The Fountain of Smart
Homebuyer Associates April 2011 E-Note
Homebuyer Associates www.homebuyerassociates.com
414.254.4129 homebuyeba@gmail.com
Michael D. Holloway/Seamus Holloway/Paul Wollersheim
The Fountain of Smart
You’ve decided to buy a home. You’ve taken the time to understand who works for whom in the real estate transaction, how are they paid, the monthly payment you can afford, where you can afford to live and that it makes more sense to own than rent, given rent-to-own index is in the range of 20 or below.
Now you must then qualify for a mortgage. The mortgage is the money that covers the difference between your purchase price and the amount of your down payment. Where does the mortgage money come from?
In the 60’s, 70’s and early 80’s loans were made by local lenders who most often retained those loans. The lender made money by making and servicing the loan. Many home buyers actually knew the person at that bank who was making the loan and the bank knew the buyer. That meant the lender had an interest in making sure you paid back your mortgage. The lender retained some risk.
The system then evolved (devolved?) to a process where loans were made by mortgage brokers. Mortgage brokers were paid a fee for making the loan. The loan was then packaged into a security and sold on the secondary market to investors. This is not to demonize mortgage brokers, rather the process of securitization allowed for the system to change.
The new system developed as a means to encourage home ownership (by the government); to make money for those who sold real estate (agents); to make money for lenders (the mortgage brokers); to make money for those who packaged the loans into securities (Wall Street) and, for some – a misguided attempt to make big money on their homestead (buyers).
In this system you didn’t know the lender, the lender didn’t know you and the people involved had very little interest in whether or not the loan was repaid.
The participants (excepting the home owner) got paid whether or not you were a good bet (no pun intended) to repay the loan. The income to the parties involved (other than the buyer) was based on the price of the home and size of the mortgage – the higher each, the more money to be made. The flaw was that there was little or no risk retention by the entity making the loan and little investment on the part of the home owner. We know the result of that approach.
The Dodd-Frank financial bill aims to change how loans are made and who qualifies for them. Specifically, the bill will attempt to address who qualifies for a mortgage, the amount of money required for a down payment and the level of risk retention which should be retained by lenders. There will also be an attempt to lessen the involvement of Fannie Mae and Freddie Mac being so heavily involved in the mortgage process. At this writing federal agencies (Freddie, Fannie, V.A. and FHA) back roughly 9 out of 10 new loans.
How might that affect you? Any changes will probably raise borrowing costs which could result in higher front-end costs for insurance and higher interest rates on loans. It is unlikely anything will happen before the 2012 election and what does happen will probably be gradual due to the impact housing has on our economy. While change will probably be gradual it speaks to why the present remains a good time to buy a home if you have done your research and are comfortable buying a home.
In the end it does no good to freeze out credit worthy buyers yet it is obvious we can’t let the market be totally “free.” I think it would be good to require a 5% down payment with mortgage insurance paid to cover some of the risk a lender/investor may be exposed to. I also think the lender should retain some risk. The higher the down payment the less the buyer should have to pay for insurance up to a 20% down payment. Having fair underwriting practices and appraisal reviews would also limit lender exposure.
As with many things a common sense approach by all would help keep housing on even footing. The problem is that common sense is a hard thing to come by. I’m reminded of a sign a 30 year old friend sent to me. The sign said, “Forget about the fountain of youth we need a fountain of smart.”
If you found this information of interest please share it with a friend. If you are a past client thank you for your business. If I can be of assistance to you, your family or friends I would welcome the referral. As always, if you have a real estate related question, feel free to contact me. Thanks for reading.