Any person who has turned on the TV at least once in the past six months or has visited the websites of news agencies knows that the US mortgage lending system is undergoing significant changes.
I entered the US mortgage business in 2003, working for a private office in the city of San Diego. In those days, retail mortgage rates fell to a record low, for example, then one of my clients’ transactions was made at a rate of 4.75%, and fixed for the entire thirty-year loan period. I remember how happy the client was when, after the transaction, he was able to pay credit card debt, when he received an amount sufficient to restore his collection of antique cars. The client had to pay a little to get such a low rate, but even without a surcharge, the rates for borrowers with a good credit history and a credit rating of at least “620” then fluctuated around 5% – 5.25%. This client of mine was a supporter of traditional banking products and chose a standard 30-year loan,
Option ARMs – product-cause
But today I would like to talk about the mortgage product, which is absent in the Russian market for banking products and which, according to many estimates, along with other negative factors, was one of the reasons for the serious imbalance in the US housing lending system. It is called Option ARMs. In general, it should be noted that the Russian mortgage market differs from the US real estate lending market by the limited choice of products and the practical absence of mortgages on the Russian mortgage market, the interest rate on which is floating, linked to one of the world indices (London Interbank Offered Rate, US Treasury index, etc.) and a corrective bank in accordance with the fluctuations of these indices.
So, in the US, the final mortgage rate for mortgages such as Option ARMs is calculated by adding the index interest rate and the bank margin rate. As a rule, the base interest rate is adjusted by the bank every six months or once a year; customers will learn about interest rate changes from mail notifications. The word Option (option) in the name of the product Option ARM means that the customer can choose the amount of the monthly payment that he wants to pay. For example, there is a payment in which the amount paid to a bank does not even cover the percentage of accrued interest for the period (No. 1 is minimal). There is also a payment type that covers only the interest accrued over the period, but a zero amount will be used to pay off the principal amount of the debt (this is payment No. 2). A payment is also proposed that covers as a percentage accrued over the period, and part of the principal amount (No. 3). And the word ARMs in the designation of this type of mortgage means nothing more than the Adjustable Rate Mortgage, which in Russian means “Mortgage with a floating rate”. The availability of such products on the market was extremely beneficial for people using the leverage available to them to buy investment properties, which were rented out after the purchase, ensuring their owners to pay monthly mortgage payments. And the rise in prices for real estate in California, which, on average, in the state was 10%, reaching 15-17% in some regions, provided a return on investment and their growth. Another category of borrowers who used this type of mortgage were people, the amount of the monthly available to use income (MDID) was lower, than 50% of the total amount of their monthly income. Underwriting (risk assessment and making a decision on granting a loan) in the US is made by full-time employees of mortgage lending agencies. And one of the criteria for issuing a loan is an estimate of the amount of monthly income that is available for use, which, to make it as simple as possible, is calculated as follows:
MDDI = Monthly income – (monthly liabilities on consumer loans + monthly liabilities on mortgage loans + other periodic obligations of the borrower)
In determining the risks of loans with a fixed interest rate for the above formula, the amount of liabilities based on the full interest rate on the loan is used, while for such an operation, in the case of Option ARM, the amount of the minimum monthly payment is used. And he, as we remember, did not even cover the amount of interest accrued over the period. Thus, people who, according to the risk characteristics of banks, could no longer be approved for issuing mortgages on traditional mortgage products due to their insufficient income, were positively approved for issuing Option ARMs. At the same time, the market continued to weaken both the controlling function of the banks themselves, which provided money for mortgages, and the controlling function of the players in the securities market.
The process of this segment of the US securities market can be simplified in the following form. After issuing money to buy a home or to refinance existing debt, the banks that issued the loan tighten up the entire amount of mortgages in their portfolios for houses. Pools differ in parameters such as the loan amount, the type of documentation submitted, the type of mortgage product, etc. The banks then sell securities based on these pools to investors in the secondary securities market in New York. Thus, securities appeared on the secondary securities market in New York for which mortgages were collateralized, the borrowers for which:
1. They were investors, for whom it was extremely important to maintain the growth rates of real estate prices in order to maintain the growth rates of their investments, while maintaining monthly payments at a lower level compared to traditional products.
2. Borrowers who could not take a loan other than Option ARMs due to incompatibility with the qualifications * parameters of traditional products.
I remember how at one of the manufacturing meetings, one of the representatives of banks lamented that the percentage of mortgage transactions on Option ARM, according to some estimates, amounted to 80–90% of the total volume of mortgages held by this bank and warned of a serious danger if the price growth rate on Real estate will be reduced a little.
Securities appeared on the New York market, the basis for which were borrowers with increased risks of late payment. In addition, market pressure has led to simplification of the procedure for obtaining a loan for the purchase and refinancing of real estate and a decrease in the amount of documentation required for its registration. For many borrowers, this was only a temporary respite. We all understand that the withdrawal of objects from borrowers and their sale subsequently from bank auctions (after a mortgage loan is more than 90–120 days overdue) are not profitable or core activities of banks and service companies. And in this regard, many US banks, after they realized that problems could not be avoided, began to produce new hybrid products, providing customers and customers refinancing their existing liabilities, the opportunity to take 40-, 50-year loans. But it was too late. Among the first to close was one of the largest players in the market – the bank New Century Mortgage. At this point, I had two transactions that I hoped to make with New Century, but these hopes had to be buried along with the hopes of my clients to restructure their debts when the bank declared bankruptcy.
No matter how the crisis of mortgage lending in the USA is commented in the media, you need to remember who this crisis plays into the hands and who does not. The crisis brought great trouble to financial groups that had significant investments in securities, the basis for which were mortgages on real estate. At the same time, for the person who is now making the decision to buy real estate in the United States, the current situation is probably the most favorable, since now property prices have declined significantly. Anyway, if to speak the language of market players, now the signal of the market in relation to real estate objects in the USA is unequivocal – to buy.