Monday, August 13, 2007

Understanding the Mortgage News Headlines

I tell you what - I think I might write a book! There is so much information and nuttiness out there that I don't know how the average consumer wades through it all. Well, never fear! I am here to help cut through the clutter!

Here's the scoop. Have you ever wondered who / what funds mortgages? Let me tell you who - Wall Street does in the form of mortgage-backed securities. Not Countrywide, Ditech, or Park Place Funding. No, investors fund home loans. That may sound complicated, but it really isn't. I know all of you have done some reading on investing and you've heard of "save" / "conservative" portfolios that have a lot of "bonds" instead of "stocks." bonds are basically loans that pay an annualized rate of return until the loan / face amount is returned to the investor. Governments sell bonds to finance debt, big corporations like Boeing sell bonds, and municipalities sell bonds. There are different kinds of qualities of bonds, but they are generally seen as "safe(r)" than stocks because they generate fixed income over a period of time plus the face value of the bond to the investor. You won't get a 30% return on a bond, but you can get a better return than you can at your bank without taking on the full risk of the stock market.

Back to mortages. Residential mortages are funded and then pooled together (securitized) into the bonds that investors purchase for fixed-income / investment yields. Financial institutions buy them, hedge funds buy them, governments buy them, etc... They are historically very save because they are collaterlized by real estate and have a very low default rate. Now - in the U.S., you can break this down into 2 types of mortage-backed bonds, "agency" and "non-agency."

Agency mortages are those that have been securitized through the agencies of FannieMae or FeddieMac. FNMA and FMAC stand behind qualified mortgages so that if the borrower defaults on their mortgage, the bond pool / investor isn't left holding the bag. 90% of my clients fall into this category. The second type, "non-agency," is not backed by FNMA or FMAC so that if a borrower defaults - guess what - the bond / investor takes a hit. Examples are jumbo loand "Alt-A" / stated-stated loans, and sub-prime loans.

Speaking of sub-prime... As you know, default rates in ths area have been rising and there is fear that defaults will get worse. The bond pools that included these kinds of loans went from AAA ratings to junk-bond status - which means they may not pay the investor the expected rate of return of rafe value of the bond. Needless to say, investors don't want to buy those any more!! Now if investors don't want to buy those bonds, lenders don't have money to lend, and sub-prime consumers can't get a loan. Period, then end.

When you hear about a "credit squeeze" or "crunch" this is what we're dealing with. Investors don't want 'non-agency paper" because they see the risk outweighing the reward. They just don't want to buy non-agency paper because no one seems to know where the the foreclosures / default rate will end. (When you hear "market dislocation" or "risk repricing" this is what is being taked about). this had made it very, very difficult to fund anything that is not FNMA/FMAC "fast-ball, down-the-middle," loan because there is no money to fund them! The investors for non-agency paper have run to the proverbial hills.

I'm not going to predict what will or won't happen in the non-agency loan arena because I really don't know. What I do know is that I am SO THANKFUL that MOST of my business is predicated on "prime" borrowers that are backed by FNMA and FMAC because investors still LOVE those bond pools! They love them because the "risk" is taken by these agencies, not the investor! if you want to stay in the FNMA / FMAC worlds - keep good credit, keep your job, and protect your home equity! Do these things and you'll never have to worry about your mortgage because investors LOVE you and the fixed income you provide through your monthly interest payments!!!

Written by: Swan Johnston
Mortage Loan Consultant

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