You are already aware of some of the problems in the mortgage market. I want to address how what has happened in the last week affects the Marin and San Francisco markets. All of the problems in the last week involve jumbo mortgages - those over $417,000. For reasons I detailed in my previous post, lenders are finding it impossible to sell these mortgages in the secondary market. Their response has been to try to dramatically decrease the number of mortgage loans that they are funding. They are doing this in two ways, either by stepping out of the market altogether, or by raising their interest rates. At the same time, underwriting guidelines have tightened dramatically over the last several months, a trend that has accelerated in the last week. Here’s the bottom line.

For buyers:
If you have been pre-approved and are actively out in the market looking for a home, check with your lender and find out whether you still qualify in the price range you have been looking, and, if you do, how much more it will cost you monthly, now that rates have risen.

Conforming loans have not really been affected. If you are looking for a loan not greater than $417,000, you will find that the rates are only slightly higher than what you had been expecting. However, underwriting guidelines for conforming loans have also tightened somewhat. Very high loan-to-value, stated income, and interest-only loan products have seen some changes. You should still check-in with your lender and see if your loan terms have changed.

For those refinancing, or planning to refinance soon:
If you are going to need a jumbo loan check with your lender or broker and see how the situation has affected you. You may find it difficult to refi if you have a high-loan-to-value, a credit score less than 700, want to take cash out, or need to do a loan with limited income or asset documentation. The situation is so fluid that in most circumstances the best advice is going to be to wait a few weeks until the dust settles and the lenders, or, more accurately, the investors in mortgage-backed securities, have stopped panicking.

Most mortgage loans are not held by the lenders who get you the loan, or collect your monthly payment. The loans are separated into different ‘pieces’ aggregated into large pools and sold as securities on Wall Street. When the sub-prime loans that were originated in the last couple of years began to turn bad, investors began to shy away from those securities. Unfortunately, the packagers of those securities - Bear Stearns and Lehman Bros. being two prominent examples - sold them as being far less risky than they turned out to be.

As the sub-prime market began to unravel in the last few months, and as the housing market continued to soften in certain areas of the country, the investors in other mortgage-backed securities began to get nervous. The next tier in risk after sub-prime is what is called ‘Alt-A’. These are, generally, the loans that are done as ’stated-income’ or ‘low-doc’. Many of these loans have borrowers who have good to excellent credit, and adequate to substantial reserves, they just can’t document their income - they may be self-employed with high write-offs, or without a history of their current income, for example. Although these loans are usually far less risky than sub-prime, the investors in these securities began to get nervous, since they had been misled about the real risk in the sub-prime loans that the lions of Wall Street had sold them.

As often is the case in markets, and in life, the contagion of fear began to spread. When American Home Mortgage closed its doors last week - it was the 10th largest home lender in the United States - the investors in mortgage-backed securities walked away from the Alt-A market. There were no buyers of the securities, none. That immediately spread to the ‘A’ paper jumbo mortgage market, because the investors began to assume that if the market melt-down began to negatively affect housing values, then all of the mortgage-backed securities might be much more risky than they had thought, including those backed by full-documentation borrowers with good credit and assets. The worst of the savagery occurred in the secondary market for securities backed by home equity lines and loans; again, no buyers, none. Most smaller mortgage banks, one of the main sources of Alt-A loans, simply stopped taking applications. Every lender dramatically toughened their guidelines, and interest rates increased by 1 to 1 1/2 points in a few days. Home equity loans for loan-to-values over 80% became difficult to find for perfect, full-doc borrowers; non-existent for everyone else.

Every day this week guidelines have stiffened and interest rates have stayed high. The market is still driven more by fear than rationality. As with all markets, this will need to run its course. Hopefully, that will be soon. Prognosis for the future in an upcoming post.