My August 4th, 2012, show titled “Attack of the Killer Loan” was an instant cult classic. It sparked a torrent of calls and emails, and I have referenced it regularly ever since its original airdate. The fall of 2012 saw the first large flurry of refinancing activity since the housing bubble of 2007, and it was astonishing to see the mortgage industry so quickly forget the lessons of the housing collapse. As the refinance boom of 2013 winds down, and the industry transitions toward a more competitive purchase market, both buyers and lenders are making the same mistakes they had made in 2007 and 2012. This post is an appeal to readers who missed the original show.
After a deep recession, such as the 2008 financial crisis, many people find their personal finances in severe distress. They also find an abundance of great deals: stocks, houses, and automobiles, to name a few, are priced to move. Unfortunately, their distressed finances prevent them from capitalizing on these deals. Lost wages may have depleted their assets; late payments may have tarnished their credit score.
Many are frustrated when their credit profiles prohibit them from acquiring credit to make high-value purchases. And so lenders find creative ways to extend credit to these people. One of the first harbingers of the financial meltdown was Mitsubishi Motors. In the mid-2000’s, Mitsubishi attempted to lure young buyers to their showrooms through long-term (60 months), no interest loans, regardless of credit scores. Few were surprised when these young buyers could not repay their loans, and Mitsubishi took a huge hit. As a result of this fiasco, it has almost disappeared from the US market.
More recently, General Motors acquired Americredit, a subprime lender, and renamed it GM Financial Services. They are repeating Mitsubishi’s mistake in seeking out subprime, high-risk borrowers. They recognize there are millions of potential customers who would love to take advantage of the incredible deals found throughout the automotive industry, but are prevented from doing so because of their poor credit.
Subprime lending has also returned to the mortgage industry. Lenders are allowing lower and lower FICO scores to pass their underwriting guidelines. They allow for more creative definitions of “down payment” such as including property taxes and the appraisal fee as part of the down payment. And they’re taking a more generous attitude toward things like overdraft and late payment histories.
These lax standards have coincided with the reemergence of adjustable rate loans—that is, loans that offer a low introductory rate, and then readjust as interest rates rise throughout the duration of the loan. Borrowers can typically afford the introductory rate, but then find their finances stretches as their payment increases with each rate adjustment. My advice to everyone is to never, ever take out an adjustable rate loan. Perhaps there were a few psychics who foresaw the recent period of historically low interest rates; for them, ARMs make some financial sense. For those of us without psychic abilities, ARMs make no financial sense and are often dangerous.
As tempting as it is to capitalize on the public’s mad rush for credit, I strictly prohibit the loan officers at Garvens Mortgage Group from putting people into mortgage products they cannot afford. Oftentimes, this means declining to even allow them to fill out an application until they get their finances in order. Naturally, some walk away and find a loan with a different lender. It would be edifying to know how it worked out for them. But for most people, these refusals are humbly accepted. They then get to work on re-structuring their finances to ensure they can afford a standard mortgage product, without introductory gimmicks or clever financing tricks.