There seems to be little question at this point that many homeowners in Orange County have struggled to make their mortgage payments. Or maybe not? Are they struggling or just walking away?
Last month, O.C. foreclosures hit a record high of more than 800 in one month. (DataQuick’s foreclosure records start from 1988.)
Mortgage Insider interviewed Susan Wachter, a professor of real estate at The Wharton School of the University of Pennsylvania, about rising foreclosures, trends in home loans and how to save a few bucks on a home loan.
Q. The blog-o-sphere is buzzing over rumors that struggling homeowners are finding it socially acceptable to simply walk away from their properties, giving the keys back to the bank. In other words, shame is not making them do everything they can to stay in the home. Do you think there is some truth to that theory?
A. I do. Whether it’s empirically true or not, I think there is a real tendency to move in that direction depending on how pervasive foreclosures become. We saw this in the S&L crisis in Texas. There is a tipping point, as foreclosures become more common. There is a point where it becomes much more socially acceptable. It becomes a solution that people know about. That’s a great concern.
As you can see there is potential for a vicious cycle here. If more people walk away, as opposed to staying and attempting to pay, prices fall and more people have less equity. This is a real concern and I will be doing a presentation in Washington on this very issue this week (Note: I Interviewed Wachter Monday, February 11.). Our models don’t typically take this kind of dynamic into consideration, but it can happen and it has happened.
Q. In your recent report, you wrote, “The immediate impact of the mortgage meltdown has been a lack of access to credit for borrowers with low FICO scores and small down payments, and those seeking exotic loans that ultimately turned out to be very risky. This is good news from a societal perspective.” I have to ask, why is it good news?
A. As a whole, it’s good news that Americans are not overextending themselves financially and ending up with more home than they can afford. It’s also good news that lenders have tightened underwriting standards and are really looking at what a borrower can afford, rather than rushing through that process in order to close more loans.
We’re now seeing the impact this has had on the financial markets too, and as more prudence and responsibility returns, homeowners, lenders, and the capital markets will all benefit. The economy overall will benefit. In the short run, we only would be deeper into the problem the longer irresponsible lending continued. The lessons of the subprime meltdown have been painful to learn, but are very important in the long run.
Q. You previously wrote that in the third quarter of last year many borrowers who held loans fixed for short periods, such as one year, refinanced into loans fixed for 30 years. Does that mean many folks who bought a home with an adjustable loan during the housing boom could have afforded a fixed?
A. Yes. They could have afforded a fixed, but a teaser may have been sold to them or they may have thought an adjustable loan was a better deal. That’s in part the purpose of (the U.S. Mortgage Payment Index written by Wachter), to show what alternative mortgages cost these days. If you are a prime conforming borrower you probably have a rate sheet in the local newspaper, but if you are not, then you have a very hard time knowing what the costs of different mortgages are. You don’t have it in front of you; what the cost is today and five years from now. And the more exotic the mortgage, the more return there is for the broker, unfortunately. So everyone needs to be informed.
This is not anti-broker. It may have been cheaper to be in the adjustable; much depends on the teaser rate. Adjustable rate mortgages are typically more risky, and over the lifetime of being in a home a lot of higher potential risk to higher rates. The slight difference in cost does not compensate for the risk, unless you only plan to be in the home for a few years.
Q. Let’s shift gears to avoiding a mortgage one can’t afford. Your report from fourth-quarter 2007 shows that a 30-year fixed loan with mortgage insurance was cheaper than getting a piggyback second to avoid paying mortgage insurance, which was a common tactic during the housing boom. Can you walk readers through that with an example?
A. In my analysis, payments on a 30 year fixed with mortgage insurance start at $1,350 and drops to $1,220 after five years. (Note: Wachter looked at a $200,000 mortgage with an interest rate of 6.16%.) That’s a drop of 9.6 percent (after the mortgage insurance ends). Compare that with another low down payment loan in my Index: the 30-year fixed combined with a HELOC. The combination loan starts low, $1,288, but actually rises 8.4 percent over five years to $1,396 (Note: In example from 2007, HELOC starts at rate of 9.93% and adjusts to 14% after five years).
It’s simple: using mortgage insurance can enable a low-down payment buyer to avoid a second or “piggyback” loan. Piggybacks are most often adjustable-rate loans, so are subject to resets and higher payments in the long run, plus they must be paid-off in full, unlike mortgage insurance which is cancelable after a homeowner builds 20 percent equity either through payments or appreciation. Mortgage insurance can also be financed into the loan amount, which makes the monthly payment even less because there is no traditional added PMI premium to pay.
Q. By the way, how has the use of mortgage insurance changed amid the credit crunch?
A. As the risks of exotic loans like subprime and piggybacks have been exposed, there has been a clear “flight to safety” among homebuyers. The use of mortgage insurance has jumped considerably – up 41 percent in the first nine months of 2007 over that period in 2006. Nearly two million families used mortgage insurance to purchase or refinance their home last year. MI is also tax deductible now, and will be through at least 2010, so that levels the playing field between MI loans and piggybacks as well.
Q. Do you follow any offbeat indicators to see what’s going on in home lending?
A. What I look at all the time is jumbo rates vs. conforming rates, which is highly relevant to your market. The jumbo and conforming rates historically have been 20 to 50 basis points apart (Note: a basis point is 1/100 of one percent). There was a period when the jumbo rate was tracking conforming (i.e. the rates were almost equal). That was telling me on the finance side the market was ignoring risk. The normal premium for risk somewhat disappeared. This is throwing out Finance 101. At that point you know the fundamental functioning went awry in the market. Then the gap widened to 100 basis points. That too is just a sign the market is not working.
It is really seizing up, and it is a problem for a market like Orange County, which is why the stimulus plan is so important, to extend that ceiling. What that does is allows borrows to move into the conforming market. This 100 basis point premium will no longer be relevant. It’s not even just that it’s very hard to get a nonconforming loan. The capital markets still are not functioning. Here we are six months after the crunch hit and the markets are still not functioning.
(Note: President Bush signed the stimulus bill Wednesday, Feb. 13. Among other things, it calls for raising the maximum-size loan that can be sold to government-sponsored buyers like Fannie Mae.)
Q. So how do we fix this credit mess?
A. The return to traditional home financing helps get us back on track. Recent rate cuts will ease the pain for some consumers, and I also expect the move to raise the conforming loan limit will help stem the tide, at least in the short term. This will especially help in pricey housing markets like Orange County, because it will allow more borrowers to refinance into safer loans.
Low interest rates and less risk being assumed by lenders and borrowers will help to fix the mess. Rapid home price appreciation and low interest rates led many borrowers and lenders to find creative and innovative ways to mortgage these homes. Home finance innovation should not be so exotic in the future; otherwise we will have not learned an historic lesson.
This is a so-called expert? And she is gonna testify before Congress? No wonder the govt doesn’t have a clue.
1. Piggybacks were and are still real good option with low down payment mortgages and more cost effective. Use the Suntrust 30 year fixed Combo 2nd with a 30 year fixed 1st. Even HELOCS are cheap now. (If you can get one) With the prime at 6%, the rate is almost the same as the 30 year fixed.
2. Getting rid of MI with house appreciation ? What market has prices appreciating? She is going out 10-15 years for that to happen.
3. The advance of MI has been because 2nds have almost gone away. How else do you get people into homes without 20% down?
4. The bond insurers are almost bankrupt. Has anyone calculated the cost of MI on a loan nowadays?
This real estate “professor” is so far behind the the state of the housing/mortgage market. Those of us in the trenches see what is happening. The subprime crisis turned into a risk crisis, which has turned into a confidence crisis, which has turned into a credit crisis, which is now turning WAY beyond the mortgage market into a complete debt liquidity crisis including credit cards, commercial loans, municipal bonds, and even student loans. The spiral keeps getting worse and there is no end in sight. How many times on Wed did Paulson, the Sec of the Treasury, ask the Senators for any ideas how to fix this mess? They have no clue.
And the Fed? Their only solution is to lower the short term rates. The net effect is that the long term rates went up a lot. It helped Wall Street but hurt Main Street. BTW- I have read a lot about why they suddenly dropped the interbank rates. The Banks reserves at the end of Dec were around $32b. One month later, the reserves were below $1b! They had to lower the rates, so that the banks could get cheap money to cover their reserve requirements.
But with all the talk about foreclosures and such, they are only talking about helping about 5% of the population. People who may not have been able to afford their home in the first place. Even with mortgage rate help from their current lenders, half or more of them will end up losing their homes anyway.
Prices need to come down so that homes become affordable again.
And now they are dropping $600 from airplanes to people, hoping they will spend it. What kind of stimulus plan is that? What good does it do to go buy a Chinese made TV set at Walmart, if you want to stimulate the US economy?
So on a Saturday morning I sit here thinking about the problem and a potential solution. Here is some food for thought-let’s not worry about the 5% who will foreclose. Let’s get out of this mess by stimulating the other 95% of us who CAN afford their mortgage. Not by a 1 time payment to us, but by saving us all $100-200/mo for 30 years. How? Get the long term rates down into the 4’s, get people to refi and free up the cash. Maybe give .5% lower rates to lower risk borrowers with less than 50% LTV, good credit and provable income. How about a govt subsidy to reward the 95% of the population that is good, rather than reward the 5% who aren’t? If the market is re-evaluating the risk premium of debt securities, let’s look at not just hiking rates for higher risk, but lower rates for little to no risk?
Do the refis under current good underwriting standards. Make it harder to get cashout of your house. By getting long term rates lower, you will also make homes more affordable, and maybe a few more buyers out there will qualify. I believe prices need to come down, but if long term rates come down as well, more people can purchase. But make sure they can afford the homes.
And penalize the home flippers by making it difficult to obtain loans. Put a 2-5 year prepayment penalty on all investment properties. Let the investor take the risk, not the bank. Have investors invest for the long term, not a quick flip. They have them on almost all commercial deals, so why not 1-4 residential units?
But the problem with all of this is that Paulson and Bernanke are more intent on helping Wall Street than the rest of us. Lowering short term rates increases the potential of inflation and hikes long term rates. Do do they increase short term rates and hurt Wall Street? Or is there something they can do to help all of us Main Streeters? A refi boom would put a lot of people back to work. But only the good ones, not the scum suckers. Make it hard to get into the business.
We have to reward the majority of morally conscious people, not the few bad apples. We have to stimulate the economy by creating jobs. And at the same time, try to help qualify more buyers (the right way) to purchase the American dream. Yes, this is self serving for me, and I am sure that someone will say that. But let’s try to find a stimulus package that stimulates the majority of America for a long period, and help the housing market get affordable and stabilized. Those are the real problems affecting American households nowadays.
Jumbo rate equal to conforming rate is throwing out Finance 101. I agree.
Last week, the dictators in Washington raised the conforming loan limit. That is making the jumbo and comforming rates equal. That is ignoring the risks of large loans. That is again throwing out Finance 101. The professor did not mention this point. It seems she didn’t get it.
Why should homeowners (renters) continue to throw hard earned cash into a black hole dug by overpaid bankers who took vast bonuses and are now fat and happy whatever happens in the debt markets.
If those responsible get to do some hard time (a la Enron) we might expect a more responsible lending environment to prevail in the future - pass the KY jelly you guys!
I will try to make this as short as possible.
1.) Low interest rates AND no underwriting standards created this mess.
2.) The fools who created the subprime mess are or going out business.
3) It is now next to impossible to get 95% to 100% financing
4.) Government help is a joke.
5.) Increase in FHA, FNMA will only help those that don’t necessasirly need it. (Kind of like a banker giving an unbrella when it is sunny outside.)
6.) People bought houses in hopes of appreciation, cash out on to pay credit cards, etc. and cannot do that any more.
100%^ loans make walking away the best bet.
Go figure.
People need to wake up to reality
Houses don’t go up in value by 25 percent a yr maybe 3-4 percent make people come in with 20 percent down with good credit.
Borrowers would not move into a 30 yr fixed because they could not afford the payment because they are over extended living way beyond there means
Eliminate equity lines of credit beyond anything over 70 percent
have minimal 7 yr fixed loans !
I have been in personal finance for over 25 yrs have lectured at a university of ca school on personal finance been a CFP with licenses in securites 24 insurance life dis variable contracts and real estate
Dropping money from the sky is a stupid political ploy by both parties
Increasing the dividend tax rate by the demos is even worse it reduces the motivation to save and increasing the cap gains rate is bad too! Talk about double taxation
Privatizing social security or letting people manage there social security accts is a huge disaster waiting to happen
nationalized insurance is bad too
People are and have been living beyond means
Option arms are good for intelligent investors which maybe 20 percent of people are about investing tops
people need to get small cars eat healthy and save too
Ethenol is a polical thing too it costs 4 gallons of gas to produce 5 gallons of ethenol
Biodiesel and nuclear power and wind energy and some solar will eventually be really good
The people that wrote before be generally have a clue
Your welcome and yes I have compassion for those that live beyond there means
I definitely agree that for those of us with a loan at 50% LTV, it would be fantastic if we could refinance for rates in the 4’s and I do think that there are enough of us for this to create some stimulus to the economy. Do I think it’s going to happen? Definitely not. Just look at the direction of fixed rate mortgages lately, they aren’t going down. I also agree that the FED is doing everything it can to help their buddies, not homeowners.
Foreclosure is the Only Best Option. Stay in the house for as long as you possibly can.
Hello? The reason we are having foreclosure issues is because we had bad valuation of properties, not because we gave people 100% financing. these houses in orange county are not worth what people paid, therefore they are giving them back in droves I laugh at these posts about how we will never get down to the level of 06 and 05 - well we skipped those tow years and went straight to 04 - by the end of 08 you will see 2000 prices in OC. Not many can afford a mortgage for $600K - not many can afford a mortgage for $400k. Be prepared for all the equity vanishing into thin air.
Matt, get Mark’s permission and run his statement in the Register……it hits the mark exactly.
I would like to see home owners at .50 LTV get a break. It will never happen. Banking is in business to make money, not simulate the economy. Why give credit on a sure thing? The fed’s recovery plan is to bail out the financial market mess and to get that stable. Once that is done, don’t expect much sympathy otherwise. Once the correction is complete, the laws of supply and demand will take over. Today there is little demand and over supply. It will be for a very long time.
Carlos!
FC is either the only OR the best option….That’s not gravy!
Lenders are 50% responsible for this mess for taking on too much risk in lowering lending standards, and the home buyers are 50% responsible for being ignorant of the risks / affordability on the biggest purchase of their lives. Both deserve to suffer. Real estate agents are not to blame. Its their job to sell homes to make a living. Its not their job to educate potential buyers on their finances and what they can afford, that’s the homebuyer’s responsibility. Bring on the pain until we return to a normal state.
I want idiot borrowers to loose their house so I can swoop in and have my choice of dozens of houses to by cheap. I want more mortgate / real estate companies to go bankrupt and lay thousands off. That will be a good painful lesson for all of them so this won’t happen again. And in the meantime, bottom feeders like me will be there to take advantage of the situation.
To the guy who made the last comment. I think you have a criminal mind cashing in on people who are just trying to do bertter the American way. First off you have know idea what each home buyer might have had to go thru to buy their homes. The lenders are the crooks that let them have the houses, knowingly allowing them to purchase them over their means!!!!! So, before you go pointing the finger, remember it could happen to you too. You sound extremely greedy just like the lenders. SO watch your back, you could buy so many houses maybe you wont be able to sell them either and end up in debt. I would just laugh my butt off at you for thinking your so smart!!!!!!!!!!!!!!!!!!!!