331: Mortgage Chaos with Aaron Kopelson

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It's my pleasure to welcome Aaron Coplson back to the show. He was on before speaking as a client doing a client case study, but he also happens to be a very successful mortgage person. So I asked him to come on and update us on the mortgage market. There's a lot going on out there, obviously a lot of news, a lot of changes. Banks are worried and they're raining in their horns. They're tightening up a little bit. So what are some of these changes? What can we expect and how does it all mesh together for us? Aaron, welcome back. How are you?

Very good, thanks for having me.

It's good to have you back on. Last time you were on, as I mentioned, you were talking as a client, but you're also in the business and we wanted to get an update. So we really appreciate you coming on and talking about this. You've got a list of bullet points here you sent me. Take it away, let's dive in.

Okay, sounds good. What we're seeing obviously is a lot of changes going on industry wide and there's a lot of kind of mixed messages being sent out. I guess we can kind of start at a 30,000 foot view in terms of what's going on and why all the chaos, so to speak. In essence, you know, we're seeing lenders tighten up, taking somewhat of a defensive posture. A lot of this is driven from the fact that lenders are, you know, the whole thing with forbearance is becoming more of an issue and lenders don't know, hey, if we make you a loan today, are you going to turn around and get into forbearance shortly thereafter? Something what we call an industry would be either a first payment default or an early payment default. In the industry, if you make a loan and the consumer does not make the first payment, that loan is not deliverable. So you have a non saleable loan and in essence the lender would be stuck with the loan it could make its way to, let's say, if it's an agency product. Fannie Mae or Freddie Mac.

So in other words, Fannie Mae and Freddie Mac act as the secondary market and they buy the loans that you are funding. And you don't want to be stuck with a loan on your portfolio, you want to sell it off so you can do more loans and make more money, right?

That's right. And Fannie and Freddie are government sponsored enterprises and they more or less set the policies and they are ultimately the ones buying these and guaranteeing these loans. So at the end of the day, the buck stops with Fannie and Freddie. Most of the lenders that are in the marketplace, the vast majority of them are originating loans with the end goal of selling that loan and moving on and doing another loan. And that's we're a direct lender or a mortgage banker. Those terms are kind of synonymous. And so we don't service loans, we just make loans and we turn around and more or less rinse and repeat.

Right. Okay, good. The jumbo loan market. Now first off, let's define what a jumbo lo means. And there are different jumbo loan limits in different markets, right?

That's right. So jumbo is synonymous with the word non conforming. Depending on your area, where you're at in the country, the base layer is 510,400. And if you happen to fall into a high cost, those limits would exceed that. Like where I'm at in Orange County, California, it's about 765,000. Generally, if you go a dollar past the conforming loan limit in the area you're in, the county you're in, it's going to be a jumbo loan, meaning it can't get delivered to Fannie or Freddie. And so those loans are made by lenders and they will not sell them off to Fannie or Freddie and they will either put them on their balance sheet, as we say, they're going to own those assets and service those loans. Up until recently there were big players like Redwood Trust and some of these other securitizers. That's just a fancy term for packaging all the loans together and selling them off as bonds to investors. And that market is pretty much dried up. We were really not seeing any secondary market for those jumbo or those non conforming products. And another kind of variation of that, that's kind of in the same bucket, if you will, in terms of there's no real market going on is what we call the non QM market. Now QM stands for qualified mortgage. So a traditional loan, such as an agency product, a Fannie or Freddie product would be a qualified mortgage. It's going to have safe harbor. And so that's the majority of the loans being made. When you think of non qm, probably the easiest way to think about it would be a bank statement loan. So if you have a self employed borrower who has a lot of write offs and they could prove to the lender that they have sufficient cash flow to repay the loan, that would be an example of a non QM loan product. And we just kind of seen those disappear, which is very much reminiscent of 0708 when the great Recession when we just saw loans, everything kind of dried up overnight. And this feels very similar.

Yeah. And so what that means is that there's no appetite from investors that want to buy mortgage backed securities for these non QM loans. And in the example you used, you know, during the Great Recession, that got dubbed the liar's loan. Right. And it's not exactly the same, but you know, conceptually it's the same. That's the, you know, the self employed person who's taking a lot of tax write offs because our system is weird and you can take all these tax write offs, but if you're not going to pay taxes, then the lender doesn't want to make you the loan on a normal qualified mortgage. So the investors don't have an appetite to back those products. So therefore they, there's no secondary market to buy those. And so the product pretty much just dries up because no one's lending for that. Right?

That's right.

Okay. That's right. And the same is true with jumbo loans. So with jumbo loans that means the expensive house market is really in jeopardy, doesn't it, doesn't it mean that because the financing has really reduced, it's declined a lot.

It has. I would say the jumbo market where we've seen the biggest pullback would be from brokers and other lenders that are non banks. The non bank market has seen that dry up. It's dried up pretty quick. The big banks and community banks and credit unions are still making those loans. And if you're a well qualified individual, there is still financing there for you. So I don't want to paint a picture that seems like that market is just there is no market for it because there is. Now how that correlates to housing prices and specifically the more expensive homes, your guess is probably better than mine.

Well, I say it's bad news for the more expensive homes because when the financing starts to dry up, so do the prices you know, real estate is a credit backed asset and anything above sort of necessity level housing is going to experience a hard time when there's just not as much financing in the marketplace for it. We'll see how that goes. Okay, good. Appraisals has been an interesting topic lately and I've read several articles that say funny things and I'm not exactly sure I understand them. So pardon my ignorance, but they say, well, you can do the appraisal four months after the deal closes or something. What is this all about?

You know, I read an article on Housing Wire about that.

I think I read the same article. Yeah.

What I found that article was it was really only designed for, I believe, credit unions. It was not loans that would end up going to either Fannie or Freddie or a government product like FHA, VA or USDA. So it's going to be a smaller subset of the market. And yeah, that's what they were saying they could do it months after. Now I don't participate in that at all. So we won't necessarily be doing that. But I can speak to what we are doing and that's most of the loans that we're doing as a company I'm doing personally are going to be that a paper or Fannie Freddie product, the agency product, and that's the bulk of the marketplace. And what we're seeing is a lot more appraisal waivers. So what that means is a lender will initially set a loan up after the application comes in. They'll fine tune all the numbers and so forth, make sure everything kind of matches, the I's are dotted, the T's are crossed and they'll run it through the automated underwriting system. Now both Fannie and Freddie have their own underwriting software and we'll typically run it through both systems and we'll see if one of them comes back with a waiver. What that means is you have a standardized census track and either Fannie or Freddie has enough data in that neighborhood and the overall characteristics of the file that is the loan to value the borrower's credit scores to income ratios, all the things that make a loan. And they say we feel comfortable with the value that you entered here. Right. And so we're seeing a lot more waivers. Now. We've seen the agency lacks those a little bit because in light of what's going on with all the help stuff, they're trying to be helpful as possible. So I've seen that just in the last week or two, a lot more of the deals I've run through, I believe actually almost every single one has received an appraisal waiver. Now mind you, a lot of those have been owner occupied deals.

Right. But what would you say is like the percentage of that in the overall market? Because Aaron, that just smacks of like a future default problem to me because this is, we got so reckless with appraisals before the Great Recession. And as I've said before, nobody in the mortgage funding system was ever paid to slow things down or to stop things. Everybody was just paid to push things forward. Meaning the appraisers wanted to bring in the appraisal, the mortgage broker wanted to get the deal done, the real estate agent agent wanted to get the deal done. You know, the borrower wanted to get the deal done. Nobody was paid to put the brakes on and look at where we ended up.

Right, sure, yeah. I mean there is a lot of truth in that. And so we, you know, lenders have to kind of play by the rules as they are. And so in this environment they are, I think it's probably a limited time thing and I suspect that once the health thing goes away we might see that go back to normal standards. By the way too, when you look at what Fannie and Freddie will allow for on these appraisal waivers, they do limit it to for example like 80, like an 80% loan to value if it's a primary residence deal. Now for an investor or investment property, they're not, it's ineligible. So you won't get that. So in other words you would need to order and appraisals and I guess that segues nicely to if you don't get the waiver, well then what's available? And so Fannie and Freddie are now allowing for exterior only appraisals. Sometimes we refer that as a drive appraisal. Right. And so they're not going into the property, but they're going to drive by the prime, the subject property, the home that's being purchased. They're going to drive by the comps, the comparable sales and they're going to do everything that they normally would except go inside the property. So we're getting, we're allowed to do that and in some cases also what they call a desktop appraisal. And that's just where you're going to have a licensed appraiser who neither they're not going out into the field and looking at properties and taking photos. They're doing everything via their computer and accessing the MLS and other information sources online.

Right, right. And I do Want to say, on balance, sort of balancing. My last statement is that this is more acceptable today because the market is bec. More of a perfect market. And what I mean by that is that the data has gotten much better as the industry has been maturing. The algorithms have gotten better. The lenders and the appraisers really know how to do it better. They learned a lot from the Great Recession and so did the regulator. So it's not as reckless as it is might seem. So I just want to kind of buffer my last statement a little bit. But, you know, it also gives rise to concern. So there's a balance there. That's all I'm saying.

I would add one other thing to that, which is I think if you just step back and you go, all right, the person buying this property probably wouldn't move forward with the deal if they thought the property was in bad condition or wasn't up to their own personal.

They've got some skin in the game. They got 20% in the game. So that makes the lender feel better, too.

That's right, yeah.

Okay, go ahead.

Okay. Something else we're also noticing is high balance pricing is worse due to market forces, and this has to do with the way that they're delivered to the agents, Fannie and Freddie. So we've seen a big gap between the high balance pricing and the conforming loan amounts.

Okay, so what does high balance mean?

That's right. If we're doing a agency product, a Fannie Freddie loan, up to the. You've got the $510,400 loan limit. That's going to be the conforming loan. And a high balance is going to be in the high cost areas. They're going to basically allow the loan amounts to go higher to account for the more expensive homes. So in California, for example, where I'm at, or any really of the sand, you know, the coastal markets, you're going to have pockets where they kind of fall into that sweet spot. They're not quite jumbo, but they're not the normal conforming loan limits. That's so high balance. We do a lot of that in my market. And so we're just seeing a dislocation in the prices. And that's just. I think it's noteworthy, that's all.

Okay, good. Good to know. And again, that won't really apply to our investors, but it might apply for their personal residence, if they own their personal residence. And it's a, you know, a more expensive property. Sure.

Now, in terms of tightening that, we're kind of seeing going on something that would apply to. That's right, that's right. So mortgage insurance, something that I saw recently come out is for investment properties. Two of the big mortgage insurers, Radian and mgic, are no longer allowing for mortgage insurance on investment properties. So your clients that were previously doing the 15% down, now I don't know how many your clients were actually doing that, but that's pop shrinking quickly.

Right? Okay, so it's really back. That was short lived. Boy, I tell you, that didn't last long at all. It's back to 20, 25% down, right?

That's right. And you see a lot of the investors, you know, 25% is kind of that sweet spot to get that bump in that lower rate. And 20% obviously being the marker for not having mortgage insurance, of course.

So the marketer for 15% down is very small now and maybe probably drying up completely.

All right, that's right. Second mortgages. I think this is also somewhat noteworthy. We're seeing investors suspend the closed end the home equity loans, which is different from a home equity line of credit, also known as a heloc. We're just seeing investors pull out of that. And if you think about it, a helo is going to have a fixed rate, fixed term. And so it puts more of the interest rate risk on the lender. And when they offer a line of credit, that line is going to be tied to the prime rate and that's going to basically shift the interest rate risk to the consumer.

Well, I'm just wondering really, do the banks even view that there's any interest rate risk in this environment? The rates are so low, low, they might even go negative. People say, you know, I wonder if they really even think that's much of a risk. I don't know, it depends how long the term is of that mortgage of that HELOC or HELO. But interesting. So HELOCs are adjustable, HELOANS are fixed, right?

That's right.

Got it.

And so the adjustable rate, that's the components are, you know, you got the margin, you got the index and then you have your cap. And so most lines of credit on homes are tied to the prime rate. And so that rate's going to adjust up or down with what the feds do with the fed funds rate because the prime rate is 300 basis points or 3% above the Fed funds rate. So they came out and said today they're going to be keeping rates low for a really long time. It's probably we're probably going to be, in my view, in a low interest rate environment for quite some time.

Right. Right now. One thing, and you may not know the answer to this, it's not really your side of the business, I don't think. But on the HELOCs, I would imagine that those HELOCs, unused portions of HELOCs are getting recalled, meaning that if a borrower has a $100,000 HELOC on their property and they've only used $20,000 of that HELOC, the lender, we'll send them a letter saying, hey, guess what? We know we said you had $100,000 available, but because you haven't used it, we're going to shrink it to 50,000. Have you heard of any of that happening?

No, I haven't heard of that. What I was going to say though is I've heard of some big banks like Chase no longer offering HELOCs as a product. They temporarily suspended it.

They just completely suspended that whole line of business. Wow.

Yeah. I think when you look at that and you ask yourself, well, why would they do that? I suspect they're obviously getting defensive and they're trying to hang on to as much capital, their reserves as possible. So they're just taking somewhat of a defensive posture there. But the lenders that we work with that offer these lines of credit, we have seen them raise the new minimum credit scores and then also in some cases reducing the cltv, the combined loan to value, so that clients, consumers, are just not getting as high leverage. Meaning they're either gonna have more skin in the game if it's a purchase or on a cash out, they're not gonna be able to get quite as much cash out.

Right, right, very interesting. So v oe verification of employment, this one a lot of people have heard about, but in a less stable environment like we're in, the lenders really wanna know you're keeping your job. And things may have changed since 30, 45 days ago when you applied for this loan versus when you're ready to close. Right. Tell us more.

That's right. Well, it used to be before the whole health scare with the virus, Fannie and Freddie would require lenders to do a verbal verification within 10 business days prior to the note date. And actually, let me back up a step. Wage earners. I'm sorry, yeah, that's for wage earners. Employed folks, they would require the verification of employment to be done 120 calendar days for those folks. So they've just tightened those up now. So what we're seeing is like at our company, we're doing it literally just the day before. We send out the loan docs for both employed borrowers and self employed borrowers.

Okay. So they're going to verify employment right at the end. That's the basic message here, right?

That's right. And they've just tightened up that, that time frame. So which kind of makes sense, right, because you know, you might have a job today and not, not tomorrow.

Right? That's understandable. On the lender's part. FHA, VA, USDA. I still, I gotta tell you, Aaron, I still can't get over talking about USDA when it comes to mortgage financing. I want to think of that as the entity that inspects meat. Okay, the USDA stamp, but they're into as well. So what does this mean? Overlays. What's an overlay?

Yeah, so overlays is you, you have the, the government products, FHA, VA, USDA. And they set the policies. So it's almost like the IRS comes out and writes the tax code that everybody follows. Well, these entities, HUD comes out and say, this is the policy manual that we want all lenders to follow. What lenders have the ability to do is create an overlay, which means that they can create more restrictive standards, meaning they want to be more conservative. And so we're just seeing more of that now. Which makes sense, right? In this environment where there's a lot of unknowns, there's a lot. Seems to be a lot more questions than answers these days. With a lot of things the lenders are just saying, all right, let's raise the minimum credit score requirements. They may in some cases reduce the total, you know, the debt to income ratio, and in some cases may want the borrower to have reserves. So reserves would just be how much money are you going to have at the end of the transaction? You know, in a purchase example, after you, you know, brought in your closing costs, paid for your closing costs and your down payment. Right. So for a long time there, there really was none of that. And now we're seeing it.

Yeah, good to know. So HUD can come out and say these are our guidelines, but then other, I'll just say groups, entities, whatever can say, well, those may be their guidelines, but ours are a little tighter than that. Well, Aaron, wrap it all up for us with either maybe just your sum total take on the market. What's the overall vibe? Or where are we going? What are we going to see a few months from now?

Well, a lot of this in the short term has to do with what the government decides to do with helping out mortgage servicers. This is creating a strain and there's just a level of uncertainty out there. So I think once lenders have more assurance of what the government's going to do and also the health impact, the fallout, you know, how bad does unemployment get? A big question is, you know, how many people that lost their job are going to be brought back right back after company gets the loan, the PPP loan. All of these things have to sort of get worked out to have any clear path. And that's going to take some time to figure out, I think months and months in my mind at least.

Yeah, yep, I agree with you, I agree with you. And the thing we haven't mentioned is that the rates with which you can borrow are incredibly attractive. So we've been talking mostly about the negative stuff, how much harder it is and you know, how the lenders are tightening up and making it a little, you got to jump through some more hoops, etc. Etc. Except for appraisals, that's a little easier actually. But we didn't really talk about rates much and maybe you want to make a comment on that and give out your website too.

Yeah, I think for, you know that your clientele, the investor, I think most of your clients are quality borrowers. They've got good jobs or they run successful businesses. Most of these folks are going to be able to get through the process just fine and they're going to be able to capture incredibly low rates. So I think for those that follow your recipe for success, which is buying in good markets where the deal makes sense day one, you're buying for cash flow, you're locking in 30 year fixed rate mortgage, most likely in the threes. That is phenomenal when you consider the net cost of the money when you subtract out inflation and the tax deduction of the mortgage. So all of those things are incredibly powerful. And I think there still is a lot of opportunity out there for investors and I'm excited to see kind of what this decade brings and I'm looking personally to keeping my eye out for deals over the next year or two and kind of see what opportunities come our way as investors because I think it's going to be while there may be pain for some, like you say, crisis, it's a dual edged sword. It's pain for some, but for those that are well positioned, it's going to be amazing opportunity for them.

Yeah, I couldn't agree with you more. Like The Chinese say the symbol of crisis and opportunity are the same and it means translated literally, it means crisis is an opportunity riding the dangerous wind. So that's where we are. I think that fits our situation pretty well. So the opportunities are definitely there. Aaron, give out your website.

Yeah, my website is Coplson Team. I'm sure you can link to that in the show notes. That's a little bit of a mouthful, but copalsinteam.com and you can find out, you know, all my stuff there.

All right. Aaron Copelsen, thank you so much for the info and thanks for joining us. And you're an investor, so I'm going to say to you, happy investing.

Thank you, Jason.

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