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Sunday, August 26, 2007

Subprime Hypocrisy?

Is there some new found hypocrisy in Congress's reaction to the sub prime mortgage market? Steve Chapman at the Chicago Tribune thinks so, and I'm inclined to believe him.

He points this out early in his most recent piece "Illusions of Home Ownership; Subpar remedies for subprime loans".

In the old days, financial institutions that refused to lend to people with low incomes or imperfect credit were accused of victimizing the needy. Today, financial institutions that make many loans to those same people are found guilty of the same crime.
A little history lesson is in order. Sub prime, or "D" Loans didn't just appear recently, they've always been there. The truth is that until the last four or five years, they were too costly to get written for homes.

Folks have been paying 16-20% on car loans for years because of credit "dings" that kept them from getting the advertised 1.9% for 60 months. In the housing market those same loans (without as big a spread) were there also, but because of the loan amount, were too expensive for the lower income, poor credit folks they normally were designed for.

For instance, in 2001, when I got an "A" VA loan at 7.5% a sub prime loan for the same house would have been around 12.5% interest. On my house, with 3% down (FHA requirement) that would mean a $1,160 per month payment, not including mortgage insurance and tax escrow.

In 2004, that same spread would have made the sub prime loan come in at about 9.5%, and lowered the payment by over $240 per month. Suddenly folks who couldn't qualify for even a "bad loan" for years became eligible using the same standards as before. I put "bad loan" in italics because in 1998 a friend refinanced his home at 9% and was ecstatic that the rate was so LOW.

Congress would now like to find a way to "fix" the sub prime market, being lead by Chuck Schumer, so that we don't have the foreclosure problems in the future that it has now. However, fix will probably mean that the vast majority of the sub prime borrowers, 86%, who make their payments every month would end up shut out of the market to prevent the other 14% from being stupid when they buy a house.

Looking at mortgage data, I also wonder if Congress, Chapman, and many pundits aren't actually lumping sub prime loans and ARMS (adjustable rate mortgages) that were written to good borrowers into the same category.

While there certainly were more creative ARMS written in the past five years, many of them are now seeing the "balloon payments" that have always been part of an ARM type loan.

I say this because one of Schumer's "fixes" is to qualify loans not on the current payment, but on the "highest expected payment during the loan". A standard loan written for 30 years (or even 40 now) will have the same payment through it's life, with adjustments for escrowed taxes and PMI (private mortgage insurance) rates. Only ARMS, as far as I've seen, have a payment that changes over time, based on interest rates.

Using Schumer's fix would probably get a lot of folks who have proven to be good credit risks out of the market, because of the lack of flexibility of lenders with loans. There are many good risk folks who take ARMS because they know that in the 3-7 year period before it starts adjusting they'll see a change in their income that allows them to refinance to a fixed rate loan. Couples with young kids nearing school age are a prime example. When the kids go to school full time Mom plans to go back to work, increasing the household income high enough to refinance on a "normal" loan.

Congress has to find a "crisis" in just about everything. In sub prime, while there have been some problems, there really isn't a crisis. People who had less than stellar credit got loans because interest rates got low enough to write them. And, surprise, some of them are defaulting on those loans. That's not a crisis, it's common sense. As interest rates rise less sub primes are being written because, surprise, the folks they are normally targeted at can't qualify because of payment size. Again, not a surprise, it's how markets work. The biggest crisis from the sub prime market may actually come after Congress decides to try and fix it.

And, as is usual, the very folks that Congress for years complained were shut out of the housing market will once again get shut out of the housing market. Maybe Schumer's new mantra for the 86% of sub prime borrowers who pay should be "Let them pay rent" (in his best Marie Antoinette voice).

Technorati Tags: Sub Prime, Mortgage, Loans, Congress, Schumer, Steve Chapman, Markets

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