The news media has been flooded with reports over the last few weeks about the meltdown in the subprime mortgage business. The big surprise is that so many people see this as a big surprise. Who could possibly think that the ‘Wild West’ lending practices of the last few years wouldn’t have consequences? The culprit isn’t just subprime lending, but the whole universe of adjustable rate and ‘exotic’ mortgage products — no money down, low teaser rates, negative amortization, interest only and other "features" — that led many to believe they could purchase homes that they really couldn’t afford. Those chickens are now coming home to roost.
I tend to be pretty conservative, at least when it comes to mortgages. I’ve never been a fan of adjustable rate mortgages, particularly if a borrower can only comfortably qualify for the initial pre-adjustment payments. I’ve also felt pretty strongly that second home buyers have no business buying a large discretionary purchase like a vacation home if they can’t scrape together at least a 10% or 20% down payment. On more than one occasion I’ve said to a client "You can’t afford this house", even if someone will lend them the money to buy it.
The direct impact of the problems in the subprime market probably won’t be that significant, for a couple of reasons. Sullivan County is heavily a second home market, and very few ‘second homes’ are financed with subprime loans (although some prime borrowers have used adjustable rate products.) In the primary home sector, New York is a relatively conservative lending state, with a much higher proportion of conservative, fixed rate mortgages than states like Georgia and California. New York also has one of the best state-sponsored subsidized mortgage program for first time home buyers in the country. Known as SONYMA, these mortgages for first time home buyers have fixed rates and help get New Yorkers into homes they can both afford to buy and to own.
Of course, New York is not immune to a wave of subprime and adjustable rate foreclosures. Last week, Sen. Charles Schumer estimated that 50,000 upstate homeowners are at risk of foreclosure over the next 2 years, based on an estimate that 3.6% of mortgages could default. That’s an estimate without state intervention. But New York has a long tradition of state aid, and will likely come up with some state program to help New Yorkers facing foreclosure stay in their homes, possibly by expanding the reach of the SONYMA program to help these borrowers.
But there will certainly be an impact. Mortgage people I work with are talking about tightening requirements for borrowers. Marginal borrowers that may have been easily approved just a few months ago are now being turned down. Facing tighter underwriting requirements, a borrower who once qualified for a $300,000 house may now only qualify for a $250,000 house. Some borrowers with low cash reserves for a down payment and closing costs may be told to come back when they’ve saved up more money. Lenders may start looking more closely at employment histories, and may again require 2 years of stable employment, and self employed people, particularly those with variables incomes, may face greater scrutiny.
Mortgage financing is the fuel that drives the housing market. Less fuel = less drive. Tighter credit requirements will ultimately translate into a smaller pool of buyers, and that can mean lower demand. However, the housing market is considered by many economists as critical to the U.S. economy, and if a substantial downturn in housing could lead to a recession, the Fed and the U.S. government could intervene to prevent that from happening. Inman News reported this morning that David Shulman, a senior economist for the
Anderson Forecast, predicted in his recent forecast report, "A Long Runway for
the Soft Landing," that the Federal Reserve will lower the federal
funds rate from 5.25 percent to 4.5 percent by yearend to help
reinvigorate the real estate market. A drop in interest rates increases housing affordability.
The collapse of the subprime market may, however, have a positive rollover impact on the prime lending market. One theory holds that there is still a huge amount of investment capital looking for a home in mortgage backed securities. As this capital shies away from subprime loans, there will be more money chasing prime borrowers. Wholesale mortgage money is like any commodity, and follows the laws of supply and demand. When supply is greater than demand, prices fall. Prime borrowers with good credit, strong employement and sizeable down payments, e.g. low risk, may be in the driver’s seat when shopping for money.
I don’t know how this will all play out. But it will be a very interesting phenomenon to watch over the next few months.