Mortgage Payment Program

This past week the Federal Reserve announced the results of the financial “stress test” it conducted on the top financial institutions. Of the 19 reviewed, 9 came through with passing marks. I was personally pleased to see that our primary business banking partner J.P. Morgan Chase Bank came through with passing marks, but that was not very surprising. Jamie Diamond and group have outperformed their banking peers for several years in terms of both results and sound business decisions. It also confirms that we made a good decision in choosing them as a banking partner for our clients. Fed chief Bernake was quoted as saying “the results… should provide considerable comfort.” Even though more than half of the institutions tested need to raise capital, the quote makes sense in that the institutions are still viable and not at risk of being shut down. But I wonder if the average American who is banking with or has funds held by a small regional bank which was not put through the stress test is comfortable.

This past week, I was talking with a friend who has some financial problems and was looking for advice.  He recounted the same story I’ve heard him tell several times before: taking a new, better paying job, moving his family to a new state, only to find that he is making less than he was before.  It seems he and his wife did not carefully consider all of the factors for the new job.  Easy for me to say, looking back on events that happen to someone else, but these are common mistakes many people make today.

Some of the items that impacted him no one could have predicted. One big factor was the cost of commuting. In order to get a home in the school district he and his wife wanted their kids to attend, he had to accept a longer (57 miles each way) commute – a huge jump compared to his previous 7-mile commute. Prior to the move when gas prices were still low, the commuting cost seemed like it would fit in their budget.  Last summer and fall, gas prices rose significantly, the long commute, and poor fuel economy in his mid size SUV added up to a huge expense they had not accounted for.

However, the biggest impact was not taking into account the pay-cycle for his new employer.  He had always been paid semi-monthly and the budget he and his wife adopted over the years conformed to that 1st of the month and 15th of the month cycle.  His new employer used a biweekly, every-other-Friday pay-cycle. Sure, that means “2 extra paychecks a year”, but it also meant that his 10% annual pay increase for his new job did not actually show up on a month-to-month basis.  In fact, with the cost to commute, property and sales tax hikes all factored in, they actually made less money!

For years he would tell me, “I’m not sure why people would use your program” and I would always respond the same way “It is not right for everyone, but really works well for those who need it.”  He now understands exactly what I meant.  Cash flow is a key part of any budget.

All you homeowners out there, as you read the real estate headlines and wonder how and if we are ever going to see a full recovery in the housing sector, I want you to think about the factors that went into you qualifying for your home.  Most of us had to fully qualify for our mortgage based on a full documentation mortgage. The mortgage company looked at several key items: your ability to pay the loan which was based on your income, your willingness to repay the loan which is based on your credit score, and whether or not the collateral (the home you put the mortgage on) supports the price you were willing to pay.

The first two factors are pretty straightforward.  You give them bank statements, pay stubs, and tax records to validate your income and ability to pay.  Your credit score reflects your payment history on your previous credit lines and loans. Those who want to blame the sub-prime market for the housing crises can look at these tow factors as the driving cause.  Sub-prime loans often overlooked the ability to pay because they did not require the borrower to fully document their income or assets.  Lenders were also willing to accept a lower credit score – and potential lower ability to pay – in exchange for higher fees and higher interest rates.  There is not denying the impact bad sub-prime loans have had one the housing market, but they are also a smaller percent of the overall loans made over the last 5-6 years. There is also a disturbing trend of people who had strong documented incomes and solid credit scores whose homes are now in foreclosure despite that.  That is where home values come in.

Home values for mortgages can be based on many different things.  Most often the value is based on an appraisal made by a professional appraiser.  The appraiser visits the home, evaluates the items inside and outside the home that make it either similar or different than the other similar homes in the area, the evaluate recent sales of similar homes locally, and then submit a report documenting their opinion of the home’s value.  This is not an exact science, but a trained, experienced local appraiser is one of the best sources to obtain an accurate opinion. Unfortunately, loan officers and brokers who source the appraiser work out often put tremendous pressure on appraisers to “hit the number” or bring in an appraised value that supports the mortgage amount requested by the borrower. When this happens, the collateral of the home is not accurately reflected and when the market slows down, as it has in South Florida, California, and Las Vegas then the overstated home values become a problem.

People who are paying as agreed see neighbor’s homes foreclosing on a regular basis and the number of for sale signs in the community seems to grow daily.  Eventually, these people ask the question: are we better off just walking away from this home since it is now worth $200,000 less than what we bought it for?

Some economist and real estate experts predict another wave of foreclosures as homeowners in down markets become frustrated, disillusioned, and ultimately walk away from their homes and good credit just to get out from under the decreased home values. Whether, this happens or not remains to be seen. One thing is for sure; expect additional oversight in all areas of the home lending process in the future.

Some lenders are investors are now looking to sophisticated computer models to determine the home value.  These models are not new – in fact millions of American’s use scaled down versions online to get an online estimate for their home values by going to sites such as Domania.com and Zillow.com.  What you may not know is that the data companies that source these models have robust versions that can accurately calculate the homes value.  Some recent models have been referred to as “hedonic” models.  Based on the word “hedonism” which means to derive pleasure, these models look at the aspects of the home where people derive pleasure from using them.  This includes things like a gourmet kitchen with granite counter, luxury master suites, upgraded roof, and in ground swimming pools.  The models gather information recorded in public record files, apply unique values for each item, and then calculate the value compared to other homes.  The process is similar to that applied by the professional appraiser but is completely automated and free from the human bias.  These automated valuation models are fairly common and may be leveraged more frequently to determine the home value for underwriting purposes n the near future.

This past weekend the inevitable happened: the government stepped in to take over Fannie Mae and Freddie Mac. The two companies were placed into a conservatorship in an effort to bring some stability to the housing and mortgage market. Who are the winners and losers from this landmark move?

Winners: The investors. By investors I mean the companies that buy the debt or securities Fannie and Freddie created from the mortgages they funded. The federal government is now responsible for losses on these investments – a move which the government hopes will attract investors back to mortgage securities and create the much needed funds to fuel mortgage originations.

Losers: The shareholders. The shares prices have been in a steady decline and the move to take over the companies is not a move to buy out the shareholders. People who invested in Fannie Mae or Freddie Mac stocks are likely going to continue to be upside down (lose money on their investment) until the future of these entities is decided and, should they remain public, regain value in their share – meaning a long, long time.

As for homeowners… we will have to wait and see. With the government stepping in that should clear the way for mortgage rates to drop down. However, lending standards are still up in the air. We may not get a decision on how conservative or liberal the lending standards will be until after the next president is elected. My guess is we are likely to see stricter underwriting guidelines that are more inline with what these two companies used originally; requirements for larger down payments and more conservative debt to income ratios which may make mortgages more difficult to obtain for many.