Government Help for Mortgages?

Sounds good doesn’t it? The government (in an election year) is going to come to our rescue by convincing the banks and investors who hold the adjustable mortgages to freeze the interest rate on these loans so that the borrowers are not hit with a huge payment increase that forces them into foreclosure. The question is, will it help or is it just election year politicking?
After reading almost everything I can get my hands on on this in the last couple of days (thank you to everyone who keeps sending articles to me, I get a little something out of all of them), I have to say it is a lot of politicking that will be a little helpful. The reason is: The freeze will not be available to everybody. You will not qualify if:

• You are already late on payment or in foreclosure
• You have re-financed your home since you purchased it.

That is the simple version and there are other reasons you might not qualify, but those two wipe out about 90% of the people I know who could benefit from the program. That doesn’t mean the program doesn’t have merits. Anything that helps slow foreclosures is a very welcome approach, but I think the problem is much larger than this program will help.

How big is the problem ultimately going to be? Good question. First of all, we have to realize that the blame for the problem runs through everybody involved in the process. There was enough fraud committed (sometimes by people who didn’t understand that what they were doing was illegal) by everyone. That includes buyers who lied about their income, mortgage brokers who advised them to do so, real estate agents who sold the homes these people had to lie to afford, and banks who loaned the money. Interestingly enough, the people with the least responsibility are going to be the ones asked to shoulder the losses and I believe that is the weakness of this solution. A friend of mine sent me an article from Sunday’s San Francisco Examiner that outlines this situation.

The article points out that the people who are really going to get hurt by this rate freeze are the investors who bought the loans. Here is a quick primer to explain how the investors are involved, skip it if you already know this:

When you take out a loan with your mortgage broker, it is issued by a bank or
other lending institution. This bank takes all the loans it issues and
packages them into one large group of loans and sells that package to
investors. The investors buy the loans at a discount and make money by
taking your payments. They understand that some of the loans will go bad,
but they buy the whole package at enough of a discount that the bad loans are
covered.

Now, these investors purchased these adjustable loans knowing that the payments they would receive would go up significantly when the loans adjusted or the loan would be paid off as the home owner re-financed. Either way, it is good for the investor who purchased the loan package as a legitimate investment. Now, the plan is for these investors to waive their right to receiving these higher payments in exchange for the homes not going into foreclosure. Sounds like a good compromise – although probably not if you are one of those investors.

Fortunately for them (and unfortunately for US Banks and the real estate market), the investors have another option. All of these loan packages have clauses that state the investor may return the loans to the banks and be paid the full face value of the loans if it is ever determined that there was fraud involved in the issuing of the loans.

Oops.

Remember when we talked about the borrower lying about his or her income and the mortgage broker knowing about it? Well, the banks knew about it too (they aren’t that dumb or they wouldn’t have all the money). So, you basically have fraud on all levels, giving the investors the right to ask for their money back. So they’re left with the quandry, “do I accept a much lower return on the investment I was told was safe, or do I return it and get all my money back?” I know what 99.9% of the people I know would do. Problem is, there isn’t any money to give them. Values have fallen so you can’t sell the house to get the money and the individual banks and lenders have been going out of business like crazy. So, where does this leave us? With the government trying to lean on foreign investors (many if not most of these loans were purchased by foreign governments and investors) to accept a lower interest rate in exchange for a stable US economy.

I sure hope it works, but not sure I want to count on it.

Short Sale Primer – Part 3

In this post, I will look at the advantages and disadvantages to a homeowner using a short sale.

A seller will have to consider a short sale when, for any reason, they need to sell their home and will not be able to fully pay off the mortgages with the proceeds from the sale. If this is your situation, you have a couple of options in addition to the short sale:

• Bring in extra money at close of escrow to cover the negative. This makes a lot of sense if you a) have the money and b) want to preserve your credit so you can buy a home in the near future.
• Let your home go back to the bank in a foreclosure.
• Negotiate with the lender to accept a short sale (see Part 2).

By far the best option if you can do it, is to bring in extra money at escrow. This can obviously be expensive, but can save your credit. If you do not have the cash, but have extra income that you can put towards a loan, the bank may be willing to take an unsecured loan for the balance you owe.

If you chose the foreclosure route, not only will it be hard to purchase a home for a few years, but if you do buy a home, your interest rate will be higher. In addition, with a foreclosure on your record, your interest rate will be higher on car loans and credit cards.

With a short sale, you loan will usually show as “settled” on your credit report. This is not as bad as a foreclosure because it shows you did not completely abandon your responsiblity, but tried to do the best you could. However, in talking with several banks and lenders, nobody can quantify the difference between a “foreclosed” and a “settled” on a credit score because the scoring system is closely guarded and the exact methods of scoring are not known.

An additional issue to consider is the tax consequence. Under current tax law, owners who do either a foreclosure or a short sale are liable for taxes on the amount of the loan that was not repayed. (The easiest way to understand this is if you re-financed your home and took out $100,000 which you used to buy a very nice car, you took that money out of your home tax free. If then you sold you home and did not pay back the $100,000, you would have purchased your car with tax free money.) This assumes you have re-financed. If the loans on the property are purchase money loans (the loan you took out to buy the home), the lender takes the property as payment in full and there may not be a tax issue. While this law makes sense in the above situation, it also punishes individuals and families that have fallen on hard times. With the rising number of short sales and foreclosures, Congress is currently working on a bill that will eliminate (in most cases) the tax on debt foregiveness in a short sale or foreclosure. However, if you are thinking of a short sale or foreclosure, please do not plan on the debt being forgiven until and if the bill is passed and signed into law.

Short Sale Primer – Part 2

This is Part 2 of my series on short sales. In this article, I will talk about what you need to get your short sale approved.
First of all, let me say that if you are going to need to do a short sale to sell your home, make sure you have an experienced agent helping you. Most buyer’s agents will not show short sale properties for several reasons:

1. The approval process can take 4-6 weeks during which buyer’s can get frustrated and move on.
2. The buyer’s agent has no control over the process as the seller’s agent handles the bank negotiations which can be very tricky.
3. The bank will most likely require the agents to take a commission reduction.

For the reasons above, most agents strongly resist showing short sale properties. To increase your chances of success, be sure to hire an agent with short sale experience.
Once you have made the decision to sell you house using a short sale, you will need to prepare a packet of information for the bank. Each bank has different requirements, but the following is a list of what the bank is most likely to ask for:
A financial worksheet that will have questions about your income, expenses, other loans, property tax situation, and assets.

• Copies of 2 most recent bank statements.
• Copies of 2 most recent paycheck stubs.
• Copies of 2 most recent tax returns.
• Copy of listing agreeement.
• Copy of sales agreement.
• Buyer’s Pre Approval letter.
• Closing estimate (HUD1).
• Copy of payoff statements from all other lenders on the property
  Hardship letter explaining why you can no longer make payments on this loan and need to sell.

Basically, the bank is trying to determine if their best option is to accept your short sale, to reject it and hope you keep making payments, or to reject it and foreclose on the property.
In the next article, I will focus on the plusses and minusses of a short sale to the seller.

Short Sale Primer – Part 1

A short sale is a sale in which the net proceeds are not sufficient to cover the seller’s debts. For example

Sales Price $800,000
First Loan $700,000
Second Loan $200,000
Closing Costs $56,000

Loss to Bank $156,000 ($800k – $700k – $200k – $56k) Also, there could be additional fees such as delinquent interest on loans, delinquent property taxes, etc.

Any time the bank is going to take a loss on the sale of your home, they need to approve the sale. If they do approve the sale (a complicated process that can take 4-6 weeks), the sale will go through and the loan will be closed. Your credit will suffer, but not as bad as in a foreclosure. If the bank rejects the short sale, your most likely option (unless you land a great raise, win the lottery or have your financial situation otherwise change for the positive), is a foreclosure.

It is important to note that the bank doesn’t want to foreclose on your home. It is expensive and they often have to sell the home for less than they could have received in a short sale. So, if you can document your case sufficiently and have a reasonable offer, in most cases, the short sale will be approved.

Mortgage Meltdown

Everybody from mortgage brokers, to real estate agents, to mortgage investors and homeowners are asking how this meltdown happened. To help explain, I’d like to use a fictional (sort of) story to show how easy it was for everyone to get into this position.
There was a lady I met, let’s call her Mona, who was already in trouble when I met her. Her story is not unusual, but it goes something like this:
Mona purchased a home in 2001 in a new development in San Diego. She bought it from a builder and put 5% down on her $400k home. As an elementary school teacher close to retirement, this was a stretch, but property values had been going up and her friends told her it was the right thing to do (she was convinced to do this because “everybody else was doing it”). By the time Mona closed on the house, it was worth $450k. She couldn’t believe it. In six months she made almost as much as she did teaching class for a year! Two years later, with her home worth $650k, she was looking for another investment so, she bought another home from a developer in North San Diego County. This one was 10 miles from the freeway, miles from shopping on a new golf course. The plan was for her nephew to live in it and pay the mortgage. They would split the profits when they sold it in two years. She qualified for the home ($600k) by “stating” an income that was higher than she really made. She thought this was no problem because everyone else was doing it. Her nephew decided he didn’t like the house, so he moved out, leaving Mona with a payment on an empty house. No problem. The house was now worth $700k so she re-financed and used the money to make the payments.
In the meantime, there were some new homes in her old neighborhood and she jumped in line to buy one, refinancing her residence (now worth $850k) to make the downpayment (like everyone else, she was now stating an income much higher than her actual income).
How was she able to do this? Foreign investors were so hungry for loans made on US property that they bought all the standard 30 year fixed loans and wanted more, so the banks gave them adjustable loans and they bought those too. Then the banks created interest only loans so they had more loans to sell these investors. Everyone was happy. More people could buy houses which pushed the value of the houses up creating the feeling that everyone was wealthy. People ran up their credit cards buying expensive cars and living like they were millionaires when in fact they were just using their homes to treat themselves like spoiled kids. Still, the investors wanted more loans. What to do? The banks figured it out. How about creating a loan where we don’t check how much money people make. We will let them tell us whatever number they want and we will make them a loan based on that income level (never mind that in overstating their income, people were committing fraud – everyone was doing it). Still the demand from investors in the secondary market was huge, so they relaxed the standards even more so that people with marginal credit could state their income and buy a home.
So, where does this leave Mona? This was the point at which I met her. She owned three homes. One was rented by the room to 4 individuals (the rent did not cover her mortage payments), she was living by herself in the newest home – a 3,500 sf home in a gated community, and she had a vacant home with a loan of $700k on it. Oh yea, she made about $60k as a 62 year old elementary teacher working in Los Angeles (she drove up every Sunday night and home on Friday because the pay was more). When we met, she wanted me to sell her vacant home that had no upgrades (vinyl floors, etc.). She wanted to get $750k for it despite the fact that the home accross the street that was the same floorplan had been on the market for six months for $750k and had hardwood floors, crown molding and a built in spa in the backyard. It was impossible. But, that was ok because Mona found a very helpful mortgage broker who was willing to put her deeper into the hole. (Due to the incredible money being made in real estate sales and lending, it seems like everyone with a high school diploma who couldn’t get a legitimate job found themselves in real estate trying to counsel people who had legitimate jobs on how to manage and purchase million dollar properties) This lender found an appraiser who appraised the home for $800k based on a 9 month old sale of a home in a better neighborhood. He re-financed the house for the $800k (no doubt making about $16k in the process – but hey, everyone was doing it) and Mona was able to make the payments for another few months. However, at the end of that time, she lost the house to foreclosure which destroyed her credit, making it impossible to re-finance her other homes. Plus, she was due to receive a 1099 for the amount of money the bank eventually lost (probably close to $150k, the tax hit of which would wipe out one year of her income).
On top of that, after she lost the first house, she still had a lot of equity in her original home (the one rented out), but she did not want to sell it because her friends were telling her not to (she also faced significant tax consequences in terms of eventual capital gains by holding the property). So today, Mona is close to 65 with terrible credit, loans that are adjusting upward with no way to re-finance them and a depleted savings account. Mortgage payments (plus taxes) on her two homes run over $11k a month and her income sits at $5k a month. Add in the $3,500 a month rent she takes in and Mona is losing $2,500 a month at a time she should be looking to retire.
Somehow, “everybody’s doing it” doesn’t sound so comforting anymore.