Chuck Ponzi March 10th, 2007

The Los Angeles Times reports that some borrowers will soon be reeling from their payments that will soon adjust, and because loan standards have tightened, they are finding out that they can no longer qualify for lending.

I have, for some time now, predicted that just this sort of thing would happen.  You see, many mortage brokers put customers into loans they knew the customer would not be able to keep.  This was partly to extract higher commissions, and partly because they believed that when the rate adjusted, the borrower would be coming back to them.  No such luck.  Once the impossibly low lending standards came back to bite investors, they withdrew their funding and marginal programs were axed (for example Countrywide has now cut out 100% ARMs financing completely and replaced them with fixed-rate products.)

This is where the endgame becomes visible.  Take a read from the LA Times’ article:

ShaRon Lewis is facing a 50% hike in the payment on her adjustable-rate mortgage next month.

This week, she discovered she can’t qualify for a new loan with payments that she could afford.

And although she’s willing to sell the West Hills home she’s owned for two years, she has been told it won’t fetch what she paid for it. “I have to laugh to keep from bawling,” the 30-something Lewis said.

Housing heads (the unclean bubble non believers) used to say that these people would either simply refinance into another product - now not available, or just pay the higher prices in an effort to hold onto their homes.  I’m not sure they’ve seen the light.  Denial can be a powerful force.  In ShaRon’s case, that’s clearly not possible:

Two years ago, when Lewis was looking for a larger house, she easily prequalified for a nearly $700,000 house even though she had no down payment and a spotty credit record. It helped that she was willing to take on two loans to cover 100% of the cost.

“I wasn’t completely aware of the mortgage terms but I knew it would adjust in two years,” she said. “Properties were still going up at the time, so I felt it might be a good time for me to buy.”

But almost as soon as she and her family moved in, Southern California’s housing market began to cool off, giving Lewis a chill.

“I knew I was in trouble the very next month, and it’s been that way since,” she said. Since mid-2005, home values in her neighborhood have flattened.

Although she has shopped around for a new loan, she can’t find one that would enable her to keep her monthly payment at its current level, around $4,000. And because her house hasn’t risen in value, she can’t use equity as a down payment on a refinancing.

Starting next month, her payment is slated to jump to more than $6,000, an amount she says she won’t be able to pay.

When this house goes back to the bank, banks typically can only recover 70% of the original loan value (in good times).  In bad times, it may be less than that.  These kinds of problems start to pile up and can wash banks out to sea.  Those of you not familiar with the S&L crisis during the last mini-bubble in SoCal, you can read about it here.  Pay close attention to historical references to “deregulation” and compare them to the democratization of credit.  It’s the exact same story told in a different way.

In the LA Times article, a local broker offers his opinion:

“You’re back to real credit standards,” said Scott Simon, a mortgage expert and money manager at Pacific Investment Management Co. in Newport Beach.

I say I’ll believe it when I see it.  Although, I have heard a lot less from Best Funding and Fernando Perez on the radio lately…

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