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In 1972, Fannie and Freddie began purchasing conventional mortgages, i.e., loans that were not guaranteed by FHA or VA. On these loans, borrowers could have downpayments of less than 20 percent, although they were required to have insurance from the newly formed private mortgage insurance companies.
As a result of several converging factors, including a plunging dollar and a sudden decrease in demand by Asian investors, interest rates increased almost 2 percent early in April 1987. This was a blow to the entire mortgage industry because it marked the end of a six-year cycle of decreasing rates. More important, many companies did not survive the impact of that rate hike. For every $1 million worth of loans closed after the hike that were locked before the increase, they lost approximately $100,000.
Over the next few weeks, many funding checks bounced, leaving buyers, sellers and real estate professionals empty handed. This period has had a lasting impact on the industry. Because rates increased so much over such a short period of time, nearly all 50 states changed their rules and laws in regard to real estate transactions, requiring certified funds at closing to avoid these calamities in the future. These events also caused a major overhaul of the hedging process for mortgage lenders.
A bond-market crash in June 2003 ended the long run of fixed-rate mortgage dominance in the market and ushered in the “ARM era.” For the next few years, more borrowers opted for adjustable-rate mortgages (ARMs) because rates were often more than 1 percent better than fixed rates. This took considerable market share from FHA, VA, Fannie and Freddie loans. It also increased the market share of so-called exotic mortgages to such a level that, from 2004 to 2006, the market was dominated by asset-backed securities (ABS) lenders, which included subprime, Alt-A, option ARM, interest-only and 80/20 mortgages.
As a result of rising delinquencies in the subprime market throughout late 2006 and early 2007, by March 2007, 24 subprime lenders had failed — and more were on the way. This triggered a massive loss of confidence in the mortgage-backed securities market.
Continued losses in the subprime market and fears that those issues would impact the prime mortgage markets triggered a worldwide credit crisis and turned the mortgage business upside down. The value of mortgage holdings plummeted and exotic mortgages virtually ceased to exist, returning the market back to loans backed by the FHA, VA and GSEs.
Despite the GSEs regaining their market share, they also suffered massive losses because of nationwide declines in real estate values and the accompanying economic turmoil. Although the GSEs made some mistakes leading up to 2007, their losses were magnified because of the real estate bubble created primarily by ABS lending.
Although the GSEs weren’t the primary cause of the crash, they have become easy targets to pin the housing crisis on because of their size and government affiliation. They have enabled the mortgage market to function efficiently for decades, and it is difficult to envision the U.S. mortgage market functioning without them.
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As the mortgage industry climbs out of the depths of the economic doldrums created by the subprime mortgage crisis, it’s important to have some historical knowledge and perspective about what brought us to where we are. This may help us avoid making the same mistakes in the future, as well as understand and accept the inevitable changes that will come.
Dave King is a loan officer and sales manager for SWBC Mortgage in Denver. He has been originating since 1985 and has been managing loan officer in his office since 1994, educating his colleagues. He has been one of Scotsman Guide’s Top Originators and top FHA/VA producers numerous times and currently sits on the State of Colorado’s Council of Advisors on Consumer Credit and Mortgage Task Force.
Reach him at firstname.lastname@example.org or visit www.davekingmortgage.com.
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