Articles
Subprime Mess
Published in the Bozeman Chronicle, April, 2007.
Unless you have been on vacation for the past month, you have probably been exposed to the latest prime-time real estate phenomenon of “subprime” loans. You have heard it on the nightly business news, read it online, and seen countless articles in the national and local newspapers and business journals. So what are the facts about subprime, how might it affect your borrowing power and impact our local marketplace?
First, how did we get here? I think David Lereah, Chief Economist for the National Association of REALTORS,says it best, “Just as children in an orderly classroom stir up a wild ruckus when the teacher leaves the room, some people and businesses stray from fundamental behavior during a frenzied market environment. It happens every time. During the savings and loan crisis of the 1980s, S&L senior management wastefully purchased expensive fine art while their institutions were crumbling. Investors purchased company stock at triple-digit price/earnings multiples during the giddy 1990s dot.com boom, ignoring fundamental investing principles. And in the aftermath of the nation's biggest real estate boom, we learn once again, about behavior in a frenzied environment… the subprime mess.”
The subprime crisis is referring to a certain variety of home loans which are currently experiencing heavy rates of both default and foreclosure. The loans are targeted towards those with low credit scores, little or no money for a down payment, or are otherwise unable to qualify for a standard, conventional loan. Lenders, who were attempting to make the most of the housing boom, offered interest-only loans, loans with payments that did not even cover the interest, and some loans where the borrowers were not even required to have employment.
The subprime market encompassed almost one in five total mortgages over the last year. Many of these loans were made with fixed rates for the initial two years, and the two years are up, so the loan payments are being adjusted heavily upwards. Since the loans already carry a higher than normal interest rate due to their risk, homeowners are quite often unable to keep up with the dramatic increase in their monthly payments. Over 8 million of adjustable-rate loans (25 percent of which were subprime) were originated during the past three years. First American Corelogic estimates that about 1.1 million of them totaling about $326 billion are likely to end up in foreclosure. A bit over $300 billion of subprime adjustable mortgage loans are due to re-set by October 1st of this year.
Although seemingly a startling new topic, these types of loans have been around for many years. In the recent years, when the housing prices were increasing at a steady pace, a homeowner had a wide array of options when their loan was due to adjust. They could put the home on the market and ideally make enough of a profit to move on; they could simply refinance the home with the equity they had acquired while living in it; or if it did come to foreclosure, the higher value of the home would quite possibly cover the foreclosure costs. Because of these factors, lenders were willing to keep taking on additional risk. Now that housing prices have leveled off across much of the country, this strategy is more difficult. Additionally, if it does come to foreclosure, these borrowers who purchased homes that they truly could not afford not only lose their homes, but any down payment they have made, the cost of any home improvements, and their credit is further damaged.
Clearly, the recent fall-out has stifled subprime lending activity today and may influence prime lending practices of tomorrow. Many subprime lending companies have closed their doors and their sources of funds—the large banks and Wall Street—have tightened credit. The regulatory agencies have proposed stricter subprime lending guidelines, emphasizing sound underwriting, greater documentation, a debt-to-income analysis that includes taxes and homeowner's insurance, and qualifying borrowers on a fully indexed mortgage rate rather than the starter rate. The lending pendulum will swing away from no-doc loans and creative adjustable options. As a borrower, look for more traditional approaches with more emphasis on payback ability and credit worthiness.
What does this mean for our local marketplace? The short answer is no substantial impact. Even though certain segments and geographic regions of the housing market will be affected by increased foreclosure troubles in the subprime sector, we should see less pressure on a local level. Factors favoring our region include the quality of local credit and the lack of true market speculators. This is not to say that we are totally immune from subprime woes, but just as the housing bubble is not an “across the board” national epidemic, neither are subprime defaults equally spread across the nation.
Robyn Erlenbush is owner of ERA Landmark Real Estate (with offices in Bozeman, Big Sky, Livingston and Clyde Park) and Intermountain Property Management. She can be reached at robyn@eralandmark.com.