Freddie Mac, one of the largest lenders of subprime loans, decided to limit lending to borrowers with below-average credit. This is important news in real estate as it is changing the lending standards for subprime mortgages, causing the collapse of companies specializing in these loans and affecting demand in our local real estate market.
Established by Congress in 1970 to support home ownership, Freddie Mac exists to make a market for buying loans of buyers with non-perfect credit. On Feb. 27, the behemoth of subprime mortgages declared it will raise their standards when lending to borrowers with below-average credit, requiring borrowers applying for short-term, hybrid loans to provide proof that they have the ability to pay for the loan, even after it adjusts.
A subprime mortgage is a loan made to an individual with credit scores in the lower half of 600's. The formula for determining an individual's credit score is a complex combination of many different factors, but basically attempts to determine the risk involved with lending money to this individual. These home buyers make up nearly 15 percent of the national buying population, minority and first-time home buyers. As a subprime borrower carries more risk, a subprime loan carries less favorable rates and terms pushing more than 75 percent of subprime borrowers to choose adjustable rate and hybrid mortgages, which have low introductory rates and then adjust higher after the first few years.
In a hot market where home prices are increasing, this scenario is not a problem. If the owner's payment changes on year three and he or she is unable to make the payment, the owner could refinance the loan or sell it before the bank would foreclose on the property. But with the changing lending standards, owners may find it impossible to refinance. And if the property is worth what it was purchased for or less, then the owner will have to pay the difference plus selling costs.
What are the changes?
Now, Freddie Mac will only purchase subprime adjustable-rate mortgages of buyers able to pay for the fully adjusted loan, not just the initial rate. The organization wants proof that the buyers have the ability to pay the monthly payments, once the loan adjusts to the higher rate. “Stated income loans,” in which the buyer would provide little proof of their income, will not be available to buyers putting less than 10 percent of the value of the home as a down payment. Freddie Mac wants to encourage the lenders it purchases loans from to fully document their client's income and assets; an important step in making sure that the loan will be paid in full.
How this applies to Carlsbad
A crucial part of the Carlsbad real estate market is the “move-up” buyer. Carlsbad has been blessed with a number of new construction projects that have enticed residents to sell their older home and “move-up” into a new, more expensive home. When these owners want to sell their old homes, other “move-up” buyers from either a condominium or a neighboring city, have taken the opportunity to move into Carlsbad.
Since the changes in subprime lending affect many first-time buyers, the worry is that this change will, in the short run, artificially lower demand for Carlsbad homes at the most basic level. First-time home buyers will have to wait longer to improve their credit and save more money for a down payment.
The changes also limit the borrowing potential of the self-employed or those in the cash economy. In the long run, the changing lending practices will be a positive force creating higher consumer confidence and a more stable lending environment. How it will affect average sales prices in the coming years is debatable.
Coming next month
The changing lending environment has caused some to anticipate more opportunity to purchase bank-owned property. Next month we will explore the details of purchasing local, distressed property.
Established by Congress in 1970 to support home ownership, Freddie Mac exists to make a market for buying loans of buyers with non-perfect credit. On Feb. 27, the behemoth of subprime mortgages declared it will raise their standards when lending to borrowers with below-average credit, requiring borrowers applying for short-term, hybrid loans to provide proof that they have the ability to pay for the loan, even after it adjusts.
A subprime mortgage is a loan made to an individual with credit scores in the lower half of 600's. The formula for determining an individual's credit score is a complex combination of many different factors, but basically attempts to determine the risk involved with lending money to this individual. These home buyers make up nearly 15 percent of the national buying population, minority and first-time home buyers. As a subprime borrower carries more risk, a subprime loan carries less favorable rates and terms pushing more than 75 percent of subprime borrowers to choose adjustable rate and hybrid mortgages, which have low introductory rates and then adjust higher after the first few years.
In a hot market where home prices are increasing, this scenario is not a problem. If the owner's payment changes on year three and he or she is unable to make the payment, the owner could refinance the loan or sell it before the bank would foreclose on the property. But with the changing lending standards, owners may find it impossible to refinance. And if the property is worth what it was purchased for or less, then the owner will have to pay the difference plus selling costs.
What are the changes?
Now, Freddie Mac will only purchase subprime adjustable-rate mortgages of buyers able to pay for the fully adjusted loan, not just the initial rate. The organization wants proof that the buyers have the ability to pay the monthly payments, once the loan adjusts to the higher rate. “Stated income loans,” in which the buyer would provide little proof of their income, will not be available to buyers putting less than 10 percent of the value of the home as a down payment. Freddie Mac wants to encourage the lenders it purchases loans from to fully document their client's income and assets; an important step in making sure that the loan will be paid in full.
How this applies to Carlsbad
A crucial part of the Carlsbad real estate market is the “move-up” buyer. Carlsbad has been blessed with a number of new construction projects that have enticed residents to sell their older home and “move-up” into a new, more expensive home. When these owners want to sell their old homes, other “move-up” buyers from either a condominium or a neighboring city, have taken the opportunity to move into Carlsbad.
Since the changes in subprime lending affect many first-time buyers, the worry is that this change will, in the short run, artificially lower demand for Carlsbad homes at the most basic level. First-time home buyers will have to wait longer to improve their credit and save more money for a down payment.
The changes also limit the borrowing potential of the self-employed or those in the cash economy. In the long run, the changing lending practices will be a positive force creating higher consumer confidence and a more stable lending environment. How it will affect average sales prices in the coming years is debatable.
Coming next month
The changing lending environment has caused some to anticipate more opportunity to purchase bank-owned property. Next month we will explore the details of purchasing local, distressed property.