Dennis' Mortgage Blog

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