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CREDITSCOREREDHERRING
BLOWNMORTGAGE.COM
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As the news of thesubprime mortgagemarket meltdown
continues an alarmingangle of the story
continues to be missedby the mainstream
media.
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The default situation insubprime mortgages(typically defined as
borrowers with a FICOscore below 620) has ledto tremendous coverage
and speculation as towhether the instability in
subprime will spill over tothe prime market.
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Famous people areweighing in on both sides
trying to predict where thisweakness is headed and ifit is contained in subprimeor not. The media is loving
this story.
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The scary part of this all isthat FICO score and prime v.subprime should not really
be the story. The storyshould be on CAPACITY.
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Capacity is aborrower’s ability to
make their mortgagepayments and pay
their debts on time.
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Whyshould capacitybe the buzzword
and notsubprime v.
prime?
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Because capacity plays a big role inmortgage defaults. Sure, intrinsically people
with better FICO’s handle debt better andshould be able to manage their finances
better (that’s how they got the score in thefirst place) but your FICO score can’t pay your
bills.
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People with good FICOs already have a history ofpaying their bills you say. Yes, they do. And becauseof that the profit-hungry banks went ahead and saidthree key things; (1) "borrow as much as you like, youhave good credit, we know you’re good for it" (2) "youtell us how much you make for a living and we’ll take
your word for it," and (3) "here’s an exotic-typemortgage where you can pay only the interest, or
even less, so you can afford a bigger house or maybetwo or three."
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1. They increased the standard debt toincome ratios (monthly mortgagepayment/gross monthly income) whenunderwriting these loans so that peoplecould borrow more, and then calculatedthe ratio off the lowest payment availableunder the loan program (interest only,etc.)
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2. They told borrowers just to putdown a monthly income figure
that "makes sense" for yourposition – we trust you. Yourgood credit obviously meansyou’re a good citizen and can
handle borrowing as much moneyas you think you need and thinkyou can afford. Just state your
income.
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3. They made up all types ofnegatively amortizing loansand interest only loans toallow people with good
credit to assume more long-term debt by minimizing their
monthly cash out-flow.
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The problem arises when it comes time for theseexotic mortgages to recast or adjust to the long-
term interest rate (or fully amortized payment) andthese people get hit with major payment shock.
Their debt to income ratio will go through the roofcrushing their available cash flow.
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The outcome is easy to see – theywill owe more money each month,
their income may or may notsupport it, depending on how
honestly they stated it, and theircapacity to pay will vanish.
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This capacity crush will lead to an increase indefaults on the "prime" side of the market. Themedia should be looking at percentage of primeloans that are high in loan-to-value, are stated
income, non-traditional loans, and then runtheir analysis. I think the outlook will be moreinline with what we are seeing on the subprime
side.
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T O L E A R N M O R EBLOWNMORTGAGE.COM
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C L I C K H E R E
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MORTGAGE COMMENTATOR
Justin McHood is Americas MortgageCommentator and has been providing
Mortgage commentary forover 10 years.
INFORMATION PROVIDED BY:
Justin McHood
Information Originally Published: March 2, 2007 BLOWNMORTGAGE.COM LENDER HOTLINE: 888-581-5008
LEARN MORE ABOUTMORTGAGE COMMENTATOR:
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