Home Mortgage Weblog

Mortgagers lend money to customers for acquiring homes, but they do not continue to hold these loan portfolios for the entire term of the mortgage. If they did, they would run out of capital to lend more. Most of these loans end up being clubbed and issued as bonds, which helps mortgagers raise more capital and continue being in business.

These mortgage bonds are now becoming risk prone due to an uncertain realty market. If realty prices begin to fall and the property market collapses, loan defaults will go up. An increased number of loan defaults will lead to a loss in the face value of the bonds and will lead to higher than expected losses for bondholders. According to the latest report by the Bank of International Settlements (BIS), ‘extension of loans to households with less than perfect credit histories had exposed investors to higher risks’.

The higher level of risk, resulting from a spree of lending to customers with less than perfect credit scores as well as exotic type of loans, was till now was not evident because of a strong appreciation in property prices. However, with the prices expected to cool, the overexposure is becoming more evident.

With interest rates having risen substantially and expected to rise further, homeowners may be unable to afford higher payouts leading to defaults.  This coupled with lower realty prices will not allow mortgagers to recover sufficient capital from the sale of these properties and mortgage bondholders stand to loose substantially under these circumstances.

Close on the heels of the Ameriquest case, where the home mortgage financier was forced to cough up USD 325 million for targeting sub-prime lending, more mortgage companies targeting credit-strapped borrowers are likely to fall in the net.

Sub-prime lending involves lending to customers, who otherwise cannot get loans due to reasons like poor credit history. Sub-prime lending is usually at rates higher than prime rates. Paradoxically, customers who cannot get prime rates are customers who usually cannot afford sub-prime rates. Hence, financiers that have targeted these groups in effect have created more trouble for them. Sub-prime turns predatory at the stage when the customers are unable to make repayments and the predatory-lender acquires the property.

State financial regulators are now working closely to monitor the situation and penalize companies that have been indulging in this practice