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Searching with Credentials
By Paul Petillo
I am reminded during this time of year of March 2000. For those of you who may be unaware of what that chronological turning point means, the similarities between then and now are reflected in the current housing market. That month seven years ago signaled the end of enthusiasm for equities, a moment when dreams were dashed across a wide spectrum of economic classes.
You probably know someone who had his or her retirement plans spoiled by the seemingly overnight although it took a full three years to hit the bottom, demise of the stock market. Enthusiasm ran very high up until the tenth day of that fateful month.
To reinvigorate the markets, short-term interest rates were cut and mortgage rates followed. Cheap money led to increased borrowing with housing as collateral. Huge amounts of cash was siphoned off and redistributed back into equities. While stocks have rebounded, the source of much of that financing has dried up as the pendulum that swung so far in one direction has reversed itself.
Like equities, the unwinding of the housing market will take time to reach its bottom. Folks who bought homes with those teaser rates I mentioned in part one of this series are among the first casualties. Following them, a near-future group is likely to cave under the adjustment of mortgages interest rates as the resetting process begins again next year and could last until 2010.
Unlike the stock market which requires only a signal to sell to begin the process of removing a bad decision from one's portfolio, the losses from bad mortgage decisions are not that easy to unload.
The bewildering behavioral reaction that often manifests itself in the stock market, buying on an equity¹s increase and selling as the price declines, has spilled over into housing.
The differences between the two markets have been a shock for some homeowners. When a homeowner wishes to sell their property, two things must be in place: buyers willing to pay the price and lenders willing to take the risk. What many sellers in the current market have found is the stark absence of either or both of these two components.
With a lack of buyers and a market place with a growing contingent of sellers, the market has begun to sag in a high profile way. Inventories are rising and prices are falling. If you only read the headlines, this has the makings of a real disaster.
But not for everyone. While the conversation has focused on the seller, often the sub-prime borrower, the borrower with good credit, a stable income and positive earnings prospects, often referred to in the lending industry as "prime", this new landscape offers numerous advantages.
Even with mortgage rates hitting a low of 5.75% this past week for the well qualified buyer (last year rates were heading towards 6.50%), buyers have not swarmed the markets as many hoped they would.
Removing the sub-prime borrower from any future mortgage purchases was easy. High profile lenders, some of who have found the protection of bankruptcy their only way to survive, have created an unwelcome hysteria among all potential buyers. Simply requiring documentation, good credit histories and a down payment has taken many qualified borrowers out of the housing market.
That's regrettable. Like the stock market, depressed housing prices do not often attract buyers. The reevaluation of the lending process is the focus of this second part of our look at housing.
Prime borrowers are faced with the challenge of not only assuring the bank that their credit histories are good, their jobs solid, and in some cases involving refinancing, that their property has retained value. New homebuyers will not even garner the attention of a broker unless they have pre-qualified with a reputable lending institution. In days gone by, according to several brokers I have spoken with, the qualifying may have taken place once the potential buyer selected a broker. Given a general set of income and job history questions, brokers would have made a determination of which home a likely buyer could afford. No more. Pre-qualification usually takes place with the lender. For the prime buyer, many of the much talked about types of mortgages are still available. These borrowers can still take advantage of creative lending by using adjustable rates (which have been falling as Treasury bond yields, which these rates are tied to, have declined), interest only or even traditional fixed rate mortgage lasting 15, 20 or 30 years. Prime buyers usually come to the market with more than the ability to pay. Because many have credit scores issued by FICO higher than 720, lenders are offering much better rates to stay competitive. Be prepared to put money down, at least 5% but usually no more that 10%, no matter what your qualifications. The second category of buyer, referred to as Alt-A borrowers come to the process with slightly lower credit scores compared to prime (620 to 700). This group of buyers can improve their chances at the best mortgage with some credit repair. Improving your credit score usually takes six months to a year and can save you thousands of dollars in interest payments over the course of the loan. Down payments are now required for this group as lenders continue to clamp down on the risk they are willing to take. Sub-prime borrowers are not without options however. The Federal Housing Authority or FHA is still offering good terms for this group despite their lower credit scores (under 620). The offer competitive interest rates with a 3% down payment. The caveat is mortgage insurance, a premium that can only be cancelled once the house has appreciated to 20% above the loan. Unfortunately, it all boils down to the quality of your credit score and has become the single best way to improve not only your qualification for a loan but the amount of potential savings. Next up in our series is a look at how the mortgage meltdown might spill over into other markets.
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