San Antonio Real Estate and the Subprime Crisis
Executive Summary
Written by Randy Watson
Recently, newspapers, cable news services, and talking heads everywhere have been tossing around the phrase, subprime crisis. What they are so indelicately referring to is the recent rise in defaults on subprime housing loans, and subsequent foreclosures on properties across the U.S. Many of these lenders now find themselves in real trouble, with some having declared Chapter 11, or having been delisted from the NYSE.
When started, subprime loans were a niche market, appealing to people with bad or no credit, and allowed these people who had previously been shut out of the American Dream, to take part in it, and to become homeowners. Subprime loans now make up roughly 25% of all housing loans.
Unfortunately, greed, and gaming of the system has facilitated the current ‘crisis.’ By placing their clients in ‘exploding ARMs or adjustable rate loans, which end up blowing up in the face of the borrower, many companies have profited briefly, only to finally see the property go into foreclosure. ‘Flipping’ houses has been a contributing factor as well, artificially raising prices, and many times causing the flipper to have to take out a subprime loan, to cover his investment when the market inevitably cooled off.
How all this will play out in the long run remains to be seen, but the effects of the ‘crisis’ can be lessened if borrowers and sellers both begin to act more responsibly and understand certain changes that should be instituted. Lenders must do everything in their power to keep people from losing their houses. Foreclosure has a far-reaching impact, not only economically, but socially as well. Newer, stricter guidelines must be applied, and due diligence on borrowers, should be practiced.
Borrowers have to understand how the loans work, and must do everything in their power to make their payments. Mortgage borrowers with lower credit scores may still be eligible for loans, but lenders may require higher down payments of up to 10-20%.
As far as the San Antonio real estate market is concerned, San Antonio, presently is not a problem area on the national level, but has seen its share of increases in foreclosures. Over the past two years, foreclosures are up 15%. San Antonio REALTORS must do the same as national real estate agents, and institute measures to help lessen the impact in south Texas, and in the rest of the country, also.
San Antonio Real Estate and the Subprime Crisis
The beginning months of 2007 have seen some interesting moves in the stock market and in the housing sector—not all of which have been good news. Subprime lenders have been especially volatile, and many experts are calling what has been occurring the “subprime crisis.” Newspapers across the country, cable news services, and talking heads everywhere have recently been reporting on this phenomenon daily, and in late February, the stock market plunged around 500 points in a day—the biggest drop in about five years—led, in part, by news of a decline in home prices and jitters about the subprime lenders and foreclosures. Many of these lenders have seen their shares’ value dramatically decreased, while others, such as New Century Financial Group, have actually been delisted from the New York Stock Exchange. On April 2, 2007, New Century filed Chapter 11 bankruptcy.
Indeed, change is in the air in the U.S. housing market. But what is subprime lending, and why is it causing such problems? What does it mean for San Antonio real estate? Let’s find out . . .
The subprime lending market was established to provide credit to people with less than perfect credit history including people with low income, bad credit, high debt-to-income ratios, judgments against them, or other blemishes to their FICO scores. Typically people with FICO scores less than 620 are subprime borrowers. These borrowers are generally charged a higher interest rate, thus earning more money for lenders, but also have a higher risk of default.
The good news about subprime loans is that they have allowed many people who were shut out of homeownership to be able to get a loan, buy a house, and be a part of the American Dream. Alan Greenspan even called subprime lending “the democratization of credit.” For years, community activists, people interested in community reinvestment, and civil rights activists have all sought to bring loans to the citizens with lower incomes and others without access to capital. To be sure, home ownership helps communities to thrive, schools to function better, crime to drop, and property values to rise. The idea behind subprime loans is to help people previously shut out of the system finally become homeowners, and attain equity and sustainable wealth. Because of these loans, many new homeowners have been created and many investors have reaped the benefits, as well. Unfortunately, the system has been gamed to some degree, and this has, in part, led to the recent crisis.
One contributing factor to the recent turn of events has been the practice of ‘flipping’ houses. ‘Flipping’ occurs when someone looking to take advantage of a hot housing market (like the one in 2004-5), buys a house only to turn around and sell it to quickly profit from the market. Many times, little or no improvements are made, and the value of the house increases because of market forces (some of which is artificial demand), not because the property is inherently better. When the bubble slowed, and buyers became scarce, the ‘flippers’ were in a bind. What to do with an extra house that can’t be quickly unloaded for a large profit? Subprime loans came to the rescue. The sellers could borrow 100% of the home’s value, inflate the price of the house, and find a buyer willing to purchase and split the profits. This buyer would then default on the first payment, pocket his share of the profits and be on his way. The loan company, meanwhile, was left holding the bag.
Ten years ago, the subprime lenders could withstand some defaults, as the nature of these type loans is inherently risky, and the system was built with a certain number of foreclosures accounted for. Recently, however, subprime loans have become more and more popular. Ten years ago, subprime loans were just a niche market, accounting for a small percentage of all new mortgages. Today, these loans are a strong market force making up roughly 25% of all new home loans.
In addition to the ‘flippers,’ lenders have borne some responsibility for recent troubles. Predatory lending, the process of lending to unqualified borrowers with a low fixed interest rate for a short period of time, only to have the rate increase dramatically in a few years, is another problem area. Predatory lending, many times, includes fees and penalties, which, in the end, strip the borrower of any equity he may have built. Risky loans, including balloon payments, adjustable interest rates, prepayment penalties, and loans given to people with little or no documentation have also increased the chances of foreclosure. The majority of all subprime loans given today feature an adjustable rate, which lure borrowers in with a low initial fixed rate, only to dramatically raise it in two years.
Finally, loose underwriting standards, in which borrowers are approved without the lender requiring escrow for property taxes and insurance, without doing due diligence on the background of the borrower, and by marketing loans with adjustable interest rates.
Of course, borrowers also must be held accountable. Borrowers who apply for loans must carefully consider whether or not they believe they can fulfill the requirements of the loan, and must responsibly calculate all the payments for the present and the future.
There are several reasons that experts, writers, and talking heads are calling the recent events, the ‘subprime crisis.’ The Center for Responsible Lending forecasts out of all subprime mortgages originating between the years 1998 and 2006, one out of every five (19.4%) will result in foreclosure. In other terms, that effectively means that 2.2 million households will lose their houses, at a cost of $164 billion to the economy.
If this 19.4% foreclosure projection comes to fruition, it will represent the worst ever in the housing market. The last time such a number was seen was in the ‘Oil Patch’ downturn in the 80s, which affected the southern oil producing states. The ‘Oil Patch’ was only a regional downturn in a few southern states. If 1/5 of all subprime loans result in default, it will be a nationwide crisis, not a local one. Data shows that states such as California, New York, New Jersey, Nevada, and Washington D.C. will be the hardest hit, but every state should feel the effects. Those states projected to be hardest hit are the ones that have seen a rapid appreciation in housing prices over the past few years. According to the Center for Responsible Lending, out of the subprime loans originated in 2006, nine out of the top fifteen cities projected to have the highest foreclosure rate are in California. It should come as no surprise that in California was a hotbed of ‘flipping’ over the past few years.
So what does all this mean for investors, subprime borrowers and--closer to home--in the San Antonio real estate market? It likely means, for investors, that they will be less inclined to continue issuing the same amount of subprime loans as in the past, meaning for borrowers with suspect credit, they will have a harder time securing a loan. The newer buyers (subprime borrowers) who signed a loan featuring adjustable rates, will soon see their rates begin to rise. They will also be looking to refinance soon. With luck they will be able to refinance into a prime loan, although statistics say otherwise. Only about 40% of all subprime borrowers are able to refinance into a prime loan, according to studies by the Center for Responsible Lending. Facilitating the ease of lending and borrowing is a proposal that is beneficial to both sides: no one prospers from a foreclosure. Instituting a Streamline Refinance program and helping homeowners to refinance into a more manageable position, save equity, and keep their homes, is a win-win situation for everyone involved. Foreclosures must be curtailed, and these families who find themselves in dire straights must be assisted in keeping their homes.
As far as San Antonio real estate is concerned, foreclosures are up 4% over last year, and 15% over two years ago. Compared to the nationwide average, San Antonio can’t be considered a problem area, as the nationwide average has seen the national foreclosure rate increase 42% over the last two years. The city is ranked 163 in the country is foreclosure rankings. San Antonio real estate agents along with lenders across the nation, must all begin to take note of these statistics and enact certain measures to ward off the crisis.
Changes are indeed underway, and knowing what the future holds will help borrowers and sellers come out ahead in the long run. For borrowers, these changes mean that the days of no money down loans are a thing of the past. People with low FICO scores will still be able to get financing, but for those in the low 600s and below, down payments will be required. The lower the score, the higher the down payment; in some cases 10-20%.
Sellers should be aware that for every house that goes into foreclosure on your street, you can expect a 1% decrease in value of your home. Also, with the tightening of restrictions on who can get loans, the pool of available buyers will be decreased.