Residential Mortgage Lending - What's Next?

As published in Scotsman's Guide; November, 2008

By now we all know that you and I --the US taxpayer-- will be bailing out Freddie and Fannie. In my case, I will be bailing out someone that took way more risk than I think they should have and that makes me mad! I kept my head, did not buy too much house, did not take out a fat home equity loan based on my “newly created equity” and I stuck to fundamentals. Now I get penalized along with my children and grandchildren. What did we do to deserve this?

I take risks every day. I evaluate the risk and then evaluate what I am willing to invest in the opportunity. I never risk my house and I adjust my required return to compensate me fairly. When you do not understand the risk and you still get into a deal you are a foolhardy risk taker and you will almost always lose.

My fellow taxpayers, we will be bailing out our over aggressive neighbor that ignored historic truisms on loan to value, affordability and much more -- GREAT…but:

·         Will the bailout help the average home owner? In some cases yes; in others no.

·         What will happen to all the borrowers that have mortgages on residential property that don’t qualify for a new loan? They will need to short sell or find a hard money lender to believe in them and bail them out on an individual level.

·         Is there anyone out there that can help borrowers out of the mess? Yes, a growing number of high net worth investors and institutional lenders are out there working on ways to fill the gap. We meet with them all the time to see how we can structure safe solutions for borrowers.

·         How can they give credit to a borrower that may have defaulted on his prior loan? They will look at it on a case by case basis. We have access to many different groups that are considering many different ways to underwrite and make loans.  The higher the perceived risk the lower the proceeds and higher the interest rate – a return to fundamentals.

·         There is still a large gap on LTV. How does a lender give a "full" loan when they do not know the true values? That is the hardest question to answer. Today they just “low ball” value to make sure they are protected. As trades occur in the market the true values will be found.  Think values prior to the run up plus modest inflation.

·         Where do we go from here? On a wild ride no one can fully predict.

The bailout will help the “conforming borrower”. However, a lot of the folks we see at our attorney -run foreclosure rescue clinics– those that broke with traditional conservative borrowing practices and instead took advantage of the drunken sailor phase the industry just went through- are in for a true lesson in risk and return.

The bailout will help everyone in the short term by lowering interest rates. The drop in rates already has the mortgage brokers operating under the old model sending out blast faxes for folks to “take advantage now."

 It amazes me that folks still think the full boat, no doc loan is out there to save them… and that someone is out there saying they can still find it for borrowers. Please, let’s act responsibly, people.

What potential borrowers should do is take action only if it makes sense for them – not just because rates dropped a bit for now.  And if they choose to get a new loan they should get a conservative one they can repay easily with the income they earn now. The folks I know that are still working the churn and burn mortgage broker model need to change NOW or they will go out of business. The old model hurt our country and many of our fellow citizens it doesn’t work and it never should have worked!

 WE NEED CHANGE! NOW!

The new model, the one we should change to, is the model we had for so many years. We need a return to the LONG TERM VIEW and a move away from the FLIP ‘TIL YOU GET RICH view.

 I refer to a flipper as a "Ralph Kramden" after the affable but misguided king of get rich quick schemes found on TV’s "The Honeymooners". He was just a bus driver but he aspired to be so much more. He was always chasing the next bad idea. I love his chasing of the American Dream. He just needed to stick to the fundamentals.

A move back to the financial fundamentals is the change our country needs and I hope the politicians will talk about personal financial responsibility in the coming election – not just say we need to bail out the lenders and speculators

 I am writing this before the new Freddie/Fannie rules and regulations are available but I would be more than a bit surprised if they allowed the over borrowing to continue. I would also be surprised if there was not a group of vibrant private sector lenders that spring up to address the “nonconforming borrower."

 We are working with a number of high net worth individuals and “institutional hard money lenders” to develop programs for these folks. However, I do not think the market will be kind to folks that earn $50,000 per year at their primary job but somehow ran up huge debt on “investment portfolios."  Unless , of course, the potential borrower is seeking a loan from a person that got rich writing How to Get Rich on Real Estate By Putting Nothing Down  books.

Many of the conforming borrowers may need to negatively impact their credit by selling short or “cramming down” their current lender with a new loan.  I love the term “cram down.” If it walks like a duck and talks like a duck...

While this may hurt the conforming borrower in the short term, facing the music and taking the medicine will be good for the borrower’s long term financial outlook.

Folks that truly took advantage of the “nothing down” mentality promoted by get rich quick artists and hot industry pundits of the early 2000’s should get what they have coming. I always forget if it is hogs that get fat and pigs that get slaughtered or the other way around but you get the point. If you could not afford it with a standard mortgage you should not have bought it. The good times are never as good as you think and they always end before you are ready.

Mortgage industry professionals should be emphasizing a return to the basics. The cornerstone of this philosophy should be to NEVER risk the core of the family’s nest egg – the home. It should NOT be treated like a piggy bank. Forgetting the fundamentals got us in this mess and only a focus on fundamentals will get us out.

So what is the takeaway? That the residential mortgage business is in dire straits but will recover sooner than most think. It will do so by returning to fundamentals – no exotic loans – just plain old 70% LTV real cash in the deal and good credit ratings. For folks that need higher LTV or have lower credit scores -- private lenders -- if you can find them are the source.  More private lenders are entering the market as it evolves.

Another takeaway is a return to borrower integrity. Over-extended borrowers need to look in the mirror and face the music. That music is a negotiated workout with the lender. This gives the borrower his best chance for keeping some of his credit intact and getting back in the game as soon as possible.

It will be a long road but we will make it back to the vibrant market again and sooner than most think.