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With the sub-prime meltdown hundreds of popular loan programs have been cancelled virtually overnight. These programs were risky loan programs and Wall Street finally said, "No thanks". For many borrowers however this was the only way to achieve the American dream of home ownership. Buyers who were self employed and didn't have perfect credit could obtain zero down stated income loans. Life was good.

The news isn't all bad however. Remember the FHA loan program? The one where you need to put 3 percent down and some or all of the down payment can be borrowed or gifted? You know; the loan program where you can use the income of a non-occupant co-borrower or co-signer to qualify? The sub-prime shakeout is sure to lead to the rise in popularity of the FHA loan. It's really the only option left for the buyer with little or nothing to put down on a home.

Here are some of the benefits of the FHA loan:

• Only 3% down payment.
• All or some of the 3% down payment can be gifted; gifts can come from non-profit agencies, family members or lifelong friends.
• Relatives or life-long friends can co-sign in which case the lender will use co-signer's income to qualify even if they live on the other side of the country.
• Lenient debt to income ratios.
• You can use non-traditional credit like your car insurance or water bill for credit.
• No credit score requirements.
• Low rates so you qualify for more Home.

How can they do it? The same way they have been since 1934. The FHA or Federal Housing Administration is part of HUD which is short for the Department of Housing and Urban Development. According to HUD's web site the FHA insures the loan so the lender can offer homebuyer's a better deal.

So, is the FHA loan the silver lining to the mortgage market fallout? It may be - especially with the onset of the discount real estate brokerages such as EZdigs, Redfin, Zip Realty and others. Many discount real estate brokerages will credit a portion of their seller paid commission to their buyer's at closing. This can help offset closing costs. So combine the benefits of FHA financing with an experienced discount buyer's agent and zero down purchases are once again possible.

Author

Mike Satterlee is president and broker of EZdigs.com. Written with the assistance of Tryg Satterlee, president of West Horizon Financial, an FHA-approved mortgage company.

About EZdigs.com

Headquartered in Kirkland, EZdigs was incorporated as a limited liability company in June of 2006 to address a growing need in the real estate industry: To keep the cost of home ownership affordable and accessible. Mike Satterlee, the company's president, chief executive officer, and principal broker, founded the company after working in several different sides of the industry, including production homebuilding, development, finance, construction, and real estate. His experience provides a unique knowledge and informs his understanding of the marketplace. The company also provides industry intelligence, monitoring the market daily and providing periodic new construction and resale reports. Additional information may be found at www.ezdigs.com or by calling 425-577-4295.

Note to editor: All or part of this commentary may be excerpted for publication. You may op-out by responding to this e-mail with "no thanks" in the subject line. If someone else in the newsroom should receive this, please feel free to pass it on.

Thank you,
Mike Satterlee
President/Broker
EZdigs.com

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By Mike Satterlee
President, CEO, Principal Broker
EZdigs

To fully understand the answer to the question - will the mortgage meltdown cause a full-blown crash? - we have to first understand the mortgage mess and how it came to be. We've all heard about the sub-prime meltdown but what does it really mean?

Borrowing more with less, the basics of the sub-prime loan

Back in the good old days when home appreciation was as automatic as a Cadillac, lenders loosened up their credit requirements. This is common when times are good but when the market slows these lenders simply pull back and reign in the criteria. This time however they let things go too far. Many loans were made with little or no income verification and with very high loan to value ratios (LTV's). In fact, many of these loans were actually 100-percent LTV loans. In addition, lenders were using very high debt to income ratios to qualify borrowers on high-risk loans--up to 65-percent (meaning their mortgage payment could be as high as 65-percent of their monthly income). But times were good and homes were appreciating and investors wanted a piece of the action.

Economic downturns in some areas hit housing prices hard

The trouble started when the housing market slowed around the country almost two years ago. The Northwest was largely unaffected because our economy is anchored by technology, international trade and aerospace all which chugged happily along. While areas like Florida, California, Arizona and Nevada, where appreciation had been very strong and consistent, were struggling and housing prices started tumbling causing the rate of foreclosures to rise. This is when it started to get big and ugly; well-established mortgage companies started dropping like flies.

Wall Street pulls out of high-risk loan market or when the going gets tough, the tough get going

Here's where it gets tricky - these mortgage companies went out of business, not because of the foreclosures directly but because the institutional investors on Wall Street that buy mortgage-backed securities by the billions were suddenly not buying mortgage paper that included high-risk loans. This means that mortgage lenders that "sell" their loans lost their source of funds, literally overnight - game over. The only survivors are those companies that balanced their portfolios with enough standard "A" paper loans to weather the storm. So panic ensues and the pendulum starts swinging and as usual - it goes clear over to the other side.

Now not only have these high risk loans been completely eliminated but all loans, even standard "A" paper loans have come under serious scrutiny. Underwriting guidelines for all loans changed overnight and finally, jumbo loans or loans over $417K have increased rates up to ~8% for a 30-year fixed. So loans have become harder to get as underwriting guidelines have tightened, debt to income ratios reduced, maximum LTV's effectively reduced, and the cost of borrowing money has gone up.

Tightening credit guidelines impact the market

We'll come back to the cost of money in a minute but now in light of the changing credit environment - let's again look at those households who used the loose credit guidelines to "buy more house". Their situation has now changed in a very profound way. These individuals got into their homes with little or no money down and now their homes have lost value. They can't refinance because the only lending instrument available to them is gone. They can't sell because they owe more than their home is now worth. Compounding this situation is the fact that most of these high-risk loans were fixed arms. Meaning they are fixed for a short period of time, for example, two years and then become an adjustable rate loan. The kicker is that the first adjustment is usually a 2-percent increase to their current interest rate. These families can't refinance, can't sell and now, within the span of a predetermined month, can't afford their mortgage payments. OUCH! All these people can do is give their keys to their lender and say with a smile--good luck getting your money back.

Housing costs continue to march upwards

The cost of ownership has gone up considerably and here is why:

• The days of easy money are gone. If you want to buy a house in today's environment you actually have to qualify for the fully adjusted rate. Meaning one has to make considerably more money to afford the same $550,000 home than they did just two-months ago.
• As mentioned above, jumbo loans (loans over $417K) are now in the 8-percent range with no good low-rate alternative.
• Down payments now are a must. Zero-down loans are still out there but they are not as easy to get as they were in the "glory days". No longer will first-time buyers be buying $650,000 homes with no money out of their pocket. Today's underwriting guidelines will force them to buy a "starter house" that they can actually afford. But this is good news for the long-term stability of the housing markets.

The net effect of the credit tightening on the cost of housing is that we are left with higher monthly cost for most homes in our market (Greater Puget Sound) and higher cost of entry due to the elimination of the easy-money, zero-down programs. Fewer people can qualify for a home and those who can qualify, qualify for much less than they did just a month or two ago.

So how does this phenomenon cycle back and affect housing prices? There are several different important factors:

• Increased cost of housing means fewer people can afford to purchase homes - those who can qualify will qualify for less (which again is actually a good thing).
• Homebuyer/seller anxiety means more people are either staying put and riding it out or they are unloading their home, getting what they can and renting before they lose everything
• Both of these factors lead to fewer buyers in the marketplace which makes homes sit on the market longer and causes those who have to sell to resort to price reductions to move their homes.

Lower housing prices will ultimately lead to widespread depreciation across the country and in the Pacific Northwest

The depreciation will affect the Northwest but how much is more difficult to determine. Homes prices will likely depreciate slightly by the end of the year, perhaps by as much as 5-percent in some areas and depreciation will be even more severe in the higher-end markets. There is no hard data that I know of however some experts have estimated that these changes in the marketplace have reduced the existing buyer pool (would be buyers) by as much as 20%.

Laying blame

Now that we've dissected the mortgage mess and it's affect on the housing market - whose fault is it? How did we get into this mess? Many have been quick to point the finger at the irresponsible individuals who took out the loans or the unscrupulous lenders who made them. Let's look at both parties.

The extent that borrowers themselves are culpable

Many have been quick to point fingers at the borrower's themselves. After all they're the ones who took out the loans putting themselves in this precarious position. They knew the risk so they should shoulder the blame, right? Just one problem with this line of thinking: Mortgages are incredibly complex and most people don't fully understand the loans themselves - let alone the potential risk associated with various changes in the market. Think about this for a second; owning a home for most people is the single largest investment they will ever make, yet there is virtually no formal education about how the process works.

Let's look at these 'unscrupulous' lenders who sold consumers on high-risk loans

The lenders certainly understand the intricacies of these loans. They understand the potential risk associated with changes in the marketplace...right? The answer is that they should understand, however, not all do. Many states do not require formal education or licensing for Loan Officers (LO's). Further, the industry is set up to pay large commissions to loan officers (LO's) - but only when they close a loan. So the path of least resistance to a nice healthy six-figure income for LO's is to find loan products that work for the largest number of consumers - the easier the loan the better, the lower the rate the easier to sell, etc.. Add in the fact that the marketplace is very competitive and the consumer is not well educated about the lending industry and one can begin to see how we came to be in this mess.

Who really benefited from these loans?

Yes, the LO's who made these loans certainly profited but what about the companies they worked for? What kind of company would put unsuspecting consumers at risk? The answer is that virtually every brokerage company and most institutional lenders were making these loans, including the likes of Wells Fargo and Bank of America. How could this be? How could America's biggest lenders be party to this economic crisis? Simple - these loans were being bought in bulk by institutional investors on Wall Street in the form of mortgage-backed securities. These loans, like any sold on the secondary market, have to meet pre-set performance criteria set in effect and guaranteed by the original lenders. If these loans do not perform as specified by the lender who sold the loan, then the institutional investor can essentially demand their money back. This gave the institutional investors the confidence to purchase these higher risk loans and they did so by the billions.

For several years this cycle proved profitable for everyone involved, until the unthinkable happened - homes stopped appreciating. Then these loan products stopped performing as originally promised for the Wall Street investors as foreclosure rates went up. So Wall Street stopped buying. Funds dried up for lenders literally overnight and they could no longer meet their existing commitments. Already strapped for cash most of these lenders couldn't afford to buy non-performing loans back from Wall Street so they had to close their doors. Over 100 mortgage companies have gone out of business since the beginning of 2007. The reality is that the financial markets are finicky and fragile. Markets can spawn entire industries overnight but can be taken away just as fast.

The bottom line is that those who knew better allowed the underwriting guidelines to become lax because they were making money. Huge profits were being made so investors ignored the risk all the way down the line. In my opinion; while the industry as a whole is to blame, the lion's share of responsibility lies at the top. The markets have already corrected but the finger pointing continues. As the coming months unfold and the crises expands, and it will expand as existing loans continue to make that 2-percent adjustment, we'll see politicians and Washington insiders placing blame at the feet of lenders and individuals.

Caveat Emptor or Buyer Beware

Since we are in a free market the end user does share some responsibility here. And because of the way that our financial systems and economy works there is simply no one to hold accountable. The lesson here is: We must educate consumers about the lending industry and specifically the potential risks associated with various lending products. In addition, those working directly with the consumer need to be held to a higher educational standard. Most states have minimal requirements (if any at all) to becoming a loan officer. Comprehensive educational requirements should be a mandatory requirement for loan officers just as it is with real estate agents.

We are experiencing a very real correction in the marketplace. The good news is that it is only that, a correction. All other points of the economy are strong. Add to those bellwether industries mentioned earlier -- aerospace, technology, international trade - biotechnology and agricultural, and you can see that once the real estate market adjusts to the more realistic and sustainable mortgage guidelines, then the real estate market here in the Pacific Northwest will be back to business as usual. Realistically, I would expect to see the market balance itself out in the late winter months of 2008.

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