I’ve been involved with the sub-prime mortgage industry for about 10 years, and recently got out of the industry right before the big fall. With all the press that has been going on recently, how could I not chime in with my 2 cents.
There was a recent article on Yahoo talking about GreenPoint mortgage closing its doors and in it they said:
As the nation’s housing market has cooled, the mortgage lending industry has struggled with a dramatic rise in mortgage defaults and foreclosures. Many homebuyers have been forced into default or foreclosure because they haven’t been able to sell their homes or end up owing more than their home is worth.
I wasn’t a broker or an underwriter or an agent; I was and continue to be a computer programmer. Which means I was responsible for building the systems and programs that helped fund the millions of mortgages that are now defaulting. What has been truly amazing is just how quickly things are falling down around everyone’s ears.
During my employment at various mortgage companies, I was in a unique position of not only building the various systems, but since we had to know the entire life cycle of a loan because we were often building these system and modifying them on the fly, I actually took time to study and understand how mortgages work from origination to selling on the secondary market. In fact, for a while, I taught a weekly “Lunch and Learn” course that we called “Mortgage Industry 101” that lasted for 12 weeks at a time. What I couldn’t believe was how little even the employees understood about anything outside of their department. I shudder to think about the lack of understanding that our customers had when getting a loan and all the implications and obligations they were committing themselves to.
The basics of the loan lifecycle go like this:
- Client applies for a loan
- Underwriter approves the loan
- Mortgage company funds the loan
- Mortgage company sells the Client’s note to an investor
- Servicing company collects payment from client and sends money to investor
- Mortgage company uses proceeds for sale to investor to fund another loan
So, how do people make money in the industry? Here is a very simplified example…
- The mortgage company has overhead and expenses, lets say it costs them $3,000 for every $100,000 they loan. So to create a $100,000 loan, it costs the mortgage company a total of $103,000 (This is called origination cost at 103%)
- Investors generally buy the loan for a premium, let’s say 105%, so It would cost $105,000 for an investor to buy the above loan. The mortgage company has now made $2,000 (This is sometimes referred to as the spread or gravy)
- The servicing company will then collect payments from the borrower on behalf of the investor and take a small percentage of the payment to cover their own expenses (generally .5% of the payment)
- The investor receives the payments of principle plus interest for the life of the loan. Obviously the higher the rate, the more money the investor makes. And if the borrower refinances then the investor is paid off and must go out and buy more loans to fill their income portfolio.
Now, there are various tweaks to the above scenarios – mortgage companies will charge origination fees, tack on prepayment penalties, lower interest rates by having the borrower pay points, but the above scenario for the most part holds true for the vast majority of loans out there.
Here is why this is breaking down so quickly now… The investors (also called the secondary market) don’t have the money to buy anymore loans because they are not getting paid. Without that money from the investors, the mortgage companies can’t fund any more loans, and even if they could they don’t have anyone to sell them to.
So, in effect, the mortgage companies are manufacturing loans, but nobody out there is buying them. Even if the Fed continues to lower their rates so the mortgage companies will borrow from them, investors don’t want to buy them and be left holding the bag when the borrowers can’t pay.
And here’s the thing that kills me. Many of the borrowers went into the loans knowing they couldn’t pay the mortgage. They aren’t defaulting through some great hardship like losing their job or a natural disaster. They took these teaser rates at 2% and were expecting to refinance before the big payments came up. But if the investors aren’t buying these products, the mortgage companies aren’t going to be making these kinds of loans, and many borrowers are now stuck with the high payments that they originally agreed to 3 or 4 years ago when they signed the loan docs. And without banks willing to refinance them and support their (IMHO stupid) decision, they’ll lose their house that they couldn’t really afford anyway.
So, the big question is… When does the federal government step in and declare a state of emergency, bail everyone out and reward them for their stupidity and greed, and we end up looking back on the “great mortgage crisis” of 2007 the same way we we’re looking back at the Savings and Loan scandals from the ’90s?
With a couple of quick lessons in living below your means and a sustainable lifestyle, I doubt these borrowers would now be in danger of losing their homes and I doubt the mortgage companies would have had to lay off 40,000 people so far this year.