How are people with a subprime score even getting a loan? When I took out a mortgage in 2015 and then again in 2017 they scrutinized my entire life. I have no idea how we’ve regressed back to 2008 after years of very strict regulations.
From the article: car loans, credit, and person loans (payday loans). Mortgages are highly regulated since 2008's financial crisis. Those subprime lenders exited the mortgage business and jumped into high interest used car loans. And I'm right there with you on the anal probing I had to practically get to qualify for a mortgage.
worth mentioning: the auto lending market in the US is a 1.6 trillion dollar time bomb and has been ever since Cash for Clunkers saw two rounds of federal funding.
the average period for an auto loan in the US is over 64 months. any disruption to the paycheck-to-paycheck living of 64% of americans could have a catastrophic effect on the ability to service this debt.
> auto lending market in the US is a 1.6 trillion dollar time bomb
It was a time bomb. Cars are easier to seize than houses. Given the present shortages, re-selling them at close to the loan balance shouldn't be an issue.
It's still a tale of personal tragedy. I know people on the new-car-every-two-years bandwagon who will get screwed when they have an income interruption. But it's not a broader risk, at least not at this time.
while it seems that way initially the reality is more complex. waves of repossession means waves of employees who cant get to work anymore. repossessions arrive on your credit history as a major blemish, meaning you cant get credit for a new car. your credit card interest goes up as a result, unemployment ticks steadily up as well until the market reacts parasitically, and eventually the car you picked up for loan balance cant go for even a fraction of that because of the surprise 1.6 trillion dollar recession you triggered.
its more palatable to subsidize these dicey loans (as we did in 2008) then come to jesus with the grim reality of following the letter of the lender instead of the spirit of the loan.
> It was a time bomb. Cars are easier to seize than houses. Given the present shortages, re-selling them at close to the loan balance shouldn't be an issue.
Will there still be vehicle shortages if a significant number of cars are seized for resale and potentially a significant number of would be buyers are not able to obtain loans?
Most likely yes, considering the major supply chain interruptions with the craziness that is going on in China, oil uncertainty with issues in Russia, e.t.c.
There is also the issue of raw materials, which can be reused.
We ended up invovled with the state A.G.'s office investigating our dealer. They 'accidentally' put a typo in my wife's SSN when pulling the credit report. That justified a higher interest rate - which they offered us without explaining why.
We weren't super worried because we were going to pay the car off in a couple months anyways, we just wanted the financing to shift some cap gains taxes to a different year. Then we got a letter in the mail from the lender explaining why our interest rate was so high.
We called the dealer - and almost no questions asked they offered to send us a check for the difference. Red flag raised we filed a complaint with the state A.G., and it turns out it was a common practice at that dealership.
NEVER finance through a dealership. They will never give you the best rates. Often they will get a rate and add their own points on top or include additional fees. Even promotional interest rates don't make sense because they're always offered with an alternative discount. The discount + a traditional loan works out cheaper than 0% interest.
Never is a strong word. Dealerships make their money on financing. Refinancing afterwards is straightforward. Negotiating poorly on the dealership's financing, using that to win points on other fronts (e.g. price, maintenance commitments, trade-in value, et cetera) and then repaying the loan a month later, once you've lined up your preferred financing, is perfectly acceptable and often worth the time and trouble.
They have this awesome thing called negative equity financing. It might have a better name now, but they will pay you X for your old car which is less than you owe and then finance the difference with your new loan. In other words, your loan balance on the new vehicle may be higher than its value but this is glossed over by focusing strictly on monthly payments and "what you can afford". Re-read that, this is not a practice they'd use on people with bad credit because to repo the car will not get them their money back. It's a rip-off for people with good credit and more dollars than sense.
You paid half the car off on the lot? That’s not a great use of cash. I mean in most markets. In most markets cars depreciate not appreciate like they have and the stock market rises not falls like it has. So I guess good move!
True but consider cars aren't a significant purchase for many people. At least to justify the maneuvering to maximize gains. Is it really opportunity cost if you didn't have another use for the cash and could replenish it fairly quick?
The point being made is that if you have 10-20k sitting around that you "have no use for," you should probably invest it in an asset that appreciates in value.
My point is that it's not always worthy of an investment at all. It's just a purchase. It's coming from operating funds. The maneuvering to take out the loan, choose which investments, tax consequences, when might you need that liquidity available again (do you really want to lock it up until retirement?), establishing investment accounts that may not already be established, and all these decisions are, or can be, such an over optimization. Especially if this is a rather immaterial amount of money to you personally. And even if that is a material amount of money for you, you're probably actually better off with the non-ROI producing peace of mind of having your transportation ownership be secured and out of reach of creditors. So, it's hard to make a blanket statement like that.
That isn't always the case. After getting up to leave several times when they said they couldn't sell it to me for my offer, they got within $40. I was prepared to pay cash for it. Then they offered 0.9% financing which I took on the assumption that inflation would be greater than 0.9%. Turned out to be a reasonable assumption.
I’ve always gotten better rates from the dealer. That’s after checking with the credit union and Capital One. Thads both with CarMax (multiple times) and a new car dealer.
One time I went to buy a car with a guaranteed loan in hand from my bank. The dealer made us wait for over two hours as they tried to find a better deal that they could do, and then finally failed and grudgingly sold us the car with our financing. That was Nissan (my car).
The next time we went to buy a car with a loan in hand from our bank, it was for my wife. We showed the guy the loan we had, he took one glance at it, and said he couldn't do anything better. He didn't waste any of our time. That was Lexus.
Suffice it to say that I'm willing to pay a higher price for a better quality vehicle with better quality service. I really don't want to buy from anyone else.
Toyota/Lexus is definitely of better quality than Nissan(and better dealer service)
Back in the day I would have said that the Nissan would have been just as reliable despite but that is not true now. It feels like cars made now are just so forgettable and also disposable and Nissan is leading the field here.
It doesn't. Dude's riding his hobbyhorse into a wall.
Most cars that left the road were the oldest and heaviest. New cars bought under that program tended to be economy cars and are already a decade+ old. To suggest that it took inventory off the road affecting today's markets doesn't hold water.
The biggest issue is that car companies make more money off reselling the loan than they do off the car. Years ago we tried to buy a Subaru in the NYC metro area in all cash and were continuously turned away. Dealers didn't make money off the cash sale, they were spiff'ed off the loan. We had to take the loan and then pay it off in order to get the car.
Since then it's gotten worse. Expensive cars (luxury, trucks) are sold with 72 month loans and are underwater shortly after purchase. It's been a race to the worst terms and empowering the worst purchases to the worse equipped buyers. I'm continuously amazed it's gone on as long as it has.
Ironically, luxury car dealerships will have no problem taking your cash. There are lots of people that are rich enough to insist upon buying a new car with cash, but those people generally don't drive Subarus.
Surprised to hear you were turned away. Usually they will take your money, just not give you any sort of deal. Either way, I think these days it makes little sense to buy new cars of the lot. If you want a new car, just go on the website and build out what you want, pay, and it's there 2-3 months later.
What I was told by a friend at an OEM is that lower-end the demand for lower end Subarus and Hondas was so high in the NYC area that it made sense to turn down the all cash offer as they'd likely sell the car with a loan the next day.
That's so frustrating. I'm in NYC and had a crappy experience shopping for cars as the pandemic was taking off. The dealers seems dis-interested, but they would certainly sell a car for their asking price. I ultimately ended up going with a cheap old used car that I bought directly from the previous owner. If I get to a point where I want a new car, I think I'll just order it.
>Most cars that left the road were the oldest and heaviest.
Pure fantasy.
Old commuter cars and family haulers were what was removed. Stuff like 90s Suburbans and F150s got turned in at a much lower rate than things like Cavaliers and Tauruses.
Remember, times were not great back then, trucks and SUVs are useful vehicles. You're not gonna get a lot of people who have old ones trading them in on a Camry because that's a net downgrade in capability. And the SUV craze was new enough that the trucks and SUVs that had been bought frivolously were still mostly worth enough to be unaffected.
>To suggest that it took inventory off the road affecting today's markets doesn't hold water.
It definitely put the used car market into a state it could have not otherwise gotten into. Whether it ever "recovered" is a matter of opinion. Many people say the private party shitbox market has never been the same but I personally think that's rose tinted glasses.
Under 700k cars were exchanged as part of the "cash for clunkers" program, or roughly one out of every 400 the cars on American roads. Emphasis on exchanged: most people went out and bought new cars with the rebate.
Plus, all of this was over a decade ago. It's irrelevant on both axes.
> All the cheap beater cars that people just getting on their financial feet would have bought evaporated overnight.
I don't think this is true. If you look at the cars that were destroyed as part of the CARS program, they don't have a large overlap with popular used cars in the US. The top CARS trade-ins were mostly 4WD SUVs and minivans; the most popular used cars a decade ago were (and are) mostly 2WD sedans.
Another way of thinking about it: the entire point of the CARS program was to incentivize car owners to prematurely (from their perspective) buy a new car by offering them credit for their old one. Combined with the disconnect between the cars traded in and the actual used car market in the US, I think it's safe to say that most of the cards exchanged in the program would not have entered the used market and therefore did not meaningfully impact it by going to the scrapyard instead.
>I don't think this is true. If you look at the cars that were destroyed as part of the CARS program, they don't have a large overlap with popular used cars in the US. The top CARS trade-ins were mostly 4WD SUVs and minivans; the most popular used cars a decade ago were (and are) mostly 2WD sedans.
Here's the top ten list:
1. Ford Explorer 4WD
2. Ford F150 Pickup 2WD
3. Jeep Grand Cherokee 4WD
4. Ford Explorer 2WD
5. Dodge Caravan/Grand Caravan 2WD
6. Jeep Cherokee 4WD
7. Chevrolet Blazer 4WD
8. Chevrolet C1500 Pickup 2WD
9. Ford F150 Pickup 4WD
10. Ford Windstar FWD Van
Everything on that list is prime shitbox, except arguably the trucks (because they cost a little much to feed).
What do you think happened to crappy vehicle prices as soon as the program was announced?
Anything that moved and qualified got listed for sale at approximately the same price as the rebate. Hence no more "$500 beaters" (not really $500 by that time but you get the point).
You see the same thing today where the scrap value of catalytic converters drives up the price of the cheapest cars because that's the alternative way of monetizing those vehicles
More precisely, it removed the portion of the bottom of the market belonging to people who were on the fence about upgrading and making their cars available, so in that way it's similar to EV tax credits going to wealthy people to subsidize their consumption, but with the added hardship on the people down market.
I sympathize with the would-have-been sellers. I spent probably 8 hours recently to sell a 16 year old car for $4,200, and it would have been easier to do it the cash for clunkers way. But people buying that car are unable to get something newer or want to get their feet under them financially.
72 million passenger cars have been sold in the US since the program so I don't follow how the <0.7 million scrapped in 2009 (valued to be worth less than 3 billion dollars back then) for newer cars have a noticeable impact on any of this 1.6 trillion dollar loan market 13 years later.
Sounds like the type of thinking that won't get you that quarterly sales bonus!
Seriously though, just like mortgage originations pre '08, anyone who had qualms about that kind of thing left that industry a long time ago, or never joined.
These lenders make money on bad and even failed loans. Why sell a car once when you can sell it 3 or 4 times.
"buyer of the 1999 Oldsmobile Intrigue at Auto World Auto Sales in February.
A 26-year-old single mother of three, she needed a car to get to her new job as a home healthcare aide. She agreed to pay $3,899 — roughly double book value — and put down $1,200 cash on the deal.
As the due date for her first installment approached, Fields realized she’d need a few extra days to scrape together the $220 payment. The dealership wouldn’t wait. It repossessed the car a week after the payment was due"
I'm sorry for her but it was her fault. $2700 at $220 per installment is 12 installments. Such a tight schedule is unusual. You should always try to get the most flexible arrangement that you can afford and pay it off sooner only when you actually have surplus money left over.
I think subprime just means you just get offered a higher mortgage rate. You still have all the documentation mandates. No more NINA or NINJA[1] loans.
The amounts that mortgage originators will hand out are still pretty incredible.
I bought a house a few months ago. The mortgage payment is right around what the more conservative rules of thumb suggest is affordable.
After the lender had all my information I asked, out of curiosity, what was the maximum they'd lend me. They came back with a number that was more than triple what I ended up borrowing and suggested there was room to go higher if that was something I was interested in.
Perhaps subprime borrowers face lower limits but it's still possible to take a risk stretching your budget to buy a house. That may be OK or even good but I'm concerned the perception is that lenders won't approve a mortgage that will be very difficult to keep up with when they absolutely will.
If you want to be depressed, go to Los Angeles and tune into a radio station that caters to people living in poor neighborhoods. Every 3rd or 4th ad is for a loan shark.
I'm not sure how that's directly related to the issue of subprime borrowers but in my recollection this was a good change. It was a regulation that was costly and difficult for smaller banks to constantly adhere to while larger banks already had the capability to do this. Much like how the mortgage moratorium policy ended up forcing smaller landlords to sell to larger property holding companies, this particular bit of regulation was causing many smaller banks to sell themselves to larger ones.
Same thing happened to me. I got denied because as a founder/owner holding more than 25% of a company they consider the P&L of the company as your personal income(loss).
Credit score impacts interest rate but debt to income ratio that is above 50% can completely disqualify you from a mortgage. Thats where the founder ownership can skew your personal DTI.
You can go to asset based lenders who evaluate and secure the loan against your existing assets (cash, etc) rather than based on your W2 income and DTI.
Same, kinda. Wasn't denied, but would have to pay a huge risk premium over conventional, regardless of how much I put up as a down payment, like the home's collateral value didn't matter. Earlier post:
Did you provide the assets as collateral for the loan? I imagine a traditional mortgage may not have this as an option, but a different kind of loan may have been possible. However, you can probably only borrow up to a portion of the collateral value.
The scrutiny may be higher, but the amounts they are approving people for is insane. Like who thinks it's a good idea to approve someone with an $80k income for a $450k mortgage?
The relevant ratio for mortgage underwriting is monthly income to monthly payment obligations. This means that the highest available mortgage amount depends on the interest rate. You get a very different answer if rates are 2.5% instead of 5.0%. That means a person with $80k is getting approved for a much smaller loan today than six months ago.
Rules of thumb like “mortgage amount should be less than 3x income” don’t make much sense because they ignore the interest rate.
"Rules of thumb like “mortgage amount should be less than 3x income” don’t make much sense because they ignore the interest rate."
They're fine as a rule of thumb. The individual should still run their own numbers to see if their limit is higher or lower.
Even at 2.5% interest, I have a hard time seeing anyone being able to responsibly buy a $450k house on $80k income. They might be able to swing it, but they'll be screwed as soon as a large unexpected expense comes up. Even a 2% property tax will eat close to 10% of their gross income. There's no way they could save for an emergency fund or properly fund a retirement account.
At 2.5% interest, the monthly payment on a 450k home is $1,778.
At 9% interest, the monthly payment on a 240k home is $1,931. Mortgage interest rates were higher than this throughout the 1980’s. They got as high as 18% which would yield a $3,617 monthly payment.
This means that the person who followed the “3x your income” rule in the 1980’s has a harder time paying the bills than the person who bought the home for 450k with a low interest rate.
This is a badly-formed rule because it ignores a key variable - the interest rate. Sometimes, it will prevent someone from buying a home they can afford. Other times, it will cause them to buy a home they can’t afford. There’s no need for such a rule, because mortgage payment calculators that take into account the interest rate are easily available. It’s like picking a shoe size based on how much you weigh instead of measuring how big your feet are. If it gives you the right answer, that’s out of sheer luck.
Of course, it’s necessary to also take into account factors like taxes and other expenses which vary from place to place and person to person, but a simple mortgage payment calculator is a good place to start.
And mortgage calculators can ignore many other variables, or would require additional research to fill them in. They also ignore a key factor - the person's income. It calculates cost, not affordability.
Also, do the math on what happens if interest rates do anything but go down - it instantly means a huge swath of buyers can't anymore and the market dries up.
This doesnt tell the whole picture and it isnt that simple. The lender is looking at your total carry costs for the home (property taxes, insurance, debt service), your non-home recurring costs (e.g., student loans, medical debt on monthly payment schemes, car payments) and your total income.
They dont usually care about wealth, they care about cashflows in vs out.
I had no other debt apart from a $15k auto loan and <$500 balance on my credit card, and $450k still felt like an enormous stretch. I was also only going in with 3% down.
I’m not aware of any mortgages that allow that debt to income ratio for a mortgage. Unless it’s a rental and then the down payment requirements are insane.
A little while ago, when 3% loans were still a thing, a $450K loan over 30 years was a $1,900/month expense. An income of $80K with a $1,900/month in debt is a 29% DTI which is comfortably below the DTI limits for a conforming loan (43-45%).
- No one making $80K is going to have money for a $90K down payment so you have to add PMI - $300/month.
- you’re also ignoring property taxes and insurance. I pay another $400 a month for that in a relatively low cost of living state and I have a $5K deductible.
Quasi-on-topic anecdote: Amazon used to (and may still) sell these DVD bundles, like 8-12 movies to a pack. There would be a few classics (Ghostbusters or something) mixed in with arrant garbage. The hope was you'd buy the pack for the classics and maybe watch the garbage later because you have it so why not.
I used to call this sales strategy "Amazon Subprime". I still think that's one of my cleverest jokes, but unfortunately you might only laugh if you know how the 2008 housing crisis actually started... and the people who do know that are not great in number.
This fall into the class of pun that is both completely perfect, and also incredibly situational. If I have a pun like this, either the situation to use it will never come up, or if it does I will become too excited and flub the delivery.
Most people believe 2008 was caused by single mothers (as an example) "buying a home they couldn't afford." The reality is it was the upper-middle class, non finance professionals just thinking they were savvy. When your doctor, dentist, or general contractor gives you financial advice you should run the other way!
I see this playing out now with cryptocurrency. Suddenly, everyone is an expert on Bitcoin!
> The reality is it was the upper-middle class, non finance professionals just thinking they were savvy.
But also lots of highly educated Ivy League Finance folks who thought they were smarter than the were. Hence Bear Stearns, Lehman Brothers, AIG, Merill Lynch, etc.
Every product in 2008 was completely viable which is why the Federal Reserve bought everything.
Only 7% of the borrowers defaulted by then, there wasnt mass irresponsibility on the people with mortgages as suggested, this alone blew up some institutions because they were leveraged nearly 50x and one month of missed mortgage payments would cause a massive drawdown on their portfolio.
Without leverage, a portfolio where 93% is going to pay a lot in interest over 5-30 years is a good portfolio.
So there is no reason to get uncomfortable or anxious by seeing the words “subprime” “CDOs” or more, as it comes down to whether the accounting is done properly and the leverage is low. Which, I believe is being done. The "big crash" always comes from a different and unexpected (or less expected) angle, where some completely different sector has too much leverage and flimsy accounting.
Yeah the contagion is important and it also needs to be several trillion dollars in value.
Given that the Federal Reserve wants unemployment numbers to rise, they're specifically trying to make share capital worth less, and borrowing capabilities cost more, making revenue-poor corporations stop being so optimistic. so I would just expect lower valuations with much lower revenue multiples (or price to equity ratios), for that reason alone.
Slowed growth in China is always a threat because thats a key revenue driver for many large western companies. Then sure, there is the leverage and accountability problem with Chinese real estate, but I don't get the impression that contagion is that big because nobody thinks that is a safe bet and also avoid too much exposure to the domestic chinese lenders involved. The rumors behind Tether just aren't big enough to matter for this, could only be a slight sting to the commercial paper market and a moderate "finally" for the crypto market as a tether implosion would probably increase confidence there after steep selloffs.
Oil/gas volatility is probably going to have some casualties.
> Oil/gas volatility is probably going to have some casualties.
The Oil Glut of the 2010s killed off all but the strongest players in this sector. So I doubt it will be a pillar that collapses. If anything, they will probably do very well in the near-term.
the producers won't have the issue, I was thinking just speculators that have over/unexpected exposure to the wrong direction of the oil/gas derivatives market
Yeah, the commodities markets are opaque to me and between food and energy it sounds like they have a major test on the way this winter.
Re: Chinese real estate, the contagion mechanism I've heard the most about isn't West->East investment, it's East->West investment that gets pulled to survive a bear market. I have no idea if it's big enough to matter.
Good article but weird chart, “Bond Markets Over Time”. Both axes are reversed to make it look like something is increasing (y-axis) over the size of the opportunity (x-axis), when instead he’s making the point that Alpha (y) decreases as size of opportunity (x) increases.
In the runup to the 2008 crisis, a commonly heard mantra was "yeah, subprime lending is fucked up, but it's a small fraction of the economy, it can't cause that much damage". Turned out that it could, via the CDO shenanigans.
I would not at all be surprised if someone has already cooked up a similar leveraged dependency from the "real economy" to crypto markets.
It depends entirely on how much cryptocurrencies are being used as collateral for leverage, which was the main factor that amplified the GFC. MBS’s and MBS-based CDO’s were used as collateral for massive amounts of leverage (up to 30:1 for the commercial banks, and 100:1 for Fannie & Freddie). Since the housing market had never crashed, that collateral was considered reliable enough for significant amounts of leverage. Turns out it wasn’t.
But cryptos have never been considered remotely that reliable by the broader financial system. Thus there is probably little to no leverage using cryptos as collateral. Crypto is currently crashing, but it will only take down itself and not 30 to 100 times as much leverage with it.
I'd be more open to this if we hadn't already seen wild swings in the crypto market (BTC is down ~50% from its 12-month peak) without much in the way of broader implications.
Generally speaking there aren't fears of a hard crash.
The main concern is stagflation due to rising energy prices. It seems like the market is now finally starting to price in the externalities of abating climate change, which results in higher energy prices across the board (which in turn raises prices of everything else, with inflation due to QE piled on top of it).
This means that output roughly stays the same, but there are more dollars competing for it.
And as much as Dodd-Frank was watered down, the orderly liquidation provisions survived and that means regulators have full authority to stop a situation like Bear Sterns or Lehman collapsing and taking down a sector of the economy with them.
> Given the very low interest rates in 21-22 and high prices, a certain percentage of folks would have purchased with a convertible mortgage.
Convertible mortgages became popular as an alternative to either fixed or nonconvertible ARMs when rates were high as a way to preserve the option of locking in on a rate drop without going through a refi. Convertibles don't offer a lot when rates are low—if you want to be able to lock in a low rate and rates are already low, you get a fixed.
Between that, changes in qualification rules, and memories of the collapse leading into the Great Recession, ARMs of all types have shrunk to a very small share (<5%, IIRC) of residential mortgages, and newer ARMs tend to have rate caps.
> Assuming the standard 5-1 and the fact that rates are rising very fast, should we expect a repeat of 2008 in 2026-2027?
Probably not because of adjustments on existing mortgages. If there is sustained stagflation, then the fact that people can't pay their fixed-rate mortgages given other necessary expenses may produce a similar collapse, though.
I thought adjustable rate mortgages were pretty much dead after '08? Why would anyone get an ARM when rates were in the 3% range for a 30 year fixed mortgage (as they were for several years until recently)?
Something like 60% of homeowners would come out ahead financially with an ARM. You can save tens of thousands of dollars in interest before the rates adjust. Many people sell or refinance before the rates adjust, or soon after. The rate early on is a little more important because that is when the principal is highest, but in practice this isn't a huge factor. Only about 35% of the original principal is paid off after 10 years for a 5% mortgage. Even if rates go up and you stay there for 15-30 years, you could come out ahead because of how much lower the interest was for the first 5-7 years. But it depends on how much rates go up.
But the long tail is some people being priced out of their home as their payment rises, and it could have been prevented. So 90-95% of mortgages in the US are fixed rate.
Say you take a 7 ARM at 2% instead of 3% for a 700k mortgage. You're saving $50,000 in interest during the first 7 years. That's 7% of your mortgage. Then 7 years of inflation can knock down your principle further which might be pretty high over the next 7 years.
It can make sense if you're financially secure enough to take on the risk.
I went through 2 ARMs between 2013 and 2021. In both cases the 7 year ARM was at least 1.5 % below the traditional 30 year I could get. Between lender rebates and such, in both cases we had essentially $0 out of pocket and in both cases a moderately. In the last couple years, the ARMs I looked at were less than a single % from a traditional 30 year. I had last 3% ARM was adjusting in mid 2023, and I refi'd to a 30 year @ 2.75% last October. Holy tamole things have changed since then!
Same reason very intelligent fund managers are buying 10y TSYs yielding 2.8% despite inflation giving them a NEGATIVE 5.2% real yield:
Everyone thinks that 5 years out, everything will be rosy. The metalworker saving 0.6% on a 5/1 ARM vs a fixed 30yr is using the same mental gymnastics that J. Poindexter on Goldman's bond desk is, that central banks are omniscient, omnipotent, and will always magic away the risk inherent in our decisions.
Also worth noting: not all ARMs have a balloon payment. For example, I bought most of my farm on a 20yr ARM with a 20yr amortization. As interest rates rise I will have higher payments, but there’s no moment when the music stops and the rest of the principle immediately comes due.
There is still the risk of an interest rate reset raising the payment amount to an untenable level though. Maybe not in your specific case, depending on your circumstances, but for many others it will be true.
I talked a number of people out of ARMs in '21 and '22 by explaining 2008 to them (they were 7-8 years old at the time, so do not remember). It is scary how bad most people are at understanding exponential growth and just how much worse 5% is than 3%
It's not exponential. And even though 5% is 66% higher than 3%, the monthly payment is $5,368 instead of $4,216 on 1m which is 27% higher. Sure you pay twice as much interest over 30 years.
Do you think a typical homebuyer stretching themselves in the heated market of the past 2 years can easily absorb a 27% increase in their payment? I have my doubts.
Because you're paying it off faster than it grows. It would be exponential if you were allowed to simply let it sit without paying it down, but that would break the contract and get you foreclosed.
Don't know numbers off hand but we had a <4% rate ARM because it was the lowest rate and we liked the flexibility of paying it off asap (or if something happened, paying it off over 30 years) versus a 15-year fixed.
Plenty of other reasons. Others have bad credit or otherwise get significantly lower payments on an ARM compared to fixed.
I guess there are other reasons, but ARMs are definitely not dead. I don't know the numbers or where to get them though.
What are more dead are the "balloon payment" residential mortgages where they may amortize over 30 years but the principal is due in 5 or 10 years.
> Don't know numbers off hand but we had a <4% rate ARM because it was the lowest rate and we liked the flexibility of paying it off asap (or if something happened, paying it off over 30 years) versus a 15-year fixed.
you can pay off a 15-year mortgage in less than 15 years - the lien will be released, etc whenever the principal is paid. Everything depends on the specifics of your contract of course but it would be extremely unusual to have a mortgage where this is not allowed.
fixed vs ARM purely depends on how the interest rate is determined, that's it. In principle ARM should be a bit lower than a fixed rate financed at the same time - but if the prime rate goes up then your rate goes up too, where with a fixed it's locked-in forever. Fixed will have a higher interest rate because someone has to assume that risk of an increase in the prime rate, where with an ARM that someone is you.
Taking an ARM vs a fixed is a bet on whether rates are going to stay the same or decrease, vs increase. And boy if you thought 2020-2021 rates weren't going to increase at some point in the future, uh... it's not every day you have a once-in-a-century pandemic that nukes the economy and drives demand for money almost to zero.
I'm not quite sure what you're saying about balloon payments either, the balloon payment happens at the end of a balloon mortgage, with the intention that values will have gone up so you can refinance at that point - but of course, what if they don't?
He wasn't worried about paying off the 15 year mortgage in 10 years. He was worried about getting a 15 year mortgage and then sometime happening so he couldn't afford to pay it off in 15 years. With a ARM you get the flexibility of lowering your payments to the minimum - which will pay it off in 30 years if bad times happen, while getting the lower interest rates of a 15 year loan (for the first X years, then who knows), and if you may the 15 year loan payment it is paid off in 15, while if bad times come you drop to the 30 year repayment amount and have more money to deal with whatever.
It can be a very good idea for someone who plans to pay off their mortgage early. If all goes well it is no worse than a 15 year mortgage, but when (really, if is unlikely) something bad happens you have more flexibility. Of course if interest rates go up you will get burned, which is why I go with a 30 year fixed rate that I pay off. I could probably afford payments on a 15 year loan, but I'm not willing to risk it.
Eh, I think we're talking past each other because none of what you said really applies to what I think I'm saying.
A 30year ARM gives you a lot more flexibility then a 15-year anything. I mean, you can pay off the 30 year in 30 years or 15 years or 5.
Regarding the balloon payment-- not sure what you're missing here. Residential mortgages with balloon payments aren't really offered any more because of huge risk of default when the balloon payment is due.
> Taking an ARM vs a fixed is a bet on whether rates are going to stay the same or decrease, vs increase
It's also taking a bet on how long you're going to keep the mortgage. When a bank offers a lower rate for a 7 ARM vs 30 fixed, they're assuming that you will keep the mortgage for more than 7 years. If you pay it off fully before then, you win the bet.
Before I gave up on buying a house this year, I was considering an ARM. Why? Because it meant I could qualify for an extra $100k, which gave me a better chance of being able to acquire a house.
It didn't matter whether an ARM was better or worse in the long run, it mattered that the ARM could get the house and the fixed rate could not.
With rates climbing to 5%+ in the last couple months, a 3% ARM (with the hope they could refi to a low interest 30yr fixed before the ARM becomes adjustable) may have been attractive for some..
I thought 2008 was because 'D' grade mortgages were repackaged into 'AAA' grade securities. When the 'D' grade folks missed payments and defaulted, it brought everything down because their securities had tainted so much of the landscape.
That was one factor. There was no single cause, but a fragile interconnected web of factors.
But yes, subprime loans were carved up and repacked in a way to make them look like AAA bonds. The banks that created these bonds knew that the loans in the bonds were crap; they knowingly lied to investors about it. The ratings agencies stamped all the bonds without any due diligence. Other banks piled on more derivative products on top of those bonds, essentially gambling on whether those bonds would go bad.
There was a slime-trail of fraud, laziness, and greed all the way back the original loan itself.
2008 was a lot of 'AAA' grade securities not being able to find a greater fool to keep the profit train running. A lot of financial instruments were basically repacking and reselling loans with a bit of interest on top. Once there were no more new buyers it was a cascade of margin calls.
Subprime was a very small cause of the GFC but it was the tipping point that brought the house down.
The article's subhead lists everything but mortgage: car loans, personal loans and credit card debt. That's where the growth has been. I remember hearing about 7 year car loans being a risky way to sell more more car loan for the same monthly budget.
There was also record high amounts paid back in 2020. I'd like to know if they adjust for that or just more fear-mongering by big banks, admitedly I'm too cheap to read further to find out.
Why would someone have opted for for an adjustable rate mortgage that adjusts after 5-7 years when they could have locked in a historic low rate for 30 years?
ARMs were not the problem in 08. The problem in 08 was interest only loans and/or balloon payments. Borrowers were intending to refinance before those deadlines hit but got stuck once values stopped rising. So they faced payments of 10s of thousands and/or their monthly payment was going to double or triple once they had to start paying principle down.
In contrast, if your arm resets from 3% to 7% it's like a 50% increase in mortgage payments. That sucks, but manageable given that your salary likely inflated along with your payment.
>but manageable given that your salary likely inflated along with your payment.
Which, anecdotally, has not been true for myself or any of my colleagues (barring the ol' job switch raise). Wage stagnation is an extremely common problem in many countries and industries. Those that have gotten or negotiated for raises aren't getting raises that account for the record-setting inflation (at least in my country, which is seeing the highest rates of inflation in 30+ years)
That's not the most analogous comparison; the most analogous comparison would be "where my rate of salary increase follows the changing interest rate on my mortgage".
It's not that your $100K salary should go to $200K if your mortgage goes from 3% to 6%, but rather that your $100K salary should go to $106K instead of just $103K if your mortgage goes from 3% to 6%.
Similarly, if your mortgage fell from 3% to 2%, you'd be pretty close to even if next year's salary went to $102K and likely in bad shape if it instead went to $67K.
Actually, I’m worried about techies specifically. It’s (was) surprisingly easy to count RSUs as income collateral, especially since the last 5 years have shown such a consistent source of income. Now that many RSUs are in the gutter, combined with an ARM, I don’t get how some techies will make ends meet especially in places like the Bay Area. Anyone know the actual magnitude of this problem though?
For mortgages, lenders will entirely or heavily discount RSUs for income calculations.
However not discouraged by that fact, some tech folks are known to instead have taken out regular non-mortgage variable rate loans with their RSUs as collateral. So there are folks, who bought a house "all cash" with loans backed by stock collateral that is now worth much less. Those types of loans also have a double-digit APR, which might have been fine if you thought you could flip your house for 30-100% in the near future. In the current housing marking it is like putting everything on black at a casino, it might work out, but it might be also be a complete catastrophe.
> lenders will entirely or heavily discount RSUs for income calculations
Multiple lenders, when I was shopping for a mortgage in October, encouraged me to take a variable-rate ARM with a balloon payment when I mentioned my options. (I declined, opting for a 15-year standard instead.) For the lender, as long as you can refinance in 5 years, the risk is minimal. For a borrower, this structure could easily wipe out one's savings.
> Those types of loans also have a double-digit APR, which might have been fine if you tought you could flip your house for 30-100% in the near future.
Nah not all of them. Margin loans were as low as 0.5% APR, and currently not much higher than that.
Techies have zero excuse for any sort of financial trouble. Not only has the job market has been insane (and still is for the most part), the amount of money you make, even with previous RSU distributions should allow anyone in the field to save enough money to ride out a recession.
There is however a definite problem of people across all income levels living way above their means.
Those of us who’ve lived through more than a few years of working life value stock options and RSUs and anything else at zero until it’s transformed into cash.
I’ve had to go through the mortgage process three times in the last two years when my income was based on a prorated two year signing bonus and a back heavy RSU vesting schedule over 4 years [1].
The first time for a refinance and the second time for HELOC. Both times they would only consider my base. Luckily I lived in a relatively low cost of living area and we weren’t talking about that much by todays standards - a $300K refinance and a $160K HELOC a so my base pay was enough.
The third time when I tried to get an investment property, my DTI was too high to qualify based on solely my base. If they had counted my RSU grants even considering the 30%+ YTD decline, it would have been more than enough. I ended up doing a no income documentation loan and paying down the loan by a point. I also had to put 30% down.
For the second one, they still questioned why my stated income for 2022 was much lower than my actual income for 2021. I had to re-explain my compensation structure.
[1] How do you say which BigTech company you work for without saying which BigTech company you work for.
To clarify I’m not sure it counts directly to income, but it starts to be taken into account when there is substantial salary and other investment funds, especially if you are right on the border of the salary/loan ratio. Someone else mentioned it’s more like collateral
Probably depends on the broker and market. We bought in the bay area and RSU were counted as income (and fairly certain 1:1 by some lenders). And in some other areas they wont look at them at all is my understanding.
This is irresponsible in my opinion. (I'm sure some disagree.) Personally, I took the conservative approach where during my home purchase we made sure our income could afford a mortgage. Our RSU's are a bonus and when they come we can pay down our mortgage faster, go on fun vacations, or do all sorts of other things.
Currently, I'm on pace to pay off my 30-year mortgage in 8-10 years by putting half of my RSU's towards my mortgage on top of the monthly payments.
> Currently, I'm on pace to pay off my 30-year mortgage in 8-10 years by putting half of my RSU's towards my mortgage on top of the monthly payments.
This is not a great idea if you have a 30-year fixed mortgage with an APR below inflation. You're better off not paying it off, and instead setting aside the cash you would have used. Even in like a Series I bond which is currently paying 9% APR.
Money loses value every year, and it's losing value faster than your mortgage is going up in cost. Therefore, why would you pay it off today using money that's worth more, when you can pay it off in the future using money that's worth less?
Especially if you can park your money in something that tracks inflation.
Paying off your mortgage early is one of those things folks are always told is good - it's really not.
That's a free 9%+ return on capital. You're giving up free double-digit returns by paying off your mortgage early.
> Paying off your mortgage early is one of those things folks are always told is good - it's really not.
It only makes sense if there is a legitimate fear that someone might otherwise waste the money on frivolities - for many people saving and the self control it requires is very challenging.
You're sort of ignoring the point which is I get to chose how to allocate my money by not factoring my RSU's into my upper limit for what I can afford. I can keep my RSU's as they vest, or I can pay ahead on my mortgage or a combination of things.
If you're in tech and paying your mortgage depends on your salary and your RSU's you are not being financially responsible.
from April says: "The adjustable-rate mortgage share of applications last week was over 9 percent by loan count and 17 percent based on dollar volume."
I would welcome informed comment on what the total outstanding % of loans by count and total volume data looks like,
and in particular, insight as to whether the amounts are likely to trigger market disequilibrium...
The subprime space is really interesting vs mortgages. Like others mention, the due diligence these providers run for these is minimal.
The business model has been so successful in recent years because there have been such large numbers of applicants. Even though they approve only a fraction, the sheer volume means their business is booming. This all translates into not having to dig any deeper than credit scores.
That doesn’t make any sense. You’re implying that they’re just lending to people with the best credit scores. Which definitioally makes these not subprime loans.
Sorry, didn't mean to imply that. Its the best of the worst. You just lower the threshold to hit the volumes / default rate you're comfortable with to make a profit. Subprime is anything lower than 670, so you don't need to go so low.
Article is essentially paywalled, I'm not in finance and I'm not well-informed (and by my own admission I don't go out of my way to be well-informed), so forgive me if these questions are covered or stupid, but my questions when reading the headline are:
1. Are these subprime loans packaged in CDOs or any other kind of highly-rated derivative instruments?
2. If so, how exposed are the banks this time? What are current leverage limits?
3. Are there swaps on these instruments, and if so, are these positions being taken by the banks that are selling the CDOs?
4. If so, how exposed are the insurance firms?
In short, are the conditions in place for a similar event to 07/08? Has any meaningful regulation been introduced that extends beyond the mortgage market?
Looking beyond conventional lending, what is the scale of cryptocurrency lending? As I understand it, there's not much in the way of regulation when it comes to cryptocurrency, and I feel like that's probably a recipe for disaster somewhere in the future.
Who knows? If you want predictions of the future you need to talk to a religious leader: they are the ones who deal in confident predictions of the unknowable future.
There are signs anyone can read about the future, but nobody really knows exactly what they mean or how it will work out. If house prices continue to increase, but at half the rate of inflation: get in now. If house prices go down then wait. Just to make this more difficult, where are you living now: unless you can continue to live rent free in your parent's basement (I'm sure someone reading this is actually doing that), then you need to consider the cost of rent while waiting: even if a house goes down in value, it may still be worthwhile as an investment because most of the payment is coming from rent. Then there is the cost of maintenance which might be significant. There is the cost of moving: if you rent you can break the contract and leave a lot faster than if you have to sell a house in a now bad location first.
If you think I covered even half of the considerations in a couple short paragraphs you are very naive.
Home prices are not going down. The math just doesn’t work. The demand outweighs the inventory by several orders of magnitude the last time I checked. Rate hikes and inflation won’t have much of an impact.
Demand is driven by ability to finance. People buy the maximum home they can 'afford' (really, that they'll be loaned most of the time).
That is determined mostly by loan servicing costs to income ratios. What happens when interest rates go up?
Hint: what people can 'afford' changes. And it doesn't get better.
Prices on the market of course won't dip right away, because most sellers don't have to sell right away, and most owners won't have to sell at all. It takes inventory backlogging and houses sitting on the market a few years (usually) before sellers get desperate and start being willing to compete on price. Short sales and foreclosures can force the issue sometimes, but since people REALLY want to avoid those, they also tend to be lagging.
In rich neighborhoods, often the sellers will just pull the listing and wait, both to avoid drops in nearby property values based on comps (neighbors will hate them, and that matters in places like that), and because they have the capital to wait out a downturn and don't want to take the haircut.
The poor/shitty areas though, once the dam breaks it is quite impressive. I've watched it happen a few times now.
This is why real estate is often considered illiquid and hard to value.
There are 100 buyers for every home (charitably assuming "several" is only 2) or 1000 buyers for every home (a more reasonable reading that "several" is minimum of 3)? That doesn't sound right at all.
Theoretically, there are close to 30M HH that want to own a home, but don't.
That's close to 100:1.
More practically, probably only a 1/3rd of them are remotely qualified to buy something they'd want to own, and only a 1/3rd probably actually want to own & are currently interested in houses at this price.
interestingly US $ to indian rupee is growing more wider at around 77.8 INR to 1 US$. by that projection, indian rupee is falling so either invest in gold or US$ to beat "indian inflation"... does that make sense?
