It doesn’t have to be this way. Stop foreclosures and you can stop the widespread erosion of home values. Why? Because when a few houses in the neighborhood are foreclosed the value of all homes are impacted.

To date, efforts to halt the mortgage meltdown have been limited, but perhaps there’s a different approach to consider, one created under a law intended to benefit coal miners.

Black Lung & Equity Sharing

The Black Lung Benefits Revenue Act of 1981 (Pub. L. 97-119) made it possible for residential property to be owned by both an occupant co-owner and a non-occupant co-owner — and for both owners to write-off expenses just like any owner-occupant or owner.

Called equity sharing, such an arrangement can work like this:

Occupant Collins has a 75-percent interest in the property and a non-occupant investor, Baker, owns 25 percent. Collins pays a fair market rental to Baker for the 25 percent of the property not owned by Baker. If the property is sold, then the profits are divided with 25 percent going to Baker and 75 percent going to occupant Collins.

Under the coal miner’s bill, investor Baker can write off his share of the mortgage interest, taxes and other costs as a business expense and depreciate his 25 percent of the property. Collins, the resident, can write off mortgage interest and property taxes, but not depreciation or regular ownership expenses because he is an owner-occupant and not an investor.

“Equity-sharing would allow many owners to stay in their homes and avoid foreclosure,” says Jim Saccacio, Chairman and CEO at RealtyTrac.com, the nation’s leading foreclosure marketplace. “Lenders would benefit because homes could be saved from foreclosure. Neighborhoods and communities would be ahead because fewer foreclosures would mean a reduced number of homes for sale at distressed prices. The result would be less downward pressure on local home values.”

Mark Cuban

“Why can’t home owners sell some percentage of equity in their homes on a listed exchange?” asks Mark Cuban, owner of the Dallas Mavericks. “Why can’t I ‘Take My House Public?’”

Cuban says such deals could work like this:

1. “The house is appraised by a company approved by the exchange that lists the houses.
2. “‘Shares’ are set with a Par Value of 10% of the appraised value. For a $100,000 house, there are 10 shares potentially available. However at no point in time can more than 40% of the ‘shares’ in a home be sold. We don’t want the opportunity for ‘hostile takeovers.’
3. “The price of the shares will of course be set by the market. In a hot market it will be set above par, in a tough market like today, it will sell below Par.

4. “All Proceeds from the sale of shares MUST be used to pay down any debt on the home.”

There’s a catch here, however, which now dooms both Cuban’s idea as well as any similar approach to bail-out distressed borrowers. Equity-sharing has traditionally been designed as a way to acquire property, not as a way to refinance. Selling an equity interest in a home with an existing owner, changing the title, sets off the “acceleration” clause found in virtually all mortgages.

If equity sharing is to alleviate the foreclosure problem, then lenders will have to agree to a new and different form of loan modification. Instead of enforcing due-on-sale clauses, they’ll have to accept a change of title and new ownership.

Losses

Is this a problem for lenders? Not hardly. With the use of equity sharing lenders could avoid foreclosures and save an estimated $40,000 to $80,000 for each property which does not go to auction. Local home values would be maintained, meaning that the value of the lender’s security would be protected and conserved. Properties would be easier to refinance at lower rates with the addition of a strong equity partner.

While Cuban offers the idea of a formal marketplace, equity sharing deals could also be done informally among family members, companies with employees who need assistance, community groups, religious organizations or any two people with shared interests.

Oh, and since you’re wondering, why are the tax benefits for equity sharing found in legislation designed to aid coal miners? Because Washington works in strange and mysterious ways.
————————

Published originally by RealtyTrac.com in November 2007 and posted with permission.

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“The U.S. mortgage giant Freddie Mac said it would no longer buy those high-risk home mortgages that it deems to be the most vulnerable to foreclosure. The surprise move came amid a deteriorating market for subprime loans affected by slumping home prices and rising interest rates.” (See: Freddie Mac tightens home mortgage standards, The International Herald Tribune, Feb. 28, 2007)

But the fact is that home prices are not slumping in some local markets and interest rates are plainly at the low end of historic norms. Such factors are simply not the root cause of today’s mortgage instability.

Instead, problems in the subprime mortgage market — and a growing sense of problems in other parts of the mortgage universe — are the result of dicey loan concepts that turned out to be exactly what any lucid person would expect: risky beyond reason.

Who could have known such things? Anyone with common sense, including readers of this column.

Let’s begin with interest-only loans. These are mortgages where borrowers do nothing to reduce the principal for the first several years of the loan. Once the interest-only “start period” ends then the loan must be repaid at the fully indexed and fully amortizing rate. Given that most interest-only loans are adjustable, and given that fewer years remain after the end of the start period, it follows that such financing will inevitably require higher monthly payments.

“There’s no doubt,” it said here in 2004, “that the newest trend in real estate financing is the interest-only loan, a trend which needs to be examined with care by anyone who prefers to avoid poverty.”

Moreover, said the column, “with an interest-only loan your initial monthly cash payments each month will be — and be sure to read the rest of this paragraph — lower than with a self-amortizing loan of the same size and with the same rate and terms. However, the interest-only borrower has more debt for a longer period and thus higher total costs. And if rates rise, monthly costs and overall interest costs could be substantially larger than with fixed-rate financing.” (See: The Beauty Of Interest-Only Loans — And The Beast, November 30, 2004.)

The reality is that buying homes with little down has always been risky, something that should neither shock nor surprise anyone. Just look at what the New York Times wrote — in April, 2000.

But what happens if housing values or the economy head south — particularly if a homeowner has a huge mortgage and no appreciable equity? Experts like Peter G. Miller, author of ”The Common Sense Mortgage” (Contemporary Books), warn that buyers who suddenly need to sell will face brokerage fees and related costs that they will have to pay out of pocket. ”Where do you get the cash?” he asked. (See: PERSONAL BUSINESS; Zero Down, And Maybe Something To Gain, The Sunday New York Times Business section, April 2, 2000)

Home prices have risen substantially since 2001 and thank goodness. While those in real estate prospered the stock market largely took a snooze during the same period. The catch, as noted in 2005, was that “the only way we’re supporting high real estate prices is by fudging traditional rules. We allow people to buy at levels that would have been unaffordable under past lending standards.”

“Playing mortgage roulette is fine as long as everyone realizes there are massive opportunities to lose.” (See: Are We Facing A Recession? September 13, 2005)

Is anyone “surprised” that a number of lenders are now in trouble — and that their backers are also taking losses? Why? Some of the risk represented by “non-traditional loans” can be offset by rising home values. But two years ago it was pointed out that if home values do not rise — and they plainly have not in many areas during the past year — then “lenders may be using ARMs to offset future rate risk, but what about future asset values? Is it worth originating loans today which may sink lenders tomorrow? A large number of foreclosures won’t look good on anyone’s books, reason enough to tighten ARM loan standards.” (See: Wrong-Way Borrowing Threatens Borrowers, Lenders, June 7, 2005)

One of the most widespread of the new financing concepts seen during the past few years has been the use of “stated-income” loan applications.

In the summer of 2004 it was explained that “stated-income loans represent too much risk for lenders — and too much temptation for borrowers. Perhaps a little rigidity in the lending process is not so bad. After all, how hard is it to produce tax returns and pay stubs? (See: Should Lenders Dump No-Tell Loans? July 27, 2004)

“What’s obviously best is to get the numbers right when making a loan application,” it said here in November 2004. “It’s equally obvious that ’stated income’ mortgages open the vault to temptation. Such no-tell loans ask borrowers what they earn and the borrower then puts down a number. Unlike a typical mortgage application, the lender usually does not verify the figure with tax returns, pay stubs or calls to employers.”

Of course, if it happens that those self-estimates of income are off a touch then lenders will have problems.

“With a growing number of stated income loans on the books, financing with exaggerated numbers could quickly become a lender concern if home values dip, the economy slows and monthly payments don’t show up. That’s the point at which stated income loans will come home to roost.” (See: How Much Is Too Much? November 16, 2004)

It’s hard to look at the tough times now facing the mortgage industry without mentioning the worst of the worst, the option ARM combined with little or nothing down plus a stated-income loan application.

Here’s a loan concept which gleefully allows borrowers to make payment after payment that will not even cover interest costs. Obviously — no “surprise” here — the loan must be repaid at some point which means that monthly costs must rise if the loan is held past the start period.

As stated here in 2005:

“In the next two to four years we’ll see elective payments end for many option loans. Then we’ll find out who should not have bought and who should not have loaned. Don’t be surprised if a lot of cheap real estate floods the market — and don’t be shocked if the value of your home is impacted as a result. As to lender share prices and dividends, how attractive will such companies appear when huge numbers of loans are unpaid, especially if in many cases the size of the debt exceeds the value of the underlying properties?

“Alternatively, if we restrict option loans now by regulation or lender choice, the pool of buyers will shrink and home prices will be under far less pressure to go up. We will see less appreciation and even price declines in some local markets. Acting now we may face moderate and tolerable declines in market activity, an opportunity which should not be ignored in the face of the financial calamity which looms ahead.” (See: The Case Against Too Many Options, June 28, 2005)

The growing number of loan failures has produced a rising volume of foreclosures. RealtyTrac.com reports that foreclosure actions rose from 885,468 in 2005 to 1,259,118 in 2006 — a 42 percent increase.

The huge number of foreclosure means that we have a growing supply of distressed properties, properties which are often available at discount. Even a small number of foreclosures can drag down local real estate prices.

“To believe that an increasing number of foreclosures will not have a marketplace impact is neither logical nor believable. Just ask the people in the subdivisions and condo projects where developers have recently cut prices on just a few units. (See: Foreclosures — No Worries, No Vision, May 5, 2006)

At this writing we have evidence that home values have fallen in about half of all major metro areas. The problem, of course, is that we really do not know the extent of value declines and thus cannot project future loan failures and foreclosure levels.

“While unit sales are easy to track, data regarding recorded prices is less certain. If you have a strong sellers market you can bet that sale prices are indeed what people paid because sellers have no need to offer discounts and buyers will not pay any more than required. But if you have a market that’s losing steam, the same assurance is not plausible.

“The problem with slowing markets is that sale prices may not tell the whole story. Sale prices may be discounted, and the extent of those discounts cannot be reliably estimated.” (See: A Time For Yellow Flags, November 28, 2006)

A major part of the problem has been the untenable view that home prices only rise. Does anyone believe that? Apparently a lot of people did, which is unfortunate:

The prevailing theory seems to be that higher monthly costs are not a problem because one can just sell the underlying property. But such thinking assumes that property values will rise — and that is not guaranteed. If property values merely stay the same large numbers of people in the next few years will be both unable to make monthly payments and unable to sell for enough to pay off growing mortgage debt. (See: Exit Strategy: What If There Is No Way Out? November 1, 2005)

The news today is concentrated on the subprime market, but guess what? This is not a problem that can be contained to poor and marginal borrowers. A lot of well-funded entrepreneurial people bought with toxic loans and they too will be facing tough times as required payments rise and in too many cases property values fall.

“We now have a large percentage of loans that involve negative amortization and potentially huge payment increases. It’s impossible to believe that some portion of these loans — and perhaps a large portion — will not result in financial disaster.” (See: Toxic Loans Threaten Home Values, February 14, 2006)

In fact, it’s not just borrowers and lenders who suffer when loans fail, it’s also neighbors and communities who suffer. How? Just think about what will happen to the value of your home if a neighbor is foreclosed. As I said in a 2006 speech to the Association of Real Estate License Law Officials (ARELLO):

A growing number of recent property owners will find that they have homes and investments which cannot be sold at a profit — as well as homes and investments which cost too much to carry. The fruits of this impossible dilemma will be more properties for sale, more supply, more pressure to moderate if not lower prices, more foreclosures and more bankruptcies. Even those without a mortgage may find that the value of their home will drop as neighbors who financed imprudently rush to dump their properties on the market.

If “nontraditional” mortgages are so great, how come loan buyers and regulators are now demanding a return to long-time lending standards? More importantly, why did they accept such risky concepts in the first place? Surely no one will be “surprised” if lawmakers start asking pointed questions as foreclosure rates rise and increasing numbers of lenders fail.

————————

Published originally by Realty Times on March 13, 2007 and posted with permission.

Mortgage Surprise? What Mortgage Surprise? is a post from: OurBroker.com -- Refinance, Home Mortgage Loans & Rates, Home Equity Loan

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That’s how many signed on at AppraisersPetition.com. And what, exactly, is their beef? As the site explains, “pressure comes in many forms and includes the following:

___”the withholding of business if we refuse to inflate values,

___”the withholding of business if we refuse to guarantee a predetermined value,

___”the withholding of business if we refuse to ignore deficiencies in the property,

___”refusing to pay for an appraisal that does not give them what they want,

___”black listing honest appraisers in order to use “rubber stamp” appraisers, etc.

“We request that action be taken to hold the lenders responsible for this type of violation and provide for a penalty on any person or business who engages in the practice of pressuring appraisers to do dishonest appraisals that do not provide for independent judgment. We believe that this practice has adverse effects on our local and national economies and that the potential for great financial loss exists. We also believe that many individuals have been adversely affected by the purchase of homes which have been over-valued.”

The Same Old Story

I have had these arguments before. Long ago I advocated that real estate brokers should be allowed to represent buyers and not act merely as seller sub-agents. Nope, can’t be done, I was told. Today buyer brokerage is everywhere. NAR reports that 42 percent of all purchasers had written buyer brokerage agreements in 2008

Option ARMs are great, I was told. Just look at the credit scores. Right. But the credit scores did not account for vastly higher mortgage payments down the road, after the loan was originated.

Stated-income loan applications are fine, it was said. Why do we have to verify income when we have so many other ways of measuring borrower finances? Sure. Consider what the Mortgage Brokers Association for Responsible Lending found in one study: “A recent sample of 100 stated income loans which were compared to IRS records (which is allowed through IRS forms 4506, but hardly done) found that 90% of the income was exaggerated by 5% or more. MORE DISTURBINGLY, ALMOST 60% OF THE STATED AMOUNTS WERE EXAGGERATED BY MORE THAN 50%. These results suggest that the stated income loans deserves the nickname used by many in the industry, the ‘liar’s loan.’”

Now we’re told that accurate and independent appraisals cost too much and take too long. Right.

The idea of appraisals is to have a fair, accurate and independent property valuation to protect borrowers, lenders, mortgage investors, and lender shareholders. That’s not something you get when appraisers are bullied to come up with the “right” number, as 11,000 appraisers can explain.

Can 11,000 Appraisers Be Wrong? is a post from: OurBroker.com -- Refinance, Home Mortgage Loans & Rates, Home Equity Loan

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I wanted to study journalism because it gave me an opportunity to travel and to meet interesting people. I have been a correspondent on Capitol Hill and at the White House, I have lived on an offshore drilling rig in pursuit of a story, I have spoken to an endless number of business leaders, senators and representatives and I have traveled to just-about every state.

There is also another aspect to journalism, the idea that reporters, columnists and the media in general are uniquely equipped to watch the government, corporations and institutions at work — and to freely report when such entities do right or wrong. The usual expression is that journalists should comfort the afflicted…and afflict the comfortable.

Jon Stewart is generally referred to as a comedian. His “Daily Show” is typically seen as entertainment. So-called serious journalists often look down their noses at Mr. Stewart.

They’re fools.

Every journalism school in the country should be studying the conversation between Jon Stewart and Wall Street commentator Jim Cramer. And so should every borrower, investor, senator, representative, regulator, shareholder, saver, and homeowner.

The Interview

Steward did exactly what journalists are supposed to do, he asked tough questions, in public, based on research and common sense. He took Cramer and the financial network, CNBC, to task for failing to fully tell the public of the risks and follies being pursued on Wall Street. Stewart essentially said the business media in general had been handmaidens and enablers of the banks and brokerages, largely repeating the what they said, doing inadequate research and rarely giving time or attention to the red flags which were so obvious.

Cramer, who is loud, bright and often insightful, had an open opportunity to defend his position. Look at the uncensored video of the show and judge what he said for yourself.

Everyone Was Responsible

At this point the claim is usually made that “everybody” is responsible for the current financial meltdown. Lenders loaned too much, borrowers borrowed too much, regulators regulated too little and journalists could only cover current events which, for several years, saw little but rising home values and stock prices.

The unstated point, of course, is that if EVERYONE was responsible than no one was specifically responsible.

This is junk.

You didn’t have to be a soothsayer to see what was coming.

Most community banks and credit unions refused to offer so-called “affordability” mortgage products, the loans with negative amortization, huge prepayment penalties and high-cost back-ends. Most homebuyers bought responsibly and borrowed no more than they could afford. They fully documented their income.

Many states wanted to halt rapacious lenders but could not because the lenders acted under the authority of the federal government and the federal government said the states could not over-ride federal authority, an authority established by the National Bank Act and confirmed by the Supreme Court in the 2007 Watters case.

Oh, and when was the National Bank Act enacted? That would be 1864.

The Real Issues

The real issues are very simple:

First, without exception every loan is supposed to be underwritten according to baseline program standards. This is the lender’s responsibility and a lot of lenders either repeatedly and routinely got it wrong or purposely failed to stop loans that should never have been made, highly-profitable errors that produced large executive bonuses, fat paychecks for loan officers and grossly overvalued stock.

Second, the Federal Reserve, under the Home Ownership Equity Protection Act (HOEPA), legislation passed in 1994, has the right under Section 129 to ban “unfair and deceptive acts or practices (UDAP).” In other words, had the Fed simply said that option ARMs, interest-only loans and stated-income loan applications were “unfair” and “deceptive” we could have prevented the current mortgage meltdown. It doesn’t matter what any other branch of government did or did not do, the Federal Reserve had an opportunity to stop the financial crisis and it absolutely failed to do so.

Third, in 2003 five federal agencies announced that they had “a plan to identify and eliminate outdated, unnecessary or unduly burdensome regulations imposed on insured depository institutions.” An official from the Office of Thrift Supervision brought a chainsaw to rip through mounds government paperwork. Could anyone miss the symbolism? Could any lender not understand that the new government policy was hands off, anything goes?

On The Record

I have repeatedly told readers since as far back as 2004 that “nontraditional” loans and practices were dangerous. Not just for borrowers but also for lenders and their shareholders.

I wish I had been wrong.

Every time I have written about rip-off mortgages I have gotten numerous emails from lenders telling me I didn’t “understand” the system.

High credit scores, they said, were a substitute for the lack of documentation. But credit scores are history, they don’t tell us what happens when mortgage payments rise 50 or 100 percent. They also didn’t say that lenders and loan officers got more money when they sold a loan with a stated-income loan application.

“Nontraditional” loan products simply reflected a new understanding of financial instruments, they said. You have to know about the secondary market, derivatives and mortgage-backed securities, I was told. And you have to look at the rates and the ability to provide financing for just about any buyer. Of course, more loan volume means more commissions and profits, something not usually mentioned.

You can see the uncensored Jim Cramer interview on the Daily Show by pressing here.

And to Jon Stewart, my congratulations — journalists ought to be ashamed that you had to do their job for them.

Mortgages, Foreclosures & The Disgrace of Journalism is a post from: OurBroker.com -- Refinance, Home Mortgage Loans & Rates, Home Equity Loan

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Under the Home Ownership Equity Protection Act (HOEPA), the Fed has the power to fight “unfair and deceptive acts or practices” or, as they’re called, UDAP. In fact, the Fed has had such power since 1994 and therein lies the rub.

The purpose of financial regulation is to create something of a level playing field. In real estate, for example, you can’t have a “net” listing. Yes, such listings could produce big profits for brokers, but state regulators across the country have banned such arrangements because of their obvious potential for abuse.

Federal regulators, in contrast, have traditionally taken a cautious approach to lenders but in the past few years they left the financial marketplace untouched and the result has been obvious: You didn’t have option ARMs or the widespread use of stated-income loan applications in the past because previous administrations telegraphed their positions to lenders: You can go so far, but no further.

Until the second Bush Administration the deal with the lending community was this: You can make profits, big profits, but use some care and caution otherwise we’ll be forced to create a bunch of regulations that will reduce your revenues. In other words, a gentleman’s agreement of sorts, an unspoken arrangement that worked fairly well for everyone.

The Bush Administration has a different view. It is not a “conservative” perspective — remember, no lender issued option ARMs when Ronald Reagan was in office — instead, with Mr. Bush we have a radical and absolutist political philosophy which argues that unfettered markets are the sure solution to all problems.

Under the Bush approach if a lender makes dim-witted loans and doesn’t bother to effectively underwrite mortgage applications the marketplace will respond. There’s no need for government action because in time loans will fail and shareholders will lose money.

The Bush regulatory theory may be worth debating in some seminar regarding abstract political philosophies, but in the real world we are each inter-connected. If large numbers of lenders make large numbers of foolish loans, it’s not only shareholders who suffer, it’s the value of our house that falls when neighbors are foreclosed.

Given the radical and extreme thinking of the past few years, we are now seeing radical and extreme responses. To right the financial ship of state — if that is possible without further dislocations — the federal government has now embarked on an economic path normally associated with third-world countries. For instance:

• The federal government over the summer of 2008 quickly and with little debate established the right to buy Fannie Mae and Freddie Mac. If this were being done by governments in Malawi, Cuba, Venezuela or Rumania, we would be talking about “nationalization” and all that the term implies.
• The Securities and Exchange Commission over the summer applied special rules to prevent short-selling — but only for 19 favored companies. In effect, we replaced the free-market system with two classes of corporations, those protected from short-sellers and those which are not.

• The Federal Reserve has made hundreds of billions of dollars in friendly loans available to selected banks and private entities on Wall Street. These loans are secured by assets of dubious quality — if the quality were so good then surely such assets could just be sold on the open marketplace. Meanwhile, legislation to help 400,000 borrowers with toxic loans was stalled for months because of alleged worries that the cost might total $4 billion.

The tragedy here, the disgrace here, is that none of this was necessary.

Go back to the new Federal Reserve rules introduced over the summer of 2008. They are weak and timid; most “protections” only apply to “high-priced” loans, meaning not prime or ALT-A financing.

But imagine if the new standards had been instituted in 2002 and 2003: For instance, the new rules say that lenders must “verify the income and assets they rely upon to determine repayment ability” when making “high-priced” loans. In other words, stated-income loan applications are out for subprime borrowers. Would there be a subprime crisis today if such baseline standards had been introduced when they were actually needed?

What makes no sense is the lack of anger. If Canadian trade regulations caused $500 billion or a trillion dollars worth of damage to the U.S., the entire country would be irate. But if a few federal bureaucrats, zealots and elected officials produce the same result, no one seems especially distressed — and that should worry us all.

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Published originally by The Real Estate Professional and posted with permission.

Mortgages & The Unnecessary Crisis is a post from: OurBroker.com -- Refinance, Home Mortgage Loans & Rates, Home Equity Loan

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To resolve this mystery, let’s go back to the 1970s when the mortgage-backed security — the MBS — was developed. The MBS was a financial device designed to resolve a problem for investors. The problem? Imagine that you’re a loan investor and bought the mortgage on a single-family home. Your total income from the investment would be impacted if your one borrower was late, didn’t make a payment or was foreclosed.

With a MBS you own a security which is supported by a large number of mortgages, perhaps thousands. If someone misses a payment your income continues with little disruption.

In theory mortgage-backed securities make a great deal of financial sense.And in practice, until the past few years, mortgage-backed securities worked well.

Today mortgage-backed securities are troubled, especially those which include subprime loans. But why should this be? Even with subprime loans, the overwhelming majority of borrowers are making their payments.

About as good as an answer as you’ll find comes from Lew Ranieri, one of the developers of the MBS concept. As Ranieri told John Cassidy in The New Yorker, today MBS securities are fundamentally different from the paper that was invented several decades ago.

“They have created the perfect loans,” Ranieri says with irony of today’s mortgage-backed securities. “They didn’t know what the home was worth, they didn’t know what the borrower earned and the borrower wasn’t putting any money into the purchase. The system had gone completely nuts. A loan without a full appraisal, thorough underwriting, and full income verification was never what anyone envisioned when we started the market for mortgage-backed securities.” (See: “Subprime Suspect,” March 31, 2008)

You listen to Ranieri and it becomes obvious why mortgages have been so freely-available during the past few years. The answer has nothing to do with a push for more homeownership or some sort of philosophical imperative: If Wall Street is going to sell more high-profit mortgage-backed securities it needs a basic feedstock. What is that feedstock? More loans.

If it happens that a mortgage fails, who suffers? The loan officer has already been paid. The “lender” is often not a lender in the sense of a company with a vault stuffed with cash, but instead a retailer that instantly re-sells any loan it originates. If the borrower makes payments for a few months, the originating lender is then largely not responsible if the mortgage goes downhill.

With mortgage-backed securities the folks on Wall Street make money selling paper, real estate brokers make money selling homes, governments make tax money every time a home is sold or refinanced, title companies and attorneys make money with each closing. The list goes on but you get the idea.

What started out as a conservative way to protect investors morphed into something strange. You could buy a typical MBS or you could get a little more interest if you bought a somewhat riskier portion of a mortgage-backed security. But why worry — credit-raters gave MBS paper strong marks.

Unfortunately, the push for higher returns outpaced the push for financial sanity. Loans without full appraisals, stated-income mortgage applications, exploding ARMs, option ARMs and large numbers of interest-only loans will inevitably produce large numbers of distressed borrowers and outright foreclosures. Add in a gross lack of federal regulation — regulation that could easily have prevented the current mortgage meltdown — and the results we see today were pre-ordained.

Once a few mortgage-backed securities failed it meant that the assumptions used to value and rate all MBS paper needed to be reviewed. The value of MBS paper fell, so investors suddenly had less net worth and thus a lot less interest in once-attractive mortgage-backed securities.

For the folks on Wall Street, the problem was not lower MBS ratings but fewer MBS buyers. Essentially, brokerages and investment banks got caught with MBS and other sagging securities in their portfolios.

And this gets worse. There are not only mortgage-backed securities (MBS) and collateralized debt obligations (CDOs — securities backed with a variety of debts, including mortgages), there are also derivatives.

Derivatives are simply bets. While there is a limit to the number of MBS and CDOs you can have, there’s no limit to the number of derivatives. The value of these derivatives amounts to hundreds of trillions of dollars.

The good news? Most derivatives are hedged so that the investor has little financial exposure. The bad news? When you deal with hundreds of trillions of dollars a minor “whoops” can be worth billions and billions of dollars.

And that’s how a few foreclosures upset the strange world of mortgage-backed securities, CDOs and derivatives.

————————

Published originally by The Real Estate Professional and posted with permission.

How Paper Mortgage Losses Turned Real is a post from: OurBroker.com -- Refinance, Home Mortgage Loans & Rates, Home Equity Loan

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That term “in the process of being foreclosed” is important. Neither borrowers nor lenders benefit from foreclosures. For borrowers the loss of a home is a personal tragedy as well as a huge credit stain that will impact finances for years. For lenders, foreclosures suggest losses, legal bills, vanished interest, unrecovered principal and lots of explaining to regulators.

The result is that a large percentage of homes which are “in the process of being foreclosed” are never actually foreclosed. The property is sold before the foreclosure, the loan is re-worked, the property is refinanced or back payments bring the loan current and the matter is resolved with as little damage as possible to both lenders and borrowers.

But figures from RealtyTrac, the online foreclosure marketplace that gets data from 2,200 counties nationwide, show that in August 2008 the number of homes entering the foreclosure process reached a new plateau: For the first time in a single month more than 300,000 American families received foreclosure notices of some kind.

Eternal optimists may say this is good news for those who deal in foreclosures. But while foreclosure clean-up is necessary, if there’s an increased number foreclosures in your neighborhood and properties begin to sell at low values, guess what happens to local home prices? Guess what happens to the value of your home?

You have to wonder: Are we seeing more foreclosures than last year as toxic mortgages mature? These are “nontraditional loans,” a sterile description for mortgages with ridiculously low monthly costs at first (but higher costs later) as well as mortgages that feature limited documentation and overly-large initial loan balances. Specifically, we’re talking about option ARMs, interest-only loans, stated-income financing and super-jumbo mortgages.

In April 2005 we asked Rick Sharga, RealtyTrac’s vice president of marketing, about the impact of toxic loans on the rising number of foreclosures and here’s what he had to say at that time:

Question: Are toxic loans linked to the rise of foreclosures?

Answer: While we haven’t seen any report that definitively links the two, it’s logical to surmise that higher risk loans will default at a higher rate than more traditional loans. And the fact that a larger percentage of home loans fall into the high risk category than at any time in recent memory makes the possibility of a spike in foreclosures more likely.

Question: Have toxic loans begun to impact the marketplace?

Answer: It’s hard to assign the increase in the number of properties in default and foreclosure specifically to high risk loans, but they’re almost certainly a contributing factor. As large numbers of ARMs reset this year and next — we’ve seen numbers as high as $300 million in loans this year and $1 billion in 2007 resetting — we’ll be better able to gauge the impact on national foreclosure rates.

Question: Will we see a further increase in foreclosure levels?

Answer: We anticipate that foreclosures will increase throughout 2006 for several reasons.

First, the number of properties in foreclosure has been below historic averages for several years, and the market appears to be moving back toward more “normal” levels.

Second, increasing interest rates are driving up monthly payments for homeowners with ARMs, and will significantly increase monthly payments for people with 3/1 or 5/1 ARMs due to reset.

Third, house values appear to be cooling off, which gives homeowners less equity to leverage in the event that they find themselves in a financial bind — and limits the opportunity to sell a property at a profit for homeowners in default.

There are ancillary economic factors that also come into play. Rising interest rates have had an effect on monthly credit card payments in an economy with a very high amount of consumer credit card debt. Energy costs have risen faster than anticipated. In some parts of the country, major employers such as Ford and GM have announced plans for massive layoffs, and there tends to be a strong correlation between higher-than-average unemployment rates and higher-than-average foreclosure rates.

Question: How long will it take to clean out weak borrowers?

Answer: It’s almost impossible to answer that question because there are so many factors involved, ranging from house appreciation rates to rising and falling interest rates to supply and demand within any given market to how far lenders are willing to extend themselves to “save” a troubled loan and even to the overall strength of the economy.

Question: Any general industry comments?

Answer: One of the trends we’re following is the number of properties that actually end up becoming REOs (bank repossessions). Over the past year, even as the general numbers of properties entering foreclosures has increased, the number of homes that actually end up as REOs has consistently stayed below 20 percent of the inventory. That relatively low number suggests that the market has been strong enough to allow owners to either re-finance, work out new terms with lenders, or sell the properties before they’re foreclosed on. It’s a statistic we’ll be watching closely, as we believe that a spike in the percentage would be a red flag.

The other statistic we’ve been tracking is the sales price of properties in foreclosure relative to estimated market value of the properties. In “hot” markets like CA, foreclosure properties have retained 80- to 88-percent of full market value over the past six months, whereas in other areas the numbers have been significantly softer (Minnesota, for example, was just below 50 percent). These relative prices also bear watching as a dramatically lower price combined with a high number of foreclosure properties could have a definite impact on home prices in a given area.

What we may be seeing is the coming together of slowing local markets at the very same time that large numbers of borrowers are facing stiffly higher payments. This combination of events will surely test those who believed that rising home values were assured, certain and guaranteed; an easy escape valve if monthly payments could not be met.

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Published originally by Realty Times on April 28, 2006 and posted with permission.

Foreclosure Numbers at New Highs: Are Toxic Loans To Blame? is a post from: OurBroker.com -- Refinance, Home Mortgage Loans & Rates, Home Equity Loan

Technorati Tags: application, ARM, foreclosure, income, interest, jumbo, loan, mortgage, only, option, stated, toxic

More than a decade ago a few California lenders came up with a clever idea for borrowers with good credit and a solid payment history: If you like, they said to selected borrowers, you can skip one payment in the coming year.

The beauty of this idea is that it works for both borrowers and lenders. For borrowers, such payment flexibility has value because sometimes finances are tight. For lenders, a single skipped payment means the interest due that month, say $1,000, is not paid — thus the loan balance increased by $1,000. Do this with thousands of loans and you’ve created the financial equivalent of many new mortgages with virtually no risk, no paperwork and no closings.

In 2002 Fannie Mae experimented with the Payment Power concept, a loan tried in cooperation with several lenders that allowed borrowers to skip up to two payments a year and up to 10 payments during the life of the loan. Like the payment skipping program a decade earlier, the Fannie Mae program represented a balance between borrowers and lenders, but was more risky because a larger number of payments could be missed.

Now we have a new category of mortgages which offer borrowers a choice of payment options during the first several years of the loan term. The programs differ somewhat but in general terms imagine that an option loan is a 30-year adjustable-rate mortgage for $250,000 with a start rate of 4.25 percent. In the first year the borrower might:

• Make monthly payments of $1,229.85 as if the loan will be paid off (amortized) in 30 years at 4.25 percent.
• Make monthly payments of $1,880.70 as if the loan will be paid off (amortized) in 15 years at the 4.25 percent start rate.
• Make prepayments so the loan will be paid off faster than 15 or 30 years, say $1,500 or $2,000 a month.
• Make interest-only payments of $885.42 a month.
• Make payments based on a below-market interest rate, say 1.5 percent. With this option the borrower pays just $312.50 a month — with $572.92 in unpaid interest added to the debt. ($885.42 less $312.50).

Of the choices above the first three are well within the framework of conventional financing. It’s the last two that are squirrelly.

Interest-only loan payments mean the debt is not being reduced. If the option period continues for five years and the interest rate adjusts to 6 percent for the remaining 25 years of the loan, the monthly payment for principal and interest at the start of year six will be $1,61075 — a huge increase from the interest-only payments of $885.42.

Is this a problem? Not if the property value increases and the home is sold or the borrower’s income has increased. Unfortunately, rising home values and growing incomes are not assured.

As to the 1.5 percent option, if the borrower never makes anything but low payments for five years the loan value will increase by $572.92 per month — that’s an extra $34,375 in principal not counting additional interest on the new and higher debt.

After five years at the low payoff level and as a result of “negative amortization,” the borrower will owe at least $284,375, money which will have to be repaid in 25 years. At 6 percent the monthly payment will be $1,832.23 — a huge increase from $312.50 per month. With interest, the actual payment and debt will be even higher.

Again, if the borrower rolls the dice and the home is sold at a higher value within five years or personal income increases substantially, then everything is fine, But what if home prices do not increase? What if the interest rate goes above 6 percent? What if the borrower is laid off?

There’s no question that some borrowers, perhaps many borrowers, will latch on to the low-cost payment with option loans for the entire choice period. And there is no question that some portion of these borrowers, perhaps many, will get burned.

Option loans now allow buyers to bid on properties that otherwise would be unaffordable. Given market trends in the past few years it’s easy to understand that people want to have a piece of the huge wealth machine represented by real estate. It’s also understandable that lenders want to originate loans, that lender shareholders want more profits and that more buyers mean more competition for homes, thus pushing up values.

I liked the one-payment loan skipping option because it was good for borrowers and represented almost no additional risk for lenders. The “Power Payment” approach was more chancy, but well within the realm of reason.

But option loans are different.

In the next two to four years we’ll see elective payments end for many option loans. Then we’ll find out who should not have bought and who should not have loaned. Don’t be surprised if a lot of cheap real estate floods the market — and don’t be shocked if the value of your home is impacted as a result. As to lender share prices and dividends, how attractive will such companies appear when huge numbers of loans are unpaid, especially if in many cases the size of the debt exceeds the value of the underlying properties?

Alternatively, if we restrict option loans now by regulation or lender choice, the pool of buyers will shrink and home prices will be under far less pressure to go up. We will see less appreciation and even price declines in some local markets. Acting now we may face moderate and tolerable declines in market activity, an opportunity which should not be ignored in the face of the financial calamity which looms ahead.

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Published originally by Realty Times on June 28, 2005 and posted with permission.

The Case Against Too Many Options is a post from: OurBroker.com -- Refinance, Home Mortgage Loans & Rates, Home Equity Loan

Technorati Tags: ARMs, borrower, lender, option, payments, prediction, risk

“Congress recognizes that today’s high cost loans negatively impact consumers, communities, and the economy. To address the problem, Congress is considering legislation to regulate these types of loans and the lenders who originate them. HUD proposes to amend the National Housing Act to give FHA the tools to offer alternatives to high cost loans by supporting privately originated mortgages to nonprime borrowers. These hardworking, credit-worthy borrowers, like generations before them, are unable to get a reasonably priced mortgage on fair terms. Many are in jeopardy of losing their homes as their mortgage payments escalate or balloon notes become payable.”

HUD — in a few years — will be able to cite the quote above as evidence showing it was aware of the toxic loans available today. But HUD does not regulate lenders. At the federal level, that’s a job for other departments, offices and agencies.

Ask yourself: Why is it that only hardworking subprime borrowers are impacted when “mortgage payments escalate or balloon notes become payable”? Why have federal banking regulators allowed — and continue to allow — the origination of loans which clearly represent a looming national debacle? If it’s true that “Congress recognizes that today’s high cost loans negatively impact consumers, communities, and the economy,” then why hasn’t Congress or the executive branch done something meaningful to resolve the problem?

We now have a large percentage of loans that involve negative amortization and potentially huge payment increases. It’s impossible to believe that some portion of these loans — and perhaps a large portion — will not result in financial disaster.

This is not a problem that can be ignored by those who own their homes free and clear. This is not something that does not impact those who have financed with dull, boring self-amortizing loans that required something down. In either case, guess what will happen to the value of your home if nearby properties are dumped on the market or foreclosed?

To understand what’s going on, consider the joys of so-called “option” or “flexible” ARM loans.

With such mortgages borrowers typically have four payment choices during the first five years of the loan term: pay as if the loan is being amortized over 30 years, pay as if the loan will be paid off in 15 years, pay on an interest-only basis, or make payments based on a “start rate” that initially generates negative amortization.

The term “negative amortization” means that the monthly payment is insufficient to cover the interest cost. The interest not paid is added to the mortgage debt. Thus, if you pay down a mortgage it is “amortized” and if the debt increases you have “negative amortization.”

Borrow $500,000 at 6 percent with an option ARM that has a 1.5 percent start rate and the initial payment will be about $1,725 — a cost that will top $4,000 in the seventh year of the loan.

However, given that this is an adjustable-rate product it’s possible that interest rates could rise during the loan term, so maybe a $4,000 monthly payment is a low estimate. You have to wonder if payments which are affordable at $1,725 a month will continue to be tolerable at $4,000 — or more.

If it’s true as that escalating payments are a national issue, then where were the federal regulators? Did they not understand the real and present dangers of the very loans they were supposed to oversee?

The argument can be made that option ARMs, stated-income loan applications and mortgages amounts above the value represented by the underlying real estate have all lubricated the economy by allowing additional buyers into the marketplace. Since real estate anchors about 20 percent of all economic activity, more buyers and more transactions are positives — but not at any cost.

There’s no doubt that more loan originations are surely good for the nation’s lenders, their loan officers and their shareholders — at least for the most recent quarter. But are not lenders in business for the long-term? Do the big “investors” who buy mortgage packages such as pension funds and insurance companies benefit from loans which are fundamentally more-risky than traditional mortgages?

Did banking regulators not see how the mortgage market has shifted to high-risk loans? And if they did see such a shift, why did they not move quickly and forcefully to protect the public interest?

The new generation of high-risk loans gained popularity at a time when home prices in most markets were rising with astonishing force. What will happen to such loans in less-robust markets is unknown, but federal banking regulators who oversee much of the loan market should be held responsible for the excess risk they have allowed and for the financial failures which are certain to follow.

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Published originally by Realty Times on February 14, 2006 and posted with permission.

Toxic Loans Threaten Home Values is a post from: OurBroker.com -- Refinance, Home Mortgage Loans & Rates, Home Equity Loan

Technorati Tags: Alt-A, ARM, federal, flexible, loan, mortgage, option, oversight, prime, regulation, regulator, subprime

It’s flattering to have someone court you, check in hand, seeking your interest and attention. And one gets the sense that more than a few properties are attracting buyer attention.

But sometimes it happens that properties are simply not for sale. In our case, given a rising population and a strong local economy we feel prices for these particular properties will continue to rise above the rate of inflation and so now is not the best time to sell.

But that doesn’t mean we’re closed to offers….

For instance, for a property with development potential it might be interesting if a buyer asked about a purchase option. It could work like this: Suppose someone wanted an option to purchase during the next two years in exchange for a given fee. We would look at the current market value, add a given percentage, and charge a non-refundable option fee. The holder of the option would then have the right to purchase during the next two years at a given price. If they didn’t purchase, the value of the option fee would be lost. Matters such as the current market value, percent increase, agreement length, option fee and other terms would all be negotiated.

Why would someone want an option? It may be because a given property has a key location, size or price. With an option, a buyer has locked-in the opportunity to purchase under given terms. If the market rises sufficiently, the option itself may represent a bargain for the purchaser. As to sellers, a sufficient option fee and/or a guaranteed price can be hard to ignore.

An alternative approach might involve a “right of first refusal.” In this situation, there is no particular sale price, merely an agreement that the right holders can match any legitimate purchase offer that would otherwise be accepted during a given period, say the next five years.

With a right of first refusal a seller could not offer the property for sale without noting that the purchase was “subject to” the right of first refusal. Such a claim, in turn, might make the property harder to sell and might be a drag on the price.

With a right of first refusal there would be a fee paid by the prospective buyer. The fee, the length of the agreement and all terms are negotiable.

Owners also need to recognize that sometimes what looks like a purchase offer is something else. For example, a “purchase offer” to buy a property that includes a small deposit, a lengthy “study” period, and no deposit penalty if the property is ultimately found to be unacceptable are really looking at an option. In such a situation, the “buyer” can get back their deposit after shopping your property to other buyers. Meanwhile, the owner may have missed an opportunity to sell to other purchasers.

Someone holding a purchase option or a right of first refusal would be wise to log such documents in the local property records office. This will assure that in the event of a title search that the claims of the option or rights holder will be known.

A purchase option and a right of first refusal are not the same thing, but both may ultimately result in a transaction on terms which work for both buyers and sellers. Such documents, however, can be complex and should be reviewed by an attorney before acceptance.

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Published originally by Realty Times on July 15, 2003 and posted with permission.

Option Versus First Refusal: What’s The Difference? is a post from: OurBroker.com -- Refinance, Home Mortgage Loans & Rates, Home Equity Loan

Technorati Tags: buyer, first, mortgage, negotiation, option, real estate, refusal, right, seller