Why 2011 might not even be the end.

Why the market still doesn?t get it.

After a year of contraction, the market still doesn?t understand risk. Now, in late November of 2007 (a year after the meltdown started) we are still closing and funding loans that we have no business closing and funding. And the industry still has a misunderstanding of what a ?good risk? is. The below numbers are used with permission of my client.

He is a great risk. Best Available pricing.

I got a file from a fairly young (24) borrower that had a 731 credit score. A perfect payment history for the four years he?s had credit. He?s had a decent job for a year and a half?was a student prior–and he earns about $37,000 per year. Right now, he lives with his parents, has no expenses. He?s got a car payment of $176.00, and his student loans are currently in deferment?he?s got up to 2 years.

In his checking account, he?s got less than $500, and roughly $1800 in an employer matched 401(k) that has doubled this year because of the performance of international funds.

His Realtor (who is a good, conscientious agent) showed and sold him a $138,000 house. He qualifies on the ?My Community,? program with a rate of 6.5%. His taxes are $2220 per year, and the condo fees are roughly $60 a month.

His ?total? payment at $1225.50?and his debt ratios are in the popular 35/45% wheelhouse. His closing costs are being paid by the seller, so he?ll have the cost of an appraisal and an inspection tied up in this house?so $500-700 bucks will be in the deal.

Of course, he gets an the best grade available, this gets him the best pricing available.

But let?s take a look at his real budget:

His GROSS monthly income is $3,083 per month. His take home is?of course?much less. $500-700 less, at the very least.

Best case: $2583 per month–let’s do the math.

$2583- $1225 = $1358 per month.

Taking out his car payment: we have $1182 remaining. Now, according to public records, this house had average utilities totaling $360 per month for gas, electric, water, sewer, and trash. A single guy that traveled a lot was the prior owner, according to the listing agent. This leaves our “A paper” borrower with $822 per month?best case scenario.

He has to carry car insurance, and it?s $96 bucks (it was $108 before he got the homeowner discount). He?s got 14 miles to drive back and forth to work each day. Let?s say he has the audacity to drive an additional 250 miles per month, beyond his commute. At 2.76 per gallon, This is $87.58 in gas, per month, and this is something of a best case scenario. This leaves our ?perfect, desirable, fought over? borrower with $638 per month to spend.

A cell phone bill is $55/month. He doesn?t have a land line. The internet is $35/month.

His copays and prescriptions have averaged $15 per month this past year. This leaves $538. When his student loans come due, they will only be $70 bucks. His job is one that he?s not likely to get a raise for 4 years. Still: this is considered an A+ borrower.

This means he?ll be left with $468 per month?best case?to spend $108.00 a week (if he drives 250 or fewer miles per month) to spend on food, clothing, surprises. This assumes that his car never needs maintenance. He won?t be able to miss a single day at work, it will be years before he can really and truly afford this home.

The way our market works, this guy is the BEST BORROWER ON THE PLANET!

Is there a difference between him and other borrowers? You betcha. Why is he then lumped into the “conforming” bucket?

Until FNMA and FCMLC radically change how they underwrite, the problems are still growing–not shrinking. Nothing is contained because of the antiquated underwriting models that both of these agencies employ.

This is why we?re not even at the beginning of the end. Our borrower is considered ?not risky,? solid and safe. If a major event happens, he is in a severe tailspin, but the current Fannie Mae underwriting model gives him preferred rates and reduced mortgage insurance. A lot of people with even thinner credentials were given these loans.

The underwriting models are still wrong. There is no disposable income test, there are people like this that are advised that this is a ?smart? decision, and the current underwriting model thinks that this is a ?safe? borrower. So, the worst is yet to come, until we include “disposable income,” in the advice that we dispense along with debt ratios.

Chris Johnson is a mortgage loan originator in Westerville, OH with a front row seat to the declining market.  You can reach him at [email protected]