The Great Mortgage Meltdown

The sky is falling!  The sky is falling!

The question was echoing over and over in my mind:  “What is happening?”  As Chicken Little might have put it, “Is the sky falling?”

Sitting in my office the other day watching my inbox fill up with warnings about the impending mortgage meltdown and loan program changes from every bank I do business with was a little disconcerting. Listening to Jim Cramer on CNBC yelling at Fed Chief Ben Bernanke only added to my consternation.  Bank after bank was going out of business, changing its guidelines, or not doing mortgage loans altogether.

I kept asking myself, “How did this happen?  What is causing this complete breakdown in mortgage lending?”  Then it hit me:  This is nothing new.  Chicken Little is wrong!  The sky is not falling after all, but visibility is low!

To understand better what was happening we have to go back to the mid 1990s.  In fact, we could go back even further—history does tend to repeat itself, and maybe one day we will learn from those valuable lessons—but the 1990s suffice for this story.  During that decade only a handful of banks were vying for the available mortgage business.  Typically, these banks had retail shops that sold mortgages directly to the public; some would also have wholesale operations that were directed toward the mortgage broker community. 

These mortgage banks had survived the nightmare of the late 1980s and early 1990s because they were conservative in their lending practices.  Then, as the economy started to heat up and the internet boom of the mid 1990s added more and more jobs, the buyer pool began to increase all across the nation.  As volume increased, so did profits; and a greater number of mortgage banks opened up to take advantage of this ever-increasing mortgage market.  As these additional banks opened, the larger ones experienced loss of market share to them.  What was once an industry of a few mortgage lenders turned into hundreds—all competing for the same business. 

Some of the banks, new to the business and having never weathered a down market, began to lower their guidelines and requirements for homebuyers.  As these banks lowered qualifications, the buyer pool (the number of qualified buyers) increased.  Historically, a down payment to buy a house was 5 percent.  In this new market a buyer could purchase a house with no money out of pocket and without showing income to qualify.  These lowered qualifications led to a ten-fold increase in the buyer pool.  More and more Americans were going after the dream of homeownership; and the greater the demand, the more opportunity to supply the demand.  As a result, a greater number of mortgage banks opened to meet that demand.  As the buyer pool leveled out, mortgage banks scrambled to come up with innovative ways to stand out among this ever-increasing number of lenders.  Qualification guidelines were lowered time and time again.  It was a booming housing market.  If buyers could not maintain the mortgage payments on their homes, they would simply refinance cash out or sell and walk away, usually with money in their pockets.

The big mistake of mortgage lenders was setting lending practice guidelines solely based on an up market.  Remember, most of them had never engaged in lending in a down market.  Indeed, they were in for a rude awakening!   Here are some of the crazy lending practices that these banks were using:

• Zero-down mortgages for borrowers with credit scores of 560

• Zero-down mortgages for borrowers with credit scores of 600 and no verification of income

• Zero-down mortgages for investors with credit scores as low as 620 and no income verification

• Zero-down mortgages for borrowers with no income and/or asset verification

• Mortgages for borrowers one day out of a foreclosure or bankruptcy

These practices opened the way to qualify everyone except the person with a sub-500 credit score to buy a home.  The buyer pool was huge, and the market was doing great.  But markets change:  What goes up must, eventually, come down.

As the housing market across the nation began to cool, the same borrowers who could sell their homes and make a profit, or to refinance cash out if they got in trouble, were going into foreclosure.  Mortgage lenders worked feverishly to stop the bleeding by changing qualifying guidelines and making it tougher to buy a home.  The first casualty was subprime loans, the loans made to borrowers with credit scores of sub 620, some as low as 560.  This change greatly reduced the buyer pool and drove down demand for both new and existing homes.  The result of decreasing demand with an increasing supply is obvious to all:  Home prices drop.  This drop in home prices coupled with a decreased demand created a greater problem:  As demand fell, home prices fell even further, which led to more homeowners, who were shouldering a greater burden due to adjustable rate home mortgages, going into delinquency.  They were unable to sell in a flooded market.  Like the proverbial snowball the market grew worse and worse. 

My opening question, “What is happening?” is answered:  We are dealing with the fallout.  Every mortgage lender out there is tightening his or her guidelines, thus making it more difficult to buy a home.  Some are packing it in altogether.

As an optimist I ask and answer a second question:  “What is the good news—is there a silver lining?”  The answer is Yes. 

The Austin market is very strong.  We had only a 6 percent coverage of subprime loans locally, and Austin has one of the hottest job markets in the country.  Now is a time for cautious optimism.  Because the buyer pool has been greatly reduced, we must watch our supply and demand curves and be ready to change our investment strategies to match the current market conditions.  Investors have reason to be upbeat about this change and can take advantage of the available renter pool.  Lately, a number of realtors have said that local rental rates are skyrocketing.  However, be careful where you buy, remembering that you make your money when you buy the house—not when you sell it.  Investing in real estate is about identifying where you are in the real estate cycle and implementing the correct strategy.

Let’s revisit the opening question:  “Is the sky falling?” Chicken Little fearfully cried.  I think not.  We are just returning to smart lending practices.  As a result, conservative mortgage lenders who are making good decisions will still be around tomorrow.  As for the others—well, I hope they have learned a valuable lesson.

John McClellan

John McClellan has more than 13 years of experience in real estate and mortgages. He has been consistently ranked as one of the top 10 mortgage brokers in Central Texas by the Austin Business Journal. John is an experienced professional mortgage expert who is thrilled to give you access to the best rates, best programs and greatest service.

John has been involved on the broker and banking side of mortgages, and handles hundreds of various types of transactions each year.  This training has given him a unique insight to the inner workings of the mortgage industry. With this expertise, he can advise and place his clients into the best loans that are tailored to meet their individual needs.

John is employed with Supreme Lending, a Mortgage lender that has its corporate offices in Dallas, with branches in Houston, San Antonio, and Austin. Supreme Lending funds almost half a billion dollars a year in residential mortgage loans.

John grew up in Central Texas and still resides here today.  John is married to his wife Laura, a native Austinite and former teacher in the Round Rock Independent School District. They have two children: Emma and Noah. John and Laura are very involved with their church and their children’s lives.

Anyone who has had the good fortune to spend even a few moments discussing mortgages and real estate can see John’s obvious passion and enthusiasm; and his commitment to his clients is legendary.  When you want a passionate, professional, mortgage expert, you want John McClellan on your team.

Please feel free to contact John at 512-279-1150
or at john@teammcclellan.com

http://www.mortgage1370.com/aboutjohn.html

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Austin Tops the Nation for Business

Austin Business Journal - 1:53 PM CDT Monday, August 6, 2007

Austin is the best place for business in the U.S., according to Moody's Economy.com Inc.

Moody's, an independent economic research firm, reported that the Austin-Round Rock Metropolitan Statistical Area (MSA) earned the top spot over almost 400 metropolitan areas tracked by the company's economic vitality index. In the last index, published in March 2007, Austin-Round Rock MSA ranked seventh.

The index, published since 2001, evaluates current economic conditions, expected trends, and potential risks, taking into account factors such as employment growth, household income, productivity, net migration, industrial diversity, and cost of doing business.

According to the Capital Area Council of Governments, or CAPCOG, the index is watched closely by agents involved with corporate expansions and relocations including market researchers and site selection firms.

"Austin's No. 1 ranking is something the entire region can be proud of," says Betty Voights, executive director at CAPCOG, which commissions the report from Moody's Economy.com. "Economic development today is a competition among regions, and this top ranking serves as a strong message about our commitment to working together toward regional success."