No Pay Stub? No Problem. Unconventional Mortgages Make a Comeback
wsj.com
wsj.com
As long as the loans are marked appropriately and the proper risk is taken with interest rates and there is nothing predatory or exploitative about them, there is nothing wrong with companies lending to subprime borrowers. In fact, it helps people break the circle of poverty by investing in them, again as long as it's not predatory.
Specifically, the models used assumed that the economic risk of a mortgage default in Connecticut was uncorrelated with the economic risk of a mortgage default in Texas. When housing prices are rising nationally, this assumption is basically true - the house can be sold by the bank for what's owed on the mortgage, refinancing is available for balloon payments, and any one borrower's cash flow situation is idiosyncratic. But when housing prices started to fall, this lack of correlation broke down, and many financial institutions became unexpectedly responsible for the losses in this asset class.
If you get surprised by a change from a low-bias regime to a high-bias one, your old assumptions will lead you to be overconfident in your model. For 538, this just meant publishing numbers that were way too confident. But in the financial context, overconfident modeling means you think you can use more leverage than you actually can.
This isn't the case for the 2016 elections. 538 ended up having a much more robust forecast because they accounted for systematic polling error (bias).
https://fivethirtyeight.com/features/why-fivethirtyeight-gav...
538 was just about the only polling aggregrator that WASN'T guilty of this during 2016 and were relatively bullish on Trump.
Their mistake during 2016 was releasing a series of editorials not really based on data at all that predicted Trump would eventually peak in support and the remaining voters would rally behind a sensible seeming conservative establishment choice like Marco Rubio. Their theory was plausible and completely wrong. Yet their numbers consistently predicted Trump victory in the primsries as he was an eternal frontrunner for virtually the entire primary.
Whenever historical growth rates have always been positive, markets react in shock at the "black swan" event when a 30, 50 or 100 year pattern is all of a sudden broken.
Unfortunately, the balloon payments made this impossible for most.
In the case of the example in the article, if she wasn't given the loan, she'd probably have $100k or more in equity in cash from the sale of the home. The entire scenario is sickening and disgusting -- using hope and taking advantage of people's ego and emotional attachment to separate them from their money.
Just don't let the bank then resell this loan as a prime AAA loan to others, so if it bombs someone else gets the shaft.
It's just like organic food. I don't think it should be illegal to sell "conventional" eggs. I only think it should be illegal to sell a tray of organic eggs - where 1-2 of the eggs are "conventional" and hope no one notices. (Especially in a case where the farmer has an inside relation with the FDA inspector that is checking for the organic nature of eggs)
She used the money to fully buy out her grandfather’s house in San Clemente, Calif. She jointly inherited it with other relatives and said she needed a loan to pay them for their shares of the property.
This is a highly unusual situation. She got a great deal on prime beach front Orange County property and could easily charge high rents to cover the mortgage and then some. The property will continue to grow in value. If she were really in a situation where she might default, her family would help her. This is not representative of any trend.
Hardly predatory. Hardly a "high risk" situation for either the bank or the borrower.
Agreed.
>She got a great deal on prime beach front Orange County property and could easily charge high rents to cover the mortgage and then some.
So is she a private homeowner or a business? Is it legal for her to rent? Given that the bank accepts letters from old ladies describing casual labor as proof of income, who knows.
I own investment property that is mortgaged and attracts high rents. The underwriting standards for that property were higher, and required 20% money down for a similar rate premium.
>The property will continue to grow in value.
That has little to do with qualification for the loan. Kind of makes my point -- it's in the banks interest to write a shitty loan to repo this house on default. (ie. predatory behavior)
>If she were really in a situation where she might default, her family would help her.
Are they cosigners?
"Wink and nod" underwriting in banking is a bad thing.
There are predatory operators known colloquially as “loan to own” guys, but they are usually unregulated and operating in the business world where the collateral value is less observable.
For a bank, I believe Other Real Estate Owned (OREO, the balance sheet category where foreclosure properties are carried) is always considered a black mark and a burden, dragging down ROA/ROE.
If I can buy a $550k property for $500k (with no cash down), with the lender not risking much when it gets repossessed and sold, let me.
If the collateral is there, it's fine.
She also took it an ARM loan at 6%. In 5 years it’s very possible it could become unaffordable. Not a good decision either.
In this case it may be a good deal for both parties. What about the other people? The atricle mentions these loans grew by 25% in 2018.
But you're speculating. If it was a good deal in this case, what makes you think it's not in other cases? Can you point to a specific case where you think it's a bad deal?
As long as we don't bail them out again, I don't really care what crazy deals banks and bank customers come up with.
I could care less if it’s a good deal for the banks.
She got a 600K loan against a property she already owned a substantial share of (not a purchase money loan with nothing down) as a working home health aide who is also a nursing student.
> In 5 years it’s very possible it could become unaffordable.
In 5 years it's quite likely that higher income and lower loan to asset value will let her refinance it down, too.
> What about the other people? The atricle mentions these loans grew by 25% in 2018.
Subprime mortgages aren't generally a problem on their own, absent the kind of incentives to misrepresent their quality for sales of securities that existed in the last housing crisis. To the extent that hasn't been corrected, that's a problem, but let's not target subprime lending as the problem (heck, in the last crisis, a lot of the problem loans weren't even subprime.)
Why does, and more importantly should, a lender care?
Not quite. Suppose I take a million subprime mortgages and say “I’ll pay you the first dollar any of these mortgages pay”. The probability that all of those mortgages default is slim. So this particular top-of-the-stack claim is, indeed, a quality one.
This is what people mean when they say “top tranche” of a CDO. The CDO is the pile. The tranche is the priority. The top tranches were rated AAA. Looking back, they pretty much all paid as expected.
The problem is a AAA rating means the security will pay out. Not that it will be able to be sold like a Treasury. So due to a confluence of things, many institutions needed liquidity, and when they tried to sell these instruments found there weren’t enough buyers. The desperate fire sold, thereby requiring others to mark down their holdings, and behold: crisis.
There was also fraud in origination. And fraud elsewhere largely unrelated to the proximate causes of the crisis. But the proximate element was a classic one: a liquidity crisis. (The root element was over-leveraging.)
https://en.wikipedia.org/wiki/Collateralized_debt_obligation...
EDIT: and what that diagram misses is that, because the originators couldn't manufacture mortgages fast enough to satisfy the demands of investors/speculators, banks started manufacturing CDOs directly (synthetic CDOs), meaning investors' total notional exposure to mortgage performance could exceed the total value of outstanding mortgages.
It's a helpful diagram! What it doesn't say is each of those AAA tranches actually [erfpr,ed. When you look back at how the AAA tranches of CDO-squareds circa 2005 to 2008 paid out, they pretty much all behaved like AAA securities.
Those tranches were solvent. In many cases, their junior tranches were solvent. What none of those tranches were was liquid. I can hold a security that will pay me $1,000 indefinitely, but if nobody will buy it for more than a penny, it isn't useful if my trading group is busy diving into a liquidity crisis. (Granted, ratings don't say anything about the liquidity of a thing. Just its solvency.)
I don't know the answer. A quick Google search suggests bucket shops were made illegal in the US, but I don't know the details, or why this doesn't make derivatives illegal.
One rationale for regulation I could imagine is to protect 'investors' from counterparty risk in case the bucket shop is inadequately hedged. Presumably synthetic CDOs were manufactured from derivatives whose counterparties were big banks, which are subject to capital adequacy requirements which in theory provide some protection.
AAA doesn't mean that the security will pay out. It means they have the lowest risk and it means that it's the most expensive. Even AAA-rated debt can fail.
What happened was that large financial institutions were paying top dollar for AAA mortgage-backed securities, but after it was revealed that all of these mortgage-backed securities were poisoned with subprime loans, the value of those securities plummeted. The value of those assets dropped, which put the holders of those assets in a bad financial situation because they didn't have as much money as they thought and they also couldn't sell them. Some companies or funds are legally required to hold only AAA securities. This caused reverberations throughout the financial industry.
My point is there was no “poisoning of AAA securities with subprime.” Subprime mortgages can be legitimately assembled to produce AAA securities. This happened, and those securities ultimately paid out like AAA securities. They just didn’t perform, liquidity-wise, like Treasuries. (Neither did other corporate AAA securities, for that matter. OTR Treasuries are OTR Treasuries.)
It was a bit more complicated than that.
Also, subprime and poorly documented loans (mortgages in the case of the financial crisis) with teaser rates that eventually reset to a rate unaffordable to the borrower can absolutely be predatory when coupled with brokerages incentivizing brokers to sign up financially illiterate folks for loans they will eventually not be able to afford knowing the brokerage will move the risk off their books within days or weeks.
Next time someone rambles on about no one being arrested/held responsible for the financial crisis, show them this thread full of reasonably intelligent people still unsure of the cause 10 years later.
- their family/friends' opinions,
- Wikipedia,
- documentaries,
- movies like The Big Short
To be frank, unless someone has spent a significant amount of time doing hard research on the topic or is a professional in the industry, they shouldn't assign any confidence to their opinions about what caused the crisis. They can agree it's bad and shouldn't happen again, but beyond that most message board conversation is simultaneously prescriptive, uncritical and conflicting.
In this particular case, we're seeing people talk about the topic who are evidently unfamiliar with the legitimate use of risk pooling in finance. It's rather too complicated to be summarized in a few paragraphs on HN.
So on one hand you've got a bank that enjoys massive profits spreading and thus decreasing their risk while assisting those in poverty to claw their way out by allowing them the benefit of lower interest rates.
On the other you've got a bank that enjoys massive profits increasing the risk of one of their portfolios while making it extremely difficult for those in poverty to keep up with interest payments.
I'm not discounting the fact that packaging large volumes of those mortgages as AAA and selling them on to other companies was fraudulent, it was, but the reality is, doing so was far less predatory than the alternative if you look at it from this perspective.
A small snippet for context, although insufficient to explain a very complex problem:
"In many ways, the practices employed by SIVs (Structured Investment Vehicles) and underwriters to structure MBS [Mortgage-Backed Securities] ... tended to magnify rather than reduce risk in the financial system. A key risk-enhancing design feature of MBS was the practice of tranching, whereby several categories of securities were created in each securitization issue ... the senior tranche would have sold at its nominal value and would have been rated risk-free [despite comprising 85% of the entire MBS]."
- "Banking: A Very Short Introduction" by John Goddard and John O. S. Wilson (pg 43-53)
I do think that the manner in which it was done and the disregard with which it was executed was the cause of the financial crisis. With banks offloading risky debt as if it were AAA to other institutions, all passing the buck to someone else making it someone else's problem until the bubble imploded and everything fell to pieces - like a giant Ponzi scheme.
I'm not saying that mislabeling wasn't fraudulent, it was. What I'm saying is that spreading the risk among your portfolio allowing those who need it to leverage lower interest rates is less predatory than forcing them to make interest payments they can't afford, thus keeping them in debt slavery longer.
You spend less time in debt slavery if you don't have exorbitant interest rates making up the bulk of your loan repayments... this is why countless times, I end up buying a new car rather than used, because when the interest payments and restrictive loan terms are taken into account, the monthly payments for a new truck aren't significantly different than those for a previously owned. Sure, the used truck at 9% will be paid off 2 years quicker, but more of my money is paid back towards the privilege of having the loan instead of paying for the cost of the truck.
I'm already paying that amount every month and I'm used to making those payments, would I rather pay off a used truck that I had to compromise on a whole bunch of features, or would I rather have the brand new truck with exactly the featureset I want at the same monthly rate, but for an extra couple of years?
I don't mind the extra couple of years payment to have the one I really want - especially given that my monthly payments for both well within my budget. I don't want to pay for the loan. I want to pay for the truck.
So that's the difference. Forcing someone to pay the higher interest rate means they can't have what they really need because they're paying more for the loan than they are for what they need. They could pay the same amount for a larger mortgage with lower interest rates and have the nicer home.
I guess this is a long winded way of saying that despite the mortgage lender's fraudulent and underhanded execution, there is a perspective here that's valid.
By borrowing beyond their ability to repay? That's gambling at best or just debt slavery at worst.
That's a different argument. I'm not arguing the point of allowing them to borrow more than they can afford to repay. I'm arguing the point of allowing them to borrow what they can afford to repay at rates that allow them the opportunity to do so rather than making them pay rates they can't afford for money they desperately need.
Preventing them borrowing more than they can afford to repay is a different and necessary oversight. Nobody should be put into a position of debt slavery. So I agree with your point, I just don't agree with your premise.
Banks would get people who undoubtably didn't deserve loans, would handwave over the details and then send people on their way with $1M loans and the borrowers would later fail. I have a friend who worked at Washington Mutual at the time, and she would routinely reject loan applications, and her manager would overrule her. The manager was making $30,000/month in commissions from loan origination, and he didn't give a fuck who was getting the loans because he was being paid and they were getting packaged up and sold to Fannie Mae/Freddie Mac.
Meanwhile, people would be getting loans that they couldn't afford, but could make payments because of the 0% interest loans that were actually increasing the principal. But they didn't realize this because the lenders didn't explain all the details to them. It's predatory to take advantage of the fact that most regular people don't have a higher-level understanding of mortgages, and by filling their heads with ideas that it doesn't matter anyway because they will sell the house in a year for a profit.
The lenders didn't care because they were incentivized to originate loans even if they knew the borrowers couldn't ultimately afford them. The thought at the time was "the house price will increase in 2 years anyway, so even if you get a $800k loan on a $1M house, you can sell it in 1 year for $1.2M, and then use the $200,000 profit for a downpayment on a real home."
An underhanded contract isn't going to be obvious to a borrower with a high school dropout's education level. Even your run-of-the-mill credit card contract is written to an eleventh grade reading level, on average.
If the loan originator thinks the latter is likely, I don't think it's unreasonable to call the loan predatory.
IE: My understanding of the 2008/9 problem where banks were more interested in their banky uses of loans than just "Hey, an investment with good returns."
Now in theory they still want to make all good loans but actually evaluating all the loans in a package is hard to impossible. This can incentivize lenders fudging the numbers on loans because a few bad loans failing is fine (so long as lenders as a whole aren't systematically issuing bad loans of course).
In the mortgage market specifically they are loans that are initiated by someone who is planning to offload them ASAP and doesn't care if the borrower has any capability to pay. They may outright lie to the borrower about the situation in order to close the deal. Then they lie to the investors about the quality of the loan in order to offload them as quickly as possible for a large profit.
Such as creating a claim on everything the borrower will ever have and turning them into a debt serf
But hey maybe housing prices go up really really fast
That said, the example used in the article seems frightening. A $600,000 mortgage on a part time student income where the borrower is forced to rent rooms to make the payments? However unfortunate the normal underwriting standards are for some portion of the population, it seems that lenders continue to take whatever rope they are given and insist on hanging themselves with it.
She used the money to fully buy out her grandfather’s house in San Clemente, Calif. She jointly inherited it with other relatives and said she needed a loan to pay them for their shares of the property.
I'd be scared s* if my $610K mortgage depended on getting a job and renting out multiple rooms every month.
My thought is if 80/20 loans weren't a thing and banks required at least 20% cash downpayment, we wouldn't have had the boom and bust debacle we saw in the oughts.
[addendum, then I finished, it's an inherited house and the mortgage is to buy out her relatives; so I start hoping it's not 610k debt but total value.]
She used the money to fully buy out her grandfather’s house in San Clemente, Calif. She jointly inherited it with other relatives and said she needed a loan to pay them for their shares of the property.
Is she a child? The lender is willing to lend and she wants to try and keep the house and is willing to borrow. She is figuring out how to do that and is renting out rooms to make the mortgage. She can also sell the house and likely recover her equity, if she discovers she can't make it. Would you rather she have no way in which to try and keep her grandfather's home?
Maybe we need an easier way to become "a person responsible for their actions". Right now you have to have $200k in income or $1 million in liquid assets to be a "accredited investor", but this seem a bit steep in my opinion and quite discriminatory to us mere plebs.
This is a pretty unusual situation, hardly indicative of any trend.
It clearly says she took out a 610k home loan which means it was still 600k. It’s likely she has a good bit of equity.
What kind of nursing student gets paid under the table by clients?
Still it’s pretty insane and I feel bad for her in 5 years.
>Ms. Hering, who is 30 years old, received a loan at a rate of just over 6% for the first five years; it adjusts after that.
With the Fed signaling they are raising rates she’s in for a shocker in 5 years.
"works part time providing home care for children and the elderly" is this a veiled way of saying she is a babysitter? If she was actually doing nursing care for children or the elderly, I assume she would be working for a company, back again to the fact that she doesn't have a pay stub, I think she is working for cash under the table.
There's a big market for this sort of thing. Agency-based homecare is really expensive and usually pretty awful. Traditionally, these sorts of casual labor jobs had to be paired with a spouse's income to avoid IRS scrutiny, but IRS enforcement isn't what it once was due to years of funding neglect.
The notion that a bank is recognizing off-book income as income for lending purposes is incredible. Eventually the prospective lender will run into a problem, and usually will take an income hit when they are forced to land a normal job. The other turd about the "part time student" aspect is that she is probably living on student loans.
Doing the math, it's $3657/mo before taxes; where the average salary of a nurse in LA is $90k/year.
[1] Memorable reddit comment about the difference between "nursing student" and "nurse"; it's about the UK, but the same points apply. https://www.reddit.com/r/AdviceAnimals/comments/2kbxs2/stude...
Non-conforming and no-doc loans weren't the only problem in the 2007s. ARMs were a big issue too because everyone thought they could refi before the initial period was up and that ended up not being true.
I wonder if banks get to see the end coming ahead of everyone else - but in order to meet business targets, have to relax lending requirements to keep the party going just a little bit longer.
Here’s a useful article where people were able to get loans on 1099, including VA loans. It seems 24 months is required.[1]
[1]https://www.trulia.com/voices/Home_Buying/I_am_a_contractor_...
The problems start when they can't pay back their $600K mortgages with a $17 an hour job or freelancing here and there. Mortgages are pretty old as a product, banks know who is likely to afford it and who isn't.
Mortgage payments are due every month of the year for 15-20-25-30 years, and that's the problem.
Doesn't the sub-prime crisis basically blow that theory out of the water?
In the world we live in, Bank of America fell by 95% or so, Citibank missed nationalization by a whisker, Wachovia was forced to merge, etc etc, and that’s not even counting the investment banks, because they were happily engaged in the traditional business of banking in addition to securitization.
"Lenders issued $34 billion worth of these unconventional mortgages in the first three quarters of 2018, a 24% increase from the same period a year earlier....the growth is notable because it came as traditional home loans declined. Those originations fell 1.2% over the same period and were on track for a second down year in 2018."