Lenders without Legal Mandates Sparked Off Foreclosure Crisis

Fannie Mae, Freddie Mac and FHA have always operated following the standards laid down by the feds. It was lenders who did not have legal mandates that sparked off the foreclosure crisis. According to rules the borrower had to make a down payment of 20%. This prevented the borrower from lapsing because already money is tied up in the house. The borrower would make an all out effort to keep the mortgage running. The down payment assured the lender also that in a time of crisis the house could be sold off and loan repaid.

But dubitable lenders entered the race and competed with tempting offers to lure in borrowers with attractive offers. Fellow lenders began to undercut each other, undercut interest rates and undercut standards leading to disastrous consequences – the foreclosure related crisis the nation is facing today. Sub-prime loans were offered to people who just could not sustain the mortgage with their poor credit history and low income. For the first two or three years it was all hunky dory but then when the rates began to increase to more realistic levels the pain began – pain for the individual, for the locality, for the country and finally for the entire globe.

Underwriting standard hit its nadir in 2006. Some lenders did not require any down payment or any proof of income. Some even offered terms that allowed borrowers to chose the amount they would pay each month. The shortages in principal now began to accumulate interest, which very few understood. This is known as ‘negative amortization’ and led to many owing more than the value of the house. In a standard mortgage the debt gradually begins to decrease and shrink.

With money flowing easily borrowers began to bid more for properties causing more loans to be taken with low rates and no documents. House prices rose by as much in 20% in 2004. In places like California and Florida it increased by 25%. By 2005 of all the mortgages on new houses, nearly 22% were from the sub-prime category. In contrast the figure was 8% in 2003. During the second quarter of 2006 the house of property reached its peak.

Professor Todd Sinai of Wharton said that the low interest rates were the main reason for the price hike. People then thought it would run along this way so they began to buy frenetically. This was the housing bubble – the bubble that burst into the foreclosure crisis.