This Is Your Father’s Mortgage

To try to help sort out how the mortgage crisis came to be where it is today, it may help to look back at where the industry has been.  Since the earliest days of mortgages, well over 100 years ago, borrowers wanting to purchase a home put down a sizeable down payment, usually 20%, or more, and proved their credit, income and assets to qualify.  The lender, usually a bank, after providing the loan, held it in-house in what is called a portfolio, bearing all the risk of repayment by the borrower.

Along these lines, one factor contributing to the crisis is the emergence of the Mortgage Backed Security (MBS), in the 1980s.  An MBS is a security that is made up of mortgages that have been bundled together.  These securities, like others, are traded by investors.  This is an important point, in that the traditional lender/borrower relationship had now changed, with the investor influencing the lending decision.

As time passed, and these securities were used more by investors, they, the investors – looking to increase their rates of return – began relaxing their acceptable criteria. They directed lenders, from whom they would buy the loans, to lend money to borrowers that were either putting down less than 20%, or less creditworthy than in prior years, or both. Many of these mortgages were what was called sub-prime.

Moving forward to the current market, as these sub-prime borrowers are turning out to have high default rates, investors, who are watching their mortgage portfolios implode, are returning to the purchase of more traditional mortgages.  This will in turn limit options of borrowers today, holding them to more strict standards, as they were a generation ago.