97% Mortgages are 100% Insane

I am not sure there was ever any excuse for considering a 97% loan-to-value mortgage as "sensible" or "responsible."  After all, even without a drop in the market, the buyer is likely underwater on day one (net of real estate commissions).  Perhaps for someone who is very wealthy, whose income is an order of magnitude or two higher than the payments, this might be justfiable, but in fact these loans tend to get targeted at the most marginal of buyers.

But how can this possibly make sense when just 5 years ago the financial markets collapsed in large part due to these risky mortgages?  Quasi-public, now fully public guarantors Fannie and Freddie had to be bailed out by taxpayers with hundreds of billions of dollars.  There are still a non-trivial number of people trapped deep underwater in such mortgages, still facing foreclosure or trying to engineer a short sale after seeing the small bits of equity they invested swamped by a falling housing market.

But, here they go again:  Fannie and Freddie, now fully backed by the taxpayer, are ready to rush out and re-inflate a financial bubble by making what are effectively nothing-down loans:

Federal Housing Finance Agency Director Mel Watt has one heck of a sense of humor. How else to explain his choice of a Las Vegas casino as the venue for his Monday announcement that he’s revving up Fannie Mae and Freddie Mac to enable more risky mortgage loans? History says the joke will be on taxpayers when this federal gamble ends the same way previous ones did.

At his live appearance at Sin City’s Mandalay Bay, Mr. Watt told a crowd of mortgage bankers that “to increase access for creditworthy but lower-wealth borrowers,” his agency is working with Fan and Fred “to develop sensible and responsible guidelines for mortgages with loan-to-value ratios between 95 and 97%.”

The incredible part is that the Obama administration is justifying this based on all the people still underwater from the last time such loans were written.   The logic, if one can call it that, is to try to re-inflate the housing market now, and worry about the consequences -- never, I guess.  Politicians have an amazing capacity to mindlessly kick the can down the road, where short-term is the next morning's papers and unimaginably far in the distant future is after their next election.

  • mogden

    Top men have assured us that this is the best policy.

  • Brad Warbiany

    In all honesty, though, the FHA first-time buyer program had these loans all through the downturn. I bought my house in Dec 2010 using the FHA loan program. I'll admit that it's a risky proposition. While I had a stable job and good income, neither is guaranteed, and I bought the house with the full knowledge that a severe shock to my earning potential (such as a job loss) would result in losing my home. But at the same time, I had been analyzing the local housing market for years, and at least thought that loss of home value was low in risk at the time. (Consequently, I was right on this front. My home has appreciated by over $100K since then--I'm glad I bought rather than tried to save a 20% down payment while spending money on rent, as I have that equity in the house already now).

    Now, at the time, lending standards were still tight enough that these weren't easily obtainable for the "most marginal of buyers", as credit score and income requirements were high (and they were full doc loans).

    But the rationale of a first-time buyer program is that you find people who are still relatively young, early in their careers, and assume that the ability to save what's needed for a 20% down payment may be very difficult to achieve -- especially if prices rise. Now, you can make the argument that homeownership isn't quite the panacea that government makes it out to be, but I think that in general when you don't have a secondary mortgage market trying to hide risk with bundling for the ratings agencies, counterparty CDS that will blow up, etc, it's a lot less of a risk than it was with what was going on in the mid-2000s.

  • Mike Powers

    "how can this possibly make sense when just 5 years ago the financial
    markets collapsed in large part due to these risky mortgages?"

    These mortgages are only risky if the mortgage writer (and underwriter) take on risky clients. Someone who, e.g., works for Google is unlikely to have trouble repaying a mortgage.

    But when you have government policy that FMA Shall Back Any Mortgage, and you have regulators who are specifically instructed to underestimate mortgage risk, then there's a lot more incentive to take on risky clients.

  • joshv

    Well, the coming 97% income tax on the one percent will pay for 97% loan forgiveness for the masses.

  • stevewfromford

    The interesting thing to me is that Republicans are correct on almost all issues and should take the lead while Democrats actually realize that the vast majority of citizens are not qualified to vote and need to be led. Bad combo. Republicans should lead but Democrats are far better at getting the sheeple to hire them to lead.

  • skhpcola

    "Top men" always requires an exclamation point directly following. It's, like, a rule or something.

  • skhpcola

    Nah, you could confiscate 100% of the wealth of the 1% and it wouldn't pay for all of that in the first year. In the second year, you'd be taxing the former middle class, because the previous 1% with real wealth would be expatriots.

  • Matthew Slyfield

    "Perhaps for someone who is very wealthy, whose income is an order of
    magnitude or two higher than the payments, this might be justfiable"

    No, the person for whom such mortgages are sensible is the professional house flipper.

  • Daublin

    The problem is not that if you lose your income you will lose your home. That is true of any mortgage: your house is the collatoral for the loan. From the buyer's perspective, this isn't a "problem" at all. It's a good thing. If you lose your job, then it's a godsend that you have a way to step away from the now-hopeless mortgage.

    The big problem is for the bank, and for everyone else who relies on that bank. If the mortgage is underwater, then the house isn't enough of a collatoral to pay off the outstanding loan. The bank just has to eat those losses and make them up somewhere else.

    I know nobody "likes" banks, but without healthy banks, but it's still wrong to gamble with their money like that. It makes a mockery of the system. It's not a law of physics that the system will keep going under such circumstances. It will only keep going if the vast majority of people pay back their debts.

  • ColoComment

    It's not only that a higher-risk borrower can OBTAIN a 97% mortgage loan, but also that he's encouraged to purchase the MAXIMUM house obtainable with that loan.

    Whatever happened to "living beneath" your means a/k/a buying a somewhat lesser house than you can comfortably afford?

    Brad, who bought a house that he claims has appreciated by over $100k since purchase, how is that any different from buying in the stock market on 97% margin (which Reg T won't permit, BTW, as too risky) & trusting that your investment will inevitably appreciate? It's nice that its market value has increased; it could have as easily gone the other way....

    There's a reason why traditional (old style) mortgage loans required a 20% down. It's called being financially prudent.

  • Brad Warbiany

    It's also a reason why there was for a long time a vibrant mortgage market supplying the second 20%, and why any lender who gives you a loan at >80% LTV makes you pay mortgage insurance. That PMI (which came out of my pocket, not the banks, even though the bank is the beneficiary) is what protects the banks if my gamble--and yes, it's a gamble, that I won't lose my job--goes bad.

    And yes, the claim of increased value is real. FHA loans don't allow excuse you from PMI unless you've owned the house over 5 years *AND* you've paid down the loan to the original 80% LTV value--they don't allow you to factor appreciation in to removing PMI. I had to refinance to get rid of the PMI because the house had appreciated enough that I was now below 80% LTV, as evidenced by comps and appraisals.

  • Brad Warbiany

    As I pointed out above, that's the reason for PMI. Paying PMI comes out of my (the borrower's) pocket, but it exists to protect the lender in case they have to foreclose and the collateral doesn't cover the loan balance.

  • Nehemiah

    Hey, I need to sell my house in the next 2-3 years and I'm still recovering from the last crash. Kind of like Warren being okay with a judge over turning the people on so-called same sex marriage because it fits a personal objective. I'm okay with the Fed, F&F inflating the home asset market because it fits my personal objective. Once I'm out I'll rant and rave about leaving the free market seek its own level, but what the heck I gotta eat too. As I'm sure Warren will rant and rave about judicial activism now that he got an activist decision on his issue.

  • Guy Skoy

    These 97%/96.5% programs are heavily promoted because they actually are extremely lucrative to Fannie/Freddie (duh)

    97% LTV requires PMI of 35% coverage, so it's becomes a 65% LTV loan, which is SAFER to the lender that a typical 80% LTV Conventional that requires no PMI. The borrower pays 1.05%-1.48% in Monthly Mortgage Premium depending on creditworthiness for that 17% non-equity slice which has an effective rate of approximately 9-13%. Since the borrowing costs for the Insurers/FNMA are near zero it's a no-brainer for them to funnel the suckers into the program.

    FHA is even MORE expensive. The borrower has to pay a 1.5% upfront fee AND 1.35% PMI rate AND the same interest rate regardless of creditworthiness. Thus, FHA is a far worse deal cost-wise at the 349K Limit almost all creditworthiness EXCEPT for those that have FICO scores below 660. Thus, adverse selection dictates FHA loans are almost entirely made up of those with poor credit and zero financial savvy. In a way Home Finance = Health Finance, which is completely depressing.

  • ColoComment
  • joshv

    You don't understand, they are both 97% - they are equal, so they cancel out 😉

  • Lawyer

    Every now and then they are at least rational, if not sensible. Certain markets with fairly bizarre market conditions--I happen to live and practice in one of them, so I know of what I speak--lead to circumstances where rents are extraordinarily high relative to purchase prices. It's occasionally possible for someone to buy a house and have their payments end up being the same (or less than) their current rent payments, especially when you take into account the mortgage interest deduction. The high rents make it hard to accumulate a good down payment, but there are many people who have provably been paying those rents for a period of many years and who can continue to do so, in all likelihood, for a while longer.

    As you correctly note, such folks are functionally underwater for at least the first couple of years, at least in one sense: although they don't actually owe more than the house is worth so long as they remain, the normal real estate commissions will put them underwater when they leave.

    So it's a gamble, of course. Precisely, it's a two year gamble: A standard 30 year fixed rate mortgage at 5% will pay about three percent pf principal off, after the first two years, at which case you could theoretically exit on a 5% commission and be fine.