More Subprime Borrowers Are Missing Loan Payments
wsj.com
wsj.com
[1] https://corporatefinanceinstitute.com/resources/knowledge/cr...
I bought a house a few months ago. The mortgage payment is right around what the more conservative rules of thumb suggest is affordable.
After the lender had all my information I asked, out of curiosity, what was the maximum they'd lend me. They came back with a number that was more than triple what I ended up borrowing and suggested there was room to go higher if that was something I was interested in.
Perhaps subprime borrowers face lower limits but it's still possible to take a risk stretching your budget to buy a house. That may be OK or even good but I'm concerned the perception is that lenders won't approve a mortgage that will be very difficult to keep up with when they absolutely will.
..because those houses are selling for over $250k now?
the average period for an auto loan in the US is over 64 months. any disruption to the paycheck-to-paycheck living of 64% of americans could have a catastrophic effect on the ability to service this debt.
Seriously though, just like mortgage originations pre '08, anyone who had qualms about that kind of thing left that industry a long time ago, or never joined.
"buyer of the 1999 Oldsmobile Intrigue at Auto World Auto Sales in February.
A 26-year-old single mother of three, she needed a car to get to her new job as a home healthcare aide. She agreed to pay $3,899 — roughly double book value — and put down $1,200 cash on the deal.
As the due date for her first installment approached, Fields realized she’d need a few extra days to scrape together the $220 payment. The dealership wouldn’t wait. It repossessed the car a week after the payment was due"
https://www.latimes.com/business/la-xpm-2012-aug-15-la-fi-bo...
Plus, all of this was over a decade ago. It's irrelevant on both axes.
All the cheap beater cars that people just getting on their financial feet would have bought evaporated overnight.
I sympathize with the would-have-been sellers. I spent probably 8 hours recently to sell a 16 year old car for $4,200, and it would have been easier to do it the cash for clunkers way. But people buying that car are unable to get something newer or want to get their feet under them financially.
I don't think this is true. If you look at the cars that were destroyed as part of the CARS program, they don't have a large overlap with popular used cars in the US. The top CARS trade-ins were mostly 4WD SUVs and minivans; the most popular used cars a decade ago were (and are) mostly 2WD sedans.
Another way of thinking about it: the entire point of the CARS program was to incentivize car owners to prematurely (from their perspective) buy a new car by offering them credit for their old one. Combined with the disconnect between the cars traded in and the actual used car market in the US, I think it's safe to say that most of the cards exchanged in the program would not have entered the used market and therefore did not meaningfully impact it by going to the scrapyard instead.
Here's the top ten list:
1. Ford Explorer 4WD
2. Ford F150 Pickup 2WD
3. Jeep Grand Cherokee 4WD
4. Ford Explorer 2WD
5. Dodge Caravan/Grand Caravan 2WD
6. Jeep Cherokee 4WD
7. Chevrolet Blazer 4WD
8. Chevrolet C1500 Pickup 2WD
9. Ford F150 Pickup 4WD
10. Ford Windstar FWD Van
Everything on that list is prime shitbox, except arguably the trucks (because they cost a little much to feed).
What do you think happened to crappy vehicle prices as soon as the program was announced?
Anything that moved and qualified got listed for sale at approximately the same price as the rebate. Hence no more "$500 beaters" (not really $500 by that time but you get the point).
You see the same thing today where the scrap value of catalytic converters drives up the price of the cheapest cars because that's the alternative way of monetizing those vehicles
Most cars that left the road were the oldest and heaviest. New cars bought under that program tended to be economy cars and are already a decade+ old. To suggest that it took inventory off the road affecting today's markets doesn't hold water.
The biggest issue is that car companies make more money off reselling the loan than they do off the car. Years ago we tried to buy a Subaru in the NYC metro area in all cash and were continuously turned away. Dealers didn't make money off the cash sale, they were spiff'ed off the loan. We had to take the loan and then pay it off in order to get the car.
Since then it's gotten worse. Expensive cars (luxury, trucks) are sold with 72 month loans and are underwater shortly after purchase. It's been a race to the worst terms and empowering the worst purchases to the worse equipped buyers. I'm continuously amazed it's gone on as long as it has.
Pure fantasy.
Old commuter cars and family haulers were what was removed. Stuff like 90s Suburbans and F150s got turned in at a much lower rate than things like Cavaliers and Tauruses.
Remember, times were not great back then, trucks and SUVs are useful vehicles. You're not gonna get a lot of people who have old ones trading them in on a Camry because that's a net downgrade in capability. And the SUV craze was new enough that the trucks and SUVs that had been bought frivolously were still mostly worth enough to be unaffected.
>To suggest that it took inventory off the road affecting today's markets doesn't hold water.
It definitely put the used car market into a state it could have not otherwise gotten into. Whether it ever "recovered" is a matter of opinion. Many people say the private party shitbox market has never been the same but I personally think that's rose tinted glasses.
We ended up invovled with the state A.G.'s office investigating our dealer. They 'accidentally' put a typo in my wife's SSN when pulling the credit report. That justified a higher interest rate - which they offered us without explaining why.
We weren't super worried because we were going to pay the car off in a couple months anyways, we just wanted the financing to shift some cap gains taxes to a different year. Then we got a letter in the mail from the lender explaining why our interest rate was so high.
We called the dealer - and almost no questions asked they offered to send us a check for the difference. Red flag raised we filed a complaint with the state A.G., and it turns out it was a common practice at that dealership.
Never is a strong word. Dealerships make their money on financing. Refinancing afterwards is straightforward. Negotiating poorly on the dealership's financing, using that to win points on other fronts (e.g. price, maintenance commitments, trade-in value, et cetera) and then repaying the loan a month later, once you've lined up your preferred financing, is perfectly acceptable and often worth the time and trouble.
They have this awesome thing called negative equity financing. It might have a better name now, but they will pay you X for your old car which is less than you owe and then finance the difference with your new loan. In other words, your loan balance on the new vehicle may be higher than its value but this is glossed over by focusing strictly on monthly payments and "what you can afford". Re-read that, this is not a practice they'd use on people with bad credit because to repo the car will not get them their money back. It's a rip-off for people with good credit and more dollars than sense.
- I got a 0% APR loan on a new Ford via Ford Motor Finance in 2016 and didn't even have to put much cash down.
- I got a 0% APR loan on a new Hyundai Palisade in 2021 (yes, even after COVID!) by paying for almost half the car in cash as a down payment.
No other finance channel would have ever offered me 0% APR.
The next time we went to buy a car with a loan in hand from our bank, it was for my wife. We showed the guy the loan we had, he took one glance at it, and said he couldn't do anything better. He didn't waste any of our time. That was Lexus.
Suffice it to say that I'm willing to pay a higher price for a better quality vehicle with better quality service. I really don't want to buy from anyone else.
It was a time bomb. Cars are easier to seize than houses. Given the present shortages, re-selling them at close to the loan balance shouldn't be an issue.
It's still a tale of personal tragedy. I know people on the new-car-every-two-years bandwagon who will get screwed when they have an income interruption. But it's not a broader risk, at least not at this time.
Will there still be vehicle shortages if a significant number of cars are seized for resale and potentially a significant number of would be buyers are not able to obtain loans?
There is also the issue of raw materials, which can be reused.
its more palatable to subsidize these dicey loans (as we did in 2008) then come to jesus with the grim reality of following the letter of the lender instead of the spirit of the loan.
The Greece bailout was actually bailing out German banks for example.
https://en.wikipedia.org/wiki/Economic_Growth,_Regulatory_Re...
Even at 5.5%, it's still "only" 38% DTI ratio.
- you’re also ignoring property taxes and insurance. I pay another $400 a month for that in a relatively low cost of living state and I have a $5K deductible.
That 1900 adds up to $2800/month real quickly.
Rules of thumb like “mortgage amount should be less than 3x income” don’t make much sense because they ignore the interest rate.
They're fine as a rule of thumb. The individual should still run their own numbers to see if their limit is higher or lower.
Even at 2.5% interest, I have a hard time seeing anyone being able to responsibly buy a $450k house on $80k income. They might be able to swing it, but they'll be screwed as soon as a large unexpected expense comes up. Even a 2% property tax will eat close to 10% of their gross income. There's no way they could save for an emergency fund or properly fund a retirement account.
I assume that is simply the way 80%+ of people in the US expect to live since it has been their reality for decades.
At 9% interest, the monthly payment on a 240k home is $1,931. Mortgage interest rates were higher than this throughout the 1980’s. They got as high as 18% which would yield a $3,617 monthly payment.
This means that the person who followed the “3x your income” rule in the 1980’s has a harder time paying the bills than the person who bought the home for 450k with a low interest rate.
This is a badly-formed rule because it ignores a key variable - the interest rate. Sometimes, it will prevent someone from buying a home they can afford. Other times, it will cause them to buy a home they can’t afford. There’s no need for such a rule, because mortgage payment calculators that take into account the interest rate are easily available. It’s like picking a shoe size based on how much you weigh instead of measuring how big your feet are. If it gives you the right answer, that’s out of sheer luck.
Of course, it’s necessary to also take into account factors like taxes and other expenses which vary from place to place and person to person, but a simple mortgage payment calculator is a good place to start.
They dont usually care about wealth, they care about cashflows in vs out.
Can't find a link to it, but someone on WSB wrote a long report on how margin loans will be behind the next housing crash.
Credit score impacts interest rate but debt to income ratio that is above 50% can completely disqualify you from a mortgage. Thats where the founder ownership can skew your personal DTI.
You can go to asset based lenders who evaluate and secure the loan against your existing assets (cash, etc) rather than based on your W2 income and DTI.
I used to call this sales strategy "Amazon Subprime". I still think that's one of my cleverest jokes, but unfortunately you might only laugh if you know how the 2008 housing crisis actually started... and the people who do know that are not great in number.
I see this playing out now with cryptocurrency. Suddenly, everyone is an expert on Bitcoin!
But also lots of highly educated Ivy League Finance folks who thought they were smarter than the were. Hence Bear Stearns, Lehman Brothers, AIG, Merill Lynch, etc.
Bravo getting this one out there.
Given the very low interest rates in 21-22 and high prices, a certain percentage of folks would have purchased with a convertible mortgage.
Assuming the standard 5-1 and the fact that rates are rising very fast, should we expect a repeat of 2008 in 2026-2027?
Plenty of other reasons. Others have bad credit or otherwise get significantly lower payments on an ARM compared to fixed.
I guess there are other reasons, but ARMs are definitely not dead. I don't know the numbers or where to get them though.
What are more dead are the "balloon payment" residential mortgages where they may amortize over 30 years but the principal is due in 5 or 10 years.
you can pay off a 15-year mortgage in less than 15 years - the lien will be released, etc whenever the principal is paid. Everything depends on the specifics of your contract of course but it would be extremely unusual to have a mortgage where this is not allowed.
fixed vs ARM purely depends on how the interest rate is determined, that's it. In principle ARM should be a bit lower than a fixed rate financed at the same time - but if the prime rate goes up then your rate goes up too, where with a fixed it's locked-in forever. Fixed will have a higher interest rate because someone has to assume that risk of an increase in the prime rate, where with an ARM that someone is you.
Taking an ARM vs a fixed is a bet on whether rates are going to stay the same or decrease, vs increase. And boy if you thought 2020-2021 rates weren't going to increase at some point in the future, uh... it's not every day you have a once-in-a-century pandemic that nukes the economy and drives demand for money almost to zero.
I'm not quite sure what you're saying about balloon payments either, the balloon payment happens at the end of a balloon mortgage, with the intention that values will have gone up so you can refinance at that point - but of course, what if they don't?
It's also taking a bet on how long you're going to keep the mortgage. When a bank offers a lower rate for a 7 ARM vs 30 fixed, they're assuming that you will keep the mortgage for more than 7 years. If you pay it off fully before then, you win the bet.
A 30year ARM gives you a lot more flexibility then a 15-year anything. I mean, you can pay off the 30 year in 30 years or 15 years or 5.
Regarding the balloon payment-- not sure what you're missing here. Residential mortgages with balloon payments aren't really offered any more because of huge risk of default when the balloon payment is due.
It can be a very good idea for someone who plans to pay off their mortgage early. If all goes well it is no worse than a 15 year mortgage, but when (really, if is unlikely) something bad happens you have more flexibility. Of course if interest rates go up you will get burned, which is why I go with a 30 year fixed rate that I pay off. I could probably afford payments on a 15 year loan, but I'm not willing to risk it.
I talked a number of people out of ARMs in '21 and '22 by explaining 2008 to them (they were 7-8 years old at the time, so do not remember). It is scary how bad most people are at understanding exponential growth and just how much worse 5% is than 3%
It can make sense if you're financially secure enough to take on the risk.
But the long tail is some people being priced out of their home as their payment rises, and it could have been prevented. So 90-95% of mortgages in the US are fixed rate.
Everyone thinks that 5 years out, everything will be rosy. The metalworker saving 0.6% on a 5/1 ARM vs a fixed 30yr is using the same mental gymnastics that J. Poindexter on Goldman's bond desk is, that central banks are omniscient, omnipotent, and will always magic away the risk inherent in our decisions.
It didn't matter whether an ARM was better or worse in the long run, it mattered that the ARM could get the house and the fixed rate could not.
Convertible mortgages became popular as an alternative to either fixed or nonconvertible ARMs when rates were high as a way to preserve the option of locking in on a rate drop without going through a refi. Convertibles don't offer a lot when rates are low—if you want to be able to lock in a low rate and rates are already low, you get a fixed.
Between that, changes in qualification rules, and memories of the collapse leading into the Great Recession, ARMs of all types have shrunk to a very small share (<5%, IIRC) of residential mortgages, and newer ARMs tend to have rate caps.
> Assuming the standard 5-1 and the fact that rates are rising very fast, should we expect a repeat of 2008 in 2026-2027?
Probably not because of adjustments on existing mortgages. If there is sustained stagflation, then the fact that people can't pay their fixed-rate mortgages given other necessary expenses may produce a similar collapse, though.
Every product in 2008 was completely viable which is why the Federal Reserve bought everything.
Only 7% of the borrowers defaulted by then, there wasnt mass irresponsibility on the people with mortgages as suggested, this alone blew up some institutions because they were leveraged nearly 50x and one month of missed mortgage payments would cause a massive drawdown on their portfolio.
Without leverage, a portfolio where 93% is going to pay a lot in interest over 5-30 years is a good portfolio.
So there is no reason to get uncomfortable or anxious by seeing the words “subprime” “CDOs” or more, as it comes down to whether the accounting is done properly and the leverage is low. Which, I believe is being done. The "big crash" always comes from a different and unexpected (or less expected) angle, where some completely different sector has too much leverage and flimsy accounting.
What are the big speculative candidates for next crash? Contagion from the Chinese real estate market?
[1]https://pivotal.substack.com/p/minsky-moments-in-venture-cap...
In the runup to the 2008 crisis, a commonly heard mantra was "yeah, subprime lending is fucked up, but it's a small fraction of the economy, it can't cause that much damage". Turned out that it could, via the CDO shenanigans.
I would not at all be surprised if someone has already cooked up a similar leveraged dependency from the "real economy" to crypto markets.
But cryptos have never been considered remotely that reliable by the broader financial system. Thus there is probably little to no leverage using cryptos as collateral. Crypto is currently crashing, but it will only take down itself and not 30 to 100 times as much leverage with it.
Given that the Federal Reserve wants unemployment numbers to rise, they're specifically trying to make share capital worth less, and borrowing capabilities cost more, making revenue-poor corporations stop being so optimistic. so I would just expect lower valuations with much lower revenue multiples (or price to equity ratios), for that reason alone.
Slowed growth in China is always a threat because thats a key revenue driver for many large western companies. Then sure, there is the leverage and accountability problem with Chinese real estate, but I don't get the impression that contagion is that big because nobody thinks that is a safe bet and also avoid too much exposure to the domestic chinese lenders involved. The rumors behind Tether just aren't big enough to matter for this, could only be a slight sting to the commercial paper market and a moderate "finally" for the crypto market as a tether implosion would probably increase confidence there after steep selloffs.
Oil/gas volatility is probably going to have some casualties.
The Oil Glut of the 2010s killed off all but the strongest players in this sector. So I doubt it will be a pillar that collapses. If anything, they will probably do very well in the near-term.
Re: Chinese real estate, the contagion mechanism I've heard the most about isn't West->East investment, it's East->West investment that gets pulled to survive a bear market. I have no idea if it's big enough to matter.
The main concern is stagflation due to rising energy prices. It seems like the market is now finally starting to price in the externalities of abating climate change, which results in higher energy prices across the board (which in turn raises prices of everything else, with inflation due to QE piled on top of it).
This means that output roughly stays the same, but there are more dollars competing for it.
But yes, subprime loans were carved up and repacked in a way to make them look like AAA bonds. The banks that created these bonds knew that the loans in the bonds were crap; they knowingly lied to investors about it. The ratings agencies stamped all the bonds without any due diligence. Other banks piled on more derivative products on top of those bonds, essentially gambling on whether those bonds would go bad.
There was a slime-trail of fraud, laziness, and greed all the way back the original loan itself.
Subprime was a very small cause of the GFC but it was the tipping point that brought the house down.
In contrast, if your arm resets from 3% to 7% it's like a 50% increase in mortgage payments. That sucks, but manageable given that your salary likely inflated along with your payment.
Which, anecdotally, has not been true for myself or any of my colleagues (barring the ol' job switch raise). Wage stagnation is an extremely common problem in many countries and industries. Those that have gotten or negotiated for raises aren't getting raises that account for the record-setting inflation (at least in my country, which is seeing the highest rates of inflation in 30+ years)
Can I reside in a world where my salary doubles if my mortgage rate doubles? It sounds very nice.
It's not that your $100K salary should go to $200K if your mortgage goes from 3% to 6%, but rather that your $100K salary should go to $106K instead of just $103K if your mortgage goes from 3% to 6%.
Similarly, if your mortgage fell from 3% to 2%, you'd be pretty close to even if next year's salary went to $102K and likely in bad shape if it instead went to $67K.
There was also record high amounts paid back in 2020. I'd like to know if they adjust for that or just more fear-mongering by big banks, admitedly I'm too cheap to read further to find out.
The 'certain percentage' actually went over 50% of new mortgages, excluding refinancing.
>Assuming the standard 5-1 and the fact that rates are rising very fast, should we expect a repeat of 2008 in 2026-2027?
You would think so but no. We should expect it in 2022 primarily harming the large cities.
[0]: https://www.ezhomesearch.com/blog/second-home-mortgage-rates....
> Borrowers with limited or troubled credit histories are defaulting on credit cards, car loans and personal loans
This is irresponsible in my opinion. (I'm sure some disagree.) Personally, I took the conservative approach where during my home purchase we made sure our income could afford a mortgage. Our RSU's are a bonus and when they come we can pay down our mortgage faster, go on fun vacations, or do all sorts of other things.
Currently, I'm on pace to pay off my 30-year mortgage in 8-10 years by putting half of my RSU's towards my mortgage on top of the monthly payments.
This is not a great idea if you have a 30-year fixed mortgage with an APR below inflation. You're better off not paying it off, and instead setting aside the cash you would have used. Even in like a Series I bond which is currently paying 9% APR.
Money loses value every year, and it's losing value faster than your mortgage is going up in cost. Therefore, why would you pay it off today using money that's worth more, when you can pay it off in the future using money that's worth less?
Especially if you can park your money in something that tracks inflation.
Paying off your mortgage early is one of those things folks are always told is good - it's really not.
That's a free 9%+ return on capital. You're giving up free double-digit returns by paying off your mortgage early.
If you're in tech and paying your mortgage depends on your salary and your RSU's you are not being financially responsible.
It only makes sense if there is a legitimate fear that someone might otherwise waste the money on frivolities - for many people saving and the self control it requires is very challenging.
Made the difference between me qualifying and not (for a 10% down jumbo, which was admittedly a stretch).
However not discouraged by that fact, some tech folks are known to instead have taken out regular non-mortgage variable rate loans with their RSUs as collateral. So there are folks, who bought a house "all cash" with loans backed by stock collateral that is now worth much less. Those types of loans also have a double-digit APR, which might have been fine if you thought you could flip your house for 30-100% in the near future. In the current housing marking it is like putting everything on black at a casino, it might work out, but it might be also be a complete catastrophe.
Nah not all of them. Margin loans were as low as 0.5% APR, and currently not much higher than that.
IBKR charges 2.33% base rate, reducing to 1.58% for balances over 1 million USD.
Multiple lenders, when I was shopping for a mortgage in October, encouraged me to take a variable-rate ARM with a balloon payment when I mentioned my options. (I declined, opting for a 15-year standard instead.) For the lender, as long as you can refinance in 5 years, the risk is minimal. For a borrower, this structure could easily wipe out one's savings.
There is however a definite problem of people across all income levels living way above their means.
The first time for a refinance and the second time for HELOC. Both times they would only consider my base. Luckily I lived in a relatively low cost of living area and we weren’t talking about that much by todays standards - a $300K refinance and a $160K HELOC a so my base pay was enough.
The third time when I tried to get an investment property, my DTI was too high to qualify based on solely my base. If they had counted my RSU grants even considering the 30%+ YTD decline, it would have been more than enough. I ended up doing a no income documentation loan and paying down the loan by a point. I also had to put 30% down.
For the second one, they still questioned why my stated income for 2022 was much lower than my actual income for 2021. I had to re-explain my compensation structure.
[1] How do you say which BigTech company you work for without saying which BigTech company you work for.
Absolutely true; the question about whether they may cause an imminent one is still a good question. Rhymes-not-echoes, etc.
Google cruft suggests that the number of ARMs was < 5% five years ago but has climbed recently, e.g.
https://www.nbcnews.com/business/business-news/adjustable-ra...
from April says: "The adjustable-rate mortgage share of applications last week was over 9 percent by loan count and 17 percent based on dollar volume."
I would welcome informed comment on what the total outstanding % of loans by count and total volume data looks like,
and in particular, insight as to whether the amounts are likely to trigger market disequilibrium...
The business model has been so successful in recent years because there have been such large numbers of applicants. Even though they approve only a fraction, the sheer volume means their business is booming. This all translates into not having to dig any deeper than credit scores.
1. Are these subprime loans packaged in CDOs or any other kind of highly-rated derivative instruments?
2. If so, how exposed are the banks this time? What are current leverage limits?
3. Are there swaps on these instruments, and if so, are these positions being taken by the banks that are selling the CDOs?
4. If so, how exposed are the insurance firms?
In short, are the conditions in place for a similar event to 07/08? Has any meaningful regulation been introduced that extends beyond the mortgage market?
Looking beyond conventional lending, what is the scale of cryptocurrency lending? As I understand it, there's not much in the way of regulation when it comes to cryptocurrency, and I feel like that's probably a recipe for disaster somewhere in the future.
The home ownership rate is ~65%: https://fred.stlouisfed.org/series/RHORUSQ156N
Theoretically, there are close to 30M HH that want to own a home, but don't.
That's close to 100:1.
More practically, probably only a 1/3rd of them are remotely qualified to buy something they'd want to own, and only a 1/3rd probably actually want to own & are currently interested in houses at this price.
That could still be >10 buyers for every house.
That is determined mostly by loan servicing costs to income ratios. What happens when interest rates go up?
Hint: what people can 'afford' changes. And it doesn't get better.
Prices on the market of course won't dip right away, because most sellers don't have to sell right away, and most owners won't have to sell at all. It takes inventory backlogging and houses sitting on the market a few years (usually) before sellers get desperate and start being willing to compete on price. Short sales and foreclosures can force the issue sometimes, but since people REALLY want to avoid those, they also tend to be lagging.
In rich neighborhoods, often the sellers will just pull the listing and wait, both to avoid drops in nearby property values based on comps (neighbors will hate them, and that matters in places like that), and because they have the capital to wait out a downturn and don't want to take the haircut.
The poor/shitty areas though, once the dam breaks it is quite impressive. I've watched it happen a few times now.
This is why real estate is often considered illiquid and hard to value.
There are signs anyone can read about the future, but nobody really knows exactly what they mean or how it will work out. If house prices continue to increase, but at half the rate of inflation: get in now. If house prices go down then wait. Just to make this more difficult, where are you living now: unless you can continue to live rent free in your parent's basement (I'm sure someone reading this is actually doing that), then you need to consider the cost of rent while waiting: even if a house goes down in value, it may still be worthwhile as an investment because most of the payment is coming from rent. Then there is the cost of maintenance which might be significant. There is the cost of moving: if you rent you can break the contract and leave a lot faster than if you have to sell a house in a now bad location first.
If you think I covered even half of the considerations in a couple short paragraphs you are very naive.