Why did this “mortgage meltdown” happen and how does it affect us on the Westside?
Why did this “mortgage meltdown” happen and how does it affect us on the Westside?
Written by REALTOR Simon Salloom for the Santa Monica Daily Press. Sources for information taken from interviews with senior members of the mortgage industry.
Despite what most people think, most mortgage lenders have a relatively small cash reserve. Their ability to lend money to a borrower is directly related to their ability to sell the rights to collect on that loan to the secondary market. When a homebuyer borrows money from a bank to buy a house the bank will often make their profit on this service by selling the loan to an outside investor. After the bank has sold this loan, the bank recoups their initial investment with profit and sells the money again to a new borrower.
These lending banks have two sources of liquidity, or sources of cash for them to sell the loans that a borrower buys. One is Freddie Mac and Fannie Mae, federally backed organizations who buy loans from companies like Wells Fargo and Countrywide. Fannie and Freddie only buy conforming loans—this means loans that are under $417,000.
The majority of mortgages in Los Angeles require dollar amounts greater than $417,000. So the majority of lenders have to sell most Los Angeles based loans to alternative investment groups such as mortgage backed securities and institutional investors. This is not easy to do at the moment.
Up until a few months ago, there was a large secondary market for mortgage backed securities. Now, due to a considerable amount of borrower defaults of both sub-prime and mainstream loans, the demand from the secondary market is practically zero. This can’t last forever, but for now, most lenders are waiting to see what happens after this “shakedown” ends. In order to avoid being stuck with a lot of mortgages no one wants to buy, banks have tightened lending standards and raised interest rates.
With lenders not knowing what the secondary market will pay for their loans, they have little choice but to raise interest rates to mitigate their risk. At Countrywide, a non-conforming loan used to sell about .25% higher than a conforming rate. That difference is now .5%. Wells Fargo has increased their 30yr fixed mortgage from 6.875% to 7.875%. It is important to note however that every lender is reacting differently to this situation. Most mortgage professionals are quoting rates that are about .5% higher than what they were selling at earlier this year.
There are also banks with large enough cash reserves that they hold onto the loans they make and have no need to sell them in the secondary market. However, there are not enough of these types of institutions to slow down a rise in interest rates or slow down a move towards more conservative lending practices. At the end of the day, this will lead to greater stability of our financial markets. At the same time, the opportunities for people not yet in the real estate market, without the equity most homeowners have or large cash reserves, the potential for buying a home has drastically diminished.
What lead up to this current situation?
As the U.S. housing market gained strength over the past five years, demand for domestic mortgage backed securities grew. The banks made more money by selling more mortgage based products to secondary investors. In order to take advantage of this demand the banking industry loosened its lending practices, creating a significant amount of higher risk loan products. Now that the housing market in most of the country isn't what it used to be the party is over and a good number of people are having a difficult time paying their mortgages.
On the Westside, one could guess that the part of the market that will be most influenced by the current mortgage situation will be properties affordable by first time buyers. For the most part, this means houses and condos under about $850,000. The advent of loans that gave 100% financing on stated income and not great credit scores gave many first-time buyers the ability to buy.In the past five years, around 65% of purchases by first-time buyers on the westside were 100% financing or 5% down. Loans that provide 100% financing no longer exist and ones that accept 5% down have very high interest rates right now. This shrinks an already small buyer pool even more. Not many young people have $80,000 in the bank.
At the end of the day, what will inevitably change property values in Los Angeles is the ratio of supply vs. demand and the cost of renting vs. owning your home. The mortgage on an $800,000 property with 20% down at 6.375% is $3,922 while the mortgage on the same property at 6.875% is $4,204. If the value of a property was directly related to cost of mortgage debt service then the value would drop 7%. If the price of a mortgage stays at these levels, the increase in demand should mitigate a drop in value.
If you account for an increase in values of anywhere from 3-10% a year, values could go anywhere from a 4% drop in value to an increase in value of about 3%. Since the 1950's real estate values have increased at an average of 9% a year in California, particularly along the coast. If there is a drop in value due to increases in the cost of a mortgage, it likely won't be anything drastic, but a slowing in appreciation is likely.
Written by REALTOR Simon Salloom for the Santa Monica Daily Press. Sources for information taken from interviews with senior members of the mortgage industry.
Despite what most people think, most mortgage lenders have a relatively small cash reserve. Their ability to lend money to a borrower is directly related to their ability to sell the rights to collect on that loan to the secondary market. When a homebuyer borrows money from a bank to buy a house the bank will often make their profit on this service by selling the loan to an outside investor. After the bank has sold this loan, the bank recoups their initial investment with profit and sells the money again to a new borrower.
These lending banks have two sources of liquidity, or sources of cash for them to sell the loans that a borrower buys. One is Freddie Mac and Fannie Mae, federally backed organizations who buy loans from companies like Wells Fargo and Countrywide. Fannie and Freddie only buy conforming loans—this means loans that are under $417,000.
The majority of mortgages in Los Angeles require dollar amounts greater than $417,000. So the majority of lenders have to sell most Los Angeles based loans to alternative investment groups such as mortgage backed securities and institutional investors. This is not easy to do at the moment.
Up until a few months ago, there was a large secondary market for mortgage backed securities. Now, due to a considerable amount of borrower defaults of both sub-prime and mainstream loans, the demand from the secondary market is practically zero. This can’t last forever, but for now, most lenders are waiting to see what happens after this “shakedown” ends. In order to avoid being stuck with a lot of mortgages no one wants to buy, banks have tightened lending standards and raised interest rates.
With lenders not knowing what the secondary market will pay for their loans, they have little choice but to raise interest rates to mitigate their risk. At Countrywide, a non-conforming loan used to sell about .25% higher than a conforming rate. That difference is now .5%. Wells Fargo has increased their 30yr fixed mortgage from 6.875% to 7.875%. It is important to note however that every lender is reacting differently to this situation. Most mortgage professionals are quoting rates that are about .5% higher than what they were selling at earlier this year.
There are also banks with large enough cash reserves that they hold onto the loans they make and have no need to sell them in the secondary market. However, there are not enough of these types of institutions to slow down a rise in interest rates or slow down a move towards more conservative lending practices. At the end of the day, this will lead to greater stability of our financial markets. At the same time, the opportunities for people not yet in the real estate market, without the equity most homeowners have or large cash reserves, the potential for buying a home has drastically diminished.
What lead up to this current situation?
As the U.S. housing market gained strength over the past five years, demand for domestic mortgage backed securities grew. The banks made more money by selling more mortgage based products to secondary investors. In order to take advantage of this demand the banking industry loosened its lending practices, creating a significant amount of higher risk loan products. Now that the housing market in most of the country isn't what it used to be the party is over and a good number of people are having a difficult time paying their mortgages.
On the Westside, one could guess that the part of the market that will be most influenced by the current mortgage situation will be properties affordable by first time buyers. For the most part, this means houses and condos under about $850,000. The advent of loans that gave 100% financing on stated income and not great credit scores gave many first-time buyers the ability to buy.In the past five years, around 65% of purchases by first-time buyers on the westside were 100% financing or 5% down. Loans that provide 100% financing no longer exist and ones that accept 5% down have very high interest rates right now. This shrinks an already small buyer pool even more. Not many young people have $80,000 in the bank.
At the end of the day, what will inevitably change property values in Los Angeles is the ratio of supply vs. demand and the cost of renting vs. owning your home. The mortgage on an $800,000 property with 20% down at 6.375% is $3,922 while the mortgage on the same property at 6.875% is $4,204. If the value of a property was directly related to cost of mortgage debt service then the value would drop 7%. If the price of a mortgage stays at these levels, the increase in demand should mitigate a drop in value.
If you account for an increase in values of anywhere from 3-10% a year, values could go anywhere from a 4% drop in value to an increase in value of about 3%. Since the 1950's real estate values have increased at an average of 9% a year in California, particularly along the coast. If there is a drop in value due to increases in the cost of a mortgage, it likely won't be anything drastic, but a slowing in appreciation is likely.
posted by Simon at
12:10 PM
0 Comments:
Post a Comment
<< Home