For more than a year, in the United States and abroad, mortgage markets have been in turmoil. Foreclosure rates have risen, Wall Street firms have become distressed, government-sponsored enterprises have required unprecedented support, and the world's banking systems have teetered on the brink of collapse. In Subprime Mortgages: America's Latest Boom and Bust, Edward Gramlich explains the origins of the crisis and outlines strategies for avoiding a repetition.
Mortgage markets ought to be well behaved. Residential mortgages are secured by properties whose values are easily estimated. Mortgage borrowers' abilities to pay can be closely approximated, and those borrowers have strong incentives to meet their scheduled payments. Lenders' willingness to issue mortgages is conditioned by the willingness of the purchasers of mortgage-backed securities to assume default risk. The result is that, for many years, credit-worthy borrowers could obtain loans to finance their purchases of appreciating assets (houses) at rates determined in national markets. Foreclosure rates were remarkably low, and when foreclosure occurred, lenders were usually able to recover the full amount they were owed. With such a predictable financing system, about 64 percent of households in the United States were able to own their own homes (Gramlich, p. 3). Less credit-worthy borrowers were relegated to the market for rental housing.
As Gramlich detailed, new lending conventions emerged in the mid-1990s that changed the mortgage market. Several new arrangements facilitated the development of the subprime mortgage market, the market for mortgages for households that do not qualify for traditional loans. The result of that development was a significant increase in the percentage of households that own their dwellings. As Gramlich explained in his fourth chapter, the social benefits of home ownership are significant; and the evolution of subprime mortgages received broad support in Congress and was generally well received in policy circles.
Subprime mortgages carry higher, usually adjustable, interest rates than traditional mortgages. Borrowers may be qualified, not on the basis of household income (and, thus, ability to meet scheduled payments from current income), but on the basis of lenders' abilities to recover the value of their loans in foreclosure (asset-based lending). Some subprime mortgages were issued without supporting documentation on borrowers' credit-worthiness. These loans serve as the underlying assets for complex asset-backed securities, whose risk characteristics are poorly understood.
One of the most troubling aspects of the subprime market is the role of predatory lenders. Although that term is only vaguely defined, Gramlich argued that some originators of subprime mortgages routinely made loans that put economically vulnerable households at substantial risk. It is clear that many of the loan originators in the subprime market, predatory or not, operated with little federal oversight.
With the evolution of subprime mortgages, millions of Americans were able to purchase their own homes. Although these purchases brought social benefits, they left the purchasing households vulnerable. When interest rates rose (and adjustable rate-based monthly payments rose with them), financial stress and increased foreclosure rates were the result. When lenders took possession of homes in foreclosures, only to discover the values of those assets had fallen, the distress spread throughout the financial sector. In recent election campaigns, the result of that distress has been described as "the worst economic crisis since the Great Depression."
Edward Gramlich served on the Federal Reserve's Board of Governors from 1997 through 2005. He was both a recognized authority on real estate finance and a skillful and engaging author. During his long academic career, he served as professor and chair of the Department of Economics at the University of Michigan and dean of what is now the University's Gerald Ford School of Public Policy. After serving on the Federal Reserve Board, he returned to Ann Arbor as provost, acting as the de facto chief executive of the University in the interregnum between presidents. Tragically, Gramlich died in September 2007, just as this volume was appearing, and as the subprime crisis was unfolding.
In this volume, he was at his best in describing the evolution of the subprime mortgage market and the many agencies, initiatives, and regulations that sought to protect consumers in it. Gramlich closed the book with a brief proposal for a thorough reform of housing finance. So many issues and problems led to the subprime crisis that no single policy change would be adequate as a remedy. Thus, Gramlich recommended intervention in the market for rental property, strengthening the consumer protection provisions of the Home Owner Equity Protection Act of 1994, and increasing federal supervision of subprime lenders.
Readers seeking an econometric analysis of the mortgage market will not find it in this volume, although Gramlich's extensive reference list is a guide to that literature. Gramlich could not have known what pain the subprime crisis would generate. Those who do know and who want to understand the history of the subprime market, its social benefits, and what steps could avoid the pain in the future will find this book invaluable.
Opinions expressed are the reviewer's and are not positions of CFA Institute.
By Edward M.Gramlich
Part of the new administration’s rescue plan for the ailing US economy is to help homeowners who have mortgage problems. Aside from asking banks to adjust mortgages and release moratorium, the Obama administration will provide assistance to mortgage borrowers even before they miss payment.
Factors such as income and the value of the property will be considered in evaluating the mortgage loan. This has caused people, from normal citizens to high officials, to express different reactions regarding this plan.
From the Home Ownership Center of Greater Cincinnati, the reaction was one of support and approval. As its president Rick Williams said, this move by the Obama administration is fantastic and forward-thinking. According to him, this will prevent people from getting neck-deep in home mortgages and encourages on-time payment.
This is amid the current home mortgage crisis that the country is in. Williams said that there have been too many foreclosures in the past year because people fail to pay their home mortgages. Homeowners get brokenhearted watching themselves walk out of their houses. States who are being hit hardly by the home mortgage crisis are California, Nevada, Florida and Arizona.
Aside from individuals losing their properties, failure to pay home mortgage have other effects such as lower property values, decline of the quality of houses and other similar properties and increase in crime threats.
Homeowners in these particular states are very welcome to the administration’s plan. One of them is Craig McHugh, a sales manager from Chandler, Arizona who recently got unemployed and facing the threat of foreclosure. According to him, although he is still able to pay his home mortgage on time, it is important for Americans to support the government in such causes.
Most negative reactions are coming from analysts saying that people are most likely to take advantage of the program and abuse it by not declaring their true situation and conditions when they are evaluated for home mortgage. According to David John of the Heritage Foundation, this solution is sending the wrong message to people, as it says that the government will solve their problems even if it may be their fault.
Author Resource:- John Cutts has been educated in the finer points of the foreclosures market over 5 years. Read articles about home mortgage information on FinancingAndMortgage.com - Home Mortgage Options for All of Your Needs.
By : John Cutts
It's not always easy to save up enough to make the traditional 20 percent down payment on a home. The good news is that there are quite a few low down payment mortgages available nowadays. But when deciding how much to put down, you should consider the following: Is 20 percent the standard down payment?
In order to qualify for a conventional mortgage, lenders usually require a minimum down payment of 20 percent. If you put down less than 20 percent, most lenders will require you buy Private Mortgage Insurance (PMI). This insurance typically costs about one half of 1 percent of the purchase price of the home and protects the lender in the event that you should default on the loan. Your overall mortgage costs will therefore be less if you come up with 20 percent down and can avoid having to pay PMI.
What if you put down less than 20 percent? If you can't afford a 20 percent down payment, paying PMI may be your best option. And once you reach 22 percent equity in your home (or sometimes 20 percent equity with a good payment history), you can get your lender to cancel the insurance.
Another option available to you is securing an 80/10/10 loan. It enables you to avoid PMI by financing half of the required 20 percent down payment with a second mortgage. 80/10/10 loans work on the principle that the bulk of the selling price of the home is paid for through the first mortgage, with 10 percent being paid off with a down payment, and the remaining 10 percent being paid off with another mortgage. You may also pay off the 20 percent down payment with an FHA loan that you secure from the government. Again, you will have to pay for insurance, but you may qualify with a down payment as little as 3 percent.
What about putting down no money at all? There are actually some financing plans available that will allow you to pay for the full cost of the home without having to pay any down payment. The downside is that these types of financing plans will entail much higher interest rates than typical mortgage arrangements. This means your monthly mortgage payment will be higher. Also, because you didn't make the standard 20 percent down payment, you will have to pay PMI.
Let us look into other payment alternatives available to you. When trying to determine how much to put into the down payment, you should explore your various options in order to find a plan that will best suit your circumstances.
Q: Would you prefer getting instant equity in your home and lowering your monthly mortgage payment? If so, paying the 20 percent down payment is your best alternative.
Do you want to save on paying PMI costs but are unable to raise the 20 percent down payment? An 80/10/10 loan may then be your best option.
Q: Can you only come up with a 3 percent or 5 percent down payment and don't want to wait to buy a home because you are concerned about rising house prices? A: Maybe a government insured FHA loan would be a good answer.
Are you unable to raise enough money for any down payment but are willing to incur the extra expense of a no down payment mortgage plan? A: Provided you are able to handle the required payments and are confident your financial situation will enable you to refinance for a mortgage with better terms in the future, it could be the way to go. The important thing is to evaluate your own situation carefully before you decide how much to put down on a home.
Article Author: Al Zan
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