given that rating. The validity of the test is shown when it is revealed that when the same test was run with the information for the second quarter of 2005, both the test portion and the actual rating were given nearly the same number, around 80%.

The article gives a couple of possible explanations for why there was a 16% difference between a model made to be favorable to the lenders and what actually happened.

First, that the firms were taking a long-term view. By taking a long term view, the firms would ignore current trends in favor of the larger movements. If the firms took this view, they would overlook housing prices. This, on its own, would not have been enough to account for the full 16% discrepancy, however.

The second option could be that the ratings agencies reacted slowly to poor mortgage performance, such as foreclosure. And the third was that the ratings agencies inflated their ratings to get more business. At this time, rating these investments was a large portion of the agencies profits.

None of these options are good, particularly not the last two options. Clearly the market did something wrong when we are hoping they just screwed up, and not that there was any intentional manipulation for profits.

This study will become another piece the government considers when it decides how to deal with the problem of overrated mortgages. There does seem to be a problem where the system gives the ratings firms an incentive to give a high rating. The higher the ratings given by the firms, the more people the banks could lend to.

So the lending firms would be allowing the banks that hired them to have more business by giving these positive rankings. The question we are left with is: what is the alternative?

Life of the Loan

Fixed-rate mortgages come in a variety of lengths: 15-year, 20-year, 30-year and even 40-year, though 15-year and 30-year tend to be the most common. Naturally, each has advantages and disadvantages.

• 15-Year Mortgage: These loans have the obvious advantage of being short—you’ll own your home in the shortest amount of time possible, assuming you make all your payments on time. Plus, you have a good chance of having both a lower interest rate and less time for the interest to accrue, meaning your loan will be significantly less expensive. The main disadvantage here is that your monthly payments will be higher than with a longer-term loan, which means an unexpected expense could throw a wrench in your home ownership plans.
• 30-Year Mortgage: These loans tend to have lower monthly payments than 15-year loans, but higher interest rates. Plus, the interest will accrue over a longer period of time, meaning you’ll pay significantly more for your house. However, you’ll have the option of overpaying your mortgage every month that unexpected expenses don’t get in the way, which, in the long term, could mean substantial savings.
• 40-Year Mortgage: Some lenders may claim that this is the “new normal,” but 40 years is probably too long to stretch a home loan. If you can’t afford your home in 30 years, it’s likely too much home for your budget.

The post at FiveCentNickel.com goes on to crunch some actual numbers to give an idea of what your options might be in a real life situation, and it’s worth a look to see the potential costs of buying a home spelled out.

When you do find yourself in the market for a house, though, keep in mind that the financial meltdown that led to the current recession began in the real estate market. There are a lot of complex mortgage products still on the market, which means you must do a lot of research before committing to one or risk losing your investment to foreclosure.

Additional Resources

Dreams Foreclosed (PDF)

How the Foreclosure Crisis Started

During the real estate bubble, mortgage lenders eagerly underwrote home loans because credit was easy to come by. But:

• Many loans had adjustable rates, meaning that monthly payments would adjust (usually upward) after a certain period of time.
• These loans seemed like a good idea because home prices had risen steadily and people assumed they’d continue their upward climb. When the higher payments kicked in, many borrowers figured, they’d refinance or sell their home for a profit.
• The rising prices were part of a bubble. When it burst, home prices plummeted.
• Many borrowers were left owing more on a house than it was worth and unable to sell their homes, refinance or make monthly payments.
• The adjustable rate mortgages began resetting and many people’s monthly payments shot up.
• Layoffs began plaguing the country, meaning that many people lost their income, making difficult monthly payments impossible.
• Without making payments on their houses, many families found themselves forced to leave their homes because of mortgage foreclosure.
• The glut of houses on the market (both new and abandoned by foreclosure victims) mean that prices have dropped even lower.

Why Modification Programs Aren’t Working

Naturally, the government is aware of the foreclosure situation (it’s hard to ignore the 2.8 million citizens threatened with foreclosure last year, or the 3.5 million predicted for this year) and has taken steps to help homeowners. But, according to the report, many efforts have been sadly under-successful.

The Bush Administration’s HOPE Now fell far short of its stated goal of helping some one to two million Americans modify their mortgage loans, and the Obama Administration’s HAMP (Home Affordable Modification Program) has been only slightly more successful, it seems. Here’s why:

• Some of the criteria for qualifying for a home loan have not been made public, thus people whose applications for modification are rejected don’t know how to improve their chances.
• Foreclosure and modification proceedings are carried out by different groups – groups which often don’t communicate with each other.
• Many temporary modifications have been issued, but do not guarantee homeowners long-term solutions for their mortgage woes.
• Many lenders stand to make more money from moving forward with foreclosure than opting for a modification.

The article explores various facets of the effects this problem has had and continues to have on the American economy, and is worth a read. Meanwhile, if your home is in danger of foreclosure and a loan modification is not on the table, you may want to consider filing for Chapter 13 bankruptcy, which could at the least postpone foreclosure for several years.

Additional Resources

Report: Why Servicers Foreclose When They Should Modify (PDF)

By the Numbers

Here’s a closer look at this worrying trend, which some experts reportedly believe could slow the housing sector’s recovery:

• The total number of households with underwater mortgages comes to nearly 10.7 million, close to one in four homes.
• Insiders apparently expect home prices to bottom out in 2011, meaning that the number of underwater homes is likely to increase between now and then.
• As many as 5.3 million homeowners currently have mortgages worth at least 20 percent greater than the value of their home.

So What’s Going to Happen?

Clearly, underwater mortgages are problematic, but how will they affect the economy and the American people? According to sources, in a variety of ways.

• Decreased mobility: People with too-hefty mortgages may find themselves tied to their house because they aren’t able to sell it to pay off their loans. This could mean not being able to move a significant distance away, even for a high-paying job offer.
• Delayed recovery: Some of the underwater houses are likely to go into foreclosure—indeed, some owners have reportedly already received default notices from their banks. If and when banks foreclose on these properties, more houses will be on the market, thus adding to the current real estate glut and potentially keeping prices low.
• Conflicted lenders: Some lenders are apparently reluctant to reduce principal on mortgage loans for fear that the move would set up expectations for all borrowers and lead to widespread abandonment of payments.

As with many of the aftershocks of the mortgage industry’s collapse, those hardest hit by underwater loans live in the states that were hotbeds of speculative and explosive real estate development during the boom: Florida, California, Nevada and Arizona.

Additional Resources

FirstAmerican CoreLogic’s June 2009 Report (PDF)