Teaser rate

The Big Picture fills in some nice little details on how altered lending rules could lead to situations where a mortgage broker lends $500,000 to a person making $37,000 a year.

In this ultra-low rate environment, where prices are appreciating, and most mortgages were being securitized, all that mattered to the mortgage originator was that a BORROWER NOT DEFAULT FOR 90 DAYS (some contracts were 6 Months). The contracts between the firms that originated mortgages and the Wall Street firms that  securitized them had explicit warranties. The mortgage seller guaranteed to the mortgage bundle buyer (underwriter) that payments were current, the mortgage holders were valid, and that the loan would not default for 90 or 180 days

So long as the mortgage did not default in that period of time, it could not be "put back" to the originator. A salesman or mortgage business would only lose their fee if the borrower defaults within that 3 or 6 month contractually specified period. Indeed, a default gave the buyer the right to return the mortgage and charge back the lender the full purchase price.

What do rational, profit-maximizers do? They put people in houses that would not default in 90 days -- and the easiest way to do that were the 2/28 ARM mortgages. Cheap teaser rates for 24 months, then the big reset. Once the reset occurred 24 months later, it was long off the books of the mortgage originators -- by then, it was Wall Street's problem.

Now, the fact that mortgage brokers didn't care about the long term future of a loan is old news. The notion that risky loans getting written by money hungry brokers is pretty well established - but (at least for me) the creation of a three month "no take back" rule would explain an awful lot of doomed loans getting written.

It would also explain the creation of short term low interest rates to shepherd the borrower just until they were somebody else's problem. A gentle ride into financial oblivion.