ARC's 1st Law: As a "progressive" online discussion grows longer, the probability of a nefarious reference to Karl Rove approaches one

Monday, December 03, 2007

Sub-prime Mess

Interesting article in today's WSJ and you should read the whole thing... (Paul Krugman took the opportunity to blog on this article and then reference post by a Moonbat blogger called Atrios, further damaging his credibility outside of the Manhattan bubble.)

But, here's a snippet that I'd like to analyze:

Subprime Debacle Traps Even Very Credit-Worthy As Housing Boomed, Industry Pushed Loans To a Broader Market
December 3, 2007; Page A1

One common assumption about the subprime mortgage crisis is that it revolves around borrowers with sketchy credit who couldn't have bought a home without paying punitively high interest rates. But it turns out that plenty of people with seemingly good credit are also caught in the subprime trap.

An analysis for The Wall Street Journal of more than $2.5 trillion in subprime loans made since 2000 shows that as the number of subprime loans mushroomed, an increasing proportion of them went to people with credit scores high enough to often qualify for conventional loans with far better terms.
The surprisingly high number of subprime loans among more credit-worthy borrowers shows how far such mortgages have spread into the economy -- including middle-class and wealthy communities where they once were scarce. They also affirm that thousands of borrowers took out loans -- perhaps foolishly -- with little or no documentation, or no down payment, or without the income to qualify for a conventional loan of the size they wanted.

The analysis also raises pointed questions about the practices of major mortgage lenders. Many borrowers whose credit scores might have qualified them for more conventional loans say they were pushed into risky subprime loans. They say lenders or brokers aggressively marketed the loans, offering easier and faster approvals -- and playing down or hiding the onerous price paid over the long haul in higher interest rates or stricter repayment terms.

The article continues and provides additional information about how these credit-worthy borrowers ended up with sub-prime loans. I point to the following two causes:
  1. Average person in the US doesn't understand finance, interest rates, mortgages, etc thanks to a sub-par education system.
  2. Many people were enticed into the sub-prime, "state your income", interest only loans primarily because they viewed the risk of an increasing interest rate as minimal when compared to the rate of return on the increasing value of their home.
As someone who's gone through the mortgage process four times in the past 10 years (2 new loans, 1 re-fi, and 1 home equity), I have to say that it increasingly involved questions from lenders as to whether I preferred to simply state my income or whether I wanted to fill out a lengthy form. I was asked several times whether I would like an interest-only loan, a higher Loan-To-Value ratio, or something less "boring." Of the 4 loans that I've taken out, only one was a 5 year ARM (fixed for 5) with a cap on the interest rate over the life of the loan. And, since the home we were living in was well within our means, even the highest interest rate possible after 10 years would have been possible for us. Add to this the fact that we knew we would probably move within a few years and we made out like bandits.

I compare my experience with the final paragraphs of the story:
Often such loans involve fraud, says Peter Fredman, a California attorney who has two clients who wound up with loans with high interest rates despite good credit scores. "Because these people had decent credit scores, the lenders said they would do a 100% no-documentation loan and that opened the door for mortgage brokers to do whatever they wanted to do," he says.

Mr. Fredman is representing a couple in their sixties with a monthly income of less than $2,500 but mortgage payments of roughly $3,400, not including taxes and insurance. The husband and wife, first-time home buyers with credit scores of 680 and 667, expected payments of $1,500 a month. They tried refinancing to lower the cost, to little effect. They haven't made a mortgage payment since January.
I assume that their expected $1,500 per month is not including taxes or insurance, but regardless: someone with a combined total income of less than $2,500 per month should not be taking on a monthly mortgage payment of $1,500!

That leaves them very little for food, clothing, transportation, etc. That this was their expected payment shows that they are not responsible borrowers. Some quick math (using an estimated 6-7% interest rate and the $1500/month payment) shows that the minimum value of the house they bought was anywhere from $225 - $250k if they had a conventional, 30 year loan. The fact that they opted for one of the "teaser" loans (with what they thought would be a $1500/month payment) suggests that the house was probably valued higher than that!

Someone with a combined annual income of less than $30,000 should not be getting a mortgage on a house valued at more than $250k. Just saying...

Perhaps Congress can make the inability to budget or understand basic finance illegal. Just package it as being "for the children" and I'm sure it'll fly through.

Your Co-Conspirator,
ARC: St Wendeler