It’s The Income, Stupid – Thoughts On Fixing The Subprime Mortgage Crisis
Slowing foreclosures have given a spark of optimism to investors on Wall Street who see the trend beginning to slow down. For the last year the foreclosure rate has steadily risen month by month over the past year’s month of foreclosures causing speculation of a continued trend in homeowner foreclosure rates. RealtyTrac, an online marketer of foreclosure similarities, said “that foreclosures fell to a 5% increase from a 6% increase in foreclosures the past year” causing speculation of brighter days.
However, foreclosures continue to rise they are just doing so at a slower rate. On Capitol Hill the politicians are working feverishly to come up with legislation to slow this rate already more, but they seem oblivious to is the inner problem that is causing the foreclosures. Ignoring the sickness and treating the symptoms is a sure way for the disease to spread. What they appear to have ignored is that these hybrid loans were not exclusive to low income borrowers with bad credit which is not the situation at all.
By in large the first wave of foreclosures has come and gone chiefly affecting low income borrowers with poor credit. For the most part these borrowers were bought homes or refinanced into 2 year ARM’s (adjustable rate mortgages). However, there is another wave of foreclosures coming and it’s a tsunami that will affect the middle and upper-middle class of borrowers and deliver a one-two punch to reeling lenders. According to Keith Carson, with TransUnion’s financial sets the foreclosure rate is trending towards the higher end neighborhoods that were seemingly immune to the first wave of foreclosures.
Self employed borrowers with good credit are responsible for almost as many of the “sub-chief” loans as the latter. These loans were made to people with good credit but needed a riskier loan that traditional mortgage lenders would not make, the subprime loan. These loans are called stated income loans and do not require the borrower to prove their income, only that they have income. These loans are shared practice for self employed business owners who can rarely show their complete income on their tax returns due to deductions and depreciation.
Due in part to increased credit score requirements these loans have been almost as stable as the chief loans that were backed by Fannie and Freddie, the Nation’s number one and number two purchasers of mortgages. The problem is that the smaller lenders that do not lend their own money but instead buy and sell loans as a commodity began lowering the guidelines during the refi expansion to compete for loans. deteriorated underwriting guidelines on portfolio loans made it possible for stated income borrowers with good credit to buy expensive homes with no money down. This is the riskiest loan a lender can make because the borrower doesn’t have an investment in the character and can easily walk away from it in stormy waters.
Meet the next wave or foreclosures. These are middle to upper class business owners in expensive houses that have mortgages that are about to adjust or already have. These homeowners held on by the skin of their teeth during the first wave of foreclosures but are looking at rough seas ahead. These borrowers are now in homes they probably can’t provide due to the economic slow-down and have little reason to continue paying on an asset that is worth less than they owe money on. Add to the mix looming legislation that will prevent them from refinancing out of these adjustable rate mortgages foreclosure becomes the most viable option.
Most, if not all legislation aimed at “bailing out” the mortgage market offers borrowers strong recourse against lenders that loan money to people who cannot provide the home. This liability will bring stated income loans to a screeching stop. This sounds like good legislation on the surface it but doesn’t address the inner problem that is about to hit us. If self employed borrowers cannot prove their income because of legal tax deductions and they cannot get another loan to pull their selves out of their adjustable mortgage what can they do?
There are over a million self employed small business owners that have mortgages. A large percentage of these borrowers cannot and did not prove enough when taking out a mortgage. An equally large percentage of these borrowers are in adjustable rate mortgages that are shared to stated income borrowers to offset the higher rates. These loans were born out of necessity and served a good purpose until they were abused by portfolio lenders.
The problem is the income and the tax deductions that self employed borrowers have to take to function in the black. These deductions cause their tax returns to show virtually no income after the deductions. We can’t ask these business owners to not take these deductions can we? This will close thousands of small businesses and cause economic havoc on too many levels to count. We cannot ignore a million people the ability to buy homes can we? The answer is in the underwriting.
As most everything, the devil is in the details. Long gone are the days of actual underwriters looking at all of the documents and making shared sense decisions on would-be borrowers. In the age of automated underwriting where lenders and brokers plug in the numbers, assets credit scores and documentation kind into the computer and the program spits out an approval. There is only one large agency that nevertheless makes shared sense decisions on loans and that is Uncle Sam, FHA, ironically the agency that will end up bailing everyone out.
The only problem is that they do not do “stated” income loans, which is why they are solvent. They keep up mortgage holders to a moderately strict debt to income ratio that can only be proven by tax returns and w2 statements. This excludes our self employed borrowers who have to write their income off to make a living. However one thing could be done to fix this problem. edges and underwriters could calculate their income ratios from the gross amount on the taxes instead of the gross modificated (after deductions) and make a shared sense decision like they do with w2 wage earners.
This move would require that edges and lenders begin to use real loan officers and underwriters and empower them to make lending decisions. Not commission junkies and high cost secretaries that have computer guidelines memorized and little authority to deviate from what the computer program tells them to do. This would truly put lending back into the hands of specialized bankers that know their business.
Instead, legislators are determined to change the rules right now that affect the retail end of the market basically throwing the car in park at 60 miles an hour. This crisis did not happen overnight and it will not be solved with one piece of legislature overnight. Changing the rules mid game will only perpetuate the crisis and punish a lot of Americans who were playing by the rules. It began with a failure in fundamentals and it will end by repairing them. A gradual change with a grace period for current homeowners is the only way to usurp the next wave of foreclosures, it’s the income.