Bad loans may cause stricter underwriting guidelines
A decade or two ago required a prospective home owner to have above average
credit to be approve for a mortgage.
But as nontraditional mortgages have been introduced, more and more borrowers
with less than ideal credit
have been able to obtain a sub-prime mortgage.
Sub-prime mortgages usually have higher rates for longer terms but will
allow a borrower to utilize hundreds of thousands of dollars in funds. As
a result of the ability to lend sub-prime loans, mortgage defaults have
risen. In the past, banks would just take the default as a loss that comes
with the business.
The article, “Bad Loans Draw Bad Blood,” written by Ruth Simon
and Michael Hudson in the October 9, 2006 edition of The Wall Street Journal,
explains how banks are no longer willing to let mortgage defaults become
regularity.
“Although the $9.1 trillion mortgage market has been relatively calm
as the housing market has slowed, players on Wall Street and beyond are
starting to grapple over bad loans, especially in the market for borrowers
with scuffed credit -- so-called sub-prime customers.”
The primary concern for banks over defaulted loans, are loans that default
very early in the lending process, due to underwriting error such as flawed
property appraisals.
“As the housing boom fizzles, cases of bad underwriting are popping
up and more mortgages are defaulting early. That has investment banks and
other mortgage buyers invoking
these contract provisions and pressing lenders to repurchase
mortgages that get sold to third parties, creating big losses for some lenders.”
In reaction to this growing negative trend, many lenders are tightening
their underwriting guidelines. Investors and lenders are also becoming more
skeptical over loan problems and are conducting more “financial sleuthing.”
“In August, Fremont General Corp. of Santa Monica, Calif., said it
was dropping or scaling back on some low-down-payment loans and on some
loans to sub-prime customers to reduce mortgage buybacks. Bear Stearns Cos.
and other companies are suing lenders that they claim passed on bad mortgages
that quickly defaulted.”
Buybacks are when the lender buys back the loan after it was funded because
of defaulted payment.
“While ‘not serious’ at this point, the buybacks are the
first real test of the modern mortgage market, said Christopher Mayer, director
of the Paul Milstein Center for Real
Estate at Columbia Business School. ‘This will continue to be
an issue even in the case of a soft landing’ in real estate, he said.”
Unfortunately, the worse the market results in more buybacks. So, as lenders
are struggling to fund loans due to high prices and interest rates, many
of the completed transactions have to be re-bought, which is more troubling
during a struggling market.
“The current round of loan buybacks began in late 2005 and picked
up steam in 2006. It probably will continue for several more quarters if
mortgage delinquencies keep rising. ‘When you see foreclosures rise,
you often see buybacks rise,’ said Doug Duncan, the Mortgage Bankers
Association's chief economist.
The current interest rates may also contribute to more delinquencies. After
the Federal Reserve raised rates 17 consecutive times, rates have considerably
lowered from 6.9 percent to 6.3 percent. This may actually lead more people
to take out loans they probably do not have the necessary finances for,
resulting in more delinquencies.
So, regardless if you’re applying for a traditional or nontraditional
loan, getting approved for the loan may not be as easy as it was a year
or two ago. This is a desperate attempt by lenders to lower buybacks from
delinquencies. Keep your credit score up.
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