Forgive and forget
Forgiveness isn’t often talked about when it comes to hard business decisions, but we’re starting to see a fair amount of forgiveness going on in the mortgage market. The question is will this prove to be a benefit to the marketplace or another step on the road back to slipshod financing practices?
We’re starting to see lenders who are willing to work with borrowers who have recently gone through a foreclosure, bankruptcy or other financial crisis making them ineligible for financing with big lenders. With underwriting remaining very tight, risky buyers have no place else to turn except the private mortgage market.
The loans are frequently funded by or sold to private equity firms and hedge funds that are willing to take the risk in return for higher yields. Most of these mortgages fall outside of the Consumer Financial Protection Bureau’s qualified mortgage definition, established last year, which set strict debt to income ratios. The bureau’s regulations also set limits on loan fees and interest rates, as well as giving borrowers the ability to sue if they default claiming the lender did not adequately qualify them for the loan. Nevertheless, both lenders and borrowers are willing to assume the risks in order to get back into the housing market and turn a quick profit.
Lenders try to protect themselves by requiring at least 25 percent down, as well as analyzing credit reports, demonstrating that recent activity is positive with borrower’s bills being paid on time. They are comfortable lending to a person who has had a one- time event such as medical bills, job loss or other hardships which impacted the borrower’s credit rating rather than someone who consistently had past due bills. Individuals, who previous to a foreclosure or bankruptcy had a high credit score, can tolerate a reduction of about 200 points that will result from these events, leaving their credit scores still in an acceptable range for lenders willing to accept the risk.
In conjunction with extending financing to risky borrowers is the return of the interest-only mortgage, which is starting to get renewed traction as home prices continue to appreciate. Again these loans are typically available with private brokers, equity firms and Wall Street investors.
Right now, most of the interest only mortgages are tied in with jumbo loans which are above the $417,000 government backed limit, except for some high cost areas where the government backed limit jumps to just over $600,000. According to Zillow.com jumbo mortgages with a 25 percent down payment have increased 13 percent in the 25 top metro areas since 2012.
However, interest only is just one piece of the jumbo loan market and one that is really built for sophisticate borrowers who want to keep their monthly cost down. These borrowers for their own reasons can usually afford to pay the monthly cost of a conventional mortgage but choose not to. Interest only does at some point adjust to a higher interest rate, and considering that none of the principal has been paid down, homeowners are gambling that the real estate market continues to appreciate. Interest only loans were one of the primary reasons homeowners got in trouble when the real estate bubble burst leaving them with a large mortgage and zero equity.
Forgiveness may be the moral thing to do, but is it the smart thing to do. Only time will tell. The temptation to take the easy road is always out there, but taking the smart road is generally the better choice.
