Subprime Lending Fallout Goes Upstream to Take Down Two Major Hedge Funds: What does this Mean To Real Estate Investors?

By: Michael Cook

Two major Bear Stearns Hedge Funds face foreclosure due to their significant exposure to the subprime lending market. While this does not fall under the category of real estate investor, I spent last summer working for Bear Stearns and interacting with many of their hedge funds. Based on the very limited details of the stories out now, I cannot be certain if I have worked with these two particular funds. I can be certain; however, that it would not be a good time to be in the mortgage space at Bear Stearns.

In my three months at Bear Stearns, I met some of the smartest people in the businiess. While this is not an advertisement to work at Bear Stearns, I think they are a very well run organization with smart people. This of course begs the question, how could something like this happen to such smart people? Furthermore, with all of the subprime lending issues out there, what does this mean for borrowers who are less creditworthy?

Simply put, in my humble opinion, the subprime market will be doomed for some years (at least five or more). Since I know this site is filled with a ton of very smart mortgage brokers, I will outline my reasoning.

Consider the following information:

1. Many subprime lenders have filed for bankruptcy
2. Major buyers of Mortgage Backed Securities (like Bear Stearns) are having issues with subprime mortgages
3. Despite what the National Association of Realtors says, the housing market seems to be taking a slow and steady turn for the worse
4. Major Banks have tightened their lending policies

Let’s take an example of a typical transaction before the subprime fallout. A low creditworthy borrower applies for a subprime loan. Some intermediary or mortgage broker, supplies them with the best loan for them from either a bank or a conduit lender. The bank/conduit lender then sells the loan to an investment bank (like a Bear Stearns or Goldman Sachs) to free up more money to lend and to remove the risk off their books. Finally, the investment bank packages this loan in the form of bonds that investors looking for high rates of return are eager to purchase. While this seems like a complicated cycle, it actually works quite smoothly as long as there are investors looking to buy these loans.

Now reflecting today’s market conditions, the picture has a lot more holes. When the low creditworthy borrower applies for a subprime loan, many of the intermediaries no longer exist. Even if they try to go to a mortgage broker, they will be hard pressed to find a lender. If they do find a lender, this lender will have trouble moving the loan to an investment bank. Investors, who have been burned by heavy defaults ( i.e. Bear Stearns Hedge Funds), will not be looking to buy high yield bonds backed by subprime loans. Additionally, those who are looking will expect to pay deep discounts.

To put the final nail in the coffin, consider areas like California where subprime lending was a driver of the housing market. With very few alternatives, a lot of buyers will be sucked out of the market. Additionally, these buyers will probably not be back for a while. For those buyers expecting a quick rebound, think again. Until prices get to levels buyers deem affordable (meaning they can afford the down payment), a recovery simply cannot happen. I would love to hear from others who have different opinion, but as an investor, I am looking into apartments more now then ever. If buyers cannot afford to buy, they will have to rent.

The Bond & Home Loan Markets Are In Turmoil

Is Your Financial Future Secure?

Interest rates, including those tied to home loans, soared sharply last week across several markets, alarming consumers and investors alike. Let’s examine what caused rates to increase, how it could impact you, and what you should do about it.

The sharp rise we saw last week was the result of an economic shift in the global market. Two different foreign central banks, similar to the Federal Reserve in the US, increased their short-term interest rates in an effort to fend off inflation. The first increase took place in Europe, with New Zealand following soon after. The results, while dramatic worldwide, were particularly so here in the United States, where interest rates increased across the board.

This had an immediate impact on those seeking home financing, as rates rose to the highest levels seen since last summer. While interest rates are currently under 7.00% , they may not remain there for long. As past years have demonstrated, a rapid rise in interest rates sometimes serves as merely a pre-cursor to even higher rates in the coming months.

Could we see a repeat of 1993-1994, when 30-year fixed interest rates rose from 6.69% to 8.23% in just five months? (These figures are according to HSH Associates.)

If you are considering a new home purchase or a refinance, act now. Waiting could cost you significantly. If we were to experience a similar increase on a mortgage amount of $250,000, the monthly payment would increase by over $263 a month.

While no one can predict exactly what will happen, experts in the bond arena have expressed concerns that rates will continue to increase throughout the rest of the year. Some believe that the Federal Reserve will be forced to raise interest rates prior to year end. This would increase interest rates for existing Home Equity loans, credit card loans, and potentially existing ARMs.

Please contact us as soon as possible. We will provide you with a Free, No Cost Analysis of how we can improve your financial position today and save you from a potential increase in monthly payments.

Property Tax Facts

When you buy a house, lenders allow you the option of impounding your taxes and home owners insurance by including them in your monthly payment every month or paying them separately twice a year at specified times on your own. Either option you select, you’ll still be paying the same amount in property taxes annually.

Most people don’t impound their taxes and insurance because of money. When you choose to impound you pay up to 6 months of taxes up front in your down payment, depending on what time of year it is. By doing this, the money is already there when the upcoming tax bill comes to the lender. Each subsequent bill can be paid with the cumulative money that you send every month along with your mortgage payment specifically towards your impound account. When given the choice, most don’t choose to part with the upfront money to set up an impound account.

The problem, especially for first time home buyers or buyers on a strict budget, is they don’t realize- and often experience financial difficulties when they find out- that in addition to their normal annual property tax bill, the first year they will be assessed a Supplemental Tax. That Supplemental Tax Bill can often total up to a few thousand dollars in addition to their normal tax bill. This can catch a borrower off guard and be enough to start that borrower on a downward spiral leading to late mortgage payments and worse. Some borrowers may never recover because they didn’t know to plan ahead.

The moral of this story: Experience does not cost…it pays! Work with an experienced Realtor. Ask questions. Knowledge is Power. Know the ramification of your options so you can plan ahead. We believe that if we do a good job coaching our borrowers and following up with them, they will be in better shape to handle what’s coming their way and our clients appreciate that. We want to keep our clients for life – both as their real estate and financial advisor.