Last week a top State official called for a ban on risky loans. At issue are so called Ã¢â‚¬Å“stated loansÃ¢â‚¬? or Ã¢â‚¬Å“liar loansÃ¢â‚¬? as they are affectionately referred to in the industry. These are loans in which an applicant merely indicates an income amount and provides no supporting documentation. These loans typically carry a higher interest rate to compensate for the lack of supporting evidence. The rate may be a quarter to three quarters higher than a fully documented loan, depending on an applicants FICO score. Now we are beginning to see a high default rate on these loansÃ¢â‚¬Â¦Ã¢â‚¬Â¦Ã¢â‚¬Â¦.Why is anyone surprised?
Over the past several years when real estate values were increasing at an annual rate of 15% – 20%, we saw a lot of 100% financing. So an applicant had no money to put in the transaction and a credit score of 640, no worries. The potential appreciation will surely cover the default risk. In California we were blessed with new found wealth, free money. Our houses were gold mines. People refinanced, taking money out of the house to pay for trips, cars, education, credit cards, whatever they wanted. The money was just sitting there, why not spend it. People became careless, the market slowed and in some cases declined. The house was still worth more than the purchase price, but not the refinance price. Homeowners became upside down. If it goes up, it comes down. Does anyone remember junk bonds, or the tech bubble? The only things sure to go up are taxes and gas prices.
If a loan applicant has no money, and therefore no equity in a property, why should a bank assume all of the risk? It used to be that a level of commitment was required to own real estate. Recent lending practices have made it to easy for people to walk away, because financially, they have nothing to loose. While much of the negative news has centered on Ã¢â‚¬Å“predatory lendersÃ¢â‚¬?, and how they have preyed on unsuspecting borrowers, it seems to me that lender’s aren’t the only ones at fault. There is plenty of blame to go around. We tell our five year old daughter Ã¢â‚¬Å“you get what you get, and you donÃ¢â‚¬â„¢t get upsetÃ¢â‚¬?. We all need to realize there is a responsibility associated with our actions.