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Tuesday, 14 August 2007

For Some Consumers, Credit Crunch Ahead

by Andrea Coombes

Mortgage lenders going bankrupt, hedge funds evaporating, the stock market gyrating wildly: What does it all mean for you and me?

There's no denying that the financial markets are on edge and volatile, and some companies are in difficult straits, triggered in large part by rising foreclosures in the subprime market and the effect on investments tied to those mortgage loans.

But the degree to which the current situation affects individual Americans depends a lot on what you've got planned in coming months.

If you'd like to tap into the mortgage market -- buy a house, refinance your mortgage, take a home equity line of credit -- the recent turmoil will directly affect what kind of loan you can get and how much it will cost.


For many borrowers now, "it's more difficult to get a mortgage loan," said Mark Zandi, chief economist with Moody's Economy.com. "You have to have a better credit score, you have to have more equity," he said.

Interest rates are rising on some loans, and lenders are going to demand strong proof of income and employment. "They're doing everything more carefully. They're more circumspect in extending credit," Zandi said.

But if you've got a fixed-rate mortgage, a good job and no plans to make changes, many economists say that the biggest risk to you right now is owning a non-diversified investment portfolio. Despite the worrisome stock-market volatility, the Dow Jones Industrial Average as of Friday afternoon is still well up from its drop in late February.

"We're going to go through a period of disruption in the markets ... but the fundamentals of the stock market have not changed," said Peter Morici, an economist and professor at the University of Maryland's Robert H. Smith School of Business.

"If you already have a mortgage and you can make your payments, you're cool, and if you have an IRA, Keogh or a 401(k), just leave them alone," he said.

But no one can predict the future, and economists vary widely in their outlook, with some saying a recession is nigh and others saying the economy is in for a soft landing.

"Clearly the big worry is that the stock market starts a big, long bear trend. I don't think that's likely because a lot of fundamentals in the U.S. and global economy are still pretty good," said Nariman Behravesh, chief economist with Global Insight in Lexington, Mass.

To investors, "I would say, 'don't panic,'" he said.

Job market hit?

Still, there may be trouble ahead for Americans in other areas.

Thanks in part to the subprime mess, companies are finding it harder to get financing for some deals. Right now, companies are mainly unable to finance their riskiest deals, but if the credit crunch should spread and hit most companies, average Americans may feel the pinch -- in the job market.

"Businesses that can't get credit or have to pay more for capital will be less aggressive in their investment and hiring," Zandi said. "The job market is weakening and I think will weaken further as a result of recent events."

To forestall a credit constriction, central banks in the U.S., European Union and Canada are pumping more money into their systems. "This whole subprime mess is creating a lot of uncertainty," Behravesh said.

"For investors, it's like you're in a minefield. You don't know where the mines are so you freeze up, you stop doing anything." The central banks' money influx is aimed at easing those fears, and if that fails, a move to lower interest rates may be next, he said.

For his part, Zandi notes the economy is still in growth mode, but the rate of growth is slowing. In a note on Thursday, Zandi wrote that "the odds of a recession over the next six to 12 months have risen from one-in-six to one-in-four."

"I do think most everyone will be touched in some way by the meltdown" in various parts of the mortgage market, Zandi said in a telephone interview.

Homeowners who aren't in the market for a loan may still find their home value decreasing as the tightening of credit constricts home sales, and that plus a volatile stock market "could affect a household's wealth and their perception of their wealth and how aggressively they spend."

Mortgage crunch

Homeowners who can afford their mortgage payment can simply sit this turmoil out, some note. But those eager to buy a home or tap home equity are jumping right into it.

The investors who buy mortgage-backed securities are eyeing rising foreclosure rates among subprime and even some "good credit" mortgage borrowers, and responding by refusing to buy loans. That, in turn, means lenders are tightening up their underwriting standards. Only those borrowers who fit certain criteria are likely to find the loans they want.

Plus, if you're hoping to max out your home equity with, say, a second mortgage, your lender might be a little more leery of a high loan-to-value ratio. For homebuyers, gone are the days of getting mortgage loans with just a 5% down payment and no proof of income, economists said.

And if you've got great credit but live in an area where home prices average more than about $417,000, you'll pay higher mortgage rates right now, even as those who borrow smaller loan amounts are enjoying mortgage-rate declines on those loans.

The investors who buy mortgage loans in the secondary market "really drive the bus in terms of what's available in the mortgage market," said Greg McBride, senior financial analyst with Bankrate.com. "Those investors are now pricing for risk to a greater extent than they've done in recent years" and they see greater risk in the larger, or "jumbo" loan area.

The average rate on a 30-year fixed-rate conforming loan -- conforming loans are for less than $417,000 -- dropped to 6.66% while the average rate on jumbo loans rose to 7.35% last week according to Bankrate's survey of 100 banks, pushing the spread between the two rates to 69 basis points, up from 28 basis points in just two weeks.

Prospective home buyers who'll need a jumbo loan may want to sit on the sidelines in hopes those rates ease back a bit.

Meanwhile, homeowners need to ensure they understand the terms of their mortgage loan. "The key is planning ahead," McBride said. "Don't get blindsided by a big payment increase."

Some "prime borrowers are still in the position that they can refinance at attractive fixed rates and avoid the type of huge payment increase that's impacted so many subprime homeowners," he said.

Note that getting a home equity line or loan is going to be "a little bit harder and a lot more expensive. It's going to require some digging by the consumer," said Ron Chicaferro, a Scottsdale, Ariz.-based real-estate industry consultant who recently retired as president of Thornburg Mortgage Home Loans Inc.

Consumers are "going to have to start making phone calls, they're not going to be able to rely on a mortgage broker running around doing this. It'll be working on the Internet, making phone calls to their bank. That's the first place they should start," Chicaferro said.

Investors: 'Don't panic'

What's an investor to do? Many say this is the time to stay put, as long as your portfolio is well-diversified.

"It's a great reminder that volatility is part of the game when it comes to investing," McBride said.

"If your portfolio is invested in tune with your long-term objectives, it's much easier to stomach the short-term volatility, and if your portfolio is out of whack, maybe you decide you don't have the stomach for this kind of volatility," he said. That might mean turning to cash investments. "Money markets and CDs are yielding well over 5%, risk free," McBride said.

Investors should not panic, Behravesh said. "I would urge a little caution. If they're going to move anything, I would say make a few sensible moves into maybe less risky assets, but I definitely would urge people not to panic."

Others say investors should be " risk-averse," said Nouriel Roubini, chairman of Roubini Global Economics in New York. "Try to stay away from risky assets and see whether this is just a temporary thing and see whether the economy is going to slow down or have a hard landing," he said.

"In my view, the real economy has been slowing down for a while and this financial turbulence is going to make the real economy worse," he said.

Even as some are pointing to an opportunity to buy cheaper financials stocks, Roubini says now is not the time, noting that there is still "a high degree of uncertainty of where these [subprime-related] losses are, I think you're going to see financial firms increasingly saying, 'yes, we had exposure,' and there will be losses that are going to emerge day after day that will keep these valuations low and falling," he said.

Un-squeezed credit

The credit squeeze has not spread to other forms of consumer credit. With credit cards, car loans and other consumer credit, McBride said there's been no noticeable change in access to credit or rates.

"You're not likely to see much movement in those rates or restriction to capital without some deterioration in credit quality" -- and that's not happening at this point, he said.

But others see problems ahead, particularly for borrowers who have less-than-perfect credit ratings. "Even in those [credit card and auto-loan] markets you have the process of securitization of these loans," Roubini said.

"You're going to have a credit crunch across any securitization market. That's going to tighten credit conditions for consumers across the board."

That's a squeeze some homeowners are already feeling. Homeowners who "bought at the peak [and] milked every last dollar of equity out of the home, then they could well be upside down," McBride said.

"In that case, lenders won't touch it with a ten foot pole. That's a tough spot and it's not one that has a whole lot of easy answers," McBride said. "If you owe more than your house is worth, good credit or not, lenders will be reluctant help bail you out."

Andrea Coombes is MarketWatch's assistant personal finance editor, based in San Francisco.

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