The Morning Report
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Thursday, March 8, 2007 | Stricter regulations among lenders of home loans geared for consumers with imperfect credit could prolong the region’s housing slump, as the pool of first-time homebuyers eligible for such a mortgage will almost certainly shrink.
Nearly 10 percent of the active mortgages in San Diego County in December 2006 were subprime, according to First American LoanPerformance. The share of the mortgage market consumed by subprime loans has dropped some since December 2004, when they accounted for 12.3 percent of the active loans in the region. In December 2005, subprime loans comprised 9.5 percent of the active mortgages.
Some homebuyers who qualified for subprime loans with low teaser payments two years ago may find they’re not eligible under new regulations to refinance into more traditional — and manageable — loans when their payments ramp up. And many mortgage brokers who flooded the scene when lax regulations meant they could qualify almost anyone for a loan are now forced to pull out of the industry and find work elsewhere.
Alan Gin, an economist at the University of San Diego who monitors the local economy, has predicted the housing market will be the big economic issue in 2007. He said anything that would slow the market, including the potential local impacts of subprime lender rule-tightening, will make things “more difficult” for the economy as a whole.
“The question is whether it is going to be ugly or whether it’s going to be a catastrophe,” he said. “Where does it stand in the full panorama with the continued health of the rest of the economy? The question is, how much worse will it get in this situation?”
It has become more and more common for San Diego homeowners holding those subprime mortgages to fall into foreclosure. The percentage of people in that category who’ve missed at least two of their mortgage payments has risen from 1.7 percent of the subprime pool in December 2004 to 11.3 percent in December 2006, according to First American LoanPerformance.
About 6,000 such loans were in some stage of foreclosure in December out of the nearly 60,000 active subprime mortgages in the county.
“This is a result of how unaffordable housing got,” said Peter Dennehy, vice president of Sullivan Group Realty Advisors. “When housing prices were going up, these were the only products people could get. The question was always, ‘How are people affording these home prices?’”
The subprime loans were reserved for people who couldn’t qualify for regular “prime rate” or “A paper” loans because of a few factors, including a poor credit scenario or an income situation that was unverifiable, such as a self-employed contractor. Thus, products were created for these higher-risk borrowers that usually initially charged a low monthly payment that ramped up after a few years. Some of them got into these loans without putting any money in a down payment — known as 100-percent financing. Others used “stated-income” or “no-doc” loopholes to get a mortgage without proving they could actually afford the monthly payments.
In the popular adjustable-rate subprime mortgages, unless borrowers are savvy and can refinance their loan at a more predictable, fixed-rate loan before the reset period, they will have to start eventually paying significantly more each month. When borrowers are unable to do that, they may miss a payment or two and thus enter the first stage of foreclosure.
Now, many subprime lenders who didn’t expect to have to deal with rising defaults and foreclosures in their loan pools have closed their doors altogether, eliminated some or all of their subprime programs or, at least, tightened their regulations.
Those who back mortgages have begun to worry about the defaults.
Mortgage giant Freddie Mac announced last week it would not buy subprime loans on the secondary market (mortgages packaged and sold as stocks) for which consumers didn’t qualify for both the initial payment and the fully-indexed, ramped-up payment that comes a few years down the road. While Freddie Mac’s share of the subprime market is not as substantial as some of the California-based subprime lenders in trouble, like Fremont General and NewCentury Financial, experts say its policies, and those of sister agency Fannie Mae, often set precedents for other, smaller lenders.
“It could trickle down,” said Craig Bramlett, president of Cal Pacific Mortgage in San Diego. “Freddie [Mac] and Fannie [Mae] are kind of the leaders. They have a strong voice and I think others will listen.”
Those rules mean it’s going to get a lot tougher for those with poor credit to buy a home. Before the rule change, a borrower hoping to buy a median-priced, $472,000 home could qualify for an initial monthly payment of $3,628 on a subprime, two-year, adjustable-rate mortgage at 8.5 percent.
Now, under the new Freddie Mac rules, that borrower has to qualify also at the fully-indexed, higher payment of $5,405 monthly, according to Mark Carrington, who compiles data for First American Loan Performance.
Assuming that the borrower needs to prove that those payments represent only 40 percent of his or her income, the borrower would need to earn more than $160,000 annually to qualify for the loan. Under the earlier rules, the borrower would have had to earn nearly $110,000.
Only 9.4 percent of the county’s households earn more than $150,000 annually, according to 2005 Census numbers.
The regulations may be too little, too late, Dennehy said. The subprime market is “symptomatic of the go-go real estate world” that doesn’t stop until it’s forced to, he said.
“It’s like slamming the barn door after the horse has gone away,” he said.
Still, whether the loan industry takes these Freddie Mac regulations and applies them wholesale, most people watching San Diego’s market agree: with any tighter regulations, the pool of people eligible to refinance out of bad loans to avoid foreclosure will shrink, as will the number of people qualifying for loans to buy in the first place.
David Cabot, president of the San Diego Association of Realtors, said he hasn’t seen any concrete evidence of a direct impact of the subprime news in San Diego.
But he said he disagrees with those stricter regulations on loans that used to allow consumers to get a mortgage on the knowledge, or assumption, that their incomes would increase by the time the payments increased. He said the local market, which has slowed since the years of double-digit appreciation at the start of the decade, could be hurt by strict loan regulations.
“Anytime you substantially remove a big chunk like that from the market, it’s going to have an impact,” he said.
And the impact is not just on buyers, but on those agents who help them find a home to buy. Jim Klinge, a Realtor in North County, has monitored the numbers of 100-percent financing and subprime loans for a couple of North County cities on his blog, and says the overwhelming majority of 100-percent financed loans for Oceanside homes were in the $230,000 to $450,000 range — the range for first-time home buyers usually, he said.
“There are some (Realtors) who handle nobody but first-timers,” Klinge said. “They’re going to be out of business.”
And mortgage brokers are worried about their jobs, too, said David Maiolo of Ocean Mortgage. Maiolo said some subprime lenders have taken a break this week, where they don’t allow submissions of new loans while they sort out what their new regulations will look like. And while the lenders sort that out, the brokers worry about what tighter regulations would mean for their client pool, and ultimately, for their jobs.
“It’s a big buzz right now, with a lot of mortgage brokers getting out of the business,” Maiolo said.
Gin, the economist, said the housing market has begun in recent months to affect those previously unshakeable positives for the local economy, such as job growth. He said he doesn’t expect the job losses among Realtors and mortgage brokers to be enough to shock the economy into recession. It would take job losses in other industries, he said, to put the region at risk of recession.
“I don’t get that [stricter mortgage regulations] are going to be a problem that will derail the economy,” Gin said. “Unless we have a lot of people losing their job and having to move. A lot of this will depend on how long this thing takes to play out.”
Klinge would not attribute to the subprime shakeout alone a pessimistic view of the next few months for the housing market in San Diego — slow sales numbers and dropping prices don’t show signs of letting up yet, he said.
“I think it’s definitely a contributing factor,” he said. “But there’s so much more going bad. This is just adding another log on the fire.”