Now here’s a man who knows risk-management in borrowing/lending. Check out these tidbits from an article by Emilian Belev over on The Niche Report:
…powerful dynamics were called “black swans” by financial statisticians, due to the rareness of such events. Risk managers named them “tail risk,” alluding to both the low frequency and high magnitude of the events. Regardless of what we call them, a lesson learned from the crisis is not to take the low correlation between markets for granted, but apply robust risk models that will unravel high correlation when it matters the most – when losses are compounded across the portfolio.
…A pre-crisis variety of ARMs offering a teaser initial rate was loaded with risk, as teaser rates quickly adjusted to higher levels, leaving borrowers with much larger mortgage payments than initially expected. An extreme version of these loans called for negative amortization, which is the accrual of additional loan principal due to the teaser payment (calculated with a fictitious interest rate) falling short of the actual interest charged. These contract clauses were often overlooked by the unsophisticated public eager to make quick returns in real estate. The severity of this interest rate risk was so high that it impacted borrowers’ capacity to repay such loans, and translated into credit risk.
The fact that intermediaries make their living by assuring transactions between willing borrowers and lenders, makes them sensitive to the same risks faced by borrowers and investors. The alternative is shortsighted and short-lived ventures of amateurship and fly-by-night outfits.
Nothing will better demonstrate your ethical stance and professionalism to your clients than educating them about mortgage risks and the measures and options to manage those risks. With low sophistication and no robust tools at their disposal, gauging mortgage risks on their own is an impossible task for borrowers. If part of your offering is an overview of how the loan options you suggest meet the requirements of the client’s risk profile, this will only help your professional image stand out, and nurture long-term client relationships and referrals.
Emilian Belev heads Enterprise Risk Analytics at Northfield Information Services and founded BorrowMind.com.
Read the whole article (highly recommended): Mortgage Risks for Everyone | The Niche Report.