Here’s an interesting guest post from one of our regular readers regarding the subprime lending situation, a topic that has gathered considerable momentum in the financial press. Realty industry news sources are just starting to pick this up. I’m guessing this story will be as big, if not bigger, than last year’s housing bubble media maelstrom.
"There will be pressure on the market at the front and the
back ends as credit tightens and we continue to experience the fallout from all
the Voodoo loans made over the past 4 years. At the front end, there will be
fewer entry level buyers. Even having to come up with just 5% down will take
all the nothing down people out of the market. If the lending industry
eventually moves to requiring 10% down, more people get removed. As higher
FICOs are required, more folks will be eliminated. The end of liar loans will
take more people out. At this point all we are doing is eliminating the walking
dead from getting $400,000 loans. It is too bad for everybody it took 4 years
to get this point. All this accomplished was to run up prices to unsustainable
levels which will, my friend, sooner or later, fall back. That process
has begun.
At the back end, we will see more and more short sales and
foreclosures as people who never should have been lent the money default on
their loans. They can’t re-fi. They are stuck with a payment they cannot
afford on a house that is declining in value. You are in a better place
than I am to experience up close the impact of all the short sales and
foreclosures on prices. Let me know what you see over the next 9-12 months.
"What none of us know is just how big is this wave
going to be. Will it be just your average tidal wave, or a real tsunami?
Remember that almost all of the trouble happening with the subprime market is
happening because of loans made just LAST YEAR!! It is the 2006 Voodoo loans
that are proving to be garbage in a big way. And why? Because this market ran
out of entry level buyers sometime in 2005. By then, 70% of all folks were in.
But in order to keep the music playing, the Voodoo industry had to make it
possible for the walking dead to buy in. We know what happened. They made
absurd loans of 100s of $1000s to people who couldn’t keep current on
their cell phone accounts. We shall now reap what we have sown.
"If this meltdown starts to spread to the ‘prime’
loan industry, watch out. I think it will. Remember that the only difference
between a ’subprime’ borrower and a ‘prime’ borrower is the
FICO of the borrower. I suspect there are billions and billions and
billions of loans out there to ‘prime’ borrowers who are just as
underwater. Somebody who bought in 2005 with a nothing down loan is no less
underwater today just because he had a 790 FICO. And the ARM reset will be no
less difficult just because he had a good FICO.
"I remember the S&L meltdown. I remember how it took
YEARS for that to settle out. I remember YEARS of slowly but surely eroding
property values. I remember YEARS of stagnation of values that followed. Back
in those days I owned several houses as investments, and so I remember it well.
I owned houses that ‘appreciated’ $5000 in 7 years. Oh yes, I
remember it well."
- Regular Reader
5 comments
I agree that there countless people out there with loans that they shouldn’t have. When these people default on their loans there will definitely be consequences that will have an influence on the market.
I disagree however with the assessment of prime loans. I don’t think the breadth of them reaches into the billions. I also disagree that there will be as many defaults by people with credit scores on the high end. When a person has a credit score over 700 it is because they have made decisions to get it there. It takes considerable time to achieve a 700+ credit score which shows that the person is consistently making choices that are prudent and don’t cause them to default on any of their debt. All of the people I know that have high credit scores weigh everything out and take their credit choices seriously because they understand what happens when you have a poor credit score. They have one mortgage, no seconds, pay cash for their cars and have one credit card that they pay off every month. Part of the scoring system is determined by debt load. When you have large amounts of debt your score goes down so people with high credit scores by the nature of the system don’t have a large amounts of debt.
I know that no system is 100% and there are always exceptions to the rule. I also don’t like the fact that we all come under the control of a very arbitrary system that doesn’t take our credit scores as seriously as we do or should. With this in mind I believe credit scores are really indicative of a person’s character and the choices they make.
So, then, what are these people with 800 FICO scores who are $150,000 upside down on their (formerly) $500,000 house in Wingfield Springs going to do?
Will they continue to pay their mortgage that is now $150,000 more than the value of their house just to preserve their credit rating? In service to their financial reputations and the credit reporting agencies, will these people continue to pay their mortgage as the value of their house sinks inexorably into the sunset? There is an entire industry that has bet its future on this question.
Last May, Harpers Magazine had a cover story entitled “The New Road to Serfdom.” I quote:
“A real estate boom that began with the promise of ‘economic freedom’ will certainly end with a growing number of workers locked into a lifetime of debt service that absorbs every single spare penny.”
“A modern equivalent of peonage, a lifetime spent working to pay off debt on an asset of dwindling value.”
We shall see, we shall see.
Diane-
Per your comment: “I’m guessing this story will be as big, if not bigger, than last year’s housing bubble media maelstrom.”
The lowering of lending standards leading to expansion of sub-prime has been a key–though only one of several–factor in the housing bubble.
The great unraveling is only beginning.
-CBam
Once again, this is not intended to be a blanket statement for all but I think most people with high credit scores tend to not be very impulsive which is why they have the scores they do. Most people buy a house and stay in it as opposed to flipping it. The media has made house flipping look more mainstream than it really is.
With regard to what is a person supposed to do whose house has gone down in value… They have to deal with it. The catalyst for selling a house isn’t a drop in value it’s a need to move due to job transfer or loss of income etc. Most people who bought at the high point will continue to make their payments because they don’t have a need to move. I wouldn’t liquidate my 401k because the stock market took a dump last week so why would I unload my house? Not everyone over extends themselves when buying a house. Not everyone got a voodoo mortgage. I moved several times over the past few years as home values increased. Every time I was offered a voodoo mortgage and every time I told them to stick their pins in someone else.
The bottom line is rent will go up and my house payment won’t. My wages will go up and my house payment won’t. As long as you don’t use your house like an ATM your house payment should become a smaller percentage of income. Ask someone who has a 10 year old mortgage what their payment is and it’ll seem cheap. Ask someone with a current fixed non voodoo loan what their payment is 10 years from now and it’ll seem cheap. For the longest time people were looked down on for not owning a home and now it seems to be in vogue to criticize those who do.
Perry posted:
“The media has made house flipping look more mainstream than it really is.”
I completely disagree. The run-up in prices over the past several years was due entirely to speculation. If anything, the media didn’t report on this enough.
“Most people who bought at the high point will continue to make their payments because they don’t have a need to move.”
This is an absurd statement based entirely upon your assumptions. Each individual loan comes with its own set of circumstances which you know NOTHING about. It is best to stick to facts.
“Ask someone who has a 10 year old mortgage what their payment is and it’ll seem cheap. Ask someone with a current fixed non voodoo loan what their payment is 10 years from now and it’ll seem cheap.”
While nobody can predict the future, I am willing to bet you’ll be proven dead wrong. I would be surprised if, in 2015, prices have even made it back to 2005 levels. Even if they have, the money wasted by those who purchased at 2005 prices is undeniable. The prudent thing to do back in 2005 would have been to rent the home for $1800 rather than pay $4000 on the note, and invest the saved $2200 for several years and then buy when prices are low. No matter what the asset, it’s prudent to “buy low and sell high”. And who was it that said “avoid the herd”? Buying at the peak is never a good idea financially.