By James R. Hagerty and Ruth Simon
From The Wall Street Journal Online
A rise in defaults is prompting some lenders to clamp down on the use of "piggyback" mortgages, a risky type of loan that helped prolong the housing boom by allowing borrowers to finance up to 100% of the purchase price.
Fremont General Corp., a major lender to people with weak credit records, has stopped providing these second mortgages, which are frequently used by financially stretched "subprime" borrowers who can't scrape together a down payment. A spokeswoman for Fremont, based in Santa Monica, Calif., confirmed the decision, which was first announced in emails to mortgage brokers earlier this week, but she declined to comment further.
Fremont's move comes amid a rapid tightening of credit standards by subprime lenders as they find investors no longer are eager to buy types of loans deemed particularly prone to default. The pullback by subprime lenders could put a further dent in demand for housing by preventing some potential buyers from getting loans at a reasonable cost.
Other lenders are likely at least to cut back on piggybacks this year because of the difficulty in selling them to investors, said Thomas Lawler, a housing economist in Vienna, Va., who refers to such loans as "oinkers" in light of their poor recent performance. This and other steps to tighten credit probably will prevent some people from buying homes this year, creating another "head wind" as the housing industry struggles to emerge from a sales slump, Mr. Lawler added.
Lenders are "getting back to the old-fashioned, makes-sense lending that prevailed before the last few years," said Daniel Jacobs, chief executive officer of 1st Metropolitan Mortgage, a nationwide mortgage brokerage firm based in Charlotte, N.C. Some are cutting back on piggybacks by making them more expensive and denying them to people with very weak credit records, Mr. Jacobs said. Mortgage brokers collect fees for signing borrowers up for loans.
Lenders also are tightening up in other ways, such as insisting borrowers provide pay stubs and other proof of their income or by making them put down at least a small down payment. "Across the board, everybody is ratcheting up" the minimum credit score at which they will make particular loans, said A.W. Pickel, a mortgage broker in Overland Park, Kan. Bob Moulton, president of Americana Mortgage Group, a broker based in Manhasset, N.Y., said he is still able to help most borrowers but that some requests for credit "are getting a little hairier."
Piggyback second mortgages typically cover as much as the final 20% of the home's cost, supplementing a first mortgage that covers 80%. Investors have grown increasingly wary of buying such loans from lenders amid a surge in defaults by recent subprime borrowers. The holder of the second-lien mortgage can hope to collect proceeds from the sale of collateral only if the holder of the first mortgage is fully repaid. In many foreclosure cases, second mortgages must be entirely or almost completely written off.
The subprime mortgage market has mushroomed in recent years as lenders found that investors both in the U.S. and abroad were eager to buy securities backed by such loans. Mr. Lawler, the economist, estimates that 17% to 18% of mortgage-financed home purchases in the U.S. last year involved subprime loans. About half of the subprime home-purchase loans included in mortgage securities last year were piggybacks, according to a recent report by Credit Suisse Group in New York. And about 43% of subprime loans packaged in securities in 2006 didn't require the borrowers to fully document their income or assets, a type of mortgage sometimes derided as a "liar's loan" because it can encourage borrowers to exaggerate their means to get a loan.
Borrowers have been rapidly falling behind on loans made in the past year or so. In November, payments were at least 60 days overdue on 12.9% of subprime loans packaged into mortgage securities, up from 8.1% a year earlier, according to First American Loan Performance, a research firm in San Francisco.
The Credit Suisse report said late payments and defaults have been particularly common on piggyback loans and those with less than full documentation. Borrowers who finance 100% of the home's cost have "no skin in the game" and so might be more inclined to walk away from the house when they begin to suspect they won't be able to afford it, the report said.
People who rent homes typically have to come up with a deposit to cover a couple months of rent, the report said. But "some homeowners who did not have enough savings to rent a home were able to actually buy a home," it said.
At a conference Monday, Goldman Sachs Group Inc. fixed-income strategist Michael Marschoun said 20% of the loans "cause more than half the losses" in the subprime market. "These are loans that have absolutely horrendous loss performance, and my prediction is these loans will simply not be originated going forward." These are "risk-layered" loans that have some combination of a low credit score, low down payment, low documentation and investment property.
Explaining the decision to stop providing such seconds, the Fremont email received by brokers said: "This is due to investors having no interest in second mortgage loans."
Fremont was the seventh-largest subprime mortgage lender last year, with $32 billion of such loans originated, for a market share of about 5%, according to Inside Mortgage Finance, a trade publication. About a quarter of Fremont's first mortgages originated last year came with a second mortgage, the publication estimates.
Borrowers who can no longer get piggyback loans may turn to mortgage insurance, often sold as a way to let borrowers obtain loans totaling more than 80% of the home's estimated value, but mortgage insurers draw the line on some risks. "We're comfortable...insuring borrowers who have lower credit scores, provided that there is full documentation," said Mike Zimmerman, vice president of investor relations for mortgage insurer MGIC Investment Corp. MGIC doesn't insure subprime second-lien loans based on the borrower's "stated," or undocumented, income. MGIC also doesn't insure subprime loans that total 100% of the estimated home value, he said.
Most subprime loans are sold to Wall Street firms and others institutions that package them into securities for sale to investors world-wide. The lower-rated portions of these securities -- those that absorb the first losses from defaults -- typically are sold to hedge funds and a variety of other investors in the U.S. and abroad.
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-- February 15, 2007