Can the Banking System Handle Huge New Write-Downs?

As discussed in a previous post, Bank of America agreed to offer concessions to 390,000 subprime and pay option ARM borrowers by reducing both the principal owed and/or the interest rate to a level that allows these borrowers to have a an “affordable and sustainable” monthly mortgage payment. An affordable and sustainable payment was determined to be a mortgage payment (including taxes and insurance) that would not exceed 34% of gross monthly income. With this agreement apparently setting a standard for future concessions to homeowners, consider some recent mortgage transactions/applications that I have seen.

• Woman wants to refinance her Connecticut home which she bought in early 2006. The home today would probably sell for no more than $260,000.  Home was purchased for $305,000 with 95% financing; the current interest rate is at 11.625% and she owes $285,000. The negative equity is only $25,000. Borrower has a gross monthly income of $3,780 per month and her current monthly payment of principal, interest, taxes and insurance is $3,682 giving her a debt ratio of 97%. She is currently in arrears on the mortgage and obviously not capable of making the payment. In order for her payment to become “affordable and sustainable” with a 34% debt to income ratio, the lender would have to reduce her loan balance to $158,000 with an interest rate of 1%.

If the home owner gets this deal, not only would her payment become affordable, she could also sell the house and reap a gain of $102,000. The applicant’s income is about the same today as it was when she purchased the home, so there was no drastic decline in income. Obviously, this woman should have never been approved for a mortgage in the first place; both the bank and borrower knew this.

• A self-employed carpenter applied for a mortgage to purchase a home for $185,000. Applicant has no credit score since he pays for everything “in cash”. The yearly income reported on his tax return for the past two years averaged $5,500. When I told the applicant that he did not qualify he became indignant and arrogantly proclaimed that his bank told him they would approve him; I wished him good luck. This guy hasn’t been reading the papers lately but the days of borrowing based on what you say your income is are over. The applicant understood his situation; his income averages $458 gross per month according to his tax return and the monthly mortgage payment with taxes and insurance would have been at least $1650 per month which he insisted he could afford. I would say that the IRS should conduct more audits of self employed individuals.

• Borrower with very good credit and working two jobs has a sub prime mortgage and applies for a lower rate under the FHA mortgage program.   Borrower gets approved with with a debt to income ratio of 56%. At this point, instead of bringing his lunch to work everyday, he might be better off to stop paying on his mortgage and  ask his bank for a loan modification once he is delinquent. The interest rate would need to be reduced from 6.25% to 1% which would put him at the recommended 34% DTI. Although most loan modifications are currently being offered only to sub prime and pay option arm customers, I am certain that in the name of equitable treatment, the offer will expand to include the multitudes of other borrowers with a debt ratio over 34%. Why discriminate against better credit borrowers?

• Borrower with fair credit purchases a home with 100% FHA financing with the help of a down payment assistance program. Borrowers debt ratio at time of approval was 48%, which is extremely high and not affordable or sustainable for very long. Why is the FHA approving loans at this ridiculous debt ratio when the state attorneys general are forcing Countrywide to modify loans to a debt ratio of 34%? I suggest that a state attorney general be named Head Underwriter for the FHA.

I could go on and on, but one thing is for certain: there are millions of homeowners currently in a stressed income situation with negative home equity who would like to refinance but can’t due to low credit scores/lack of home equity or both. As word spreads of the great deal that Countrywide borrowers got from the recent Bank of America settlement, there will be many indignant and angry homeowners demanding the same treatment. Can the banking system, already insolvent, handle huge new write-downs?

Disclosure: None

Comments

[DAD08:]

Did you ever think that maybe the homeowner is also responsible? What kink of person buying a home would not take into consideration their own ability to pay their mortgage? It is just as much the homeowners fault as it is the lender. People assumed their house would appreicate- if they could not make payments- they sell for a profit. Foolish. What ever happended to the standard conventional 30 year fixed with at least 10% down? I blame the homeowner just as much, if not more than the lender. People wanted to be in a house they knew they could not affort- and now they have to face the ramifications of their own foolishness. Hey- I'd love a bailout too...I have a 30 year fixed $400,000 loan at 6.75% - put down 20 % to avoid PMI..I could have bought a house twice as big...but that would have been wreckless and foolish. Will they take my rates down? I am not banking on it!

2008 Oct 13 06:42 AM

[turkeyeyes:]

So sad all this talk about 'predatory' lending.
Most folks knew full well what they were getting into and welcomed the chance to get a mortgage.

2008 Oct 13 07:19 AM

[captainccs:]

Why can't the government just build houses and give them away? It would be less complicated than the Paulson rescue plan and the end result would be the same: the tax payer pays for universal housing.

2008 Oct 13 09:45 AM

[Augustus:]

The exact same problem with treating everyone "fairly" was what caused the bubble on the way up. Giving everyone the same deal of renegotiating a lower loan amt and rate will kill the lenders on the way down.

2008 Oct 13 09:51 AM

[madasiwannabe:]

What about my loan. I put 40% down and have a debt ratio below 20%. Sure I screwed up by living well within my means and paying my bills on time, but my property value has dropped 15% too. That drop is before all of my neighbors get their mortgages slashed and their new deals become my comps. Under the bailout deal it seems like I get to pay twice; first through my tax dollars and then again with the further depreciation of my property value.

What gets me is if we let them default, I lose anyways. The banks will auction off the properties at a huge discount and once again their sales become my comps. Where's the bill that offset my losses when the irresponsible borrowers and lenders get done destroying my future?

2008 Oct 13 10:39 AM

[Rhett:]

There are always people out there who will buy what they can't afford if someone will sell it to them. Should that be a surprise? Debt is what our consumer economy is based on. And now that collective consumer debt is too much for monthly payments, the government is coming in to re-negotiate debt on hoiusing so that overall consumer debt can still be sustained by monthly payments. Obviously, this only postpones the inevitable collapse of the debt economy, but the idea is to keep it going as long as we can. Buy that furniture and make no payments until 2012! Buy that car for no money down and pay for it over 5 years! E-a-s-y!

2008 Oct 13 11:04 AM

[Thomas J. G...:]

Bill, Thanks for the article, it's good.

turkeyeyes: the term predatory lending is an oxymoron I think. These people are receiving 100's of thousands of dollars to purchase scarce and valuable assets. Some lenders were stupid and lent even though the borrowers couldn't make the payments, but they were always covered by rising prices. I suppose terms of repayment could be onerous, but when someone is receiving 100's of thousands of dollars I have a hard time thinking of that as predatory.

I think Paulson and Bernanke think this: If we are having this much trouble because housing prices went from 100% to 80%, it's the end of the world if housing prices go from 80% to 60%. so they're doing anything they can to keep housing prices up. I think that part of the solution is for prices to find their own level, which right now is generally lower.

for those of us who lived in "super" cities, we become aware of a great irony. a yuppie couple in 2006 in a super city buys a 1.5 million dollar place in a "better" neighborhood. They are now negative equity have trouble with the payments and now ma and pa kettle from middle americ are expected to bail them out? How does anyone find that "fair". but the winds of time are blowing against those that believe in personal responsibilty. "There will be a time when all will turn against us... " ... Dune

2008 Oct 13 09:32 PM

[sumosama:]

good article...

I find it offensive, however, as many of the posts indicate. Liar loans and the like...

2008 Oct 14 01:05 PM

[richard_nog...:]

A $400,000 house? Holy Cow that is $346,000 more than my small farm! In rural Kansas a home costing that much is considered a mansion. Of course the folks living in them take perfectly good pasture and turn it into acres of yard so big it takes the mowing company two days to cut it all.

2008 Oct 14 03:09 PM