- John Polk said “I knew Charles when he was EVP of The Atlanta Chamber and I worked for ...” on Memories of Oklahoma City circa 1993
- John Polk said “Back in the mid-80's and early 90's, Cleveland was actually recognized as one of the ...” on Economic development in NEO: A view from the street-level
- John Polk said “Is there any way to substantiate Dimora's claim re: GCP and the PD, other than ...” on Cleveland’s new development dynamic?
- George Nemeth said “Like all glimmers of newness in CLE+ I expect this one to be crushed too” on Cleveland’s new development dynamic?
- Cleveland’s new development dynamic? | Brewed Fresh Daily said “[...] by Ohio voters, as gambling interests convert the Ohio constitution into a zoning ordinance. ...” on Ohio’s casino deal gets a bit more messy
- About BDP Comments
There has been a lot of talk about all of the ills of subprime and a fair amount of discussion over what happened and who is to blame. I thought it might be helpful to see what an actual subprime loan looks like and see why it was issued in the first place.
Joe makes $4,000 per month but he built up serious credit card debt (groceries, electronics, music, travel, medical bills, whatever) and after monthly expenses, he has nothing left. Joe gets a letter in the mail (or a phone call) from XYZ Mortgage, Inc. The letter says – we can help you consolidate your debt. So, Joe decides to meet with the broker and they go over his financials:
Joe’s gross income: $4,000 (~$50,000 annually)
Joe’s net income: $3,250
(I have played it a little loose with the numbers here since I don’t have anything specific to work off but this was fairly typical of a subprime loan in the late 90s. In the 90s though, the interest rate spread between prime and subprime loans was wider, 3% or more (I think) then it was during the bubble. The interest rates used here may be low and may actually paint a somewhat more favorable picture. This example is a 30 year fixed rate loan.)
$150,000 mortgage ($1100/mo) (8% fixed, 30 years)
$10,000 credit card 1 ($250/mo)
$15,000 credit card 2 ($375/mo)
car, ins, taxes, etc. ($700/mo)
Joe’s total monthly fixed expenses: $2,525.00
$500 groceries (has kids)
$100 misc. (many other possible variable items)
Joe’s total monthly variable costs ~ $1,000
$2,425 + $1,000 = $3,425 = no breathing room
The broker informs Joe he can get a new $175,000 mortgage and move the credit card debt into the mortgage to free up some cash. The new deal looks like this:
The appraiser reports that Joe’s property is worth $200,000 indicating the property has appreciated by $50,000. (This could be legitimate appreciation or the broker may have informed the appraiser in advance that he needed a $200,000 valuation so the deal could close. There is a considerable amount of documentation that this type of appraisal fraud is common. More on this later.)
New $175,000 mortgage (1300/mo.)
New monthly fixed expenses:
$175,000 mortgage ($1300/mo)
car, ins, taxes, etc. ($700/mo)
Monthly total: $2,000
Old fixed – new fixed = available cash
$2,425 – 2,000 = $425
Once Joe has his new subprime loan, he has around $400 of additional cash available per month.
Does Joe live happily ever after?
A lot of that depends on Joe. Does he start saving money? Does he get a new credit card offer in the mail and get himself into credit card debt again? One thing that people may have trouble understanding is that once you have gotten yourself into debt, it is very difficult to get out. The burden just increases over time. Getting in debt is a lot like gaining weight. When you are 200 pounds overweight, it is that much harder to get up and exercise.
In this example, the debt-to-income ratio is 50% ($2,000 debt / $4,000 income). [I think Fannie will go up to 40-45% debt, I need to look that up.]
So, even under the best circumstances where the borrower is fully documented and the broker acted properly, the situation is tenuous. If you start layering-on the various forms of mortgage fraud (falsified income documents or statements, appraisal overstating property value, predatory lending, concealed debt, etc.) and the situation is entirely unworkable. The borrowers will default even if it is not an ARM.
If you are going to blame the Federal Reserve for keeping interest rates too low and creating a credit bubble (which basically means that money was cheap enough for people to act irresponsibly) then I think you need to drag the credit card companies into the equation as well (as this example illustrates). (it is a lot easier to get a credit card than a mortgage.)
Let’s look at a variation on this loan. Now, suppose that Joe’s house, though it appraised for $200,000 was really only worth $170,000. He’d owned the house for seven years but his neighborhood was not seeing the type appreciation of some of the other, nicer neighborhoods. When the broker placed the order for the appraisal, he also informed the appraiser that he needed a $200,000 valuation (Joe is likely not aware of this). So, the appraiser, not necessarily a bad guy, but dependent on the brokers for income, cherry picks the comps (the property comparisons), the appraisal is good enough to get through underwriting and the deal gets approved. Now, for whatever reason (lost his job, he needs to re-locate, etc) Joe needs to move. This time, when the house is appraised it comes in at $170,000. Joe figures out that if he sells his house he won’t have enough to pay-off the loan, realtor fees and other expenses – he is underwater.
There are many different types of subprime loans but this is a fairly typical example…
Last 5 posts by Rick Pollack
- Open Fabrication - Part III - November 12th, 2009
- Open Source Digital Fabrication - Part II - August 11th, 2009
- The Desktop Manufacturing Revolution (Fast Company) - July 15th, 2009
- Would you like to be able to do this? - July 14th, 2009
- Open Source Digital Fabrication - July 9th, 2009