A Requiem for the Loosest Mortgage Terms

"No."  It's a simple word but one that hasn't been heard from a lot of mortgage lenders over the past few years. 

Beginning with a period of historically low interest rates set by the Federal Reserve which dovetailed into the [ed: snark alert] almost artistic creativity in developing high-margin products for people with marginal credit looking to buy a house, lenders haven't had much of a reason to use the word which must not be spoken aloud to a customer.

Altos Research writes about trouble staying in business at subprime lenders New Century Financial and Fremont General.  And another subprime darling, Novastar Financial has seen its stock do the windsheer formation.

Bad credit, no credit, no money, no problem, right?  The tide is turning...

Who Wants to Buy a Time Bomb?

Lenders really haven't had any reason to say "no" to even the riskiest of loans.  After all, most lenders don't keep these high risk loans in their own portfolios; they parlay the expected payments on that loan into cash upfront.  How?

By selling them.  They do a lot of these loans and, with the information they've learned, they know how much money each one makes on the average.  Then they slap a price tag on a bundle of these mortgages, turning them into securities which can be bought and sold.

One huge customer, Freddie Mac, is changing its buying habits starting September 1, 2007.  And that means lenders have to change the products they sell.

"Liar Loans"

Once upon a time, you needed to document your income and assets in order to get a mortgage.  While this was generally a reasonable practice, many self-employed people and folks who were mostly paid in cash had great difficulty getting credit this way.  So, the industry developed "No Income, No Asset" NINA loans (where no documentation required) and "Stated Income, Stated Assets" loans to ease this burden.

Today they're called "liar loans" for good reason and are often used to inflate the amount of a loan over what people can get with their actual incomes.  This also implies that the borrower has targeted a house he can't really afford.

The Difference Between Dangerous and Deadly

That's no problem though because the lender can get you into that house.  The option ARM they use isn't deadly because of the negative amortization or pre-payment penalty which make them only dangerous. 

They're deadly because you can be qualified for the loan based on the lowest monthly payment --- the negative amortization option where you owe more than you did the month before even if you paid the minimum balance.  So you can't actually afford the house even though you successfully receive a loan for it. 

The problem is that the reason why you qualified for the loan goes away after the initial rate expires and the rate resets causing the monthly payments to jump.  The teaser rate is so low that this rate increase is inevitable, making it a ticking time bomb.

Are Loose Mortgage Terms Dead?

That word cannot be spoken, but there is definitely a market shift.  Freddie Mac will no longer purchase NINA loans and is restricting the criteria for stated income loans.  They're developing a hybrid ARM which has a more gradual increase using longer fixed-rate periods and more time for rate resets. 

Their underwriting requirements will be strengthened as well so that these loans can only be approved if the borrower qualifies at the fully-indexed rate, equal to the benchmark rate used to set the price of the loan plus the margin the lender takes.  The bar is higher because being able to make the minimum payment isn't enough to qualify for a loan purchasable by Freddie Mac anymore.

Also, Countrywide, top dog in the U.S. mortgage lending industry, said that their wholesale business channel won't be offering any more 100% loan-to-value (LTV) ratio loans anymore.  Other major lenders like Washington Mutual are requiring at least 5% down and aren't offering piggy-back loans to cover the difference anymore.

Seriously, Are Loose Mortgage Terms Dead?

No, loose mortgage terms aren't completely dead, but then again, I'm old-fashioned.  Even as a real estate agent, I think there are times when you shouldn't buy a house and there are other times when people make it easy to lose their house. 

Folks need to be careful with how much they can afford financially and psychologically so that they're quality of life really is as good as the American Dream makes it out to be!