What A Great Business We Screwed Up

One of the first loans I did in the mortgage business was one that showed clearly just what a sophisticated business mortgages was in 2002. A family friend was attempting to buy a condo with no money down. Furthermore, he was a fairly new business owner as a masseuseand so his tax returns would have shown very little income. (He had a decent credit of 660) I found a bank that did a program in which they would take the last twenty four months of bank statements, add up the deposits and then figure out the monthly average of deposits. I was able to get him a loan with no money down in this program. As I learned later, this sort of "bank statement" program was actually rather standard in the industry in the sub prime niche. Still, I was amazed by the possibilities of the business I had just entered.

That was the way in which the industry was structured. Each loan program was like a giant and sophisticated jig saw puzzle. For every negative that a borrower had, there also needed to be something equally positive in order for the loan to be approved. For instance, one of the tenets of sub prime was something we called "tradelines". In simple terms, sub prime banks wanted to see a minimum level of breadth and depth of the borrower's credit history and current credit profile. Banks often required anywhere from two to four "open tradelines". This simply meant that banks wanted to see that the borrower made regular payments to at least two to four creditors currently. Often times, some banks even asked to see at least one installment payment like a car loan, student loan, etc. among those tradelines. By making tradelines a part of the approval process, banks measured a borrower's ability to handle multiple payments monthly. Often, banks would allow for "alternative tradelines" if a borrower didn't have enough "tradelines" on their credit report. In other words, if borrowers didn't show enough creditors on their credit report, they could use things like their phone bills, insurance bills, and health club membership bills as an alternative.

So called stated loans were always a staple of mortgages however when I entered they were reasonable and limited. For instance, they always required a fairly substantial downpayment on a purchase or substantial equity on a refinance. Furthermore, they were limited to small business owners and others with erratic or unpredictable incomes. Finally, even in sub prime, they required credit scores well above 650 to qualify.

Bankruptcies, foreclosures and mortgage lates often meant that borrowers wouldn't qualify or at a minimum reduced the amount a borrower could qualify for. Alt A was a niche that often mirrored loans normally approved by Fannie Mae/Freddie Mac. Fannie/Freddie have a funky approval process in which a loan is entered into a software system. As such, ultimately a computer algorithm is approving their loans. Alt A were loans that were good enough to be approved by Fannie/Freddie but were rejected by the software for whatever reason. Also, they allowed for slightly less stated income restrictions and slightly higher loan to values. Their rates were by extension slightly worse than what Fannie/Freddie allowed.

As such, the industry created an ingenius system of sophisticated approvals in which many had the opportunity for purchasing a property, but also, the banks were able to match up the risk profile with the rate charged.

Then, the real estate boom hit and slowly the tension that allowed banks to match up risk and rate began to erode. The first thing to go was any requirements for "tradelines". Once one bank removed that restriction most others followed quickly. This was an easy removal because mortgage brokers hated adding up these tradelines and breaking them up into subsets.

Then, like dominos other lending guidelines quickly went away. Soon enough, banks opened up stated loans to those with W2 or other fixed incomes. Then, quickly the highest loan to value started to creep up until eventually you could state, or lie, about your income and do it with no money down. After banks went to 100% loan to value on stated loans (for W2 borrowers no less), they then began to slow process of requiring lower and lower credit scores to do it.

Then, banks began to overlook bankruptcies, foreclosures, and mortgage lates until finally the industry standard became that only credit score mattered. In other words, a borrower could have multiple mortgage lates, bankruptcies and foreclosures and as long as their credit score met their minimum requirements they would qualify for the loan. Alt A began to loosen their standards so that they weren't merely mirroring Fannie/Freddie loans, but rather, they were giving borrowers another opportunity to buy a property with no money down while stating their income. Whereas sub prime went all the way down to 620 on their no money down, Alt A "merely" stopped at 660 minimum for no money down stated.

The revolution was complete. The business went from a sophisticated jig zaw puzzle to a business where anyone with a heart beat could get a loan.