Mortgages - Are Lenders to Blame for the Present Housing Market Crisis?

Rising fuel and food prices. Crashing stock markets and property values. Fluctuating currencies. Rising unemployment.Recession.
Are you tired of these kinds of headlines?

Thought so.

Just a year back, everything was fine and people were making money in business, on property and the stock markets. Today, you would be very fortunate if you did not lose money in any of these areas. In times like these, I ask myself, why bother saving? The answer to that question is that you have to save if you want to see your children through to independence and then retire comfortably. And that, my friend, is the purpose of my blog on Wordpress, the address of which you will find in the resource box.

I will be posting comments on my little understanding on mortgages, loans, insurance and savings and investments in general. Hopefully, there will be other intelligent and successfull investors and businessman who will also contribute to this blog, so that all participating here may be wiser when it comes to handling their personal finances.

Here is my take, as a mortgage broker, on how we arrived at the present housing market situation.

The federal funds rate which was around 6.5% in the second half of 2000, was slashed through out 2001 till by February 2002, it was about 1.75%. Rates were then more gradually cut till they reached 1% in April 2004 and though they started rising from July of that year, it was 2 years, July 2006, before they exceeded 5%. The Fed cut rates in 2001 to avert a recession, but inadvertently planted the seeds for the turmoil in the housing market today. As rates went down, mortgages became affordable and people who normally would not qualify for such loans, based on their incomes, suddenly found themselves being offered mortgages from banks. For large numbers of families, their dream of owning a home became a reality. There was only one problem in this scenario. The lending banks did not ask the borrowers to prove that they would be able to maintain their mortgages when interest rates eventually rose. It was then about this time, that foreclosure rates started rising.

There were other factors as well. The banks came up with self certification mortgages which did not require any proof of income. They would accept the income stated on the application form with out running any checks, on the reasoning that they had the property as security or collateral. These mortgages came to be known as Ninja mortgages - No Income No Job No Assets, as customers who took out these mortgages probably would not have qualified if their circumstances had been looked in to with more diligence. As foreclosures increased, property prices crashed. Many properties lost even more value on account of vandalism as empty properties inevitably suffer this fate. The end result was that families lost their homes, banks lost their loans and as financial sector shares crashed, shareholders lost a substantial part of their investment in these institutions. Further, the problem was not confined to the USA only, as many banks frequently sell their mortgage portfolios or mortgage backed securities to other banks to raise capital. European and Asian banks bought many of these portfolios or securities as on paper they offered a very good return on their investment. Subprime mortgages are highly profitable as the interest rates levied from customers are quite high in line with the higher risk these mortgages carry. Nobody wants to be left out when there are profits to be made and so when the housing market in the USA crashed, European and Asian banks felt the pain. The net result has been that all banks have become extremely cautious in lending, not only to customers and businesses but even among themselves. Since lending generally fuels business and consumption, we now find ourselves heading towards a recession.

So how do we prevent this kind of a situation in the future?

I am no economist but the First Amendment grants me the right to make my opinion heard, even though it may be the dumbest thing you ever came across. So here goes.

The sole criteron for lending should be the ability of the borrower to pay back the loan and not the value of the property. The property should only play a secondary role in the lending decision.Mortgages should be granted only to customers who can prove a consistent and reliable income. They should not be granted on property values as these can fluctuate drastically or disappear completely. The loan can be quantified as a certain multiple of the total net disposable income of a family and no more. Another way arriving at the loan figure would be that the total net disposable income should be atleast twice the annual mortgage interest. This would ensure that the mortgage installment on an interest only basis would be affordable even if the interest rate doubled. By disposble income, I mean the portion of the income left after all taxes and everyday expenses have been deducted. Banks should be compelled to do their due diligence and keep detailed records of their investigations before lending to customers. An independant body would then be responsible for monitoring mortgages and would have the power to impose penalties to erring lenders.

Purchasing a mortgage payment protection insurance policy should be mandatory for all borrowers. These policies pay out if the borrower is unable to work on account of accident, sickness or redundancy. They are usually two year policies and relatively cheap. They usually do not pay out in the first 6 months of purchase or where the person covered knew that he/she was going to be made redundant. In genuine cases, they pay out an amount covering the mortgage installment and utility bills. This payment provides some relief while the breadwinner looks for a job or recovers his health.

Finally, the lenders themselves could help avoiding such a catastrophic situation again. They could set up their own insurance company to guarantee the cost of mortgages in default. The reasoning behind this suggestion is that a property rapidly loses its value once the lender forecloses and puts it on the market as explained earlier. It seems to me that it would be a much better proposition for the lender to let the family stay in the home and maintain it and advise and encourage the bread winner to sort out his problems. The insurance company would cover the cost of interest on the mortgage for a fixed period just like the mortgage payment insurance mentioned earlier. The insurance would only cover the basic interest cost of the loan to the lender and not the interest charged to the borrower.Also, the insurance company would do its own due diligence before selling the policy and shaky loans would probably be declined for cover.

In conclusion, I would say that most people are over optimistic on how much they can afford to borrow. It should be the lender's responsibility to arrive at the right figure to lend so that neither they nor the borrower need suffer on account of inappropriate lending.

Thanks for reading and I hope you will let me have any comments, positive or otherwise, on my thoughts.