Lot of ink in the news these days about the mortgage problems brought on by subprime loans. What are these anyway?
Why would lenders or borrowers do this? Short answer is money.
Who benefits from these deals? Lenders (when the loans are good), but more importantly, lenders reward loan officers with bonuses for loaning money. Often times, loan officers have quotas or goals for volume of money lent. Lenders make money on the origination fees, points, etc, so they push their loan officers hard to push money out the door, and reward them when they do. Realty agents work off commission and often times 5% or more of the purchase price is divided up among realty agents in the transaction. Let’s see…..commission or no commission? To be fair, there are a lot of RE agents who saw the problems and did none of these deals. But there are a lot of RE agents, and some made a lot of money doing it. Hope they sleep well.
Then there is the rest of the RE industry (title companies and escrow agents, surveyors, inspectors…… and appraisers!) who benefited from these transactions. A lot of folks were getting a piece of the action.
And lastly, the borrowers themselves. Why not take on a house with nothing down? Keep in mind, when these loans were being setup, home prices were soaring…maybe a $100,000 house today would be worth $120,000 next year? The only way to screw up the deal was to not be a part of it. So these borrowers took a chance and rolled the dice. Why not? If you have nothing to lose, you have nothing to lose. But with the perfect vision afforded by 20:20 hindsight, we can now see it was as if it were setup to fail.
So aside from all the money that was dispersed, what went wrong? The lending industry is based on a system of checks and balances……the Five C’s of credit:
In the subprime mess, just about every one of these were ignored. Collateral (as reflected by an accurate appraisal) is one of them. Appraisals are to be relied upon in the loan process as offering a realistic level of market value. Lending only a portion of that creates a built in cushion of equity from the borrower. When all the standards are ignored, such as when appraisers are instructed by lenders to make deals work or lose the business, and there is no equity, trouble is bound to happen. So why ignore the Five C’s? Money.
The best thing for government to do is to stay out of it. Let the lenders work it out on their own or fail, after all, it was something they themselves created. To those caught in the middle, this is a painful process, but this correction is a good dose of medicine the industry was in desperate need of. A government bailout would only encourage more of the same type of reckless behavior.