Dennis' Mortgage Blog

One interesting phenomenon I have noticed in the past couple of weeks with the credit/liquidity crunch in the mortgage markets is in FICO scores: they appear to be dropping for those with derogatory credit.

Quick tutorial/reminder on credit scores: they are generated by computer models that analyze millions of credit users in several categories. Using the past credit of consumers and their current credit the score is a predictor of future credit behavior. The higher a consumer’s score the lower the risk to a creditor extending credit to say buy a home; and conversely the lower the score the higher the risk of default or late payments.

Recently I have seen several clients with derogatory credit on their reports whose scores have dropped, even though their current credit is better than previous reports with more derogatory information. Example: Jack and Jill came to me in the spring, we ran their credit reports and they had on them a bankruptcy from 2006 and several accounts that were reporting late payments through the bankruptcy. Jill contacted the credit bureaus with copy of her bankruptcy filing and had the late payments all removed. As well they paid off a few accounts and lowered the balance on others. In the past all these positive changes to their report would raise Jack and Jill’s scores. Not this time, they went up. I have had a few clients in the past month or so where this has happened—some delinquencies from the past, activity on the report that in the past would result in a higher score but today showing scores dropping somewhat significantly. Why?

Because Fair Isaac (FICO) and other credit score models use past behavior and results to predict future performance the models are reinterpreting scores in light of the increasing number of mortgage lates and defaults being reported to the bureaus. The software programs are now receiving significant data on mortgage payment delinquencies that have been missing from the statistical analysis for the past decade or so (almost the advent of credit scoring in our industry). With refinement of the software programs and increased analytical capability of the software and hardware the credit scoring companies are able to process a tremendous amount of data, and this data includes the prior credit histories of those currently late or in default. From what I am seeing on current credit reports it appears that the credit scoring models are deducting considerably more points from reports with serious past delinquencies (defined as bankruptcies, multiple collections, accounts with 90+ days late, mortgage and auto lates). As well it appears that more points are being deducted for more recent derogatory reporting than before (i.e. in the past lets say a 30 day late on a Visa payment that occurred within six months of the report was worth 15 points, today it may be worth 30. These are not actual numbers; I am merely using them as an example.).

As more data is available for the programs to analyze payment patterns and histories the software programs will correct their scoring. In this same line of thinking I am wondering if we will see improved scores from those with good credit histories—unlikely but possibly since the purpose of the score is to predict future payment patterns.

I have no hard data or commentary on the change in scores I have been noticing, just passing along an interesting observation based on my own client database.

Dennis

 Monday, September 10, 2007

We have seen a huge jump in the pricing on non-conforming mortgages since the beginning of August when the rates on non-conforming, or “jumbo”, fixed rates started moving the opposite direction of conforming fixed rate mortgages. The primary reason for this jump in rates is investor confidence, or lack of it, in the non-conforming markets. Across the country the number of foreclosures is rising and overwhelmingly those in foreclosure have non-conforming mortgages. Of these, a huge percentage are hybrid/interim ARMs (2/1, 3/1, etc) and sub-prime mortgages—they started with higher than market rates and at their first adjustment climbed even higher. With this small percentage of the market being responsible for starting the credit/mortgage crisis and the increase in defaults and foreclosures, the effect on Wall Street was to severely slow, or in some cases shut down, financial backing and investment in really good non-conforming mortgages. And it is costing Wall Street billions of dollars.

For years our industry has had what is known as “tiered pricing”, certain factors in a loan, such as non-owner occupancy, low down payment, cash out refinancing, and more, have increased the cost of a mortgage to the borrower. Only in the relative recent past has the tiered pricing become a factor of credit score on jumbo mortgages and even then it was not a significant impact on the price of a loan. Essentially a borrower purchasing their first home with a 670 credit score with 10% down, little reserves and non-verified income with high income to debt ratios was able to get about the same price on a mortgage as someone purchasing who has been a home owner for the past twenty years putting 25% down, with 770 FICO scores, fully documented income and low income to debt ratios. Sure there was some pricing differential, but in the overall equation it was relatively insignificant. From experience I can tell you the latter borrower with long time of homeownership experience, significant down, qualified income and excellent credit scores is about as close to a no risk loan as you can make in the mortgage industry—yet there was no benefit to the borrower. As importantly, for the investor there was little additional compensation for the risk on the first time borrower in comparison to the experienced home owner.

If an investor on Wall Street were to come to me and say, “Dennis with your experience in the mortgage industry we want you to consult with us to develop a mortgage product that will benefit the borrower and us as the investor.” My response would be to tier the risk across many factors and with many tiers. Sure this would make my job more difficult to give an even more accurate quote to potential clients, however it would serve the purpose of risk-reward for the investor and borrowers would get mortgages in line with what their overall financial and credit portfolio deserves.

Some suggestions:

I would tier pricing based on prior homeownership. Off of what we term “base-pricing” I would subtract in price for those with more prior homeownership and add to those with no or limited prior homeownership; say first time homebuyers looking for a jumbo mortgage add .375 to price, 1-2 years add .25, 3-6 years no change, greater than 7 years subtract .125 or something to that effect; if the investor does not want to make it look like the first time buyer is being penalized then use that as base pricing and lower the price for increasing years of homeownership—same result but different perception. But Dennis you are penalizing first time buyers! Yes, for an individual with no experience paying a mortgage purchasing a home for $750,000 I think there is a greater risk than someone purchasing the same home who has exhibited ability to pay a mortgage for sever or more years, as such should pay more for a mortgage.

I would tier pricing for increases in monthly housing payment. Increasing your monthly housing from making no payment now (living with the folks) to 300% (say going from $1000/mo in rent to $3000 in PITI), increase the fee by .375 points; 200% increase it by .25%. Someone going from little to no monthly housing payment to a significant portion of their income is a greater risk than someone going from say $3500/mo to $5000 per month a month, as such the investor should be able to factor into the risk-reward equation.

Create greater tiers for FICO scoring, say at 15 or 20 point intervals from 670 to 775. Someone with a credit score of 670 add .375 to the price, someone with 685 add .125 to the points, make 700 FICO scores par, or the base price; and tier up until someone with score of 775 or greater has 0.500 subtracted from their price—these folks are as close to guaranteed no risk as we will see.

Finally, tier the mortgage brokers and originators. There are data bases that show the number of mortgages that are in default or foreclosure that are made by individuals or companies. Use these data bases and offer significantly better pricing to the mortgage brokers who have proven their ability to properly qualify, process and close mortgages for homeowners who go on to make their payments and not go into default or foreclosure. Why should Stratis Financial, who has an exceptional record in regards to defaults and foreclosures, our latest estimate is less than one-quarter of one percent of all loans we have funded, have the same pricing as a company that funded a significant number of borrower who later went into default or foreclosure? While we may have been losing clients to the other broker because we did not feel comfortable with a no income verified mortgage with a 625 FICO score on 100% financing on an adjustable rate mortgage, we have been getting the same price for our A++ clients as they have. We made investors money, the other guy cost them money yet we see no benefit in the risk-reward equation.

There is a lot of money to be made for investors willing to step back into the market with the right pricing scenarios with the right origination partners that will help thousands and thousands and thousands of homeowners across the country. We just need a bright guy on Wall Street to see this and ask the right people (or person: me!) the right questions about how to put the programs together.

Definitions:

Conforming: used to describe Fannie Mae and Freddie Mac mortgages, generally those up to $417,000

Non-conforming: used to describe anything not Fannie Mae or Freddie Mac, but more specifically those loans that are neither conforming or sub-prime mortgages

Sub-prime: those mortgages that are high risk, generally because of less than average or poor credit scores and histories

Hybrid/interim ARMs: Mortgages that have a period with the interest rate being fixed before it converts to an adjustable rate mortgage (ARM). I.e. a 2/1 ARM has the initial interest rate fixed for two years, then the loan adjusts every year until paid off.

Dennis

 Sunday, September 30, 2007

Searching through an extensive amount of news articles, blogs, websites and other sources it was very difficult to find any “high profile” individuals speaking out against a so called “Federal bailout” of homeowners facing foreclosure of their home mortgages. Given the amount of coverage that the rise in foreclosure filings, decline in property values, closing of mortgage companies and other news has generated, one would think there would be some commentary on the role of the Federal government—and commentary usually comes from both sides of an issue. Not on this one. There is a significant void in argument against any Federal assistance to homeowners and lenders. Below I will point out some issues that would argue against extensive government intervention in the mortgage industry and homeowner foreclosures. Note that the professional associations to which I belong for mortgage brokers and also the mortgage bankers associations and the realtor associations are all lobbying for a “bailout” or intervention; but because of the lack of commentary and analysis available against a bailout I will provide my opinion from that viewpoint.

On Tuesday the House of Representatives passed H.R. 1852 The Expanding American Homeownership Act of 2007 by a vote of 348-72, all of the votes against were Republicans. The primary provisions of the act that could have a positive impact on the mortgage industry are a) considerably higher loan limits (almost double the current limits in California and other high cost areas) and b) eliminating requirement for any down payment or equity in the property to qualify for an FHA mortgage. H.R. 1852 is now in the Senate where modifications may be made to the lower the maximum loan amounts and require some down payment/equity stake in the property (currently FHA requires 3% equity).

The purpose of this is to allow those with mortgages not currently in the FHA qualification range, either because of loan amount or equity in the property, to qualify and fund an FHA mortgage. Under this proposal the limits in California for FHA may exceed $700,000---with no down payment. Aren’t these the types of loans that are causing so many of the current foreclosures?

What I see as a very bad portion of this legislation is the relaxation of the requirements to be an FHA approved lender or mortgage broker. FHA has a history of fraudulent transactions and individuals who abuse the FHA system for personal gain. In the mid to late 1990’s the “605 Corridor” in Southern California was filled with brokers, agents, appraisers, tax preparers and others creating straw buyers for transactions and selling over inflated properties to each other and literally stealing millions of dollars using FHA insured mortgages. Further, FHA carries a very high mortgage insurance premium on every loan, but still not enough to cover defaulted loans in a high foreclosure market, even under the current regulations requiring 3% down payment or equity. With 100% mortgages to homeowners who previously exhibited poor credit histories or inability to verify income or assets suddenly FHA will become solvent and save the housing markets? In my local market the FHA, and Fannie/Freddie, loan limits need to be raised as the current limits do not allow entry level buyers access to median priced homes, however raising the limits to well over the median market price and not requiring any equity in the property is asking for future defaults and eventually a tax payer bailout of FHA as its insurance pools do not cover the losses.

Combined with the Fed rate cut on Tuesday there was a lot of news and a commentary on the movement by Federal agencies that appears to be focused on homeowners who are in or may face foreclosure. As stated above however, few prominent individuals have spoken out against a Federal bailout. This could be for many reasons, primarily however is the political and public relations danger an individual would face in light of the overwhelming press and media coverage on current foreclosure markets and extensive use of individual homeowner’s situations that portray them in very sympathetic terms. In the end who wants to go on record saying a family of five in Georgia deserves to lose their home?

On dedicated and subscriber websites within the mortgage industry many individual brokers are speaking against any bailout and adding commentary such as, “Like you for the past two to three years most of my clients wanted 100% interest only financing—if I said “no” I would lose the deal to the guy across the street. Now they are upside down and calling me telling me it is my fault.” The underlying tone in the mortgage blogs and bulletin boards is one of resentment and anger at being attacked and portrayed as greedy brokers purposefully putting families in “bad” loans to make more money. Virtually none of the major media sources have included statements from mortgage brokers that are in any way similar to what is being said on the dedicated subscriber sites.

The primary national story on someone against any Federal intervention or bailout was an AP story by J.W. Elphinstone that was picked up by most major newspapers last week (week of 9/10/07) such as the Orlando Sentinel. The article’s headlines throughout the country indicated there are people against any Federal action to “solve” the mortgage foreclosure situation, the article’s main “against” is Thomas Roach who has created an on-line petition “Tax Payers Against a Wall Street and Mortgage Bailout” (http://www.petitiononline.com/bailout/petition.html) that has almost 5400 signatures as of the morning of 9/20/07. Also in this article are comments by Jim Gaines, research economist at the Real Estate Center at Texas A&M and a few other private individuals.

That is pretty much it, no politicians, major Wall Street executives or CEOs, the usual Sunday morning talking heads or radio talk shows. It is silent on this issue.

Picked up by a lot of websites and some print media were comments by Bill Gross, Managing Director of PIMCO on his monthly commentary . Gross advocates the Federal government involvement to assist homeowners; says in recent history government has bailed out the S&Ls and Chrysler, “why shouldn’t it bailout 2 million homeowners?”

**It should be noted that after Gross’ comments, which as stated were widely circulated, PIMCO created a “Distressed Debt Fund” of $2 Billion. PIMCO intends to buy “distressed” mortgage paper. Lacking from the coverage of the new fund was relation to Gross’ comments about the need for government intervention in the mortgage markets—which of course would also help anyone holding distressed mortgages by reducing the number that would go into default and/or foreclosure.

The moves by the Fed to cut rates and Congress to raise the FHA limits and relax some of the qualifying guidelines may assist a small percentage of homeowners who otherwise may face foreclosure on their mortgages. The overwhelming majority however will not be helped for several reasons. One, I have had many clients over the past several years during the housing boom and price run up with poor credit, no money for down payment and knowing the only way they could get a loan was with interest only mortgages fixed for only two or three years. A lot of these clients I turned down explaining they could not afford the mortgage—they went to someone who would provide the loan and bought the home anyway. Almost everyone felt their property would go up in value and they would either be able to refinance—provided they changed their habits and made payments on time—or be able to sell their property and make tens if not hundreds of thousands of dollars. I wonder if they are now or soon will be in default? Bad credit habits are like bad eating habits, smoking or substance use: they are habits and they are extremely difficult to break and change. Someone with very low credit scores due to habitual inability to pay credit on time put into a home with no investment and an adjustable rate mortgage is a poor risk and as we say in the office “tomorrow’s foreclosure today.” Meaning anyone who makes that loan today will be facing a foreclosure tomorrow—which has come to pass.

Two, in the current environment lenders have tightened lending criteria severely, affecting even extremely well qualified borrowers. Take the family with very high FICO scores, qualifying income that supports a mortgage payment and in a home they thought they would be in for five years, but now that the five years is up they are unable to afford their new home because home prices today are higher than they were in 2002, and need to get out of their mortgage. Given the current lending guidelines they may not be able to afford a new fixed rate jumbo mortgage—so they must let their 5/1 ARM adjust and face much higher payments. Situations change for families, some beyond their control. In many cases families will be caught in the middle of needing to refinance their home and tighter lending criteria preventing them from doing so.

Three, with the tighter lending criteria comes a shrinking pool of qualified buyers, fewer qualified buyers means less demand, less demand means….over supply and a decline in market prices. This evaporates equity for current homeowners who may need that equity to qualify for a refinance of their existing mortgage under the new criteria. A circular problem that the government cannot solve unless they are will to treat housing like dairy farmers and offer price supports.

In the end the free markets will have to work this problem out. Supply and demand will rectify the situation and eventually the cycle of upward prices will start again—the question is “when?” In the meantime elected officials, local, state and federal, will impose requirements tighten lending criteria—artificially shrinking the number of qualified borrowers—and spend perhaps billions of tax payers money to assist those in or facing foreclosure on loans they entered and agreed to pay.

Let me close with this, I know there are fraudulent brokers and lenders in my industry, I know there are those who use deceit and lies to get applicants and fund mortgages. I also know that every single mortgage has a Note that must be signed by the borrower that spells out the terms of the loan. These are lengthy documents, seven to eight pages, that are in the company of about one hundred other pages of documents in the closing package (most of the documents I might add are because of government regulations that end up adding more and more pages of confusing paperwork to the borrowers), but they are the most important pieces of paper an individual will sign in their lifetime. They are pledging to pay back a very large amount of money, and the terms of the repayment. Every loan that is in foreclosure has a Note signed by the borrower, it was their responsibility to read the Note and if they did not understand to get advice and understanding. Hire an attorney, consult with someone not party to the transaction, but get advice. Because they did not we are in the situation we are in today with the overwhelming majority of those in foreclosure—and now you will probably have to pay for it.

Dennis

 Friday, September 21, 2007

Important to note that along with rate cut the remarks out of the meeting were that "the Committee judges that some inflation risks remain, and it will continue to monitor inflation developments carefully."  This is the Fed Governors telling us, "we are cutting the rate because most of the cut is priced into the markets, to not cut would send them into turmoil.  We are still concerned about inflation and when the current credit crunch is alleviated we may raise the rates again if inflation pressures persist."  In other words: we just made this cut, and made it big, so do not bet on us making another one.

What does it mean?  In the short term rates are going up as the stock markets take off on the news that credit is a bit cheaper.  In the next few days we may/could see mortgage rates descend a bit to a new range a bit below the current range.  In the meantime those with equity lines just saw their interest rates drop half of a percent.

I am not convinced that this rate cut will loosen up significant money on Wall Street for investment in non-conforming mortgages, which is what we need in California.  There has been plenty of liquidity in the investment markets, what there has been is a lack of confidence.  While borrowing money is cheaper and may create a better yield on the risk/reward decisions, it has to be seen whether the cheaper funds boost confidence to invest in jumbo mortgages in Long Beach, California.

If you have any questions or comments please do not hesitate to contact me.

September 1, 2007