Restoring Confidence in Residential Lending

"Trust is a peculiar resource; it is built rather than depleted by use." – Unknown

I read this quote recently and it left me wondering how we are going to restore confidence back in the residential real estate and mortgage markets.

As part of my research for this blog I began reading about the crash of 1929 and the Great Depression. The period left a psychological scar on the entire nation, if not the entire world.

The stock market lost 89.5% of its value from 1929 to 1933. Unemployment went from under 5% in 1929 to almost 25% in 1933. They didn't have a misery index* back then, but if you talk to anyone who lived through that period you will hear stories of very hard times. There are many factors that economists and historians will say contributed to the Wall Street crash and the Great Depression that followed. Here are the main four:

1. An over-stimulated economy during the 1920's (buying stocks on margin)
2. Tight monetary policies by the Federal Reserve from 1930-1933
3. Global trade protectionism (Smoot-Hawley Tariff Act)
4. Increase in income taxes in 1932 (1.5 to 4% at the low end, 25 to 63% at the top end)

This got me thinking of the similarities that exist between the Wall Street crash of 1929 and the Great Depression and our current economic crisis. Could it happen again? More importantly what are the differences?

We could point to a similarity in the over-stimulated economy from 1995-2005. These were the peak years during which we saw both easy credit and rapidly increasing real estate values.

Many investors in the 1920's purchased stock on margin (or credit) putting as little as 10% down on the purchase of stock. The hope was that stocks would continue to rise and everyone would get rich. Stories abound about people buying stocks who probably had no business being in the stock market.

Fast-forward to our real estate crisis and you can see a parallel in the housing market. The difference is that loans were being made to people who literally put no-money down. Worse yet, many loans were made with no or limited verification that the borrower had the income to repay the mortgage.

A historical twist is that our nation's mortgage business had become intertwined with the investment brokerage business (Wall Street) and loans were being funded by investment vehicles called mortgage-backed securities. When property values began declining, borrowers began defaulting and mortgage-backed securities (and many other sophisticated investment vehicles) became virtually worthless; mainly, because the market to purchase these instruments dried-up.

One more similarity: Both were speculative investment bubbles and both burst.

The differences are certainly subject to change and we will all have to wait a few years to see how our current financial crisis plays out. But here are a few items for you to consider:

1. The real estate market in the US has been robust for years and the bust in values (although declining values are seen in most markets in the US) are particularly concentrated in Florida, Nevada and California. Many of the defaults and foreclosures are a direct result of subprime lending and speculative investments in non-owner occupied properties. According to the Mortgage Bankers Association** fully half of all new foreclosure starts (in 2008) are subprime adjustable rate loans in Florida, Nevada and California.
2. Quick governmental action to the crisis. The Emergency Economic Stabilization Act of 2008 or so called Wall Street Bailout passed by congress and signed into law October 3, 2008. The bill hopes to, among other things: stabilize the economy, improve liquidity, stop foreclosures and help investor confidence.

Only time will tell if these government programs will have the desired results. If so, we will all share a big sigh of relief. However, significant damage has already been done to our economy. The trillions of dollars in lost property values, retirement accounts and jobs will take years, if not decades, to recover.

There is blame to share everywhere you look: from the politicians who wanted to expand housing (a noble cause) but who overreached by allowing Fannie Mae and Freddie Mac to offer subprime loans; to Wall Street and the investment bankers who created sophisticated investment products that ultimately were not sufficiently backed with cash reserves (in the event of a default) and who created the mortgage products that cast all semblance of prudent lending out the window; to the banks, mortgage bankers and mortgage brokers who offered these products to consumers without fully considering the impact on their customers (ultimately treating them like transactions instead of relationships) and finally; to the borrowers who did not take the time to understand the terms of some of these loans or who borrowed more money than they could afford to pay or who speculated in an area where they had no business. Yes, there is plenty of blame to go around.

Is the cure worse than the disease? For some, yes. Let's hope not for everyone. To restore confidence we need to get “back to basics”. Here is how we do it: First, the law of supply and demand should take care of the excess inventory of homes on the market; second, we need to re-establish sound lending principles for home mortgage loans; third, we need to establish national standards (for ethics and integrity) for individuals working in the mortgage business. There needs to be licensing, back-ground checks and continuing education standards across the board; fourth, the government needs to go back and look at the Gramm-Leach-Bliley Act that deregulated the banking industry and blurred the lines between banks, investment bankers and securities firms; fifth, the government needs to do a thorough investigation into the financial meltdown and hold individuals and companies that violated any laws accountable, as they did with the Enron and WorldCom investigations.

Lastly, we need to re-discover and go back to a more old-fashioned way of doing business with people and here the Golden Rule would be a good start.

* Misery Index- The misery index is an economic indicator, created by economist Arthur Okun.

** Mortgage Bankers Association-Press Release Delinquencies and Foreclosures September, 2008

Mortgage Fraud and Things You Should Look Out For

Becoming a homeowner is one of the most exciting moments and one of the biggest expenses you probably will ever incur. One of the most important factors in this purchase is a home loan that is affordable with fair terms and reasonable closing costs. Keep in mind some loans are riskier than others and education is the key.

The majority of mortgage fraud occurs within the "subprime market". Subprime usually involves people with poor credit and high debt. Below are some warning signs of a predatory loan.

• Sounds too easy. "Guaranteed approval" or "no income verification" regardless of borrower's current employment, credit history, and assets. These claims indicate the lender doesn't care about whether you can afford to make the payments over the long haul.
• Excessive fees. Higher lender and/or mortgage broker fees than are typical. Because these costs can be financed as part of the loan, they are easy to disguise or downplay. On competitive loans, fees are negotiable. It is common for homebuyers to pay only one percent of the loan amount for prime loans. By contrast, a typical predatory loan may cost five percent or more.
• Large future costs. High-risk adjustable rate mortgages where the payment rises a lot after a short introductory period are seldom appropriate for families who already have had problems repaying other loans. Homebuyers also should avoid a large single "balloon" payment (a lump sum due at the end of the loan's term).
• Closing delays. The lender deliberately delays closing so the commitment on a reasonably-priced loan expires.
• Over-valued property. Inflated appraisals that allow excessive fees to be included in the loan and result in the borrower owing more to the bank than the home is worth.
• Barriers to refinancing. Prepayment penalties that make it hard for the borrower to refinance in order to pay off a high-cost loan by taking advantage of a low-cost loan.
• No down payment loans. These loans may be split into two mortgages, with one having a much higher cost. Homebuyers should be sure they can afford the payments.
• Unethical document management. An ethical lender or broker will always require you to sign key loan papers, and they will never ask you to sign a document dated before the date you sign it.

Information taken with permission from the National Association of REALTORS.

In a nutshell, protect yourself by doing the research to make sure you are working with a reputable lender and always check with the Better Business Bureau!

It takes more than PITI to own a home!

Most homeowners and prospective buyers are familiar with the term PITI.  It is a financial term that stands for Principal, Interest, Taxes and Insurance.  Your PITI is a critical number for a lender to determine how much your monthly expenses will be when you purchase a home.

The other day I was talking to Marty Bhatia, of Om Homes.  He has been developing green residential projects in Chicago for eight years and always has something insightful to share.  This time he was talking about an even more important number for homeowners he has come up with:  PITIUM.  It's a mouthful.  But I definitely agree that it's something that every homeowner should pay more attention to.

So what is PITIUM?

The first part is PITI.  But that's just the bank's perspective on owning a home. The rest of the picture is UM:  Utilities and Maintenance - the operating costs associated with owning a home.  (Condo owners have PITIUAM, which includes Assessments.)

Green homes definitely have an edge when it comes to operating costs. In my opinion, a true green home is one that is well planned.  It is one that focuses on conserving water and energy, and maintains a healthy environment inside.  Planning like this inevitably leads to significantly lower utility bills.  And, many green technologies lead to lower maintenance requirements.  For example, skylights or solar tubes means less light bulbs to burn out and replace.  And a tankless water heater is designed to be repaired using individual parts like a car engine, rather than the whole thing being thrown out like a traditional tank water heater.

One simple step homeowners can take at any time to manage utilities and maintenance is to purchase ENERGY STAR products.  People often associate ENERGY STAR with the yellow tags on appliances that calculate estimated energy savings.  But consumers overlook the point that these products also have to meet strict quality standards to be called ENERGY STAR.  They are built to outlast other products which lowers maintenance costs.  ENERGY STAR products range from light bulbs to humidifiersso be sure to ask for them!

When buying a new home, do your own homework in addition to what the bank requires.  Don't be afraid to compare features as well as utility bills of the homes you are considering.  And, be sure to carefully consider dates and ages of equipment and materials of the home as well as the results of any home inspection.  If maintenance may be an issue, be sure to make a plan to fund upgrades as soon as they are needed.

Do yourself a favor and shop for homes beyond PITI so you can make a choice based on how much you'll spend to operate it!  

Questions to Ask Your Condo Board Before You Buy

Before you buy, contact the condo board with the following questions.  In the process, you'll learn how responsive - and organized - its members are.

1. What percentage of units is owner-occupied?  What percentage is tenant-occupied?  Generally, the higher percentage of owner-occupied units, the more marketable the units will be at resale. 
2. What covenants, bylaws, and restrictions govern the property?  What grandfather clauses are in place?  You may find, for instance, that those who buy a property after a certain date can't rent out their units, but buyers who bought earlier can.  Ask for a copy of the bylaws to determine if you can live with them.  And have an attorney review property docs, including the master deed, for you.
3. How much does the association keep in reserve?  How is that money being invested? 
4. Are association assessments keeping pace with the annual rate of inflation?  Smart boards raise assessments a certain percentage each year to build reserves to fund future repairs.  To determine if the assessment is reasonable, compare the rate to others in the area.  
5. What does and doesn't the assessment cover - common area maintenance, recreational facilities, trash collection, snow removal? 
6. What special assessments have been mandated in the past five years?  How much was each owner responsible for?  Some special assessments are unavoidable.  But repeated, expensive assessments could be a red flag about the condition of the building or the board's fiscal policy.
7. How much turnover occurs in the building? 
8. Is the project in litigation?  If the builders or homeowners are involved in a lawsuit, reserves can be depleted quickly. 
9. Is the developer reputable?  Find out what other projects the developer has build and visit one if you can.  Ask residents about their perceptions.  Request an engineer's report for developments that have been reconverted from other uses to determine what shape the building is in.  If the roof, windows, and bricks aren't in good repair, they become your problem once you buy. 
10. Are multiple associations involved in the property?  In very large developments, umbrella associations, as well as the smaller association into which you're buying, may require special assessments. 
11. Are their any assessments that have been unpaid by the seller of the unit you are interested in?  Many times in a short sale, the seller has failed to pay their association assessments, potentially leaving you with the bill.   

Information used with permission, National Association of REALTORS (REALTOR Magazine)

IMPACT OF FORECLOSURES ON TENANTS

Are you currently renting and the home you live in is going into foreclosure? There may be some relief for you. Congress recently signed the"Helping Families Save Their Homes Act of 2009" which became effective on May 20, 2009.

Many families who were tenants found themselves being evicted with no prior notice when the home they lived in was foreclosed on. Most of the time, the rental family had no idea the homeowner was delinquent or the subject of foreclosure until they were evicted. Notice will now have to be provided to tenants of rental housing before they can be evicted following a foreclosure.

The Helping Families Act provides that tenants will have to receive 90-day notice prior to being evicted when the home they are renting is foreclosed on. Tenants must also be allowed to stay in the property through the end of their lease with 2 exceptions:

     *the new owner wants to occupy the property as a personal residence and

     *there is no lease(month to month), or there is a lease but state law allows the lease to be terminated at any time upon notice

Even with these exceptions, tenants must still be given 90-days notice prior to eviction.

This act protects "bona fide" tenants who have a written lease, the lease is the result of an arms-length transaction, and the rent is not substantially less than fair market value. This act expires on December 31, 2012      

90% of Buyers Interested in Green Features

A survey just out by the National Association of REALTORS(r) shows that 90% of buyers are interested in green features in a home.  The report does not provide details of the survey such as who was asked.  Regardless, it still indicates the predicted growth rate of green buyers is taking hold.

In 2007, an National Association of Home Builders/McGraw-Hill Construction survey found the number was 63%.

I think there's a big takeaway here for home sellers.  For the sake of argument, let's assume the number is actually just 50% of buyers interested in green features.  That means that half the people coming into your home would be impressed with features like a high-efficiency furnace, ENERGY STAR appliances, etc.  Now think of your own block for a moment.  Do half of your neighbors have something in their homes to impress these buyers?  The answer is undoubtedly, no.  So, if you are thinking about improvements to your home, think about the green ones.  That's what the market wants, and the sellers that can create some instant inventory will come out ahead.  Check out my previous blog post with tips on getting a jump start on some green improvements here.

Removing the Widgets

As the economy continues on its foggy path to recovery, cost cutting is all the rave. It is funny to see how many people who were spending left and right now realize they could have lived with out those "widgets" all along. I have personally removed a few of the widgets from my life. I have also adjusted and consolidated the necessary stuff. What is interesting to see is that sometimes by "cost-cutting" you are in essence "efficianizing" what should have been efficient all along! Take for example home insurance; you pay Acme Insurance to rebuild your house in case it was to burn down. We all know that house insurance covers more than 4th of July mishap, don't we? Actually most companies today cover a wide gambit of the "plausible’" that might happen to the house or the people living in it. Knowing what “plausible” you will likely encounter and which ones you will not can be the difference between an affordable home premium and an overinflated one.

 

As an insurance guy myself I try to steer my customers onto a path of self realization of what will, could or might happen in their lives as it relates to their insurance needs. I give them the basic tools and help them through the process of self realization of what coverage’s they can live without, the ones they should have had ten years ago and the ones they might want to look at when the kids are in college. I find that when you do this, the customer always ends up happy; even if they are spending more money on the home insurance; they walk away with a feeling of security. If we can give our customers security in these turbulent times, they will agree it is worth every penny!