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Thread: Will 'Blemished Borrowers be Blindsided by Congress ?

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    Default Will 'Blemished Borrowers be Blindsided by Congress ?

    from Jack M. Guttentag The Mortgage Professor

    (snip)" Posted on Monday, December 10, 2007, 12:00AM

    In the wake of the subprime crisis, the mortgage market has turned against all but the "cream-puff borrowers" -- those with no weaknesses. The cream puffs can borrow today on pretty much the same terms as they could before the crisis. But borrowers with blemishes on their applications are paying much higher rates, and they face a far greater risk of being turned down altogether.

    As if that isn't bad enough, The Mortgage Reform and Anti-Predatory Lending Act of 2007 (HR 3915), now winding its way through Congress, would worsen their plight. That is not the intention, of course, but the law of unintended consequences has a home in the home-loan market.

    Blemished borrowers have one or more of the following risk factors: They can only make a very small down payment or none at all; they cannot fully document their income and assets; their property is something other than a single-family home; their loan is intended to raise cash or to purchase an investment property; they have low credit scores; their income is low relative to their expected total obligations; and their mortgage carries an adjustable rate that will result in substantially higher payments in a few years.
    The Chickens Come Home to Roost: Defaults

    During the go-go years of 2000 to 2005, the mortgage market was extraordinarily tolerant of risk factors. It was not unusual to see five of these factors present in an accepted mortgage, a phenomenon termed risk layering. Lending to a borrower who had no money for a down payment, who could not document adequate income, and who had a poor credit history was a kind of market insanity associated with the rapid run-up in house prices. Inflation of house prices converts even the worst loans into good loans. When the housing bubble burst in 2006, the chickens came home to roost in the form of mortgage defaults, which are rising to levels not seen since the Great Depression.

    Markets tend to overreact. Just as the housing bubble was accommodated by insanely liberal lending terms, the pendulum has now swung toward Scrooge-like stringency. The price increments associated with risk factors are now two to three times as high as they were a year ago, and risk layering has gone way down. Roughly speaking, if you have two risk factors, the price is substantially higher, and if you have three, the deal is probably rejected.

    A major provision of HR 3915 establishes "minimum standards for mortgages," which include requirements that borrowers have an "ability to repay" and that they receive a "tangible net benefit" from refinancing. What these rules have in common, in addition to their discriminatory impact on borrowers already victimized by misfortune, is their lack of specific operational guidelines. In an article I wrote recently on the tangible net benefit rule, I gave several examples in which the ultimate determinant of whether there was a net benefit to the borrower could not be known by the lender without reading the mind of the borrower.
    Offering a "Safe Harbor"

    The inability to know whether or not they are in compliance creates risk for lenders, which translates into higher costs for borrowers. But HR 3915 also provides a way to avoid this risk. It offers a "safe harbor," which is a presumption that the standards have been met provided that the loan at issue is a "qualified mortgage" or a "qualified safe harbor mortgage."

    A "qualified mortgage" is one with an interest rate that does not exceed the rate on Treasury securities or an average mortgage rate by more than 3 percent or 1.75 percent, respectively. On second mortgages, the maximum spreads are 5 percent and 3.75 percent.

    A "qualified safe harbor mortgage" is a loan that is fully documented, is not a negative amortization ARM (adjustable-rate mortgage), and either meets an income adequacy test, has a fixed payment for at least five years, or is an ARM with a margin of less than 3 percent. The overlap between a qualified mortgage and a qualified safe harbor mortgage will be very high.

    The combination of vague standards and a safe harbor means that lenders will classify loans with regard to whether or not they belong to the safe harbor. The safe harbor removes some of the sting from the imposition of vague standards, because many loans will qualify. But some will not qualify, and they will be priced at a higher rate than they are now -- or they will disappear. Already clobbered by the market, they will get the deathblow from Congress."(snip)



    I would point out that as self-employed 'independent contractors' involved in an 'insecure' business segment, exotic dancers are likely to be at the top of the list of would-be borrowers to get clobbered by HR3915 ... via reduced approval rates on future loans, or by extra high interest rates being charged by future lenders to compensate for the extra risk inherent in their 'non-qualifying' borrower status.

    Also, once the concept of 'non-qualifying' borrowers involving an inherently higher risk factor becomes entrenched in the financial industry as a result of the mortgage bailout bill, it is highly likely that the same elevated rate of rejected loan applications or the charging of extra high interest rates will carry over to other types of loans as well ... i.e. car loans, credit cards etc.
    Last edited by Melonie; 12-11-2007 at 11:33 AM.

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    Default Re: Will 'Blemished Borrowers be Blindsided by Congress ?

    It won't stick. We are dependent on credit in today's society (like that is anything new. People have been dependent on credit since the invention of money).

    The credit 'crisis' will be filled with people acting like lenders ie; home owner financing, car lots offering buy here/ pay here options, etc.

    That is really bad news for people with bad credit, as many many people who offer personal financing are scandalous not unlike loan sharks. This will go on for a little while, then some laws will get passed to force banks and other regulated financial institutions to write a certain number of high risk loans with some kind of insurance policy that is backed by a government agency like the FDIC did for personal savings.


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    Default Re: Will 'Blemished Borrowers be Blindsided by Congress ?

    ^^^ well ultimately it comes down to a very basic question ... given the future earnings potential of Americans (or lack thereof), given the rising cost of 'necessities' like energy and food and taxes, and given the future true costs of buying a house / a car / whatever, private investors are no longer going to be willing to risk loaning their capital to consumers who don't actually have sufficient disposable incomes available to afford that house / car / whatever. They're going to be doubly cautious after the US gov't shoves mandatory investment losses down their throats as a result of the 'subprime bailout', bankruptcy court 'cram-down's etc. on capital that they have already loaned out to Americans that can't afford to repay.

    As to your government backed 'insurance policy', this is only insurance if there is a real possibility that the insured loans can actually be paid back by the borrower. Therefore if the government does mandate that people who can't afford to buy houses or cars MUST be given loans to purchase houses or cars, knowing full well that these loans will never be paid back (at least not under original terms at market interest rates) the risk and ultimate cost must gravitate back to the US taxpayer a la your comment about the FDIC. This is not 'insurance' against a possible failure, it is a subsidy against a certain failure !!! When the s#!t finally hits the fan, i.e. the US taxpayer is finally presented with the 'bill' for mortgage failures and bank loan failures by being forced to recapitalize the FDIC and Fannie Mae, the end result will be no different than if the house or car were 'given' to those that couldn't afford them as a social welfare benefit !

    Yes there is a chance that this could be attempted ... however it would quickly fail as the 'rich' would quickly exit to avoid the massive tax increases necessary to bail out the FDIC and Fannie Mae. And with the 'rich' running for their offshore tax havens, there is simply no way that the 'middle class' can afford to make their own home mortgage payment and car payment, while at the same time being forced to make part of a mortgage payment and car payment for their 'poor' neighbor too via taxation and transfer.

    Ultimately, the root of the problem is that America no longer has any core of savings a.k.a. sovereign wealth in order to loan money to itself. America runs a current account deficit with virtually every country on earth. Many individual Americans also run a current account deficit with their creditors. Thus we are dependent on people from other countries to lend America THEIR savings as the basis for virtually all loans. The US gov't has no authority by which it can force foreigners to loan us their money. The authority that the US gov't DOES arguably have is to confiscate earnings from some Americans via higher taxes and transfer the proceeds to other Americans ... but even here US gov't authority to tax is limited, as the 'rich' who avoid US taxes by banking in the Cayman Islands or by purchasing triple tax free Muni bonds could tell you if they would own up to it. The only other authority that the US gov't has is to print new money, something that arguably amounts to the same thing in terms of wealth transfer.

    like that is anything new. People have been dependent on credit since the invention of money
    Perhaps true on the face of it, but the terms were far different. For example, loans in early America were short term (like farming loans which had to be repaid in a matter of months). Also, previous loans required collateral with real value (i.e. a 20% down payment), plus the lender's absolute right to repossess the collateral if the borrower violated the terms of the loan. Zero money down loans with long terms are a recent development, as were HUD mandates and bank regulator 'community service' mandates that home loans be written to borrowers having little or no down payments and insufficient ability to repay, as were bankruptcy court rulings legally preventing lenders from repossessing the houses / cars of bankrupt borrowers in order to recover their collateral and mitigate their losses ! The latest 'bailout' plan only aggravates these losses to loan investors (by denying them the right to sue for breach of contract because the original terms of their loans have been forcibly changed).

    Failing an outright transition to open Socialism, IMHO the only way that this can end is that Americans will be forced to start living within their means - via greatly reduced availability of consumer credit, and by significantly higher borrowing costs for those who have enough down payment / cash and a good enough credit rating to actually qualify for future loans, and by denial of loans to those with no down payment / cash and/or bad credit rating. Those Americans who were 'lucky' enough to have already obtained loans to make home / car purchases that they couldn't actually afford will get 'bailed out', but the door will be closed against other Americans being allowed to do the same in the future.

    ~
    Last edited by Melonie; 12-15-2007 at 10:11 PM.

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