The collapse of the US real estate market a dozen years ago is obviously an old story for many mortgage lenders.
The underwriting standards for mortgages have eased considerably in recent years. One of the largest US mortgage lenders is now offering a jumbo mortgage of up to $ 1 million with only 10% less if you have a FICO value of at least 760 able to get up to $ 3 million , A smaller lender is now offering home buyers a loan of up to $ 2 million with a FICO value of up to 640. This was considered below average in the bubble years in the early 2000s.
Such favorable conditions suggest that the property markets are in decent shape and there is nothing to fear on the horizon. In fact, it is now agreed that mortgage loan defaults have steadily decreased and are no longer a threat.
In reality, jumbo mortgages – loans that exceed the guarantees set by Fannie Mae and Freddie Mac – are a problem of jumbo size.
Lessons in history
Jumbo mortgages have played a big role in financing single-family homes. Take a look at this table, which shows how jumbo loans are created for both buying and refinancing:
During the four wildest bubble years – 2004 to 2007 – around $ 3.1 trillion was raised on jumbo mortgages. Note that there were far more originals for refinancing than for purchase. In my previous column, I showed that the vast majority were disbursement refinancing, and the new loan was often much higher than the original mortgage. For the top 25 metros, more than $ 1 trillion was produced in Jumbo Refis in 2005 and 2006 alone.
The bubble years are worth a quick review as it is important to remember the story so as not to repeat it.
Probably the most important factor in inflating the real estate bubble was the widespread use of the specified income loan – also known as an income-free loan – known as a "liar loan". This type of loan was originally designed for self-employed borrowers who could not easily prove their income.
Its use increased during the speculative madness of 2005-07. The borrowers provided income, employment and wealth when they applied. Neither the broker nor the lender verified the reported income by getting pay slips, W-2 forms, or income tax returns. The temptation for applicants to lie and exaggerate their income was almost irresistible. A 2009 report by the United States General Accountability Office (GAO) found that nearly 80% of all interest-bearing mortgages in 2006 were income-related loan applications nationwide.
Another key factor that stimulated borrowing and rampant speculation was pure interest rate mortgage. Without this type of mortgage, at that time few first-time buyers would have been able to afford the monthly payment in much of California, Florida, and several other hot markets. This mortgage also made it considerably easier for investors to acquire one or more properties. As early as 2005, more than 60% of all California mortgages were linked to interest rates.
Finally, widespread investor fraud contributed significantly to the boom and bankruptcy of the real estate market. Mortgage applicants had to indicate whether they wanted to live in the house they wanted to buy. Underwriters needed this information because investor-owned property has traditionally been at a much higher rate than owner-occupier. As a result, investors have been given increasingly stringent credit terms. Research has shown that many borrowers have lied, stating that they want to live in the house they bought.
As you might guess, these tremendous drawing standards were a recipe for disaster.
Risk of a large mortgage debacle
Fast forward to today's market. I recently discovered a massive study of 1.6 million California loans published by the San Francisco Federal Reserve Bank in 2011 between 2000 and late 2007. A third of these loans were jumbo mortgages. The 300,000 loans taken out by the banks were almost exclusively jumbos with an average mortgage volume of $ 497,000. If most of these mortgages are still active, how can this not be a big problem?
The company with the most comprehensive data – Black Box Logic – no longer exists. It is therefore difficult to find up-to-date, reliable statistics on mortgage loan defaults. We know the following: Most of the first mortgages that the largest banks have in their portfolios are jumbo mortgages. For their modified mortgages, which are known as "Troubled Debt Restructuring" (TDR), two of these banks have a default rate of 41% in their latest termination reports and a third bank has 51%.
Other data on deferred mortgage modification gives us a good picture of what's coming. In its April 2015 mortgage monitor, data provider Black Knight Financial Services reported that 70% of all borrowers who had received a new test modification or repayment schedule had already defaulted on one or two previous modifications. This is in line with the diagram from my last column on the default values for changes, which shows that the default values increase with each new change.
The Currency Control Office (OCC), which regulates all national banks, publishes a quarterly report on mortgage ratios. Although the eight major banks on which the report is based served only 42% of all outstanding mortgages at the end of 2015, it provides a good insight into the modification and replacement situation across the country.
From early 2008 to the second quarter of 2015, reporting service providers had changed 3.8 million mortgages. Half of these had left the service portfolio either through full repayment of the loan, foreclosure, short sale or transfer to a new servicer who had not contacted the OCC. Less than 1% of all loans that had been withdrawn from the mortgage portfolios had repaid their loan in full. Around 265,000 had been liquidated through foreclosure or short sales.
Almost 30% of the 1.92 million modified loans that were still “active” in mid-2015 had already failed. The repayment rate for private, non-guaranteed loans was even worse – 41% within two years of the change. While we cannot be certain, it can be assumed that the 1.13 million loans transferred to other service providers had default rates at least as high as those that remained in the reporting service providers' portfolios. Later OCC reports unfortunately do not show the updated failure rates for the entire service portfolio. For example, the OCC report for the first quarter of 2016 showed six-month failure rates for new changes that are similar to the six-month rates for previous years.
Serious crime problem
As house prices in the US fell in 2008 and early 2009, mortgage defaults increased and cure rates for these borrowers plummeted. The graph below shows that a steadily increasing percentage of criminal homeowners have been unable or unwilling to pay their arrears and provide electricity to the mortgage. While around 60% of borrowers in arrears for 60 days did not clear their arrears until mid-2006, three years later this figure had dropped to less than 1% for loans with a term of at least 90 days. This is one of the main reasons why lenders and their agents panicked and concluded that something had to be done to stop bloodshed in the housing markets.
During the bubble era, five states dominated the emergence of jumbo mortgages. Almost two thirds of all jumbos came from California, New York, Florida, Virginia and New Jersey. By early 2010, approximately 13% of all $ 1 million plus jumbo mortgages were seriously criminal, compared to only 8.6% for all mortgages. Three months later, more than 10% of all securitized prime jumbo loans were in arrears, after only 4% in the previous year. Check out this table below, which comes from my March 2019 column.
By mid-2010, mortgage service providers across the country were pursuing a strategy of supporting real estate markets by not putting expensive, foreclosed real estate on the active market. They had also started to take the next step to reduce long-term crime isolation. According to a comprehensive report from data provider Amherst Securities Group in 2012, service providers liquidated default, non-guaranteed mortgages of around $ 175 billion in 2009, but only $ 125 billion in 2010.
Despite this decrease in foreclosures, the number of late payments remained extremely high. For securitized loans that were neither guaranteed by Fannie Mae or Freddie Mac nor insured by FHA, the unpaid balance of outstanding mortgages increased in 2009 and reached $ 500 billion in early 2010.
As I have repeated many times, mortgage service providers have consistently followed this strategy of not excluding jumbo mortgages. What appears crystal clear is that the vast majority of long-term criminal jumbo mortgages have not been excluded and are still outstanding. Many jumbo borrowers have not paid in years. As a result, the mortgage jumbo market is now a ticking time bomb. Lenders, mortgage service providers, investors and homeowners should prepare for this.
Read: This mortgage catastrophe is ready to punish the real estate markets
More: 5 ways the housing market will surprise us all in 2020
Keith Jurow is a real estate analyst who deals with the debacle of real estate finance in the bubble era and its aftermath. Contact him at www.keithjurow.com.