Are Lenders Seriously Writing These Real Estate Loans...Again?

Posted by Chris Clothier on Wed, Aug 28, 2013

Where is the U.S. Housing Market Going Next?

Some economists and experienced real estate investors think they know and most will not like the news they have.

I was recently in Los Angeles at a dinner with a real estate mortgagesgroup of investors and investment service providers and at one point the conversation turned to the current housing market.  The dinner was sponsored by MOR Financial and one of the partners was recounting an advertisement he had heard earlier in the week.  The advertisement was from a mortgage lender and they were promoting a brand new product they had for home buyers...the 5/1 ARM.  For anyone not familiar with the terminology, that is an adjustable rate mortgage that has an artificially low interest rate for the first year and then can increase by 1% each year for the next 5 years.  Traditionally, an offering like this is tied to the LIBOR, which coincidentally has nothing to do with the housing market.

Oh, and...they are not new!  To many economists and real estate professionals they were a HUGE reason for the housing crisis in the mid 2000's.  Our conversation that night was one of amazement that such an offering was coming back.  For those of us who managed to survive the last housing crisis, we look back at these types of mortgage products and realize that they were abused by lenders to create more transactions and many home buyers used them to purchase properties that they could not afford.  To make the conversation more amusing, they recounted how stated income loans are starting to slowly make a come back in the California market.  Stated Income loans!!  As if adjustable rate mortgages were not bad enough, some bright thinker some where has determined that it is a good time to bring stated mortgages back.

I don't think it was by coincidence that I stumbled across a commentary article on Monday located on the DSNews.com website.  This is already one of my favorite places to read blog articles and commentary as it relates to the real estate industry.  I opened my email on Monday and clicked on the first article and this little gem jumped off the screen at me:

"In the spring and early summer, more lenders, as surveyed by the Federal Reserve, said they were easing standards for mortgage loans than were tightening."

Yikes!

The Real Estate Investing Worlds' De Ja Vue

These types of loans are used across the boards when buying real estate so they are not simply a method for investing.  Problem is, investors try to use them.  Just as homeowners try to justify their use of a 5/1 ARM as a good prudent decision because "the market is going up" or "I expect to make more money in the future", investors also use the 5/1 ARM for the same reason.  It is a great way to boost cashflow - although ABSOLUTELY ARTIFICIALLY!!  It does not last.  When the rates adjust so does the income and the fallacy that a product like a 5/1 ARM is a good idea comes to roost right on the front lawn...just like a present left by the neighbors dog.

I asked DSNews.com if I could repost the article here for you to read in its entirety.  Please visit their site as well if you like keeping up with the most up to date real estate news.

Commentary: Déjà Vu All Over Again

In the spring and early summer, more lenders, as surveyed by the Federal Reserve, said they were easing standards for mortgage loans than were tightening.

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In the spring and earlier summer, the median price of an existing-single family home was increasing by an average of 1.8 percent per month as sales increased about 0.5 percent per month. Personal income, according to the Bureau of Economic Analysis, was increasing at about 0.5 percent per month.

In the spring and early summer, the Case-Shiller Home Price Index was increasing by an average of 1.5 percent per month

In the spring and earlier summer, the nation added about 230,000 jobs per month, about one quarter to one half of which were retail and leisure and hospitality, the two lowest wage industry sectors tracked by the Bureau of Labor Statistics.

That was 2005, the year before the housing bubble burst brought the economy down with it.

In 2013, numbers look eerily similar:

According to the latest Federal Reserve Senior Loan Officer Survey, an average of 4.6 percent of lenders surveyed acknowledged easing lending standards for prime residential loans and 16 percent of lenders surveyed reported an increase in demand for loans to subprime borrowers.

So far this year, the median price of an existing-home has increased an average of 2.5 percent per month and sales are increasing an average of 1.4 percent per month.

The Case-Shiller index has increased an average 1.3 percent per month.

Of the average monthly increase of 192,000 jobs per month, retail and leisure and hospitality jobs have accounted for nearly one-third.

While some of the 2013 numbers look better than 2005, other coincidental indicators are reason for concern. In 2005, sales at furniture stores and building and garden supply stores—retailers who thrive when homes are purchased—increased an average of 0.3 percent and 0.4 percent respectively. In 2013, those stores experienced average monthly increases of 0.2 percent and 0.4 percent. Sales at appliance stores went from an average monthly growth of 0.8 percent to an average monthly contraction of 0.1 percent.

The falloff at furniture and appliance stores suggests homeowners may be stretched to make monthly mortgage payments—even in an era, until recently, of low mortgage rates, rates that will only increase when the Federal Open Market Committee begins to tighten monetary policy.

And, according to a newly published paper, monthly payments are critical in forecasting defaults.

While economists Andreas Fuster of the Federal Reserve Bank of New York and Paul S. Willen of the Federal Reserve Bank of Boston studied the effect of payment size versus reducing principal in loan modifications, their conclusions are equally applicable to new mortgages. “Little is known about the importance of mortgage payment size for default,” they wrote.

In their study of workouts, they said “interest rate reductions dramatically affect repayment behavior, even for borrowers who are significantly underwater on their mortgages, adding “our estimates imply that cutting a borrower’s payment in half reduces his hazard of becoming delinquent by about 55 percent.”

Fuster and Willen didn’t directly study new loans, but the parallel approach to determine what borrowers have left over for discretionary purchases, which offers a reason for concern as the housing sector struggles to recover.

The impact of housing on the rest of the economy—construction jobs and suppliers as well as the financial sector—is, to be sure, a reason to look to housing as a stimulus but not, if as the numbers suggest, history may be repeating itself.

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Topics: real estate investing, DSNews.com, real estate mortgage, real estate lending