Lending Tightens
By Charles TurnerWe’ve had some discussion in the last couple of weeks about lending requirements tightening and how that will effect our market. I’ve been more optimistic outlook on how it will impact the Portland real estate market than other commenters. Subprime lending is clearly in dire straits. A clip on the news yesterday said that 31 subprime lenders have closed their doors. If you had a loan lined up for a purchase at one of these institutions, tough luck.
Lending rules are dynamic. Just because you have a rate locked and everything looks good, the lender can change the rules before closing unless you have a “loan lock” not just a rate lock. If you are on the cusp, the lender might ask for reserves (a number of months worth of payments) in the bank where none were originally required.
Our market has shifted towards the buyer. There are more homes on the market and they are taking longer to sell. There is not enough data yet to show how prices are fairing. Sellers (and some Realtors) are being forced to make the mental shift that houses aren’t going up at double digit rates anymore. This has resulted on some aggressive opening listing prices which then force more rapid price reductions. We should see the percentage off original selling price drop.
The buyer mix will probably change too. Investors may increase as high loan to value buyers are forced out of the market. Cracking the market is the hard part but I think there is a big enough pool of qualified buyers, even under stricter requirements, that our market is not going to freeze or crash. Others may disagree.
Something else we may see is sellers asking buyers to be preapproved with a certain lender. If there are two offers and one is qualified with a subprime lender, the seller may want a second opinion of that buyer’s ability to perform.
Not only are rules changing prior to closing, but there’s talk on the mortgage broker boards about some subprime lenders not funding loans after closing:
http://forum.brokeroutpost.com/loans/forum/2/100677.htm
(notably, New Century) They’re scrambling to find other funding options, but you can imagine the kinds of nightmares this is causing.
“I think there is a big enough pool of qualified buyers, even under stricter requirements, that our market is not going to freeze or crash.”
I don’t think we’ll see a crash as I think by definition that would be a greater than 30% drop in prices… but a freeze is possible. A freeze couldn’t last long as someone would have to blink and I suspect it’ll be the sellers as some percentage of them usually have to sell for some reason or other (relo, bought another place before selling the current one, etc.)
As far as the pool of qualified buyers goes, again, I think that ultimately the food chain starts at the bottom (first time buyers) and problems there eventually move up the chain. In recent years first-time buyers had to use a lot of ‘exotic’ loan products to get into a house. Now those are going away on the supply side and people on the demand side have less of an appetite for them as they hear more horror stories involving interest-only, negative amortization and ARMs. Otherwise, as was mentioned in the other thread about market conditions, there are a lot of folks who are just completely priced out of the market at this point. And these are people who are making a solid income compared with the median income for the area.
Charles, thanks for the honest assessment of the market. I don’t think there are very many realtors who would have made a post like yours today as so many of them seem to be in continual cheerleader mode.
Here’s another theory. It may not be the correct one but it has merit. Sellers remain in control because they own the scarce resource. Sellers that are not desperate can either sell or rent out the property. If the buyer can’t afford to buy the property, they are forced to rent. If the seller has held the property for long enough and has not pulled out all of their equity, the rent should cover the cost of holding the property. If the market isn’t to the seller’s liking they can hold the property until the market turns. The buyer still needs a roof over their head regardless. Long-term this view would probably collapse but for now our other market conditions may support it.
The simplest way to look at the current state of lending is that we’ve gone back to more traditional guidelines.
An investor needs to bring money to the table and should be prepared to live with a 6 month to 1 year prepayment penalty. They will also need 6 months reserves.
If someone needs 100% financing, loans are still available but they are getting a little more expensive. If they are able to document income and bring a 3-10% downpayment then there are still some very attractive options available.
Mortgage insurance is deductible for loans orginated this year and FannieMae online approvals will consistently give large Debt to Income approvals for strong credit scores. I got a 63% DTI approval several weeks ago. This is a loan that otherwise would have gone stated. The borrower could afford the payment, we just couldn’t add all of his income to the application.
3-2-1 buydowns are also seeing a resurgence. Rather then have a seller lower the selling price by $10K, use it to either buy down the rate or to fund the 3-2-1 buydown.
Basically, everyone just needs to work a little harder and smarter these days. We can’t rely on aggressive subprime and Alt A lending…
It’s even more important then ever for the Realtor, Buyer and Seller all to be working closely with a trusted mortgage professional who can turn the dream into reality.
just my 2 cents…
Larry: if I understand the 3-2-1 buydown correctly, it’s a way to allow a buyer with lots of cash but not much income to qual. I suspect that most 1st time buyers don’t have lots of cash on hand especially since during the last few years people have been encouraged to put little or nothing down (“gotta preserve your capital to invest in the stock market” syndrome). Also, doesn’t it assume that the buyer’s income will be higher by the 3rd/4th year? What happens if their income is flat or increases less than the payments increase? Still seems a bit shady.
The comment about lending returning to “traditional guidelines” is key. How much of the run-up in prices that’s happened over the last 6 years or so could have happened if people had to put at least 10% down on a fixed-rate mortgage? Most people have been conditioned not to save at this point because of all the easy money that was out there via subprime/Alt-A. The negative US savings rate for the last couple of years is exhibit A. A return to more traditional guidelines will necessarily mean a return to a more realistic tie between incomes and prices – in the longrun that should be a very good thing.
If houses in the $300K range means saving up at least $30K for a down (+ another six months payments saved up in reserves + plus a chunk of closing)… well, not a lot of people have the kind of cash laying around, especially not first timers. (no need to even mention what it takes to put 20% down in this market)
Also your comment about the Florida potential buyer who now is renting because they can’t unload their Florida property (I’ve heard similar stories from people from So. Cal) just illustrates how real estate markets are ‘long chains’ and now these chains are especially vulnerable.
Charles: You say “sellers remain in control” but in your post you say it’s a buyers market. It can’t be both ways. Sure, buyers need a roof over their heads, but most of them can either continue to rent (or live in a current home instead of upgrading) and take a “wait and see” attitude at this point while in the meantime they save up for their 20% downpayment.
I think it’s sound. The key is the sellers need to sell and their equity position. They could also structure a lease option at a higher then market price and allow the buyer to “refinance” in 12-24 months.
The flip side to this is I recently lost (for now) a borrower who ismoving here from Florida. We were days form closing when they backed out due in part to their inability to sell their home in Florida. They are now renting while they see what they will be left with once their current home sells.
My comment above says it is another possible theory so I can have it both ways
Case in point: we listed one of our properties and it didn’t sell so we lowered the price, lowered it again and then decided that we would just hold onto it. Relisted it (18 months later) and sold it in three days for 25% more than we took it off the market for. It didn’t appreciate that much, it was market timing.
“Your statement on savings in interesting. I can’t remember where I saw it, but basically people have been saving, but in real estate equity.”
How can it be savings when you have to pay it back? Yes people saw increasing equity as prices went up and lots of folks borrowed against that equity to do things like take vacations, buy SUVs, etc. Now that prices aren’t appreciating at anywhere near what they were in the 2002-2005 epoch those same people find that they can’t borrow against their home again to upgrade that SUV (oh, my they’ll have to stay with the 2005 model, so sad.)
My point is that all those HELOCs have to be repaid with interest. How is that savings? Prior to the mid-90′s not many people even thought about borrowing against the equity in their home – it was a foreign concept (and I suggest that was a good thing)
Let’s look at it another way: The only way to really get the money out of your house is when you sell it and either a) move to a cheaper area and buy a less expensive home, or b) when you sell your home for the last time, that is right before you check into the retirement home. How can I say that? Because if you sell your home and then turn around to buy another (you’ve gotta live somewhere, right?) in the same market that has appreciated at essentially the same rate that your previous house did you don’t really pocket any money. In fact you’re probably out some money paid to the real estate agent and for closing costs. So how has the massive appreciation in my house’s value really helped me? Let’s see, my property taxes are going up because of it. Oh, and when I get old I can sell it and maybe afford a better retirement home.
Home equity is not savings. Very few people priort to about 1995 ever thought that it was. Now because incomes have been pretty-much stagnant for the last five years while home prices have gone way up, people were convinced that they could continue to live the same lifestyle by borrowing against their home equity.
Another way that home equity is not savings: say you lose your job. You go to your banker and ask for a home equity loan thinking you’ve got plenty of equity in your house to live on for a while. S/he will ask what your income is and when you tell them that you’ve hit a rough patch and currently have no income the banker will show you the door. HELOCs and mortgages are loans against income flow that just happen to use a property as collateral. No income, no HELOC. No savings. This is why the government does not count home equty as savings and that is a good thing.
TIP – I agree with your statement on buy-downs, but they can also be used creatively by sellers to entice buyers. Say that you could afford a payment at 6.5%. If the seller paid the buydown, the 1st year payment would be 4.5%, the 2nd year 5.5% and the 3rd year on at 6.6%. Add up the savings and it should be greater then the cost of the buydown.If the cost of the buydown was equal to an accepted “lower asking price” then why not do it? (This is a great subject for my blog. I’ll work on actual scenarios…)
As far as qualifying for a home at a lower rate based on the expectation of future increases, that needs to be case by case. A young college graduate with a good job could expect a higher income in the coming years, as could a seasoned commissioned sales rep working for a new company. A buy down isn’t an answer to all of the problems, but it’s another tool that can be used to solve problems.
I agree that a lot of speculation fueled by easy credit of Alt A loans contributed to rising prices, but ultimately it was fueled by greed. The old “do guns kill people or people kill people”… I like to blame it on the infomercials…
Your statement on savings in interesting. I can’t remember where I saw it, but basically people have been saving, but in real estate equity. Yes, many have foolishly stripped their equity to buy things. But the jist of the story I heard/read, was that why save when rates are at 1-2%? The question is will people start saving now that we are getting better rates of return?
I wasn’t clear enough on the 10% down and 6 months PITI reserves. This was for Non Owner Occupied properties. Owner Occupied is still available at 100% financing with seller contributions and minimal, if any, reserves. It’s all based on the borrower.
Charles position is correct. It’s a buyers market, but sellers are still in control…unless they have to sell. They just can’t sit back and wait for multiple offers at ever increasing prices.
“The buyer still needs a roof over their head regardless.”
This is true, but they don’t need to buy that roof. For downtown condos, renting is 30-50% cheaper than buying, and that includes the mortgage interest tax deduction.
Your argument only works if 100% of owners can afford to make mortgage payments when it doesn’t sell. It doesn’t really matter if 90% of owners can afford to hold because it’s the other 10% that set the market price. The desperate owners are the only ones conducting transactions.
Also, with lending standards tightening, it can very quickly turn out that the scarce resource will be money.
TIP, I’m not trying to defend the use of equity as savings. I’m merely pointing out that a lot of people have been putting their money into real estate. This could be buying a bigger home then they had before, buying a vacation property or an investment property. Some have done it wisely and others haven’t.
I know several people who lost it all during the dotcom bust. Some of them have only made money investing in real estate. Others invested just as unwisely in real estate.
Many of my mentors teach that you should either have no mortgage or be mortgaged to the hilt. This is for the very reasons taht you speak of. If you lose your job or are disabled you can’t access the equity in your home. If you’re mortgaged to the hilt then you had better have the right mortgage on your home and been saving aggressively.
Used wisely, a mortgage can be a vehicle to help manage your wealth, not just a tool to buy a home.
“NEW YORK, March 9 (Reuters) – Tougher lending standards stemming from the shakeout in the beleaguered subprime mortgage industry could prevent up to 1.1 million U.S. homebuyers from getting mortgages this year, a Bear Stearns analyst told investors on Friday.”
http://tinyurl.com/37klx5
I agree. It’s going to be interesting. Many borrowers were put into lousy loans due to their situation and now won’t have the ability to refinance unless they improved their credit scores.
There is a place and need for subprime loans, especially now, but lenders made the loans to easy to obtain and to lucrative to sell. Many lender would charge 2-3 points in orgination fee and charge a higher rate and get 2 points in Yield Spread. This put many borowers into a no win situation. And now the rules have changed and many of these people will not be able to refinance.
Of the 1.1 million, if they are buyers getting into the market then it’s not a big deal.(except to they realtors and lenders who can’t make a living off of them) Many of these are people who would not have been able to purchase several years ago any way.
But for those who have subprime ARM’s that are adjusting and cannot refinance, this could be a tragedy. But, they had 2 years to improve their credit in order to get a better loan. Some of the responsibility needs to be put back on their shoulders.
Much of the rest of the problem lies with the speculitive investor who purchased in the hope of short term riches. This helped drive up prices and when they either couldn’t sell, or rent at a price that services their loan, then they either sell short or go into foreclosure. Both of these are helping reduce prices.
Part of what we need to look at is that if home values are declining, and in our area they are not, then what we are seeing is a natural correction to bring them back to where they should have been in the beginning.
I can guarantee you that by this time next year there will be solutions in the marketplace to provide better loans. They might not be as easy to get, but that’s ok. They need to make sense to the borrower and the lender.
What we’ve just witnessed is a very expensive Free Market experiment that went very wrong.
Thanks for the info. You know, most of these changes can be contributed to the fact that there have been more and more cases of mortgage fraud as of late. I know it will make it more difficult for us homeowners to purchase or refinance, and that’s the sad part of it.
I think we can all agree (is that possible?) that anything that is not sitting in a savings account devoid of risk is not really savings, it is an investment. If I have $100,000 in the stock market and it crashes, I don’t have $100,000 in savings.
If I have $100,000 in equity and I want it out, it is not liquid and it is going to cost me to get it. Until it is moved into a savings account, it is as much risk as any other investment and as TiP points out, I am paying for it unless I have sold the property it is attached to.
I’m going to do a little research and see if I can find something that compares $X invested in the stock market versus $X in real estate and see if I can come up with anything instructive. I’ll take the path of least resistance rather than doing the math myself if possible!
Charles: Over the long run both stocks and real estate are good investments. You’ll get differing opinions on whether stocks are better or RE. Personally, I like RE is because even if the price crashes, you’ve still got a place to live assuming you haven’t leveraged yourself to the hilt to get into RE (as has been the case in recent years).
However, “long run” is relative. The NASDAQ is still less than half what it was right around this time of the year in 2000, seven years ago. And I suspect that real estate right now is sitting pretty close to a peak that may not be seen again for a few years. Of course if you’re in CA that price peak was probably sometime in the middle of last year. For us here in Portland we’re probably just starting down the slope.
BTW: here are some quotes from a research note this morning from Credit Suisse, titled: “Mortgage Liquidity du Jour: Underestimated No More”,
“we surveyed our private homebuilders and their mortgage lenders to asses the new home market’s exposure … and … it’s not just a subprime issue. …
We believe that 40% of the market … is at risk of significant fallout from tightening credit and increased regulatory scrutiny. In particular, we believe the most pressing areas of concern should be stated income (49% of originations), high CLTV/piggyback (39%), and interest only/negative amortizing loans (23%)….”
http://calculatedrisk.blogspot.com/2007/03/credit-suisse-not-just-subprime-issue.html
Also, here’s a breakdown of subprime loan share by region:
http://www.ocregister.com/ocregister/money/housing/article_1615833.php
It shows that subprime made up 13% of loans in Portland in 2006. (this does not include Alt-A)
Lucy: The biggest problem will be for people trying to refi out of various flavors of ARMs this year. If their FICOs have gone under 680 or so and they haven’t seen much appreciation (or if they’ve had depreciation) they’re likely in trouble. And then there are the option ARM folks who paid only the minimum payment – those people are in big trouble. However, for buyers with a good 20% cash down payment there could be some really good buys out there by the end of the year or this time next year. This is the kind of market where it pays to wait and save up.
This Wall St. Journal article today says real estate isn’t such a hot investment afterall:
http://tinyurl.com/2d79oy
Here are a couple of links to support the advantage of the stock market over real estate in the long run. Both admit weaknesses as their are too many varibles.
http://infoproc.blogspot.com/2005/08/equities-vs-real-estate.html
http://www.forbes.com/realestate/2005/05/27/cx_sc_0527home.html
One item neither speak of is arbitrage. Rarely will an individual borrow to buy a stock, but most borrower to buy a home. But there is no reason that you couldn’t, that’s what banks and insurance companies do… They borrow from us at 2-3% (if that) and invest it out at much more.