Sunday, May 08, 2005

Alarming Levels Of "Liar Loans"

According to its profile "Saxon Capital, Inc. originates, purchases and services non-conforming residential mortgage loans, including sub-prime residential mortgage loans." While not a huge firm, it is interesting that 23% of the loans made this past quarter are stated income, or liar loans. The cash-out refinancing activity is revving up again too. Thanks to the reader who posted the link. From the press release:

Summary by
Income
Documentation
----------------
Full
documentation 72.91%
Limited
documentation 4.08%
Stated income 23.02%

Summary by
Borrower
Purpose
--------------
Cash-out
refinance 69.50%
Purchase 22.34%
Rate or term 8.15%

30 Comments:

At 5:20 PM, Blogger John Law said...

oh boy, liar loans.

 
At 5:25 PM, Blogger John Law said...

boy, they'll loan to everyone, and looks like they want to spread some risk. or they see new ways to make money:

Fund lets retail investors bet on CDS

By Ivar Simensen in London
Published: May 5 2005 19:00 | Last updated: May 5 2005 19:00

The first credit derivatives fund aimed at retail investors has been launched, giving individual investors the chance to gain exposure to the potential rewards – and risks – of an investment product that is becoming a core part of markets.

http://news.ft.com/cms/s/056de904-bd8e-11d9-87aa-00000e2511c8.html

 
At 5:55 PM, Anonymous bob r said...

This might be somewhat off the subject, but I couldn't resist sharing this with the group:

Real Estate: Can You
Handle the Truth?
May 8, 2005

It'll end in tears.

When I was growing up, that was one of my mother's favorite battle cries, as she stormed into the room to break up yet another fight between my brothers and me. Recently, that phrase popped into my mind again -- as I was thinking about today's overheated housing market.

We have entered the silly part of the real-estate cycle, where folks are saying things and doing things that are utterly ridiculous. Don't want your housing foray to end in tears? My advice: Never forget these seven harsh truths.

• 1. A house is an undiversified bet on a single piece of property.


Even in today's booming real-estate market, making big money isn't guaranteed. Sure, we have all heard about the hefty gains in places like California, Rhode Island and Washington, D.C., where home prices have more than doubled over the past five years, according to home-finance corporation Freddie Mac.

But not every market is like these three. Indeed, homeowners in Alabama, Iowa, Indiana, Mississippi, North Carolina, Nebraska, Ohio, Tennessee and Utah have eked out cumulative gains of less than 25% over the past five years.

• 2. Real estate doesn't always go up.


When the current real-estate frenzy dies, the downturn probably won't look like the 2000-2002 stock-market rout, with its terrifying plunge in share prices. Instead, the housing market will likely see moderate price declines accompanied by a sharp slowdown in sales, as homeowners balk at selling their properties for less than what they deem fair.

To get a sense of how much prices might drop, check out the early 1990s performance of two of today's hotter markets, Boston and Los Angeles. According to Freddie Mac, prices in the greater Boston area sank 10% during the 30 months through mid-1992, while Los Angeles was hit with a grueling six-year 21% decline.

• 3. Leverage bites when you get it wrong.


Homeowners often quip that the bank owns most of their house. This, of course, is nonsense. The bank has merely lent these folks money. Whether their property is 60%, 80% or even 95% mortgaged, they are still the owner and thus benefit from every $1 of price appreciation and suffer every $1 of loss.

Usually, that's reason to cheer. Suppose you buy a $300,000 house, putting down $60,000 and borrowing the other $240,000. If your home's value climbs 20% to $360,000, your home equity would double, from $60,000 to $120,000.

This leverage, however, can also work against you. Let's say you bought that $300,000 house in Los Angeles in the early 1990s, just before prices dropped 21%. Suddenly, your house is worth just $237,000 -- and your down payment has been wiped out.

What if you need to sell? With any luck, you will have whittled down a decent chunk of your loan balance with your regular monthly mortgage payments. Still, once you figure in the brokerage commission you will pay to sell, there is a chance you could leave the closing empty-handed.

• 4. A house is a long-term investment.


Because it costs so much to sell real estate and because the combination of leverage and a home-price decline can be so devastating, you shouldn't purchase a house unless you plan to stay put for at least five years and even longer if you are buying in one of this year's frothier markets.

Yet, today, stories abound of people buying properties with a view to unloading them in a matter of months. What can I say? A few years from now, we will look back and marvel at such foolishness.

• 5. The big money is in the rent.


Unlike today's housing "day traders," most successful long-term real-estate investors don't buy properties solely for price appreciation.

Instead, these investors are focused on the rental income they can collect and how that rent compares with each property's monthly mortgage payment, property taxes and other costs.

There's a lesson here for home buyers. The biggest reason to purchase a house is so you can, in effect, rent it to yourself. Indeed, the value of this "imputed rent" will likely be far greater than any gain you score from price appreciation.

The bottom line: When you buy a house, focus on finding a place that you will enjoy living in and where you can envisage staying put for a good long time -- and view any price appreciation as a bonus.

• 6. Home improvements aren't an investment.


Many homeowners think that remodeling the kitchen, adding a deck or replacing the roof somehow constitutes an investment. It just isn't so. In 2004, Remodeling magazine analyzed 18 home-improvement projects. In all 18 cases, the magazine found that homeowners were unlikely to recoup the full cost when they went to sell.

In other words, if you fix up your home and sell it a year later, you might recover 80 or 90 cents out of every $1 spent. And the longer you wait to sell, the less you will get back, because your home improvements will look increasingly shabby.

That doesn't mean you shouldn't fix up your home, especially if you will get a lot of pleasure from the resulting improvements. But think of these improvements as spending, not investing.

• 7. Mortgage debt has to be repaid.


These days, I hear stories about folks borrowing against their homes to take vacations and buy new cars.

Their justification: Whatever they borrow is less than their home's price appreciation, so they are still ahead of the game.

Eventually, however, all this mortgage debt will have to be repaid. But when? In many cases, homeowners plan to trade down when they reach retirement and use the proceeds to pay off their loan balance.

This plan may work. But keep in mind that trading down can involve unpleasant choices. To get your mortgage paid off while buying a comparable home, you may have to move to another state.

Alternatively, you could opt to purchase a smaller place in the same part of the country. Problem is, you will probably be inclined to buy in a better neighborhood or get a home with a better view. "I've had people downsize in size," says Charles Farrell, a financial consultant in Medina, Ohio. "But they don't downsize in price. The price is pretty comparable."

 
At 5:59 PM, Anonymous bob r said...

That's from the Wall Street Journal, by the way.

 
At 6:15 PM, Anonymous tearsacoming said...

Actually, prices in SoCal fell thru 1994-1995, not 1992. The years with the big foreclosure numbers were '93 and '94.

Also, prices didn't exactly ramp back up. The SoCal median price peak in '89-90 wasn't hit again until about '99. So a full decade to go nowhere. And this boom is far more bubbly. Not to mention, buyers back then weren't nearly as extended, nor did they take on ARMs to the same degree, and I/Os were practically unheard of...as were stated income loans.

 
At 6:27 PM, Blogger deb said...

The late '80s boom in CA ain't got nothin' on this one. This one is in a class all its own!

 
At 6:29 PM, Anonymous pennysaved said...

A friend of mine got a $250K "liar loan" last summer for an "investment" property that throws off negative cash flow. She has no assets (less than $5K in bank), doesn't own a home and makes less than $30K a year.

Her broker told her how much income she needed to "state" to get the loan. So she made up a number. She told me that she got the loan because she had a good credit score.

I find this whole notion of credit scores troubling. I grant you that my friend has a good credit score. But that's because she pays her credit card balances on time. To me, there's a big difference b/w paying off $50 a month on your $1,000 credit card balance and paying your phone/utility bills versus taking on a $250K loan on a negative-cash-flow "investment" property. I bet there's lots of people with good credit scores who don't have two nickels to rub together.

A year ago, my friend bought a used car because she told me she didn't want to go into debt by financing a new car. Yet she thought nothing of borrowing $250K to buy a money-losing piece of real estate. The difference? She knew the car would depreciate in value. Conversely, she's convinced that her property will dramatically increase in value. So she doesn't mind losing a few hundred a month to sustain it until her ship comes in.

 
At 7:04 PM, Anonymous bob r said...

And this boom is far more bubbly. Not to mention, buyers back then weren't nearly as extended, nor did they take on ARMs to the same degree, and I/Os were practically unheard of...as were stated income loans.

That's so true. Things today are way more out of control today. It's really astounding how complacent the powers-that-be are about the risk built into this market. I guess everybody's in denial (except for the people on this blog!)

 
At 7:45 PM, Anonymous Anonymous said...

Whats wrong with liar loans? The primary determinant in qualifying for these loans is credit score; with 660 the general, but not absolute cut off. Dont you believe in credit scoring? Does someone with a history of deliquency but ability to document income represent more or less risk than someone with a solid and responsible payment history(reflective in the higher score) but inability/unwillingness to document income?

 
At 7:58 PM, Blogger deb said...

I heard an ad on the radio for stated income loans for borrowers with a FICO as low as 475. This should end well.

 
At 8:06 PM, Anonymous Anonymous said...

Deb, are we supposed to feel sorry for someone with a 475 credit score who takes on a stated loan and ends up getting put out in 12-18 months. I am a landlord and pull credit scores for tenants. I would NEVER rent to someone with a 475 score. So if they manage to eek out the good life for a second or two, more power to them. But i certainly wont feel sorry for them.

 
At 8:08 PM, Blogger John Law said...

liar loans are bad because you should have income backing up your purchase.

 
At 8:12 PM, Blogger John Law said...

(I am a landlord and pull credit scores for tenants. I would NEVER rent to someone with a 475 score.)

do you check if they have a police record? that's what some are doing who've had bad experiences. one of my classmates told me that he learned you need to know who you want to rent to.

 
At 8:13 PM, Anonymous boulderbo said...

a fico of 475 would amount to a horrific credit history, but they are available to the public. we've talked about this over the past several days, but bob r and others are correct, these borrowers are betting on appreciation to bail them out and really have no options if the market turns. hate to be a stick in the mud, but i'm only in my mid 40's and i can't see anything but disaster ahead with just a mild adjustment to prices, let alone a drop that could happen if the yuan gets marked to market.

 
At 8:18 PM, Blogger John Law said...

I yahoo'd saxon.

SAX

13.3% dividend!!! holy moly. it's dropped 10 points from around 26 to 16. ouch.

http://finance.yahoo.com/q?s=SAX&d=t

 
At 8:32 PM, Blogger deb said...

I don't feel sorry for the guy with the 475 fico. I feel sorry for our society that we have stooped this low to try to prolong the good times. We will all suffer. Hopefully, those of us who know what's coming will be better prepared, but we will all suffer the consequences.

 
At 10:43 PM, Blogger Albert L Berriz said...

Nice bloggin'

Check out free cognition, I think you'll enjoy it.

 
At 10:56 PM, Anonymous theredqueen said...

What kind of financial Neverland do we live in when a person with a 475 FICO score is unqualified to rent a home but can get a no-down loan to buy that same home?

We have clearly gone through the looking glass---up is down, black is white. I am sitting on plenty of cash and could buy a home in my area mortgage-free. But I won't compete in bidding wars with buyers who were previously-bankrupt or bringing no cash to the table. Our economy right now is perverse, rewarding debtors and punishing savers and those who are prudent and responsible.

 
At 11:01 PM, Anonymous crimeariver said...

***

---Does someone with a history of deliquency but ability to document income represent more or less risk than someone with a solid and responsible payment history(reflective in the higher score) but inability/unwillingness to document income?----

Neither of your examples should be rewarded with bountiful credit.

Someone who has a history of not paying their bills should not be extended more credit regardless of their income.

And just because someone has a good credit score does not mean they can handle a giant mortgage. Big deal that someone can pay the minimum on their credit cards. Big deal that they can pay their cable bill on time. These are tiny numbers. The game changes considerably when you are talking about loading up with mortgage debt---particularly when the purchase in question (as in the above example) is throwing off negative cash flow.

It's like saying that someone who ran a profitable paper route is qualified to become CEO of Knight-Ridder.

 
At 5:13 AM, Anonymous Anonymous said...

folks, they've run out of suckas...indeed it will end in tears it always does and it will be a matter of time when it does end.

 
At 5:58 AM, Blogger Gasman said...

This whole discussion about FICO and stated oncome loans is very informing about this whole current issue. It goes right to the very word credit and what does it mean.

Credit is to receive present goods with the promise of payment from your future income. Some one must trust that you will pay from your future income. This is the whole basis of "traditional" lending.

Now the system has morphed to one of " asset backed" lending. No longer is trust required to make a loan because the asset backs the loan. So FICO scores become irrelevant. The problem is that this creates a circularity because the asset drives the loan and the loans drives the asset. And in the background it remains true that the loan must be repayed from future income. A day must come when the impossibility of reapayment is recognized.

In 19th century Britain the circularity of asset backed lending was explicity recognized and legally banned. Oh if only our masters had such wisdom.

 
At 7:24 AM, Anonymous walklikeanegyptian said...

&&&

(So FICO scores become irrelevant. The problem is that this creates a circularity because the asset drives the loan and the loans drives the asset.)

Think you've hit the nail on the head. As asset prices go up, lenders feel "safe" lending to what they would normally consider bad risks using the "rising" asset as collateral. The very act of lending drives the asset price even higher. And so on.

This is exactly how pyramid schemes work. Throughout history, there is no example of a perpetual pyramid scheme. They always fail. But they can go on for a very long time. The problem is, the longer they go on, the more people are sucked into the scheme and the greater the pain when the scheme falls apart.

 
At 7:24 AM, Anonymous Memphis said...

Whats wrong with liar loans? The primary determinant in qualifying for these loans is credit score; with 660 the general, but not absolute cut off. Dont you believe in credit scoring? Does someone with a history of deliquency but ability to document income represent more or less risk than someone with a solid and responsible payment history(reflective in the higher score) but inability/unwillingness to document income?

Credit scoring is a rear view mirror: this is how successful the candidate has been at juggling various debts in the past. You'd be amazed how many bankruptcy filers had absolutely sterling credit right up until the moment that the house of cards came down. Oh, and don't forget that no credit is terrible credit - no brownie points for those who pay cash; lots and lots for those who charge everything and keep revolving balances. Without a default on file, a borrower who is racking up simply horrific and effectively perpetual interest charges will generate some sort of credit scoring flag, but he's still likely to get that favorable interest rate loan ahead of the bankruptcy-stained borrower now living well within or below his means.

Credit scoring is a silly sham, and I'm guessing that pretty soon we'll come to a pass where the lenders assemble with torches and pitchforks to avenge themselves against those infernal credit rating agencies that brought them to such a sorry pass - what with raging inflation, decling incomes, and plummeting values on foreclosed realty. (Not like that will help the lenders' plight, but it's always nice to have a scapegoat.)

 
At 7:40 AM, Anonymous everyoneintothepool said...

---Now the system has morphed to one of " asset backed" lending. No longer is trust required to make a loan because the asset backs the loan.---

Asset-backed lending is fraught with peril, particularly when the assets in question have inflated dramatically in value.

Imagine if I went to a bank in 2000 and asked for a $1M loan. As collateral, I pledged my 5,000 shares of JDS Uniphase at $200/share. Obviously, no bank would accept those terms because they understand that stock prices are volatile.

Yet for some reason, everyone assumes that home prices always go up or stay flat. Tell that to a property owner in Bangkok, Shanghai, Tokyo, Buenos Aires, etc. History is replete with examples of real estate booms and busts.

My guess is that a big factor in driving this booms is not just the switch to asset-backed lending but also the ability of lenders to offload their risk by selling mortgages to MBS pools. Many banks/brokers are mortgage sellers, not mortgage holders.

 
At 8:45 AM, Anonymous Loren said...

Just to stir the pot, some of the "liar" loans may be refinances with the same company. I have a mortgage at BoA, and they gave me a streamlined refinance to keep me from going to a competitor. I didn't have to document anything to refinance.

 
At 10:01 AM, Anonymous Anonymous said...

If 19th century Britain banned circularity, then did 21st century Britain allow it? Supposedly Britain has a bigger housing bubble than the USA.

 
At 10:20 AM, Anonymous ringaroundtherosie said...

This whole scheme is like a game of musical chairs. But instead of removing one chair every time the music stops, another chair (and another participant) gets added. I guess the game can go on indefinitely under these circumstances, until there are no more chairs or participants available or until the chairs begin to get taken away.

 
At 10:20 AM, Anonymous Anonymous said...

Credit scoring is a silly sham, and I'm guessing that pretty soon we'll come to a pass where the lenders assemble with torches and pitchforks to avenge themselves against those infernal credit rating agencies that brought them to such a sorry pass"

Hang on a second, it's not the credit scoring companies that are making any of these loans. They don't even decide the loans. What they do is give a quantative analysis of a persons prior dealings with credit. So if you pay all your credit card bills, your car loan etc on time every month, you get a higher score then someone who pays late, or who has been bankrupt. I don't see how that's a "silly sham". Credit scores aren't predictions into the future, they're just a way to objectively view past behavior.

 
At 11:21 AM, Anonymous Memphis said...

Hang on a second, it's not the credit scoring companies that are making any of these loans. They don't even decide the loans.

Take it one step further - they probably don't even decide their own scoring system. If a large lender is unhappy with Experian's scoring system, Equifax will have an excellent opportunity to "earn their business". (Which is what I mean about scapegoating.)

What they do is give a quantative analysis of a persons prior dealings with credit. So if you pay all your credit card bills, your car loan etc on time every month, you get a higher score then someone who pays late, or who has been bankrupt. I don't see how that's a "silly sham". Credit scores aren't predictions into the future, they're just a way to objectively view past behavior.

The system is a silly sham because if you keep your eyes locked on the rear view mirror...damn, you just hit another deer there. Oops.

What's the phrase, "Moral Hazard"? You've got it right, creditors don't worry about predicting into the future. So long as you've got an eager borrower who has consistently proven that he's more concerned about his FICO than his long term prospects of retiring on a diet of Alpo - and so long as the assets backing his loan keep going up-up-up, why worry that much about three, four years down the line?

I suspect that after the credit bubble bursts, the next generation of lenders will be positively obsessive about that whole "future prediction" business, and will shake their heads in astonishment that products such as "liar loans" could ever have gone mainstream. Hindsight being 20/20, the credit scoring system of 2015 is unlikely to look anything like today's.

Of course, there's plenty of room to debate who's to blame for the whole "silly sham". Fault not in our stars but in ourselves, yada yada.

 
At 1:55 AM, Anonymous katie said...

Credit scores try to predict how profitable you will be to a lender/creditor, not necessarily how likely you are to repay.

 

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