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As interest rates climbed and the refinance boom ended, lenders, eager to maintain profitability, turned to an untapped market — marginally qualified borrowers with nicked credit files. By offering “innovative” (read “risky”) loan products and loosening underwriting standards, lenders expanded lending opportunities to borrowers by chancing higher default rates. Stringent lending practices were over, credit was easy, and confidence was high.

Yet, things were bound to turn bad, and today’s media reporting reveals extensive mortgage industry problems. Analysts decontructing the bad loan deluge are already pointing the finger at easy credit terms — too many loans chasing too few borrowers. After the dot-com era, investors bet on real estate and flooded the market with cash — all that liquidity found its way to new borrowers through attractive products with easy credit terms.

An array of lender offerings made loan approval easy and lowered up-front costs. Stated income loans allowed borrowers to apply for loans without the formality of income verification. Adjustable-rate loans were made with little regard for a borrower’s ability to repay higher mortgage notes when rates reset. ARMs were sold on the bet that loans could be refinanced later at fixed-rates, but slower appreciation is clouding many borrower’s refinancing options, and sending more into foreclosure.

In the end, the credit wave was bound to wash out as rates increased, house prices decreased, and lenders reined in loose standards. For many lenders its too late, as some rode the liquidity wave only to break their businesses across the rocks.

Once a prominent subprime loan originator, First Century Mortgage recently stopped funding loans and their stock was delisted when they couldn’t make good on promises to investors to buy back their bad loans. Bank lenders stopped funding First Century’s operations as their loans turned bad. Without bank credit, their operating cash dried up, and what’s left is the bankruptcy filing.

Another lender, NovaStar, recently reported to stockholders their problems loans and its effects on shareholder value. Layoffs are eminent and loan volume is down. Reporting declining profitability to stockholders, executives cited lax underwriting standards and inflated appraisals as the bad-loan culprits.

It’ll take many months to reveal the meltdown’s full scale, and more lender failures will occur. In the end, we’ll see that it was all predictable — lenders bet their businesses on short term profits by making poor-quality loans. While politicians are starting the call for stiffer loan regulations, lenders are asking for a second chance.

Across the nation, over 1 million home owners risk loan default and foreclosure. I wonder who was advising them?

John Huval, Broker Realtor® GRI e-Pro Copyright© 2007