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Wall Street Turn Their Backs On Wacky Sub-Prime Loan Originators As Foreclosures Explode

paul@brokencredit.

paul@brokencredit.com.

Best regards

Paul Jerome
http://www.brokencredit.com

Wall Street Turn Their Backs On Wacky Sub-Prime Loan Originators As Foreclosures Explode
The lending term populating portfolio buy/sell agreements
to package and sell loans into the secondary market to Wall
Street investor groups is the term "sold with recourse". As
the loan goes bad, some before the first payment is made;
many lenders are being asked to buyback bad loans per
portfolio selling contract. Only problem, many of the
wholesale sub-prime (higher risk loans) mortgage
originators are being forced out of the business lacking
the funds to buy back the loans. One of the major sources
of revenue for a wholesale sub-prime originator is selling
loans into the secondary market at say 105% (could be
more-could be less) of the portfolio face value. When the
buy window shuts for new loan originations, the loan may be
worth maybe 95% of the face value and the originating
wholesale lender takes a hit before getting out of the
blocks. When the game is over, it's over.

For example, if a loan is sold into the secondary market
which has an original face of $250,000 with an interest
rate of 7.875%. The payment on this Adjustable Rate
Mortgage (ARM) with a two year fixed rate and then the
remainder of 28 years that will adjust every 6 months. This
loan among a portfolio of other loans would be sold for the
105% premium thus the originator would receive: $250,000 x
105% = $262,500 thereby giving a gross profit of
$262,500-$250,000 = $12,500.00. This would give the
portfolio buyer an approximate gross yield of 7.373% for
the first year, if on time payments are received and is
paid as agreed.

Portfolio buyers are not "babes in the woods" who just got
into the secondary market business. There are refined tools
to underwrite loan portfolios from looking at each loan in
the bulk sale to looking a just a sampling. The Street is
hungry for high yields with tempered risk. When risks
become unmanageable the money spigot is shut off of
throttled down. When times were good many of the new hybrid
sub-prime loans were lumped in with the less risky loans to
make up a portfolio or some in other cases it's made up
with just the hybrids. It depends on the loan seller's and
the loan buyer's contractual agreement. Most of the 2/28s
ARMS (Fixed for 2 years then adjust every 6 months
thereafter) carry a two year prepayment penalty. The loan
was sold as a two-year Band-Aid loan to allow borrowers to
set their credit histories right and improve their
positions. With improved credit histories a borrower could
qualify something like a conventional loan with a much
lower rate and even a 30 year fixed term giving the
borrower some stability and certainty of principal and
interest payments for years to come. This was great as long
as the market prices were increasing by sufficient amounts
to allow sufficient equity to absorb the closing costs on
the lower interest rate loan. With a general market turn
down on price appreciation in many areas of the country,
many borrowers found themselves upside down where they owed
more than the property appraised. Thus the plan of rolling
into a lower rate on a fixed rate basis at the end of the
two-year period was foiled.

It is here that many borrowers were set up from the get go
to fail. With the option of refinancing at the end of the
two-year period foregone, the borrower was now faced with
the margin and index kicking in to determine he new rate
adjustment. In the prior example above the 7.875% fixed for
two years is set to adjust to a rate of the index (Six
Month LIBOR Index), currently at 5.32% plus the margin
which was at 6.5%. The index plus the margin would give a
rate of 5.32% + 6.5% = 13.82% adjusted upwards to the
nearest .125% (1/8th). Per the ARM Rider attached to the
mortgage the rate increases were limited to a 1.000-%
increase per every six months. So if the index remained the
same the first rate increase at the end of the two year
period would be 7.875% + 1.00% = 8.875%. The payment would
move from $1,812.67/month to $1,982.73/month with two years
of amortization and pay down of the loan or an increase of
$170.06/month. On the surface this isn't too bad, but in
six months it will go up to 9.875%, then 10.875%, then
11.875%, then 12.875%, then as long as the index remains
(it could go up some more) the same leveling off at
13.875%. It would take two years to get there from the
fixed rate period. Tracking the payment progression: Month
336 at 8.875% = $1,982.73/month; Month 330 at 9.875% =
$2,156.51/month; Month 324 at 10.875% = $2,333.47/month;
Month 318 at 11.875% = $2,513.12/month; Month 312 at
12.875% = $2,695.06/month; then on month 312 the rate
floats to 12.875% = $2,878.92/month. This is an increase
from the original $2,878.92(month 312)- $1,812.67/month
(the original payment) = $1,066.24/month increase. For most
families, this is a devastating hit. Many do not survive
this hit. It destroys family budgets. This borrower has
been set up to fail. The lifetime cap on this particular
loan is pegged at 15.00%.

When things were flying high, the possibility of continued
appreciation was good that would bode well for the
refinance at the end of the two-year period and the
Band-Aide loan would be paid off with a replacement loan at
a much reduced rate and on a fixed rate basis. But
appreciation did not happen to save the day. The market
fell and the borrower is upside down with an accelerating
payment. If the market would appreciate a degree it could
save the day, in the meantime the payments erode any hopes
of maintaining a family budget. Some options are (1) to
sell quickly and possibly get the lender to consider a
"short sale" where they settle for less than what is owed.
(2) Pay the cash difference at the closing table just to
get from underneath the payment (however many sub-prime
borrowers have not had a lot of cash to work with). (3)
Propose a deed in lieu of foreclosure where the property is
just given back. (4) Stay and get second jobs and tough it
out till the market turns. (5) Possible Chapter 7 or
Chapter 13 Bankruptcy to deal with the other debts that is
owed. A Bankruptcy would buy a few months on the mortgage
but would lead to a foreclosure with continued non-payment
on this secured debt. The whole challenge is complicated
with being upside down on the loan. If it falls to
foreclosure in the early years then the "full recourse
buybacks" kick in to the original wholesale mortgage
originator.

Again, many of these wholesale mortgage originators with a
flood of buyback demands have had to close their doors and
go out of business. The major institutional paper buyers,
to protect themselves have found it necessary, in some
cases, to take over those companies to give themselves a
chance to get their lost money through the flood of
foreclosures. This transfer happens by negotiation and
agreement with much of the management team and staff
continuing to run the business and engineer a recovery
during this rough patch of sub-prime mortgage originations.
The days in the Sub-Prime Mortgage Business with Lower
Credit Scores, high Loan To Values, Interest Only, Stated
Income on Fixed Income Borrowers, Option ARMS, and other
high risk products may have seen the last ray of sunshine
for a while. These programs are being locked away in a dark
place for another time and another hot market. Federal and
State governments are seeking more control of these types
of loan products, which can be hazardous to consumers.
Watch for more development in that area with hearings and
such.

A borrower can have some input in this loan scenario as it
happened in this case. If the loan documents and the entire
loan program is not totally understood then it may not be
the best deal for the family. The brutal use of the margin
which guarantees the increase needs to be scrutinized
closely. A borrower needs to take a moment and see what
those payment increases will mean to the family budget if
every thing does not turn out as the "peachy keen" picture
that may have been painted. On 2/28 ARMs caution is the
word. Option ARMs can be a challenge as well. Regardless of
the mortgage product, borrowers need to demand explanations
for every detail and possibility. The borrower is betting
all their chips in this case and the house has the
advantage. A borrower needs to even up the game and give
themselves a fair shot of making the mortgage work for
their budget. If the loan product appears looks "scary" it
probably is.

----------------------------------------------------
Dale Rogers is a bad credit mortgage expert who contrubutes
to the Broken Credit Blog website. Broken Credit Blog is a
free site online assisting the public with information on
credit repair, responsible mortgage lending, and
refinancing.
http://www.brokencredit.com
http://www.sellerhelpsbuyer.com

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