How Sub-prime Crisis Could Hurt Home Sales

Written by Posted On Sunday, 18 March 2007 17:00

The sub-prime crisis has turned into quite a nightmare for some homeowners and the lenders who originated those loans. Now, the $64 million question is: if and how will it affect the housing market.

"Delinquencies and foreclosures are going up because rate re-sets are kicking in on exotic arm loans -- the interest-only and negative amortization arms -- the very aggressive type of mortgages," says economist Zoltan Pozsar, of Moody's

The problem, Pozsar says is that borrowers were not properly qualified for these mortgages.

"The way lenders have qualified these borrowers is by saying, "let's look at the teaser rates—it's two percent for the first two-years of the loan'—and sure [borrowers] could qualify on that. Lenders were basically not looking at whether the same borrowers could qualify when the rates re-adjust to six or seven percent," says Pozsar.

Pozsar says that even a two to five percent rate increase can translate into a few hundred dollars increase in a monthly mortgage payment—something he says many of these borrowers did not completely understand nor are they prepared for.

"Especially for these low-income households, who were mainly targeted for these loans, a few hundred bucks is a lot," says Pozsar.

As homes are foreclosed on, the original mortgage loans on those homes are not being paid to the investors who bought them as investments. So the investors are looking for the money from the original lender.

"The reason these lenders are going bankrupt is that investors [to whom] they have sold these mortgages are now forcing them to buy these "junk" loans back, so to speak, and [the lenders] don't have the cash to do so," explains Pozsar.

As this happens, a domino effect is set in motion.

"The issue here is that lending standards are tighter, the funds that flow to lending institutions to make mortgage loans are drying up, there's less [money] going into that part of the financial system, there is a mini-credit crunch developing especially in the sub-prime market," says Pozsar.

The scenario creates a very volatile situation for not only potential borrowers, homeowners, lenders, and investors but also the entire housing market.

"One predication I would make is, once all these mortgage lenders go out of business because they are choking on these losses, this firewall that exists between investors and originators is going to go away," says Pozsar.

He says, that leaves investors in a far more vulnerable position.

"The next act of the sub-prime mess is going to be investors and hedge funds getting [financially] hurt, especially the ones that hold the riskiest of these sub-prime-mortgage bank securities.

But Pozsar says the real threat may still lie in the future.

"Now, if that happens, through contagion, the fear could easily spread from the sub-prime market to the prime MBS (mortgage-backed securities) market and that would further reduce the funds that are available for mortgage lending out there and that could translate back into the real economy by even the good borrowers not being able to find the money and get a mortgage. So that could force an extra round of decline in home sales and home construction," cautions Pozsar.

Before you think it is all doom and gloom, Pozsar says about this hypothesis, "This is a risk that we are very carefully monitoring; it's not happening yet but it could."

However, some mortgage and real estate organizations don't believe the situation is quite that ominous. Credit tightening rather than defaults may have a more substantial effect. But these associations still point out that we have a strong, solid economy in which people are being employed, not laid off. It's this sound financial environment that some experts say makes today's housing market different from the last housing crisis in the 1990s -- and gives them reason to expect a brighter picture on the housing front.

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Phoebe Chongchua

Phoebe Chongchua is an award-winning journalist, an author, customer service trainer/speaker, and founder of Setting the Service Standard, a customer service training and consulting program offered by Live Fit Enterprises (LFE) based in San Diego, California. She is the publisher of Live Fit Magazine, an online publication that features information on real estate/finance, physical fitness, travel, and philanthropy. Her company, LFE, specializes in media services including marketing, PR, writing, commercials, corporate videos, customer service training, and keynotes & seminars. Visit her magazine website:

Phoebe's articles, feature stories, and columns appear in various publications including The Coast News, Del Mar Village Voice, Rancho Santa Fe Review, and Today's Local News in San Diego, as well as numerous Internet sites. She holds a California real estate license. Phoebe worked for KGTV/10News in San Diego as a Newscaster, Reporter and Community Affairs Specialist for more than a decade. Phoebe's writing is also featured in Donald Trump's book: The Best Real Estate Advice I Ever Received and The Complete Idiot’s Guide to Buying Foreclosures. She is the author of If the Trash Stinks, TAKE IT OUT! 14 Worriless Principles for Your Success.

Contact Phoebe at (858) 259-3646 or [email protected]. Visit for more information.

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