News – In recent weeks, world financial markets have been bubbling up with the subprime mortgage crisis. What exactly is a subprime mortgage? And how can the Republic of Indonesia not be caught up in the crisis? The following is an analysis by Sid H. Kusuma, who is now a member of SMF and has specialized in studying the residential mortgage market in the fields of securitization, IT, risk management services and consultants. He has also joined Citigroup & Bear Stearns Inc in the US and PT Ernst & Young Indonesia.
The phenomenon of the Subprime Mortgage market meltdown that has occurred since mid-2006 has had a negative impact on the capital market, including Indonesia. In order to understand what is happening, it is necessary to understand what a subprime mortgage loan is and its characteristics.
Definition of Subprime Mortgage Loan Subprime mortgage loans in America are given to consumers who have less than adequate creditworthiness. One way to measure consumer creditworthiness is by looking at the credit score.
The mortgage granting system in America is highly dependent on credit scores issued by credit scoring companies such as those using the FICO method. For information, consumers can have FICO scores ranging from 300 to 850 depending on the results of calculations carried out by credit score service providers by looking at the 5 main categories as below:
- Payment history (35%)
- Amounts owed (30%)
- Length of credit history (15%)
- New credit (10%)
- Types of credit used (10%).
Although it changes periodically, currently the average credit score for consumers in America is around 620. The lower the credit score (FICO<620), the less eligibility the consumer gets for a mortgage. Subprime mortgage borrowers are given to consumers who have a FICO score < 620.
Apart from credit scores, subprime mortgage loans can also be seen from several things:
- High Loan-to Value ratio of up to 100%
- Mortgage collateral that does not meet the fundamental value calculation.
- Incomplete mortgage documentation (low-doc) or no verification of stated income, source of downpayment & work history.
- High Debt-to-Income (DTI) and Payment to Income (PTI) The characteristics above directly increase the risk for mortgage lenders.
On the one hand, the increased risk is compensated by high interest rates and other special features. On the other hand, high interest rates lead to the inability of consumers to obtain mortgages. In this case, mortgage lenders make mortgage products that still compensate for the high risk but are accessible to consumers, at least so that they can be orientated.
The well-known subprime mortgage loan product is 2/28 ARMS.
This type of mortgage is quite developed, covering nearly 75% of adjustable subprime mortgage loans originating. This product features a fixed rate for the first two years which is a Teaser Rate and will change at the end of the second year to an adjustable rate and every subsequent year.
The problem is that mortgage lenders in orienting mortgages measure consumers’ ability to pay by using a low teaser rate. When mortgage interest rates change at the end of the second year to an adjustable rate, consumers’ monthly payments can increase drastically because the margin for consumers with high profile risks can reach 300-500 basis points.
This causes consumers who are not creditworthy to have difficulty paying mortgage repayments, and then fail to pay. In addition, there was a Predatory Lending practice carried out by rogue mortgage lenders. The above consumer segment is tricked with various tactics such as deliberately providing high loan amounts at high interest rates to consumers who are clearly unable to pay.
It is hoped that if there is a default, the collateral will be executed and the mortgage lender will benefit from the sale of the house. What happened to Subprime mortgage loans in America?
The growth of the subprime mortgage market in America is accelerating, accounting for 22% of all mortgage originations in total outstanding loans of over $650 million at the end of 2006 (see chart).
Some of the main factors increasing the market. From the demand side, the housing sector was good during 2002-2005, low mortgage interest rates & appreciation in house prices. From the supply side, with high demand and business opportunities still open, mortgage lenders are flocking to this market to offer their services.
With increasing competition, mortgage lenders are competing to get consumers by offering a variety of mortgage products without in-depth knowledge of the risk characteristics and relaxing the provisions on mortgage origination. This has resulted in many mortgages with high-risk features being approved for unfit consumers.
With the declining growth of the housing sector since early 2006 marked by declining house prices and rising mortgage interest rates, many mortgage consumers in this market experienced difficulty paying their installments and were later declared defaulters.
The results of a survey issued by the Mortgage Banker Association (MBA) said that the delinquency rate for subprime mortgage loans for Q4-2006 was 13.33%. As a comparison, the deliequency rate for prime mortgage loans is around 2.57%. Meanwhile, the foreclosure rate is 2% compared to 0.24% for subprime & prime mortgage loans as of Q4-2006. And the foreclosure inventory rate is 0.5% and 5.1% for subprime & prime mortgage loans as of Q4-2006 Lessons for the Mortgage Market in Indonesia Housing loans have various risk characteristics and can be mitigated with a pattern of origination to good servicing.
In several countries including America, standardizing mortgage documents is one of the efforts to create standardization & reduce risk. The benefits of this standardization are proven by the difference in delinquency & foreclosure rates between conforming (prime) mortgage loans and subprime. In Indonesia, standardized mortgage documents have been made to be used by mortgage lenders.
KPR document standardization covering 5 topics, namely:
- quality control
- Servicing & MIS.
Some examples of the main things in standardization such as how to calculate the correct LTV and the maximum limit, the type of documentation that must be available and the verification process that must be carried out before a mortgage can be approved, PTI & DTI. The underwriting process where interviews with consumers to get a feeling about consumers is important.
In addition, providing education to potential customers so they can find out about the mortgage process and their rights & obligations is very necessary. Educated consumers can help avoid being tricked by mortgage distribution schemes that are unhealthy and harm consumers.