A couple of months ago we posted information regarding the state of the sub prime mortgage market. Unfortunately, as this situation has continued to play out, things have started to spill over into the prime side of the market. I wanted to bring everyone up to speed on where things are and where we may be headed.
The Background - Sub prime issues
Starting around November of last year, sub-prime lenders (those lending to people with credit scores under 620) began to fail. The problem was that their underwriting guidelines were dependent on appreciating home values. Meaning that as long as prices continued their march upward, folks who would otherwise be forced into foreclosure were able to do a cash out refinance and delay that foreclosure. When home prices stalled 12 to 24 months ago, these borrowers were no longer able to make their mortgage payments and the foreclosure rates skyrocketed. This started a domino effect.
Sub prime lenders typically sell their loans to investors by packaging a number of loans together. This is done usually within a month or two of closing the loan. When they sell these packaged loans, there is typically language in the contract that when the foreclosure rate on these bundled loans exceeds a certain percent, it triggers a buyback clause whereby the originating lender must begin buying back the loans. These buyback clauses began kicking in late last year and caused a liquidity crunch in the sub prime market. The lenders only have a minimal amount of liquid assets available at any given time. When they are asked to buy back too many loans, they run out of cash and then they lose access to money for new loans. At this point they are no longer able to fund the loans that are in their pipelines and they quickly fold up shop. This has happened to dozens of sub prime lenders over the past 9 months.
Problem expands to the "Prime" side of the business
What is happening now is that this problem is beginning to spill over into what is known as the "Prime" side of the business — Lenders who lend to borrowers with credit scores above 620. Specifically, it is currently affecting "portfolio products". These are products which for one reason or another do not meet the guidelines set forth by Fannie Mae or Freddie Mac, and that makes them "non conforming" loans. Examples would be jumbo loans (loan amounts above $417,000), stated income or stated asset loans, certain investor loans, no doc loans, etc.
Monday of this week a company called American Home Mortgage was caught in this liquidity crunch and was unable to fund $300 Million in mortgages that day, probably affecting 1,000 or so borrowers. The problem got worse on Tuesday. They have not funded a single loan this week and last night they announced that they were permanently closing their doors. Now, you may be saying to yourself, I've never heard of this company, who cares? They were the #8 mortgage lender in the US by mortgage volume in 2005 as ranked by the Mortgage Bankers Association. Ranking ahead of companies you have heard of such as Wachovia, Citigroup, First Horizon, Homebanc and many others.
The good news is that the sky is most certainly not falling. The vast majority of mortgages are conforming or government loans which to this point are basically unaffected. I expect there will be some changes to underwriting guidelines on conforming mortgages in the months to come, but the bottom line is that the entire US economy is very dependent on the real estate market, and the powers that be are not going to let this get too far out of hand.
What you need to do
That said, you need to take a close look at your clients who have been pre-approved and who are still looking for a house. Specifically look for these three things: 1) Are they going to need a Jumbo loan? 2) Are they planning to use stated income loans or no doc loans to qualify? 3) Are they planning to borrow 100% of the purchase price of the house? If you have pre-approved clients who are in those situations, let them know that their pre-approved status is at risk. That if they are ready to move, now is the time. It is possible that this will blow over and they will remain unaffected, but present evidence suggests otherwise. In the last 24 hours I have one lender who raised rates on their portfolio products by 2 points across the board in a single day and another who simply will no longer accept new loans on a large percentage of their portfolio products. Obviously, you may also have potential clients who have no idea this is occurring - they have great credit, so they thing how could they possibly be impacted? You'll want to get these clients in touch with a reputable mortgage lender - and by making them aware of this issue, you'll solidify your standing as an expert in the real estate world.
How does Primacy Mortgage fit into all of this? We are a mortgage broker, so we cannot be caught up in this liquidity crunch - only the lenders we work with can be. As a precaution, we have ceased doing business with a number of lenders who we think may be in trouble. At this time, we're working with several of the largest banks pretty much exclusively. These are very strong financial companies who have a well diversified portfolio of business who are highly unlikely to end up in a situation where they cannot fund a loan. If any loan officer you are working with on current business is not aware of what is going on with this liquidity crunch and is still funding loans with smaller companies, be very careful. This situation will continue to play itself out over the next several months. Until things stabilize, proceed with caution.
