So apparently the subprime mortgage crisis did not teach us much about the mortgage products we originate. FHA loans have replaced the subprime loans that caused the financial crisis and economic recession, and it is my opinion that they are not much better. FHA loans are loans that banks can issue and that the government will 100% insure so long as they qualify under FHA guidelines (which don’t seem to be to strict). So lets compare:
Characteristics of a subprime loan:
Stated Income Stated Assets: Mr. Jones might make $60K a year but “state” that he makes $100K a year and qualify for a larger mortgage. Originally this type of program was designed for borrowers who earned 1099 income and did not disclose their actual income on their tax returns for obvious tax purposes. Therefore the borrower did in fact make enough income to pay for a higher mortgage they just didn’t have the documentation to prove they made a higher income. In turn the bank charged them a slight premium for not providing full documentation of their income. Although this seems sensible initially, it turned out to have many problems. Namely, 1099 income is not always consistent and therefore on a bad month Mr. Jones might have trouble paying for his higher mortgage. However, the bigger problem is that these mortgages were issued to people who had W2 income. So for example Mr. Jones works as a hospital worker and makes 35K a year however he tells the bank that he also does construction side jobs on the weekends. The bank says ok Mr. Jones for get about your W2 income we won’t prove how much you make we’ll just state that you make 60K a year and you will qualify for the nicer house you were looking to buy. Mr. Jones says, “heck ya, let’s do that”, I’ll just work a few extra jobs on the side and I’ll be able to afford the mortgage.
The bank is happy because they just sold a larger loan amount. They don’t really care if Mr. Jones makes his payments because they will sell his mortgage to an investor in a week. The investor who buys Mr. Jones’ mortgage from the bank doesn’t care because he doesn’t actually know what went on behind the scenes, he thinks Mr. Jones in deed makes 60K a year and along with other characteristics will simply pool Mr. Jones mortgage without even looking at, with a bunch of other mortgages and create a debt security and make money.
Other banks that would have kept Mr. Jones mortgage or cared whether or not he made payments issued the loan anyway. Their thinking was: well if Mr. Jones defaults and we have to foreclose (which we don’t want to do) but if we have to, property values are rising so the equity in Mr. Jones’ house will be sufficient enough for us to re coop our losses and be on the upside in case of foreclosure.
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