Has the subprime crunch hit Traverse City?
REGION – When Mr. Jones (a fictional name used by request) found a job in Traverse City, he and his family put their Colorado house up for sale before moving. Within a month they had a pre-qualified buyer. As the closing date grew close, Jones quit his Colorado job, arranged to start his new Traverse City job and scheduled the movers. Two days before closing, Jones learned that the buyers had "lost their financing." The Joneses' realtor couldn't offer much explanation, except to say that many mortgage lenders had raised credit standards recently.
"We couldn't wait; we still had to move. My husband's job was starting. The movers were coming," explained Mrs. Jones. "Now we're paying the mortgage on our house, plus rent in Traverse City." The Joneses have put their house back up for sale, although their original buyers are still trying to get financing.
The Joneses witnessed firsthand the effects of changes in the subprime loan industry. They are not alone. Nationally, real estate values are no longer rocketing upwards, setting off a complicated set of economic and financial circumstances. In short, it is harder now to get a mortgage if your credit scores are at the low end. This change affects the whole economic spectrum: from home buyers and sellers like the Joneses to homeowners looking to refinance; from realtors to mortgage lending companies, and even investors in hedge funds.
The evolution of the subprime loan market
The development of the subprime loan is largely a response to Wall Street, says Dan Giroux, president of Crest Financial Inc., headquartered in Traverse City. Investors looking for stability sought out funds based on real estate. Having the property as collateral made these funds attractive, especially after the stock market crash attributed to the dot-com industry.
As demand increased, lenders looked to expand beyond the prime loan industry, developing new products: subprime or non-conforming loans. Wall Street responded by investing in funds supporting these companies and loans. The industry continued to grow, sustained by a hot real estate market and single digit interest rates, explains Giroux.
Traverse City-based Freedom Financial Mortgage CEO Brian Miles agrees. "The reason these pools of money were put together (by Wall Street) is that investors didn't want to invest in risky stock. They figured mortgages and securities, invested in homes and land with a history of going up in value, were investments backed by an appreciating asset."
As the demand for mortgage-based investments grew, lenders allowed consumers with credit scores as low as 500 to buy homes with very little or no down payments.
Some loans, such as adjustable-rate mortgages (ARMs), kept monthly payments affordable by offering very low interest rates for a short term. After that term was up, anywhere from one to three to seven years, the loan would adjust to new interest rates available then and, probably, a higher monthly payment.
Consumers believed that they would move, have improved wages or be able to sell their house at a higher value before having to pay the higher monthly payment when the rate adjusted. It's important to note that to qualify for an ARM, the borrower must qualify at the fully indexed rate of the adjustable mortgage.
What went wrong?
"We live in a microwave society, where everybody wants everything right now," says Miles.
In addition to non-traditional first-time home buyers, many people used their home's equity, based upon a runaway housing market, to resolve credit card debt or afford more spending. "A homeowner may have borrowed money based on a real estate market that valued his home at $190,000. Now he can only sell it for $168,000 but he owes $173,000."
Giroux adds that most loan defaults are triggered by events like divorce, unemployment, under employment or overwhelming health costs-all the same factors contributing to bankruptcies (see Traverse City Business News, February 2007, "Bankruptcies down nationally, but what about locally?"). In these cases, most mortgage lenders will work with their clients on a solution, trying to keep families in homes.
"We look for a pattern-a history of paying on time. Were you okay before the crisis?" says Giroux. He concedes that some subprime defaults are from consumers using poor financial judgment, which produced the low credit score in the first place.
"You'd be surprised at how many people will go to Disneyland but they can't pay their mortgage."
He describes the average subprime candidates as young families working in the trades and in retail. He believes that basic financial awareness isn't addressed as well as it should be in high schools. To help bridge the gap, Crest provides a lot of pre-qualifying counsel to loan applicants, including a Dos & Don'ts List with advice like, "Don't quit your job," and "Don't purchase a new vehicle."
Miles agrees. "Our nation as a whole has not been taught how to pay for their mortgage." He's concerned that consumers use their home as a credit card and become so leveraged that, "a small twig in the road, like a health problem or the loss of a job, becomes a major train wreck."
Giroux, who was named vice chairman of the Michigan Mortgage Brokers Association's Standard Procedures and Ethical Codes Board in December of 2006, points to another issue contributing to the recent increase of subprime defaults nationwide: inexperienced and untrained mortgage professionals. Because there was so much activity and so much money being made, people with no experience flocked to the mortgage industry.
"Our industry is looking at whether we need to license mortgage professionals," says Giroux, "to ensure that Michigan consumers get responsible advice."
Miles also believes a lot of unqualified loan officers got into the business during the refinance boom when rates were at a 40-year low.
"A lot of the people who shouldn't have been in the business, will be out of the business in the coming months. A lot of these loan officers didn't know how to financially structure a loan to benefit their clients." In the last six months, Giroux has seen at least 37 lending companies disappear.
One of those companies to disappear, South Star Funding LLC, notified brokers via email, citing "… this decision was necessary due to unprecedented downturn and policy changes in the mortgage industry." (South Star president Kirk Smith didn't return a voicemail.) New Century Financial Corporation, which once described itself as one of the nation's premier mortgage finance companies, filed for bankruptcy April 2 and fired 3,200 employees. Its Livonia, Mich. office is closed.
Many of these companies cease business unexpectedly, leaving employees, brokers and consumers in the lurch. Buyers at every stage of a real estate deal have to start over-some on the day they are to close.
While certainly a very small segment, Giroux believes there is some fraud in the market that would be avoided by tighter industry self-regulation. It is possible to refinance a loan based on a property's equity and take the cash, intending to default on the loan. That hurts the industry overall.
Investors are also starting to feel the impact. Hedge funds, feeling the sting of the lending company bankruptcies and loan defaults, are growing more vigilant, looking for tighter standards and more stable loan practices.
What's the impact on
The tightening of guidelines may be what killed the deal for the Joneses who are trying to move to Traverse City. Both Crest and Freedom report that many companies are tightening standards for new loans. Companies that might have offered loans to those with credit scores under 600, have returned standards to 620, 630, etc. Overall, both Crest and Freedom maintain that although the subprime options may not be as broad as they were six months ago, there are still options for home buyers seeking subprime loans.
"I believe this is a healthy market," says Miles. He cautions that the subprime market is only 18 percent of the total mortgage market. And he estimates that only four or six percent of the area's subprime homeowners have defaulted, which is less than has been reported nationally.
Approximately 50 percent of Crest's business is in the subprime market. When asked about defaults, Giroux points to a wall covered in plaques.
"Each one of those plaques is an award for consecutive quarters of no defaults from the lenders that work with us. We work with clients so they don't default."
Trent Graham, group manager at the Traverse City office of GreenPath debt solutions, a non-profit financial counseling organization, says he is seeing a lot more mortgage issues now.
"If it's not double, then it's pretty close," says Graham. "Either they are having a hard time selling a home or they owe more than the home is worth … and we're seeing more people with higher incomes."
Most of these clients are adjusting to less income, either because they've lost a full-time job or a supplemental part-time job, or had to take a job that pays less.
According to RealtyTrac, a real estate company focusing on foreclosure properties, national foreclosure filings were up 12 percent in February over 2006. (Filings include default notices, auction sale notices and bank repossessions.)
Locally, RealtyTrac's website listed 34 foreclosure properties in April in Grand Traverse County, nine in Benzie and one in Leelanau County. Detroit had a total of 57,494 foreclosures in April: 33,692 in Wayne County, 14,849 in Oakland and 8,958 in Macomb.
Is regulation the answer to turning the tide?
Because the lack of subprime loans contributes to the nationally sluggish housing market, the industry and the government are working on solutions. House Democrats introduced legislation on April 2 to increase Federal Home Administration loan limits, reduce closing costs and make it easier to qualify. The MBA reports that consumer advocacy groups are pushing for a six-month moratorium on foreclosures from subprime loans. The organization discourages blanket regulations.
Doug Duncan, the MBA's chief economist, feels the market is working and will gain its equilibrium.
"Given our macroeconomic forecast of below-trend economic growth and a slowly recovering housing market, we would expect delinquency and foreclosure rates to level off as the housing market regains its footing toward the end of 2007." BN