Tuesday, October 16, 2007

Why did you take the ARM?

Countrywide is getting criticism for not permanently fixing the rates of several hundred thousand homeowners in risk of foreclosure. Part of this is being fueled by a protest group, NACA (or the Neighborhood Assistance Corporation of America).

If you take a look at their site, you will see all kinds of emotional statements designed to make you sympathetic to their cause, things that have nothing to do with subprime borrowers in foreclosure. Information such as "Chairman of Countrywide, one of the leading companies, is reported to have earned $22 million per year" seems to encourage the thought that because the CEO of a multi-billion dollar corporation is rich, he should forgive people who haven't been paying their mortgage.

These “geniuses” and their companies actually compensated their brokers and agents more if they marketed and closed loans containing abusive yield-spread premiums, low teaser and high re-set rates, and other costly loan terms and conditions
In other words, it worked like just about every commission based sale out there. Shocking that the company would give higher commission for a loan that makes the company more money.

Why on earth would the rates for these loans be so high? Why is lending to people with bad credit and lots of debt result in high rates? They answer it themselves: "almost one in every five subprime loan goes into default", yet they don't seem to make the connection. To be profitable, a bank has to get paid for the money it lends out. If a group of people tend to default at higher rates, their interest rate will be higher to ensure the bank doesn't lose money on those loans.
Modify every loan back to the rate at which these borrowers were or should have been qualified, and everyone wins. People can keep their homes and avoid financial ruin, and lenders can still receive payments on mortgages that borrowers can actually afford.
Here's the problem, NACA, they weren't qualified for payments they could afford. They were qualified for high interest adjustable rates, and that's exactly what they got. It is not the banks duty to set payments that someone can afford, it is the borrowers responsibility. What you are suggesting essentially shafts every single American paying a regular rate on a 30 year fixed.
These “genius” profit barons have pretended to create unparalleled homeownership opportunities for working people and families. Instead, they have preyed upon the most vulnerable, often based on a low credit score -- people with marginal credit and limited resources who could and should have obtained homes through fair lending practices. They charged people interest rates above 10% and often enticed them with teaser rates of 6% and less for the first two years.
The banks took a huge risk by putting these people into homes with teaser rates, when all the statistics showed that there was a high probability of default. To make such a venture profitable, they needed to charge higher interest rates later in the loan. These people could have used that time to rebuild their credit, save up to afford the new payments...anything. Instead, they rode along and when the teaser rate expired, cried foul. They can't refinance because, surprise, their credit still isn't any better.

Bottom line, it is not the banks responsibility to create a loan that is affordable to the borrower. Their only interest is in creating a loan that is profitable. It is the borrower's responsibility to determine whether that loan is affordable to them or not.

Banks don't want to foreclose. It costs money to foreclose. They end up with a house, which in all likelihood has been trashed by the deadbeat homeowner, that they have to sell for cheap at auction. They want you in your house, paying your mortgage, paying that interest. But because the group you fell into, that bad credit group, is a high risk and will default in higher numbers, your rate is higher in order to make up for the other deadbeats who do foreclose. Why is this so difficult to understand?
At the same time, some acknowledge that regardless of whether their loan is modified, some borrowers could lose their homes anyway because their financial situation is otherwise precarious.

"It all comes back to affordability," said Richard Pittman, housing services coordinator for ByDesign Financial Solutions, the Los Angeles branch of the Consumer Credit Counseling Service (CCCS). "As recently as 12 months ago, some were refinancing themselves out of their problems. A lot of them were just kidding themselves. They were fine through their second refi, but the third refi caused them problems."
Yes, I have read that a good number of these people in subprime loans in foreclosure, perhaps even the majority, are refinances. They refinanced equity to pay off their debts. This is the consequence of such a debtors lifestyle.

What is missing here? Case studies. No one appears to be asking these homeowners one very important question: "Why did you take the ARM?"...I would be very interested in hearing their answers.


Mrs. Micah said...

Case studies would be really interesting here.

I think that ethical banks should be very careful when explaining loans to people and should discourage them from getting in to deep. But that's just being a good company, that's not what they're legally required to do and it would probably not make business sense. In the end, the consumer took a loan they couldn't afford...

Jim said...

I have a 7 year ARM at a rate on the edge of 6%. The reason for doing this was we did not plan to live in our house very long. Secondly, the house is completely financed under me because my wife and I were engaged at the time. It is stupid beyond stupid to buy a house with someone you are not married to. We looked at the possibility of refinancing later on but she has a lot of student loan debt that pushes the debt to credit ratio. She doesn't have bad credit, just too much credit, so it's safer for me to handle the debt load of the mortgage.

Our careers are just starting out so once we start to settle down in our later 20s we'll look for a regular family home that we can park it at least a decade. We'll have a 20% down payment and get a fixed rate mortgage and try to pay it off quickly.