HAHAHAHAHAHAHA who woulda thought that I'd have run into THIS discussion on a VP thread?????
Flame on guys - I own a mortgage & real estate company. I personally have an interest only loan on one home and a negative amortization loan on another. These loans were created for financially sophisticated borrowers as a TOOL to use for specific reasons - i.e., fluctuating income causing differences in monthly cash flow; taking advantage of arbitrage available in the tax code, having to do with the tax-deductibility of mortgage interest along with the tax savings that can be found by investing in tax-leveraged investments; diverting cash away from home equity, which has a 0% rate of return by definition, into something with a positive rate of return, and other reasons. What happened is that consumers started thinking of the home purchase transaction as like buying a car, and we all know that car salesmen are always about "what payment do you want", and they never talk price, term, total cost of the loan, and etc.
You want to know who's really at fault on this mortgage crisis deal?
1) Not the government because this is a capitalist economy, basically that means "buyer beware". The disclosures on the subprime loans that are blowing up are very clear and nothing is hidden from the borrower, if they bother to read the documents. It shows very, very clearly on the Truth In Lending disclosure that after 2 or 3 years, the payment on an Subprime ARM was guaranteed to go up significantly. However, the government is culpable in one case - HUD. The HUD rules have not been revised significantly in many years, and the current rules prevent many mortgage companies from originating FHA loans. In addition, FHA needs a true $0 down payment options, which it does not have. The only way it can currently be done is to juice the sales price, add in a Down Payment Assistance to the contract, and borrow 97% of the "new" purchase price. In other words, institutionally and legally legitimate fraud. If FHA loans were more easily originated, many subprime loans that blew up on homeowners would never have been made.
2) Investment Bankers, Bond Insurers, and banks/mortgage lenders came out with some insane programs. Here's one for you: 100% financing for purchase or refinance, 575 credit score, interest only, 2x30 day lates on the mortgage in the last 12 months, 50% debt ratios, oh and I forgot to say - it's a 2 year ARM where the payments were guaranteed to go up significantly in 2 years because the loans were based on LIBOR + about 5% once they started adjusting. Since there were loans like this available, there was artificial demand pent up in the marketplace.
3) Unscrupulous mortgage brokers sold these programs to unsophisticated borrowers who did not read the fine print, or ignored it, or did not understand it. These particular ARMs were designed to get someone into a home and give them a 2 year "band aid" so they could fix their credit and get into a better loan later. Again, the were a TOOL with a specific use and target consumer. Problem was, no one took into account human nature, namely, that if someone has done something a certain way in the past, the statistical likelihood of them doing it the same way in the future is quite high. Whenever we did a loan like this for a borrower, we stayed in contact with them throughout the process and kept them accountable for their credit status, and we refinanced about 95% of the clients out of them before the 2 years were up. The rest? Well, they did what they had done in the past, in spite of the education we gave them and the other support. Subprime loans should carry a mandatory homebuyers' education program, like many conventional programs do for first time homebuyers.
Basically what happened is this, in the most quick & dirty possible way I can think of to explain a very complicated situation. First you have to understand where the money from a mortgage comes from.
First, you come see me for a home loan. I take your loan application and documents, and I "sell" it to a lender, like Bank Of America. Bank Of America then bundle your loan up, with hundreds of other peoples' loans, and they sell it to an investment banker on Wall Street. The investment banker then creates a bond, collateralized by the mortgage loans in the bundle, which can be sold on Wall Street like any other security. However, before the bond can be sold, it has to be graded by a bond insurer. The bond insurer will do due diligence on the bond, and the collateral on the bond (the bundle of loans). Here's where it gets tricky.
The investment bankers took A+ loans, Alt-A loans (which are loans to self-employed people who can't prove their income, and situations similar to that), and Subprime loans (which are loans made to people with credit scores below 620), and they then mixed them all together as collateral for the bond issue. By doing this, they basically worked the system and fooled the bond insurers into giving these bonds a AAA rating, even though they had been tainted with the Subprime paper.
The bonds, now being freshly stamped with a AAA credit rating, were purchased on Wall Street by pension funds, mutual funds, banks, and even little old ladies.
When the loan defaults started piling up, the investment bankers, bond insurers, and bond investors started taking a bloody beating. Once they figured out what the underlying problem was, they turned off the money faucet. This caused banks & brokers to not be able to make certain loans that they had been able to make before. Since a measurable percentage of home purchase transactions were funded by these loans, you had a sizable chunk of the homebuying population out of the game all of a sudden. Hence the issues in real estate prices right now. All of the losses you hear about with the banks are simply them having to re-balance their Balance Sheets to account for the drop in value of these bonds. The only place they can take the money out of on the Balance Sheet is "retained earnings", which is basically the account that profits are booked to over the years. That figure is derived from their annual profit & loss numbers, so when you hear that ABC Bank lost $10MM, that means that they had to write down the value of the bonds to account for the lost value in the portfolio, and the way that they did it was by taking a one-time charge to profits/income. They already had the money set aside, as statutorily mandated by the feds, to cover the loan losses.
What has to happen here to fix the problem is that the banks who hold the defaulting loans have to aggressively work to restructure the deals so homeowners can stay in their homes. HUD has got to revise their rules to make FHA financing more readily available to borrowers. Consumers have to learn to make good decisions with their money, and to hold off on instant gratification. Insanely overheated markets like Las Vegas, Miami, DC, and others have to correct. The individual states have got to better police the mortgage brokers, because most of the departments of banking are woefully understaffed and underfunded (the mortgage industry is largely/mostly state-governed, with the exception of the blanket rules that HUD publishes, like RESPA).
The American economy is incredibly resilient, and real estate will come back - 2008 will continue to be soft, and it will be back to normal sometime in 2009 in my opinion. Here in Atlanta, the market is picking back up already because we haven't had the big run-up in values that would have led to a cratering.
As far as interest-only loans go - my opinion is that borrowers should be qualified based on the principal & interest payments. If someone does qualify based on that, good times. I then think that a borrower who can handle their money well should take the cashflow savings realized from not paying down principal, and invest it in a tax-leveraged account so they can build up money for retirement, etc, in a tax-efficient manner. Over time, equity will be built in the real estate from natural appreciation far more quickly than by paying the loan down. In a 30yr conventional loan, you only pay off approximately 10% of the balance over the first 10 years. And, the average life of a mortgage loan is about 4 years. The only people getting rich off people making P&I payments in the first years of a loan are the banks. They know how the game works....anyone interested in the *exciting* world of advanced mortgage finance can email me via myspace because I think we're going to get this thread moved due to it being jimmy-jacked by the mortgage crisis!!!!! =)
Oh yeah - Vanden Plas - my understanding, since most of you guys know we were right there with Shane when all that went down - is that it was the wrong type of visa. Apparently the label paid for tourist ones and not work ones, and someone apparently let the concert info slip. I may be wrong on this because there was a lot going on then, but that's what I think I heard.
I do have an interest-only for my main mortgage, but I'm very well aware of what that means, and it has not and will not be a problem, unless the value of my condo drops by more than 10%, and even then I'll be okay. It just means I have to live there longer. (I made sure the payment amount when it goes up was something I could already afford.)
