“Oops:” How Mortgage Lending became a Crisis
Sarah
10 December 2007
General Information, Market News
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Chances are, you have heard the phrase “mortgage crisis” more than a handful of times in the past few months.
If you are dipping your toes in the first-time mortgage pool, it is important to assess your own finances before relying on lending companies to guide you.
As this crisis has shown, you have to take responsibility for your own actions, as a homeowner and an investor, so that others will not take advantage of your foray into home ownership.
How it Happened
Like any good, old-fashioned financial crisis, the mortgage lending crunch began with speculation and risk–in this case, lenders issued high-interest loans to high-risk borrowers, or people who would normally be unable to afford to own a home. In the past, high-risk borrowers were far less likely to receive a loan than the financially stable. The high interest rates associated with this high-risk lending motivated some lenders to seek out high-risk borrowers, with the expectation of a high-interest return. While the housing market was strong, lenders saw no reason why they could lose money on what they thought was a foolproof asset. This risk-based pricing is common with major investments, but only gets complicated when the “risk” is not only based on the economy, but on the responsibility of the individual homeowner.
Enter: Middleman
Between 1997 and 2006, American home prices increased by 124%, and many people purchased homes they could not afford. Interest rates rose steadily with real estate prices, and new homeowners could not afford their monthly payments when their once-low interest rates rose astronomically. Once the real estate bubble burst, some homeowners were left with a depreciating investment and an increasing monthly payment. Foreclosures ensued.
Bank lenders then used their mortgage-based equity to attract bigger investors interested in mortgage-backed securities. The risk was passed onto these investors, who, essentially, had invested in an investment of an investment. These investors could fire-sale of homes for well below market value if they ever needed to recoup money lost on failed mortgage payments. While the investors lost money, homeowners lost both the financial and personal investments tied to their home mortgage. Since this risk has been passed onto bigger investors, a chain of careless lending left the homeowner homeless, and the lender with a pile of foreclosed properties.
Cleaning Up the Mess
Counselors are dealing with victims of foreclosure in order to educate them about risky, misleading, and predatory lending. Some banks are reevaluating their current mortgages, switching many adjustable-rate mortgages to a manageable fixed-rate mortgage. While many homeowners bought into a home that they couldn’t afford, there are countless others who are getting a second chance for financial stability. While risk-based lending is common on a market scale, it is much harder to judge who can and cannot pay a mortgage. The error was unmistakably human, and it is the people—not the investment companies—who have paid the price. Oops.
Know How it Works
As a rule of thumb, you can usually afford a home that costs two-and-a-half times your yearly salary. This does not account for maintenance or property tax associated with the home, nor does it factor in any of your own recurring debt.
Taking these factors into account, you need to find out how much banks are willing to lend to you. For this, you should seek prequalification for a loan from a few different lenders. Your best bet is working with Buy Owner’s mortgage partner, Guaranteed Rate, which will work hard to get you the best rate possible.
Prequalification is not an official loan approval, but it will give you a better idea of what the lender will grant you, and what the best interest rate you can get is. The preapproval, then, will tell you exactly how much you can mortgage, based on an assessment of your credit and finances. It is important to remember that the maximum that the lender will offer you is not necessarily the maximum that you can afford. While the lender may calculate that you can afford $3,000 a month, that may not include the cost of your lifestyle, other needs or special debt. The most important factor in finding a mortgage is to take responsibility for what you can afford, and not just the maximum of what a lender will provide.
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