The Mortgage Professor

The Price of Risk for Borrowing Is Up, But Don't Call It a Market Meltdown

By Jack Guttentag
Saturday, August 11, 2007

I have been getting a lot of mail from mortgage brokers and small lenders complaining that they are no longer able to get funding for loans that previously would not have been questioned. One of them described it as a market meltdown.

I have been developing a database on wholesale mortgage prices that lets me peer into the heart of the problem, if there is one. Wholesale prices are those that lenders quote to mortgage brokers and small lenders called correspondents.

My database covers 11 of the largest wholesale lenders. Because they account for a large share of what is an extremely competitive market, it is safe to assume that their prices are representative of the overall wholesale market. While most price differences are small, in every case I took the lowest of those shown.

Wholesale prices have much less statistical noise than retail prices because they do not include markups, which can vary widely from one transaction to another. Further, the transaction characteristics underlying the wholesale data are well-defined. I know the loan amount, property value, type of property, state, purpose of loan, use of property, borrower's FICO credit score, type of documentation, whether the borrower escrows taxes and insurance, and lock period. None of the available data series on retail prices contain this amount of detail on factors that affect mortgage prices.

The data are available for 14 loan programs, of which six are fixed-rate and eight are adjustable-rate. Data are available for individual states and for a U.S. average. Subprime mortgages are not covered, though Alt-A and other intermediate credit categories are included.

To simplify price comparisons, I adjust all rates to zero points and fees. The interest rate is the only price used.

Because this is a work in progress, I don't yet have the data series that permit day-to-day monitoring of the market. However, I did a test run on May 4 covering California and will use that as a benchmark for assessing the state of the market on Aug. 3.

On cream-puff loans, interest rates rose by about 0.4 percentage points from May 4 to Aug. 3. On some programs, it was a little more, on others a little less.

A cream-puff loan is one with a 20 percent down payment on a $500,000 single-family house bought as a permanent residence by a borrower with a credit score of 720 or more. The borrower fully documents income and assets, and escrows taxes and insurance.

The lenders who are writing to me, however, are not complaining about cream-puff loans; their concern is the riskier niches, and the evidence supports their claim. The price of risk has gone up.

One of the tables I ran on May 4 showed the rate at different FICO scores. On scores ranging down to 680, rates on Aug. 3 were about 0.4 percentage point higher, but at 660, the increase was 0.56 percentage point, and at 620, it was 1.4 percentage points. Below 620, there were no quotes on either date; that's subprime territory.

I also looked at rates on loans of different sizes on May 4. The loans were for $75,000, $417,000, $418,000 and $2 million. The two middle sizes distinguish between loans that can and that cannot be bought by the two government-sponsored entities, Fannie Mae and Freddie Mac, which have a ceiling of $417,000 on mortgages for single-family homes in most areas.

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