Bankers’ Hours column: The return of low credit loans doesn’t mean recession redux
September 24, 2017
Last week, a mortgage wholesaler came out with a program that touts credit scores as low as 500 on loans slated for FHA insurance, VA guarantee, and for sale to Fannie Mae and Freddie Mac, the massive conduits that package into mortgage backed securities almost all of the home loans produced in the U.S.
As just about everybody knows, that's a very low credit score. Currently, other lenders are holding the line at a 620 score for borrowers.
This has prompted many experts to opine that it's déjà vu all over again, and we're headed to another housing debacle just nine years or so after the last one.
Maybe; but, maybe not.
As in the case of many catastrophes, the root causes of the crisis of 2008 are misunderstood, even though there was nothing really complex about the Great Meltdown. One overlooked element is that qualification for the so-called toxic loans that trashed housing prices and torpedoed the stock markets, was credit score driven.
Meaning, that if your had a fairly good FICO score, you could qualify for a pretty weird loan. Weird, as in "stated, stated, stated": You were able to make up how much money you made, how much you had in the bank, and how much you owed. Your income wasn't verified, your bank statements weren't viewed, and you could owe so much money that your debt service would preclude your being able to service the mortgage that was being handed to you.
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In other words, nobody underwrote the loan.
So, borrowers lied about occupying the collateral property, because they figured they'd flip it in less than six months, make a 30 percent profit, and never have to make a mortgage payment. Or, they were able to buy a five-bedroom mansion that they thought they'd never be able to move into, courtesy of the helpful lender that handed them a really big loan to buy that really big house. And then there were the homeowners who refinanced their mortgage just because they could, and took out a chunk of cash to spend in a lot of creative ways: "Gee, a quarter of a million because I've got a 750 credit score? Where do I sign?"
At the top of the food chain were the investors, who ponied up billions to buy the securities supported by those toxic loans, because the yields were just too good to pass up.
But there was a neat little booby trap planted the moment that one of these deals was originated.
We're going to digress a moment into the esoterica of accounting. I don't speak accounting, fluent or otherwise. I can never remember the difference between "debit" and "credit." But I do remember some rules from spending more than a few years in — gulp — banking.
If you sell an asset, like a loan, to somebody else, and, say, you have to buy it back if it goes delinquent, then you've sold it "with recourse." Which means that you haven't really sold it; you keep it on your books, even though you get no benefit from it, like interest payments. On the other hand, if you sell it and are not compelled to buy it back, then it's "without recourse," and it's not on your balance sheet anymore. When a lender originates a loan for sale to, say, Fannie or Freddie, which buy most of the residential mortgages made in the U.S., that loan, according to the accountants, is sold "without recourse." It's off the books of originator.
But — and I know you've been waiting for this — there's a catch. The seller makes very specific "representations and warranties" that cover a plethora of certifications, from the validity of title work, to the viability of the appraisal to underwriting the borrower's qualifications. If the loan goes delinquent, and the purchaser of the loan finds that one of these warranties was violated, then the originator can be compelled to buy the loan back and suffer the loss, if there is one.
Of course, fraud is always a trigger for a repurchase demand. So what about those "stated, stated, stated" loans that the big mortgage conduits like Bear-Stearns, Merrill Lynch and Lehman Brothers snapped up to package and sell? You got it: They were technically, but also definitively, fraudulent, if the borrower misstated income. And virtually all of them did; that was the idea, after all.
This is just an example of why lenders today are very meticulous in the creation of a home loan. A mortgage producer/lender might quote a low FICO score loss leader product, but there'll be some bells and whistles attached designed to limit loss and exposure.
Gone are the days when you could apply for a loan, and then throw darts at a board with various big salary numbers to see what you would enter in the monthly income box of the app.
With nostalgia, I remember a call I got from a mortgage broker back in about 2006. Seems he had an app from a librarian applying to buy a very nice home. He wanted to know if the bank I worked at would do the deal. I asked about the borrower's income, and the reply was, "$90,000 per year."
"Gee, that seems kind of high for librarian. How come she makes so much?"
"Because that's what it takes to qualify for the loan" was the reply. He didn't add "idiot," but I got the message.
Pat Dalrymple is a western Colorado native and has spent almost 50 years in mortgage lending and banking in the Roaring Fork Valley. He'll be happy to answer your questions or hear your comments. His e-mail is email@example.com.
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