Ask the Expert

I’ve been hearing a lot, lately, about a pending “credit crunch” in the mortgage market. I don’t understand how this is connected to the sub-prime mortgage problems that have been in the news. Please explain.

Back a few decades ago, banks were the only source of mortgage funding available and it was a limited source, at that. Because banks could only lend out a certain percentage of their excess reserves, many times there was a shortage of money available for even the most qualified buyers to finance a home purchase. Then along came the concept of mortgage backed securities (A/K/A “MBS”) and the secondary market, which is where the funding for most mortgages comes from today. A lender originates a loan, or a group of loans, and packages them into a mortgage-backed security which is then sold to investors like pension plan managers, or into individual shares to small investors like you and I. You may have even looked over a prospectus to invest in a mortgage-backed security, yourself, at one time or another. The monies invested in these MBS instruments fund mortgages in an indirect way. The lender will typically use a line of credit to close and book the loans and then wait until they are sold to a secondary market investor to pay off or pay down their operating line. The difference between the funds generated from the sale of the loan pool(s) and the outstanding line balance is the lender’s profit margin.

While the problems resulting from high numbers of defaults in sub-prime loan categories affect mostly that particular group, it needs to be recognized that mortgages are sold into investment pools and any risk to the quality of these large investment pools sends shivers through the mortgage-backed securities market and can turn otherwise motivated investors into sellers of those securities instead of buyers. When that happens, the ultimate source of funding begins to dry up. Something else happens, as well. The lines of credit extended to those mortgage lenders to bridge the gap between closing a loan and getting it funded by their investor may also be jeopardized. Large commercial banks and institutional investors who offer operating lines of credit to a business that no longer appears viable because its primary operation is being impacted, tend to stop lending to those businesses and in many cases shut down the lines of credit in order to curb their own potential losses. So, what started out as strictly an issue related to high risk, sub-prime mortgages can carry over into the entire market, at least temporarily.

In the meantime, your professional Realtor is the best resource to know where you can get your home financed. As part of their training and ongoing education, Realtors monitor what is happening in lending circles and will know how to guide you to finance your purchase.

Barbara Cunningham

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