Is it 2008 all over again? : RealEstate

I will preface this by saying I am in no way predicting what will happen to the market ( be it up or down). I am not saying invest or don’t invest.

Sparked by numerous ill informed comparisons between 2008 market and today’s market I wanted to highlight some very clear distinctions. The lending environment leading to the 2008 crash is a once in a lifetime event which is never repeating again. A whole set of fundamental changes in lending guidelines were forced upon lenders to never again allow for that to occur. Even if these guidelines were to get scrapped the lenders themselves faced such losses (I remember BOA stock down to $5/share) that they will not allow themselves to take that kind of risk again. Lets look at some fundamental differences.

– The biggest elephant in the room were the ” No Income No assets loan” (https://www.investopedia.com/terms/n/nina.asp) . Real estate had became sort of a Ponzi pyramid scheme, where the property value increases were too fast for the qualified borrower to catch up. Once the market of qualified borrowers dried up, this program allowed anyone willing to get a loan to buy a house. All they had to do is declare how much money they had in the bank and how much money they made. No proof of income or assets was required. As you can imagine, everyone was practically Elon Musk and would qualify for any amount.

– 100%+ financing. “Well how did they come up with the downpayment if they just had to state they had $1Bil in the bank but actually had $0?”- you may ask. Here is the fun part, you did not need any downpayment. As a matter of fact, when the system was collapsing you did not need to come up with closing costs, escrows and even the first 6 months payments. (Of course we still have 100% financing now, but this is limited to Veterans and State sponsored programs where the whole risk is taken over by the state or the VA, the % of these loans today are completely negligible)

– Negative Amortization. To address this lets just talk for a bit what happens to your loan once it closes. It ends up in the secondary Market. One of the requirements of the secondary market is for the loan to make the first 6 payments on time every month. Clearly we have some borrowers that will not be able to make this payments since they are ” stating their income”. Well to address this the Neg AM (https://www.investopedia.com/terms/n/negativelyamortizingloan.asp) was invented. This loan may have an interest rate of 8%, however for the 1st year you are only paying 1% interest. The other 7% is added back to your principal balance, which grows every month. Essentially you have a very low payment the first year and then are hit with a huge payment increase in the end of the year.

– Compounded risks. A lot of other variables were added as the things become dire. Interest only loans became popular, borrowers did not have to prove residency in the US or have a credit score/ social security, lenders would give incentives to make the first 6 payments on time (from coffee maker the first month to couches by month six). So essentially you could have someone enter the US the day before (non documented), state his income and his assets, have no downpayment, have no money in the bank, no credit score, and be able to get a NegAM loan for 100% + closing costs financing.

There was a big difference in points and rates you paid as a qualified borrower buying a house and someone in this last example. However eventually it became apparent this was a disaster in the making, lack of additional qualified borrowers combined with increase of caution from the secondary market and tightening of the risk resulted in the collapse. Borrowers could easily walk away from properties they had no money invested in and had barely made any payments on, especially for those whose credit could not be impacted. What has happened since then:

– Dodd Frank Act, CFPB. Following the crisis a serious of changes were implemented to stop the repeat of the factors that contributed in the crash. (https://www.investopedia.com/terms/d/dodd-frank-financial-regulatory-reform-bill.asp). The Act set a series of guidelines and government overview/control of the lenders to prohibit predatory lending and subprime mortgages. So programs like NegAm, No income no assets etc never again become mainstream. This ACT also created the Consumer Financial Protection Bureau that oversees and has tight control over the programs and lending guidelines.

– Ability to Qualify. One of the biggest differences of todays market is that the vast majority of the loans (excluded here are investment properties and HELOCS) are done under the Ability to Qualify ACT. https://www.consumerfinancemonitor.com/2020/12/14/cfpb-finalizes-ability-to-repay-qualified-mortgage-rules/. Under this act for all loans made for primary residences the lender must evidence that the borrower has the ability to pay back the loan. Essentially this means that lenders need to evidence borrowers have sufficient income, sufficient credit and sufficient assets. Borrowers must have funds invested in property that makes it harder to walk away from it. We still have loans with 3, 3.5, 5% downpayment but the risk for those is mitigated by Mortgage Insurance companies, HUD or VA. This essentially means we are unlikely to see a flow of foreclosures that sell at 50% of the market value so the bank can recoup costs (which in turn impacts the entire neighborhood).

– It’s no longer just an owner occupant game. A big driver in 2008 was lack of qualified borrowers. We live in a global economy today where the competition is anyone with cash anywhere in the world. IN addition raise of property values has helped existing homeowners to pull cash out and invest again creating additional competition. We are not running out of buyers any time soon.

Fear and the unknown often play a part in what happens to the market. Changes and fluctuations are part of the game and will always be there, but 2008 was a learning lesson and the conditions leading to it will not be repeated.