Foreclosure Epidemic-Bad As It Seems?

Is The "Foreclosure Epidemic" as Bad as It Seems?

I'm sure that you have heard that foreclosures have increased.
The national and local media publicize the statistics that defaults
are up from last year on a month-to-month comparison.

The primary segment of the mortgage business that has exper-
ienced the biggest problem is the "sub-prime" loans.

When you consider the spectrum of lending, the most qualified
borrowers who seek mainstream lending products are classified
in the "A" category.

Qualified borrowers who seek less mainstream products, or who
need to obtain loans that allow them to borrow as much as 95%
to 100% of the purchase price are commonly classified in the"A-"
category.

When you categorize borrowers who have diminished credit
scores, who need loans approaching 100% of the purchase
price, and who may have difficulty documenting their income
and assets, they fall into the "B" and "C" classifications.
This is the category that is commonly called "sub-prime".

Over the past few years, the lenders and investors who purchase
loans have been much more liberal in their willingness to approve
loans in the "sub-prime" group. They were willing to accept
lower credit scores than normal; they were willing to accept
borrowers who merely stated their income without asking the
borrowers to prove it; they were willing to accept borrowers who
did not have much in the way of provable assets for downpayment,
closing costs, and cash reserves.

The media and legislators are making headlines out of the fact
that foreclosures have increased. There are some calls for more
legislation to protect borrowers from potentially losing their homes.
They suggest that all the defaults may be a result of
predatory mortgage practices and bad faith on the part of the
lenders to put people in this position.

The fact that lenders have been more permissive in the approval
process in the recent past has been a very good thing for many
people.

The appreciation of home values can be directly tied to the fact
that more borrowers had been able to qualify and that increased
demand kept prices high. The slowdown in property appreciation
and lenders tightening their underwriting practices have been
occurring at the same time.

The bigger point that I want to make is that there are many
people who want the American Dream of home ownership. If
we adhered to the old paradigm of loan approvals, we would
expect every loan to be fully documented, for borrowers to
have 20% cash down payment, and to have strong credit
histories with only the occasional blemish on their credit reports.

This old underwriting standard would eliminate many borrowers
from ever having a chance at home ownership. Because the
lending industry was creative in the development of new mort-
gage products and felt comfortable to be more liberal in their
qualifying (especially when they thought that property values
were increasing), many people were able to move from being
renters to homeowners.

Once they became homeowners, they have an opportunity for
any appreciation in property values to start adding to their
equity and to their net worth. They are no longer on the outside
looking in.

One statistic I heard recently was that about 13% of the sub-
prime borrowers were facing default and foreclosure. As bad
as that is for those borrowers, it still means that 87% of these
"lesser" qualified borrowers were still maintaining their payments
and still having the opportunity to build equity over time.

Now, please don't misunderstand me. I do not want to see
anyone lose their home to foreclosure. I especially feel bad for
borrowers who were not well-advised by their loan originator as
to potential risks for certain loan products that may not have
been a suitable fit for them. (You know that I have railed against
those less-than-scrupulous lenders who see borrowers
as dollar signs, and not as real people that deserve respect and
suitable advice.)

I don't think, however, that the system is broken when a certain
percentage of homeowners don't succeed in keeping their homes.
I don't think there is any benefit for legislators to create more laws
to protect against this spike in the number of foreclosures. Market
forces will be able to adapt to this much more efficiently and effectively.

Lenders will cut back on their approval process (like they are
now doing). They will insist on higher credit scores. They
will insist on the borrowers proving their income and their
assets to show that they providing accurate information for the
lender to make their decision. There will be fewer "unqualified"
borrowers obtaining home loans and once these new standards
are in place, there will be fewer foreclosures going forward.

I think it is important for us to realize that more people have
benefited from the opportunity to buy homes, to provide a more
stable home environment for their families, to realize the benefits
of the tax law for interest and property tax payments
(instead of paying rent and buying the landlord's property for
the landlord's benefit) and to have the pride of ownership that
comes with all of that.

The pendulum swung too far to the side of laxity in under-
writing and is now correcting itself by adhering to stricter
standards. The system works, despite some rough patches
at times.