Okay. Here it is. My first stab at a blog!

What is the bubble everyone has been talking about? How did we get into this sub-prime mess? How can you avoid getting caught up in the middle of it?

Years ago, about the only way to get a mortgage loan, was to put down a twenty percent down payment and basically prove to a bank that you didn’t need to borrow the rest. Then they might loan it to you. Home ownership was relatively difficult to achieve at an early age.

Then along came federally and privately insured loans, and a general relaxing of mortgage loan guidelines. FHA and VA loans are not made by the government, but rather are government insured loans. A borrower could, under a FHA loan program, put down as little as three percent. Qualified veterans could get one hundred percent financing. With the advent of private mortgage insurance (PMI), borrowers could pay a small monthly premium to insure the difference between the down payment they had (e.g. 5%) and the previously required twenty percent. Qualified borrowers could then finance more than eighty percent of the purchase price, or appraised value. Newer guidelines allow buyer’s down payment funds and or closing costs to come from the seller, as a gift from a family member, or as part of an approved assistance program.

Previously stringent mortgage lending guidelines requiring certain debt to income ratios, employment and credit history, and funds needed to close also became more relaxed and flexible. Mortgage brokers, once a rarity, popped up in business park and street corners everywhere. The trend for mortgage loan qualification to become easier and easier continued. Until now when we actually have people with insufficient income, erratic employment history, limited or no funds of their own, buying a house. To cap it all these borrowers in many cases, by virtue of a low credit score, have proven to the world that they don’t do well at paying their bills!

I am all for the American Dream. I am totally in favor of opening the door to the opportunity of home ownership for as many people as possible. But the truth is, the door has opened too wide. Some people, who arguably shouldn’t be buying shoes at this time, are being encouraged by a hungry lending community, to stretch their resources and make a huge investment and commitment, before they are truly ready and able.

Okay, where does the bubble thing come in? We have an unprecedented number of home owners as previously described that are stretched to the maximum. They have often used every penny they have, and then some, just to get to the closing table. Never mind any unforeseen moving or move in expenses. The problem is, that life happens. Someone gets sick and is off work for a while, worse they get laid off. Or, gas prices go up. Utility bills spike. The car breaks down. You get the picture. One or more of life’s little tests comes along and they have nothing to fall back on. Often during the first year of home ownership these borrowers find themselves in trouble. The property may finish up in foreclosure. Now imagine this scenario playing out all over the country. This would initiate the bursting of the so called bubble.

Predatory lending practices are also largely responsible for the so called sub prime mess. Sub prime loans are typically made to those buyers who do not readily qualify for conforming loans. The lenders who make sub prime loans know these loans are riskier than their conforming counterparts. Therefore, they will typically charge a higher interest rate. Nothing wrong with that. Where the problem comes in is often at the point of origin. Literally, a less than scrupulous mortgage broker (or loan originator). Now I want to be careful not to tar all mortgage brokers with the same brush. There are plenty of them out there providing a fine service for fair and reasonable fees. Lets focus on the others for now. Originators will typically charge a loan origination fee to "originate" the loan. Mortgage brokers determine their own fees. Often the origination fee will be around one percent of the loan amount. They may well charge a processing fee to help cover the costs they incur while going through the approval process. These will vary but I’ve seen them in the $200 - $300 range mostly. In a case where a borrower qualifies for financing, but is less able to pay these fees at the closing table, RESPA (the Real Estate Settlement Procedures Act) allows the originator to receive a fee from the lender known as a yield spread premium. Borrowers should be aware that they are going to pay an elevated interest rate when the mortgage broker receives such a payment from the lender. A sure sign of predatory lending is when a borrower is charged a substantial origination fee, plus a processing fee, and then the originator still receives a yield spread premium.

Now here’s the kicker. In order to get in to a house, the buyer has paid over the asking price, having the seller assist substantially with down payment and closing costs. So the buyer, now a home owner, has negative equity. He owes more than the house is worth! He has quite possibly got an ARM (adjustable rate mortgage) with a prepayment penalty. Which means his house payment may well increase substantially in the not too distant future. And, if he has to sell within the first few years of ownership, he may well have to pay the lender a substantial penalty. So the likelihood is for this fairly typical home buyer, when life happens, so might a foreclosure!

If you are a buyer now, or will be in the future, keep in mind that a REALTOR® actually has an agency relationship with you. Put more plainly the REALTOR® represents you. The lender or loan originator does not. They must work within certain guidelines, but have no obligation to give you the best rate or charge you the lowest fees. Typically they are going to get what they can. A well trained real estate practitioner knows the ropes when it comes to financing and can guide you through the entire process. Our agents have saved many buyers (and sellers) thousands of dollars. The sad part is that very few un-represented buyers will ever realize how much the unscrupulous originator has cost them. Again I emphasize that there are far more legitimate lenders out there than there are predators. You just have to be able to get inside the numbers to be able to distinguish them.

The bottom line is, tread carefully when it comes to mortgage financing. If you are not an expert, hire one. Work with a REALTOR® whenever possible. Customarily sellers pay the brokerage fee or commission, so it is not an out of pocket expense for the buyer. All Gammon Realty agents are licensed in the state of Indiana and are members of the National Association of REALTORS® (they are all REALTORS®). We will work diligently to assist any potential home buyer achieve the American Dream. But we will not encourage anyone to bite off more than they can chew.