In Depth Analysis: CalculatedRisk Newsletter on Real Estate (Ad Free) Read it here.

Wednesday, September 05, 2007

It's Not All Bubble Markets

by Tanta on 9/05/2007 08:10:00 AM

The Chicago Tribune tells a story about borrowers facing foreclosure.

PITTSBURGH - For Donna and Steve Love, the plan seemed perfect.

Priced out of the Boston-area housing market, where 2-bedroom homes can cost about $500,000, the working-class couple thought it was time to head to a more affordable market.

They chose Pittsburgh. They liked the city, thought they could get jobs there and were sure they could afford a home without having to win the lottery.

After finding their home -- a $59,000, 3-bedroom, brick row house near the city's downtown that they paid for with a subprime loan -- they moved in June of 2006 and tried to settle into their new life.

But within a year, they were facing foreclosure. . . .

In March 2006, they reached what they thought were final terms for the loan: $5,000 down, a 7.75 percent interest rate, fixed for two years and then adjustable for the remaining 28 years, with a cap of 14.75 percent.

The $429 mortgage payments would be higher than they expected, but still within their budget -- equal to less than one week of Steve's salary with CVS. Plus, it was still cheaper than their $700-a-month rent in a suburb of Boston.

Then, on April 20, two weeks before the May 3 closing date, they said they got mortgage documents in the mail with a letter that said they should sign all the papers and return them as soon as possible.

But they quickly noticed the final contract listed a higher interest rate of 12.125 percent, with a cap of 19.125 percent. That pushed the monthly mortgage payments up more than $200 to $692 a month.

"We both said, 'Oh my God!' and started reading page by page," recalled Steve Love.

They called Countrywide and talked to several representatives who told them "that the fluctuating market went up and investors had asked for a higher percentage rate on the loans, and this was the best they could do," he said.
So, the CFC flack quoted says there's more to the story than that. I'm sure there is. There is always more to most stories.

However, I'm having a hard time figuring out what could possibly be the story that would justify a 12.125% start rate on a 2/28 ARM in April of 2006. The 6-month LIBOR, the index for this loan, was 5.2879% in April 06. That means these borrowers were paying 6.8371% over the index for two years' worth of "rate protection." That's why they aren't having a "reset" payment shock problem; their payment was not discounted in the least in the initial fixed period of the loan.

I for one do not remember the major credit market crisis of April 2006 that suddenly required subprime borrowers to get premium ARMs. I cannot think of anything that might "change" between original underwriting and closing of the loan that would move the borrower's interest rate from 7.75% to 12.125%. Even if they didn't have a rate lock agreement.

But notice the situation these borrowers were in: they had already left their jobs and given up their apartment in preparation for moving, and they had a deposit on the home at stake. Allow me to observe that we lenders have known, since dirt, that this happens frequently on purchase money loans. People make hard-to-revoke decisions based on the commitment letters we send out. We therefore took great care to make the terms of the commitment letter accurate. You simply do not pull the rug out from under a relocating borrower unless you're a predator trying to squeeze someone who has no negotiating position. (I don't think you ought to do this with anyone, of course; I'm simply pointing out that lenders understand how the purchase-relocation process works. It might be a new thing to some consumers, but not to us.)

And all of this over a $59,000 120-year-old home in Pittsburgh for borrowers who can find work at the going rate for Pittsburgh, but are being charged a mortgage interest rate as if they worked in Boston. CFC would rather own that REO than give up some of 12.125%.

I don't think any purpose is served by turning this into an argument over who "deserves" sympathy. I think a good purpose is served by looking at the economics of the thing and asking how this could possibly make any sense. If Donna and Steve's credit history or employment prospects or debt load was "so bad" that they "deserved" a rate of 12.125% (but CFC didn't notice that until the second set of paperwork got drawn up), then they simply should have been denied a loan: they can't afford 12.125%. CFC extended a loan knowing that the borrower couldn't afford it. Now they refuse to play ball on a workout?