The Mortgaging Class of 2006

As Wall Street shudders about the mortgaging class of 2006, that is those who obtained mortgages during 2006, I thought it useful to examine this class to asertain where problems might lie.

This analysis does not necessarily describe those who purchased a home in 2006. They may have purchased homes in earlier years and simply refinanced. They have borrowed against their homes either for purchase or for better payment terms or for cash.

There were two types of loans created: conforming and nonconforming. A "conforming" loan is a mortgage that conforms to certain guidelines (such as debt-to-income ratio limits and documentation requirements) set by Fannie Mae and Freddie Mac. For the class of 2006 these limits were $ 417,000 for single homes and $ 208,500 for second mortgages.

For "nonconforming" loans, three groups of borrowers were distinguished by their FICO scores. FICO is the acronym for Fair Isaac Corporation, a publicly-traded corporation (an interesting investment idea) that created the most widely used credit score model. The credit score model is based on information gathered from a credit reporting agency (such as Equifax). A FICO score is between 300 and 850, with 60% of scores between 650 and 799. According to Fair Isaac the median score is 723 (half of scores above and below).

Non-conforming Group ------------FICO Score
"subprime," ..........................................630
"alt-A," .................................................709
"prime-Jumbo"..................................... 741

Subprime borrowers have below average scores. Alt-A borrowers have nearly average scores, but have trouble documenting their incomes. For example, business owners are generally Alt-A because their earning power is understated due to the tax structure of their businesses. Prime-Jumbo borrowers have better than average scores, but their mortgages are too large to be conforming.

In 2006, $3.0 trillion in mortgages were originated. Of this, only about half or $1.5 trillion was conforming. In past years, conforming loans have comprised a much higher percentage of loans (over 70%). The breakdown for 2006:

Non-conforming Group ------------Loans (Blns.)
"subprime" ..........................................600
"alt-A" .................................................400
"prime-Jumbo"....................................480

Thinking that home prices were rising, these purchasers were willing to pay the increased costs of being "non-conforming" to make their desired home purchases. As an earlier post indicated, the rapid increase in these three categories did not rapidly increase home ownership, but was a means of "movin' on up." Now that home prices are declining, are they going to be "movin' on out"?