One Reason for the Subprime Lending Mess

Here is an excerpt from the Senate Committee on Banking, Housing, and Urban Mortgage Market Hearing of March 22, 2007, available  at 2007 WL 892889 (FDHC). The speakers are Senator Dodd, Committee Chair and Sandy Samuels, Executive Managing Director of Countrywide Financial Corporation.

DODD: Let me ask all of you here -- the lenders, anyway -- one
of the arguments we frequently hear against underwriting at the fully
indexed rate is that the borrowers are not qualifying because the
debt-to-income ratios would be too high.

I wonder if you can each give me a ballpark figure of what the
debt-to-income ratio would look like if the hybrid-ARMs borrowers, if
they were underwriting at the fully indexed rate.

Mr. Samuels?

SAMUELS: I don't know what that number is, Mr. Chairman. I will
tell you that about 60 percent of the people who do qualify for the
hybrid ARMs would not be able to qualify at the fully indexed rate.

Now, there may be other products for which they might qualify,
but there is a not insubstantial number who would have difficulty
qualifying in any event. And that is the concern. And I think that
that's, I think, what Mr. Pollock was referring to; that we have to be
concerned, in adopting any kind of regulation or legislation, that we
don't make it harder for families to qualify for a home purchase or
refinance when they can qualify to do it and when we can be sure that
they can -- or we have a good idea that they can be successful in that
loan.

It appears that the "fully indexed rate" is the interest rate that the loan will jump to after the teaser rate expires two or three years down the road.  In other words,  60% of those who qualified for the hybrid ARMs would not be able to qualify for the rate they were to be charged in the relatively near future.  Of course some people's circumstances could be expected to change over that period, but it seems unlikely that most borrowers' situations would.  If lenders were making loans with the expectation that consumers would not be able to qualify for those loans under the terms (i.e., make the payments) they would switch to two or three years later, is that fraudulent?  Were lenders that confident that home prices would continue to rise so that consumers would be able to refinance before the bill came due (incidentally, generating new fees for the lender) or did they just not care because someone else (investors) would be left holding the bag?  Or am I missing something?

Comments

[Elizabeth]

Back when I bought our last home and we were looking at mortgages, I thought that the rate didn't necessarily automatically go up to the maximum rate - it depended on what interest rates were doing generally. Also, it didn't get there all at once - there was a maximum rate increase per year such that even if it went to the maximum rate, it would take several more years to get there. So perhaps lenders were not assuming that mortgages would definitely go up to the maximum rate.