The Housing Chronicles Blog: Why it's always important to read the fine print.

Tuesday, December 4, 2007

Why it's always important to read the fine print.

There are few things more boring to read than mortgage documents (although the plain toast-dry textbook in my first microeconomics class would be a contender -- why do they always use 'widgets' as examples?), but they really do spell out the specifics. I remember when I refinanced a loan and a nice lady came to my home accompanied by a Notary Public; we all sat down and I read through EVERY SINGLE PAGE over the course of an hour because signing a mortgage is, quite literally, signing part of your life away.

Now it seems that even more credit-worthy borrowers -- who either didn't read the fine print or do their homework on the options available to them -- were blindly paraded into sub-prime loan products without their knowledge. According to the Wall Street Journal article:

An analysis for The Wall Street Journal of more than $2.5 trillion in subprime loans made since 2000 shows that as the number of subprime loans mushroomed, an increasing proportion of them went to people with credit scores high enough to often qualify for conventional loans with far better terms.

In 2005, the peak year of the subprime boom, the study says that borrowers with such credit scores got more than half -- 55% -- of all subprime mortgages that were ultimately packaged into securities for sale to investors, as most subprime loans are. The study by First American LoanPerformance, a San Francisco research firm, says the proportion rose even higher by the end of 2006, to 61%. The figure was just 41% in 2000, according to the study. Even a significant number of borrowers with top-notch credit signed up for expensive subprime loans, the firm's analysis found.

So what does that mean now? Volleyball tournaments by former loan agents and brokers at minimum-security prisons throughout the country? Maybe!

The analysis also raises pointed questions about the practices of major mortgage lenders. Many borrowers whose credit scores might have qualified them for more conventional loans say they were pushed into risky subprime loans. They say lenders or brokers aggressively marketed the loans, offering easier and faster approvals -- and playing down or hiding the onerous price paid over the long haul in higher interest rates or stricter repayment terms.

I remember when I first heard about the option ARM when I was buying a property, and I thought it was very interesting. But then I sat down and did a spreadsheet in Excel and calculated that if I were to pay the normal P&I amount for the option ARM that it was only $50 less than what I'd pay on a 30-year fixed note (which at the time had briefly dipped back down to just over 5.6%).

Although I know Excel is a fairly common software, I remember thinking at the time that what I was doing -- my homework to double-check what the broker was telling me -- was probably pretty rare. When she kept pushing me towards the ARM, I told her that I was going with the fixed note, and that if she mentioned the ARM again I'd go elsewhere. I also went through the settlement statement and wrote in what I'd be willing to pay for various items (i.e., not $50 for a FedEx) while repeating, "No junk fees!" I'll bet I was her favorite client ever.

But the fact that higher-income households may be holding sub-prime mortgages may also be good news:

Credit-worthy borrowers holding subprime loans may turn out to serve as a sort of shock absorber for the current mortgage crisis. They may be more likely than traditional subprime borrowers to withstand the double whammy of declining home prices and adjustable-rate mortgages soon due to reset at higher interest rates. The data perhaps explain why, so far, nearly 80% of the borrowers with subprime loans have continued to keep their loan payments current, according to some analysts. That could indicate the crisis won't continue to deepen as much as some fear.

Yes, it's true that brokers got a higher commission for an option ARM than a traditional fixed-rate note -- that's also why they couldn't keep quiet about it!

So thank you, Microsoft Excel, for helping me make an informed decision, because I knew that it was folly to count on objectivity from someone who saw me mostly as just another commission.

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