Although the credit union didn’t officially announce the next recession in their advertising, their actions speak louder than words! A credit union in Colorado announced they are offering 100% no money down mortgages. “We are looking for a way for individuals to get into the market right away rather than having to save up a down payment while the prices are going up,” said Doug Schneider, vice president of marketing at the credit union (Denver Post).
What is the number on predictor of a mortgage loss?
Being a lender for over 20 years, riding through the various cycles, one item is the number one indicator of whether a lender will take a loss. Loan to value is the metric that matters most.
Why is LTV so important?
Regardless of what all the economic experts say, people do not act in a rational fashion. This was true in the last real estate downturn and will continue to be true in the next cycle. As soon as a loan is “underwater” the default rate increases substantially. With 100% financing, the minute there is a hiccup in the economy these loans become at risk. In the last recession values dropped precipitously putting many borrowers underwater almost instantly. If you are a borrower and values declined 10% in Denver ( a conservative estimate), why would a borrower continue paying on a mortgage that they owe more on than it is worth? We saw in the last recession millions of borrowers did just this causing values to fall further and saddling lenders with large losses. This will happen again regardless of what the experts are saying. Loan to value is the primary indicator of a loss and will continue to be in the next recession
Why is this the top?
Whenever financial markets get “creative” to continue driving volume is an indicator of the top. This occurred in the last recession and is occurring again. This new 100% product according to the credit union is safer because they are focusing on higher credit quality borrowers. Unfortunately, credit score is not a great metric for success on a mortgage with high leverage products. If you look at this last cycle, towards the tail you saw a large increase in “creative” financing in order to drive volume that doesn’t fit conventional underwriting. This is exactly what is occurring now with this new product.
You are impacted
Even if you do not take out one of these mortgages you could be impacted and need to protect yourself. Areas with higher concentrations of high leverage loans are much more prone to declines. In the last recession areas that had high concentrations of subprime loans (like 100% financing) declined considerably more than other areas. This occurred because there were more foreclosures in these areas.
How can you tell if your neighborhood is impacted?
Whenever a sale occurs in your neighborhood, go to the county assessor to see what was paid for the house and what mortgage was used (loan to value). As a lender when I look at a property I do a radius search and it tells me the last 15 sales, what they sold for, and how much their loan was. This is critical to identify areas more at risk. Ironically, a few years ago, I started noticing this trend of higher leverage in my neighborhood in Evergreen and decided to sell and buy in a more “stable” area.
I’m a big fan of creativity, but when financial creativity is used to fit a square peg in a round hole, I know there is a storm brewing. Will you be impacted by the next storm? Will you take the appropriate steps to ensure you can weather the next cycle?
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Written by Glen Weinberg, COO/ VP Fairview Commercial Lending. Glen has been published as an expert in hard money lending, real estate valuation, financing, and various other real estate topics in the Colorado Real Estate Journal, the CO Biz Magazine, The Denver Post, The Scotsman mortgage broker guide, Mortgage Professional America and various other national publications.
Fairview is the recognized leader in Colorado Hard Money and Colorado private lending focusing on residential investment properties and commercial properties both in Denver and throughout the state. We are the Colorado experts having closed thousands of loans throughout the state.
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