I am baffled. I know there are ARM’s, and that lending companies sell their mortgages to others to collect payments and so that their books look excellent at the end of the year. I just don’t know a few equipment:
1 – if the Fed has cut interest rates, wouldn’t that rate cut trickle down to the mortgage industry? If so, why would mortgage interest rates increase?
2 – Were people knowledgeable of the “ballooning” that was going to happen?
3 – Why did lending institutions issue mortgages at adujustable rates knowing that they were going to increase out of peoples budgets?
Any explanation of what is happening would be appreciated. Thank you!
1. Sometimes fed rate cuts will lower market mortgage rates, but they are not directly linked. Other factors affect mortgage interest rates.
2. Yes, they were knowledgeable but some ignored it.
3. Lenders offered them and people took them assuming housing prices would keep spiraling up and they could re-finance their way out of the ARMs.
1. Depends on where people choose to place their money. The Fed rate cut is for small term money, not mortgages.
2. People were knowledgeable. They don’t care about what is going to happen in 5 or 7 years. Disclosures are signed at application & at closing.
3. ARMs are excellent for some people. There are benefits but you need to know how they work. There are disclosures & a excellent loan officer will clarify it. People want what they want & they want it right now. They do not want to reckon of the consequences down the road. They had to have that house that was too expensive right now.
1 – if the Fed has cut interest rates, wouldn’t that rate cut trickle down to the mortgage
A: US interest rates are determined by the US Bond market.
Many banks are charging a premium because they are concerned about default risk.
Look at 10 year Treasury prices (benchmark for most consumer rates).
Compare that to the LIBOR rate (many mortgages tied to LIBOR).
LIBOR = London Interbank Offer Rate. Complicated. Basically it’s an agreement with all U.S. charter banks under UK law.
2 – Were people knowledgeable of the “ballooning” that was going to happen?
Yes, I have been saying this since summer 2005. Most people, and lenders weren’t paying attention.
3 – Why did lending institutions issue mortgages at flexible rates knowing that they were going to increase out of peoples budgets?
Greed. Simple money. Lenders resold loans to Wall Road and to banks and governments world wide to reduce their loan risk.
How did we get in this mess?
1. Former HUD director, Henry Cisneros under the previous administration strongly advocated that we should have home loans to more people, including people who could not meet the deprivation of them by current standards.
2. The FED kept rates at historical lows which made this job simple.
3. Real estate prices soared with these low rates and money that went out of the stock market in 2000-2002.
4. By 2004, the FED started raising rates due to their nutty thought on inflation fears. Their inflation thoughts was and is incorrect. The FED mistakenly saw inflation but failed to attribute the cause was obsessed by higher commodity prices (oil, corn, wheat, steel, milk, etc). The huge drive in oil prices was and is due to demand for oil by China and India’s explosive growth. These FED rate hikes continued until 2006.
5. The FED Funds rates went from 1.00% to 5.25% in two years – a 425% increase in rates. This killed the subprime market and hit everyone with an flexible rate mortgage, no money down mortgage, and interest only mortgage.
6. Greedy banks and other lenders were lax on their credit standards and gave out loans to anyone without any qualifications. This was a mistake.
7. The higher rates triggered loans to go into default as many people could no longer meet the deprivation of their house payment. They should not have got the loan in the first place.
8. Some alleged “predatory lending” may be a slight factor. It is ridicules to reckon that someone could buy a $500k home who makes $18k a year, and never expect rates to rise and never expect home prices to fall.
9. Creditors made their own problem worse by tightening credit standard in spring/summer 2007. The tighter standards increased defaults. As defaults increase the problem perpetuates on itself. Mortgage insurers are to a degree stuck with huge losses as they guaranteed payment on these higher risk loans. These companies are 1 step from bankruptcy right now (ABK, MBI, PMI,. MTG, RDN).
10. Banks and other lenders started taking huge losses as they write off part of their terrible loans. This problem is huge. Banks and lenders will not admit how terrible their selection really is. The result is the wave of selling in the stock market.
Future issue?
Terrible credit card portfolios. if people can’t pay their mortgage, what makes anyone reckon they can pay their credit card?
Proof Note: Amer Express (AXP), Capital One (COF) reported large Q4 (2007) losses due to credit card defaults. Were just getting started with this issue.