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March 8th, 2011

Warren Buffett & the secret of subprime mortgage success

by Peter Miller


Beginning this week, long-time financial expert and author Peter G. Miller will be contributing some original posts to blog.HSH.com. Below is Miller’s first post for HSH:

Sold sign on windowProbably the smartest person in finance is Warren Buffett. So when Buffett has something to say about real estate and mortgages, it can be worth listening.

Forbes magazine says Buffett is the second-richest person in America with a personal fortune of $45 billion. That money comes almost entirely from Berkshire Hathaway, a diversified financial company that Buffett heads and a company that just happens to make a lot of subprime loans through its Clayton Homes subsidiary.

Bad Credit Loans

The term “subprime mortgage” has certain connotations. The frequent perception is that such financing goes to borrowers with bad credit, folks with a high probability of both non-payment and financial failure.

There is some truth to the subprime perception. Just look at figures from the Mortgage Bankers Association for fourth-quarter foreclosure rates:

  1. Prime fixed-rate loans — 0.84 percent.
  2. Prime ARMs — 2.38 percent.
  3. Subprime fixed-rate loans — 2.73 percent
  4. Subprime ARMs — 4.24 percent

The catch to such woeful subprime results is that lenders and borrowers can do better.

Outperforming the Market

Clayton produces manufactured homes and finances much of what it sells. It now owns more than 200,000 mortgages.

“At the origination of these contracts,” says Buffett, “the average FICO score of our borrowers was 648, and 47% were 640 or below. Your banker will tell you that people with such scores are generally regarded as questionable credits.”

In comparison, the typical FHA borrower had a credit score of 703 in January.

Given this background, the conclusion might be that Clayton is holding a lot of mortgages from people who don’t pay. In fact, the reality is different.

In 2010 Clayton had a typical loss of just 1.72 percent on its loans. This is actually down from 2009 and far lower than subprime mortgages generally.

How could this be?

“Our approach was simply to get a meaningful down-payment and gear fixed monthly payments to a sensible percentage of income,” says Buffett. “This policy kept Clayton solvent and also kept buyers in their homes.”

Mortgage Strategies

There’s a lot to be learned from Buffett and the Clayton experience. The three major points look like this:

First: save. You have to have cash for a down payment and emergencies.

Second: always ask “how much house can I afford?” Buy no more than you need, including a house which is not a financial burden. A good guide to such thinking is the Millionaire Next Door by Thomas Stanley and William Danko.

Third: opt for fixed-rate mortgages so you have payment certainty and a hedge against higher mortgage interest rates in the future.

“Our borrowers,” says Buffett, “get in trouble when they lose their jobs, have health problems, get divorced, etc. The recession has hit them hard. But they want to stay in their homes, and generally they borrowed sensible amounts in relation to their income. In addition, we were keeping the originated mortgages for our own account, which means we were not securitizing or otherwise reselling them. If we were stupid in our lending, we were going to pay the price. That concentrates the mind.”

Oh, and what about the future? Is it still a good idea to buy real estate?

“Homeownership makes sense for most Americans, particularly at today’s lower prices and bargain interest rates,” says Buffett, a guy who paid $31,500 for the house he has owned for 52 years.

Peter G. Miller is syndicated to more than 100 newspapers and operates the real estate news site, OurBroker.com.

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3 Responses to “Warren Buffett & the secret of subprime mortgage success”

  1. Tina Says: March 9th, 2011 at 1:19 pm

    If Mr. Buffett and Mr. Clayton were to go into one of their homes they’d be shocked at the cheap condition these homes were built in. I purchased a home from Clayton Homes and it was put on the propety and they had to completely rewire the entire home and it still wasn’t correct. They have been to my home 3 times. If i could get a News crew to walk through my home the sales would decrease in large numbers. And to top it off my husband is currently in Afghanistan. If I had it to do over again – I would not have bought from them. I will get the word out to the Military.


  2. Peter G. Miller Says: March 9th, 2011 at 3:52 pm

    Hi –

    I’m not a spokesman for either Mr. Buffett or Clayton homes, but they did come to your house three time — a lot of new home buyers should be so lucky.

    Did you also get financing through Clayton?

  3. Tina Says: March 9th, 2011 at 4:30 pm

    I’m sorry – neither gentlemen came to my home and no I did not get financing through them.

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HSH.com's daily blog focuses on the latest developments in the mortgage and housing markets. Our mission is to relate how changes in mortgage rates and housing policy, as well as the latest financial news, impacts consumers, homebuyers and industry insiders alike. Our 30-plus years of experience in the mortgage industry gives us an edge as we break down the latest changes in an ever-changing market.

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