Another edition of our new series: Blog Spotlight.
We put together a short list of excellent but somewhat overlooked
blog that deserves a greater audience. Expect to see a post from a
different featured blogger here every Tuesday and Thursday evening,
Second up in our Blogger Spotlight: Michael Shedlock and Mish’s Global Economic Trend Analysis.
Mike is one of the editors of The Survival Report, covering stocks and
the economy. He also writes for the Daily Reckoning, and co-edits
Whiskey & Gunpowder. He also runs stock boards on the Motley Fool,
Silicon Investor, and TheMarketTraders. He is an avid photographer,
when not writing about stocks or the economy, with over 80 magazine and
book covers to his credit.
The following post is an email from Michael J. Dorff, a mortgage broker with Trans World Financial about the state of affairs in Orange County California. Monday evening I will have an update from Mike Morgan to share:
Here is a synopsis of the mortgage side of things here in Orange County and for that matter California in general.
What people don’t see, the NAR in particular, is the upcoming train
wreck. I am talking about all the sub prime loans for refinances as
well as purchases that were taken out 2 to 3 yrs ago and are now all
coming due to reset. My guess is that 99% of all sub prime loans are
all done on a 2 or 3 yr fixed interest only type program. People
thought that it made no sense to take a 30 year fixed loan those homes
when the short term rates were a lot lower, but they were all wrong.
The time bomb is about ready to go off. All of the subprime loans
taken out 2 to 3 years ago have margins of at least 5% or higher and
usually based on the London LIBOR program. Those loans are starting to
reset now at fully indexed rates somewhere in the high 9% to 10% range.
When those loans were initiated 2 to 3 years ago, they all had start
rates of high 5% to low 6%. As of now, the LIBOR alone stands at 5.388
for the 6 month and 5.336 for the 1 year. Take those LIBOR indexes and
add the margins to see what is going to happen.
Here is a case in point. One of my clients who took out an interest
only subprime loan from another lender just received her reset notice.
Her current margin is 5.25% and her index for the 6 month LIBOR index
is 5.388%. This means her new interest rate will shoot up to 10.638%.
Her note states that her first adjustment cannot go higher than 9.2%.
So she will be at 9.2% for the next 6 months. With an initial loan
balance at $251,000 at 6.2% interest only, she had a monthly payment of
$1,296.83. In December her new payment will be $1,924.33 for the
following 6 months before it adjusts again. This is a $627.50 jump in
monthly payment. She simply can not afford this payment.
Given her low credit score near 550, she is fortunate to still have
equity that will allow her to refinance at all. Even still it is a
tough task because not only does she have a bad score, she also a late
pay on her record. The best option any sub prime lender would give her
was 8.5% but she can not even afford that. The only option left is a
Neg Am Option Arm Pick a Pay Loan where her payment is based on an
payment rate of 2% but with a fully indexed adjustable rate of 7.4%.
She will go negative if she cannot make the interest only portion of
this loan. She also needs cash, $75, 000.00 of cash. Mish, that is your
typical home ATM machine at work.
These Option Arm, Neg Am Pick a Pay Loan programs were one of the
things keeping the home building bubble and mortgage lending bubbles
going for the last 3 years. Without these products, the market (at
least in California) would have collapsed 3 years ago. Instead the
bubble just got bigger and bigger and we will see even a greater
collapse when it comes. Ninety percent of those who take an interest
only loan can only afford the interest only part and not only that,
there entire lifestyles are planned around that payment.
Lenders don’t really want people to pay the principle off anyway
unless there is a prepayment penalty on it. Prepayment penalties are
another scam in and of themselves. You can bet the lenders have made a
killing on these 6 month interest prepay penalties. Bear in mind that
once someone is subprime the odds of that ever being corrected are
slim. Refinancing on better terms is usually not an option. Average
credit scores for this group on the whole have not improved much if
indeed at all over the last few years. I would guess that 80 to 90% of
sub prime borrowers stay sub prime borrowers. Those borrowers are in a
hole so deep they will never cleanup their credit to get A-paper rates.
To top it off, many of them end up paying multiple prepayment penalty
each time they need more money. They simply can’t wait for their prepay
period to expire. Ultimately it is a death spiral to bankruptcy.
Ask any Realtor out there if they know or really care about the
types of loans there clients are getting. They may say yes but my
assumption is they just want to make the sale. Ask any mortgage loan
officer if he or she cares about what loan program they put their
client in. Many will say yes but the reality is that they just want to
close the loan and get their commission. First greed took over. Now it
is a matter of survival.
Here is another reason why these loans are pushed: Lenders pay a lot
of rebate on the back end on these loans which fuels the greed even
more. Mortgage professionals can make up to 3.5% back end points on
these loans while their client’s minimum payment stays the same. When
you are talking about the high loan amounts in California, the money to
be made by pushing someone into one of these programs is huge. So are
the temptations. Some lenders went so far as to put on their rate
sheets that the maximum a broker or mortgage loan officer can make is
$50, 000.00 on a given loan.
Initially investors and flippers loved these loans because their
payment was so low that by the time they could flip a home there out of
pocket expenses were nothing. It all works well when the market is
going up. When it stops or even falls, say good bye!
Everyone is in same box. Realtors need sales, homebuilders need
sales, and mortgage brokers need sales. Unfortunately those needs too
often come before their clients needs. In the end, the bankruptcies and
foreclosures that result from this mess will just keep adding to
inventory, ultimately forcing home prices lower. We are only in the
first year of decline. From where I sit things will get a lot worse
before they can get better.
Michael J. Dorff
Trans World Financial
Huntington Beach, Ca. 92646
And thanks Mish!