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Lease-options: the good, the bad, the ugly   Betting on Financial Armageddon   Is down-payment gift taxable income?   Housing and Economic Recovery Act of 2008   Imagine housing without a secondary market   Six Signs of a Housing Recovery  (Part 1 of 2)   Evaluating Market Psychology in Real Estate
   Watch the Midyear Housing Market Update Video   What baby boomers want in next home   Mortgage Insurance Cheaper Under New Plan   Homeowners React to Falling Real Estate Values 

 

 

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Lease-options: the good, the bad, the ugly

 

Lease-options: the good, the bad, the ugly 

REThink Real Estate

By Tara-Nicholle Nelson, Thursday, October 23, 2008.

Inman News 

Q: I owned a home for eight years, but borrowed heavily against it, took a subprime loan and recently lost it through foreclosure. My credit is shot from the foreclosure, but I have found another home I would like to buy. The seller will agree to do a lease-option, and I think it sounds like a great way to buy. What are the pros and cons of a lease-option that I should know about? Are there any pitfalls I need to beware of?

A: A lease-option arrangement may present a great opportunity for someone who has just gone through a foreclosure to immediately regain some of the benefits of homeownership. Before you enter such an arrangement, though, I'd urge you to cultivate order and clarity in your financial and life plans, and take several steps to protect your pre-purchase investment in the property.

Mindset Management

I recognize that due to your foreclosure, you might need to move quickly, and it seems ideal to move directly into a property under a lease-option. Before you agree to make any form of investment in such a property, though, spend a few hours examining the thoughts, actions and habits that got you into this situation in the first place. Get clear on where you must take responsibility for the overspending, excessive debting, underearning or undersaving -- now is the time for you to identify the poor decisions and destructive behavioral patterns in the context of your relationship with money that resulted, over the long term, in you losing your home.

This is not at all about blame or guilt -- probably the two most counterproductive emotional states known to humanity. This is about taking responsibility, the flip side of which is the ability to respond to your current circumstances in a manner that will allow you not only to survive through the foreclosure dilemma, but thrive in the future by rehabilitating your money- and mortgage-related habits and decision-making skills.

Obviously, part of what is attractive about a lease-option is that you have the option to buy or back out at the end. A lease option will usually involve you paying an option fee up front, or above-market rents -- or both -- in exchange for the seller's agreement to forego all other offers to buy the property for the term of your lease-option.

You must do this responsibility introspection (and experience the insights I promise you will have in the process) before you enter any lease-option so that you don't end up overpaying to secure a home that will present unsustainable financial obligations to you in the long run. Also, once you have clarity as to where your past missteps were, you will have fresh and potent motivation to carry out the perhaps less-than-sexy due diligence you need to avoid pitfalls and make the right decisions in terms of committing to a lease-option.

Need-to-Knows

In a lease-option, you rent the property from the seller/landlord for a period of time, under the agreement that you have the right to purchase the property at any time for an agreed-upon price. Lease-options have always been thought of as skewed slightly in favor of the buyer/tenant, who gets an option to buy or back out at the end of the lease, while the seller/landlord foregoes immediate cash and has to live with the uncertainty of the eventual outcome. However, in a market like today's, where some sellers often struggle to sell their properties at all, lease-options are coming back into vogue for sellers looking to secure a buyer for a tough-to-sell home.

Lease-options can present some incredible advantages for buyer/tenants, too! In this particular market, where mortgage money is hard to come by, credit and income requirements are tougher, and mortgage lenders want to see more down payment money, a lease-option allows a buyer/tenant the time to work on her credit and down-payment savings, while securing the property she wants to buy now.

Other lease-option benefits for buyer/tenants include:

• At least a portion of their monthly rent payments is not being thrown away, but will eventually go toward homeownership;
• You get to 'test drive' the home before committing to it;
• If you aren't sure whether you will stay in their neighborhood, town, job or relationship, you can get some time to see how things pan out;
• Buyers who want to move now but have their own home to sell can get time to sell their current home;
• Buyers can negotiate bargain-basement pricing with a motivated seller in areas where prices are still on the incline (they do exist!);
• If the market value of the home declines during the lease-option, you can simply choose not to buy the place at the end of the term, or renegotiate the price.

Of course, there are pitfalls, too. You should watch out for:

• Paying too large of an option fee up front or agreeing to pay an excessive purchase price or rental rate; having a Realtor to advise you on what is normal in your market really helps avoid this. The more of a buyer's market is, the less of an option fee you should pay -- maybe even none at all.

• Condition issues -- if you get into a lease-option with the intention to buy the place at the end of the agreement, you may want to have all the standard home inspections (e.g., pest, property and roof) before you sign the lease-option agreement to uncover any major condition issues up front, during the price negotiations.

• Sellers failing to make their payments on the property (so that it ends up in foreclosure), overencumbrancing the property (i.e., placing so much mortgage debt on the property that the option purchase price won't pay off all the loans), or selling the property to someone else during your lease-option period.

This last one is the big one -- the worst-case scenario: Buyer pays a $10,000 option fee, plus $500/month above market rents for two years of a 36-month lease-option; Seller stops making payments, and the property is lost to foreclosure. Buyer has no recourse but to take Seller (who's probably already broke!) to court, at potentially great time/money expense to buyer. To avoid this, get professional representation and investigate the type of loan the Seller has. Where the seller's mortgage is a loan that is set to have payments adjust to be significantly higher than the rent Buyer will be paying over the time of the lease-option, that is definitely a caveat emptor situation. Also, recording your lease-option with the county recorder will prevent others from buying or lending more money against the home without notice of your rights.

Action Plan

1. Introspection -- Get clear on the role you played in losing your former home, and take steps to improve your money patterns going forward.

2. Do some mortgage planning for the long term. Talk with a mortgage broker about a) what your down payment, monthly payment, taxes, etc., would be if you purchased the lease-option property on a long-term, sustainable mortgage, and b) developing an action plan for rehabilitating your credit and cash savings to position yourself to buy again. Get real with yourself as to whether the property you're looking at would be a sensible financial obligation for you over the long term.

3. Work with a Realtor or attorney to negotiate and document your lease-option agreement. Look to them for advice on standard practice regarding option payments, how much above-market rent to pay, and how much rent should be set aside by the landlord/seller each month toward your eventual down payment. Have a title search completed to understand the seller's outstanding obligations on the property. Then, follow all the way through and record your lease-option with the county recorder's office, once you're in contract.

Tara-Nicholle Nelson is author of "The Savvy Woman's Homebuying Handbook," and "Trillion Dollar Women: Use Your Power to Make Buying and Remodeling Decisions." Ask her a real estate question online or visit her Web site, www.rethinkrealestate.com.

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 Betting on Financial Armageddon

 

Betting on Financial Armageddon 

 

Thoughts from the Frontline Weekly Newsletter

 

In this issue:
Pricing in Financial Armageddon
Inside a RMBS
Ratings to Collateral to Ratings: A Vicious Cycle
This Too Shall Pass
             

My Dad used to tell me there is no accounting for standards when looking at something that seemed odd. Today, we have faulty standards for accounting that are ripping apart the fabric of the world's economy. How can a security that has a high probability of full repayment be downgraded from AA to junk levels? What we will explore today tell us a lot about why we are in the crisis state of affairs. Since I wrote you last Friday, the financial landscape of the world has changed even more. And what will happen this weekend will change it even more. And our kids will be paying for it for a long, long time. At the end I offer a few thoughts on the events, and if there is time my thoughts on the new short covering rules. All in all, it should make for an instructive and interesting letter. We'll jump right in with no "but first."

I was invited to an invitation only presentation to a room of chief executives of a number of small Texas banks made by Rich Berg of Performance Trust Capital Partners this week (http://ptcp.performancetrust.com). He graciously gave me permission to go over the main points of his presentation. I think you will find it eye-opening to say the least. You probably have seen Rich, as he is all over the media lately.

Let's jump back 18 months. I spent several letters going over how subprime mortgages were sold and then securitized. Let's quickly review. Huge Investment Bank (HIB) would encourage mortgage banks all over the country to make home loans, often providing the capital, and then HIB would purchase these loans and package them into large securities called Residential Mortgage Backed Securities or RMBS. They would take loans from different mortgage banks and different regions. They generally grouped the loans together as to their initial quality as in prime mortgages, ALT-A and the now infamous subprime mortgages. They also grouped together second lien loans, which were the loans generally made to get 100% financing or cash-out financing as home owners borrowed against the equity in their homes.

Typically, a RMBS would be sliced into anywhere from 5 to 15 different pieces called tranches.  They would go to the ratings agencies, who would give them a series of ratings on the various tranches, and who actually had a hand in saying what the size of each tranche could be. The top or senior level tranche had the rights to get paid back first in the event there was a problem with some of the underlying loans. That tranche was typically rated AAA. Then the next tranche would be rated AA and so on down to junk level. The lowest level was called the equity level, and this lowest level would take the first losses. For that risk, they also got any residual funds if everyone paid. The lower levels paid very high yields for the risk they took.

Then, since it was hard to sell some of the lower levels of these securities, HIB would take a lot of the lower level tranches and put them into another security called a Collateralized Debt Obligation or CDO. And yes, they sliced them up into tranches and went to the rating agencies and got them rated. The highest tranche was typically again AAA. Through the alchemy of finance, HIB took subprime mortgages and turned 96% (give or take a few points depending on the CDO) of them into AAA bonds. At the time, I compared it with taking nuclear waste and turning it into gold. Clever trick when you can do it, and everyone, from mortgage broker to investment bankers was paid handsomely to dance at the party.

Will we ever forget Charlie Prince's line, the CEO of Citigroup, saying that "As long as they are playing music, you have to get up and dance?" just a few weeks before the market imploded? Apart from having his rhythm being proven totally horrendous and overseeing an implosion which cost Citigroup tens of billions, it was a great statement of the zeitgeist of the financial world at the time.

The key word here is model. The ratings agencies used data supplied by the investment banks on what the likely default rates would be. It was something like taking an open book test where you get to write the questions. And since home values had only gone up, default rates were low. And of course, the data was from an ear when bankers lent money actually expecting to get paid back.

Inside a RMBS

Let's look at a RMBS. As Berg points out, when you are buying a mortgage backed security, there are really only three questions you need to know the answers to:

1. How many mortgages will default?
2. How much will I get back on a defaulted loan?
3. How much credit enhancement is there in the security?

Let's set the table by looking at a few terms and definitions. Using his example, let's take a mortgage where the home was originally appraised for $400,000 and there is a $300,000 mortgage on the home. Let's assume a default and the bank takes back the home. If they sell the home and recover $240,000 that means they lose $60,000. This is called a 20% severity. If they sold and recovered $150,000 it would be said to have a 50% severity.

Next, let's look at how the rating agencies come up with the AAA rating. First they model the expected losses, with emphasis on the word model. If they figure that worst case that 8% of the loans default at a severity of 50%, then the security would lose 4% of its value. To get an AAA rating you have to have at least two times the coverage of the "modeled" loss. In this illustration, that means that 92% of the loans would be put into the AAA tranche. An A rating assumes a coverage of more than 1 times but less than 2. B means you expect to get your money back and if they model that you will get below 100% back then the rating would be at junk levels.

Now, this next fact is important. All ratings assume a par value of 100. The rating of these bonds has nothing to do with price. After the presentation, Rich sat down with me and pulled up an actual mortgage backed security that was being offered that day on his screen. It was once a AAA rated Alt-A security. If I remember correctly it was a 2006 vintage security.

As of the latest reporting, a little over 5% of the mortgages were over 60 days past due or in foreclosure. In this security, there are no toxic option ARMS. The numbers of mortgages in this security that are in trouble are rising. S&P has downgraded that AAA tranche to BBB, which of course means its value is going down.

And sure enough, the offered price of the security is 70 cents on the dollar, or 70% of the original par value. Now remember, this particular AAA bond will only start to lose money after the lower tranches take up the first 8% of losses. Thus, this bond can be said to have an 8% credit enhancement.

Pricing in Financial Armageddon

Now, let's stress test that loan. For the AAA portion of the loan to lose money, that would mean that 16% of the loans would have to default with a severity of 50% losses. Could that happen? Sure.

But let's look at what buying that loan at 70 cents on the dollar does for the new owner. First, you are getting a much higher yield (interest rate) because you are buying the security at a lower valuation. But something else even more interesting happens.

Even though the security sold at 70 cents, it still gets all of the first of the proceeds of the home owners who pay their mortgages, up to 92% of the original value in the security. How many loans would have to default in order to make the buyer at 70 cents lose money? Remember, we already had credit enhancement of 8%. But at 70 cents, we just "bought" or priced in another 30%. Let's think Armageddon and that 50% of the mortgages default and they only recover 50% of the loans. That would only be a total loss of 25% to the entire collateral of the deal, but it would mean that the new investor still get all of my 70 cents plus another 13% back! The proud new owner could get up to 92% of the monies paid. Even in a pretty bad scenario, you get more than you paid for the security.

Let's walk through the math. Let's say the original security was $100 million (which would be a very small RMBS). The AAA tranche would have cost $92 billion. If you have it at 70 cents on the dollar you paid approximately $64 billion. In my Armageddon scenario above, the security loses 25% or $250 million. The lower rated tranches are completely wiped out losing $8 billion. Your tranche loses the remaining $17 billion which means you get $75 billion and you only paid $64 billion.

So, how bad would things have to get to lose money on this security? If I am doing the math right, 72% of the loans would have to default with a severity of 50% before your investment of $64 billion was impaired by even so much as 1 dollar. If that happened, it would be Armageddon.

So, why is it rated BBB? Because the rating is over the entire tranche and it is made at a par price of 100. The rating is not affected by the current price. As of today, assuming that even double the number of mortgages currently delinquent default with a 50% severity, your returns over the life of the security would be well over 12%. You would get back $92 million for your $64 billion dollar investment along with interest payments.

The reason this presentation was being made to banks and institutions? Because if you are a bank, you can generally only get prime plus 2% on a loan you make. But if you buy this security with your capital, you can make prime plus 6%. That is a large difference to a bank. Performance Trust has sold billions of this type of paper to banks and institutions.

If this is such a good deal, then why isn't everyone hitting the bid? Because these securities are very difficult to analyze. It is time consuming. You need to analyze every loan and develop your own valuations. You simply can't trust the ratings, as they are measuring something completely different.

And the real truth is that many of the various RMBS securities will in fact be totally wiped out or lose a great deal. Many are seeing default rates of 30% or more. You have to be very careful when you walk through this minefield. And in a time of crisis, it is not clear what the new rules will be. What if the government forces lenders to re-set mortgages at some loss level? What if the housing crisis gets worse? On the other hand, what if the government comes in and buys up all the bad mortgages in an attempt to stop the erosion in the home markets. The level of uncertainty in these times makes people a lot more cautious.

There are Alt-A RMBS like the one mentioned above that are probably not worth even 70 cents on the dollar. These things are marked to a market that is frozen. Everything gets lumped into the same basket and it all has to be marked to market by the new accounting rules called FASB 157. The institution selling the above mentioned security is being forced to do so, either because they are in financial trouble or they are not allowed to hold BBB securities in their portfolios and by law are required to sell. And in times of crisis, the selling price is not that of normal times.

Ratings to Collateral to Ratings: A Vicious Cycle

What's a recipe for a perfect financial storm? Let's make a massive amount of bad loans and get them on the books of most of the major financial institutions because they are rated investment grade. Then let's have the loans start to go bad. Throw in some general panic as everyone tries to sell the loans. No one is buying.

Let's make a new rule that you have to mark your illiquid securities to the last price paid by someone desperate to sell. That means that many institutions now have to mark their capital down and that means those pesky rating agencies must by their own rules mark down the ratings of the institutions which of course means that it costs them more to raise capital at a time when they can't get it which means they get lower ratings and so on. It becomes a vicious cycle.

In the early 80's, every major US bank was bankrupt because they had loaned Latin American countries far more than their capital they had on their books. The Latin American countries defaulted. If the US banks had been forced to mark to market, they would have all gone down taking the US economy along with them. So, the Fed simply allowed them to carry the loans at book value, offering liquidity and allowing the banks to buy time to make enough money to eventually write off the loans.

The current mark to market rule, while nice in theory, works in normal times. But it has the unintended consequence of making things worse in crisis times. Why should an institution have to write down a security which over time is going to pay back the lion's share or more of its value just because a severely stressed institution was forced to sell that security at a very low price in a time of crisis?

Yes, there needs to be transparency and we as investors need to know what is on the books of the companies that we invest in. But it is somewhat like my bank asking me to mark to market my home and pricing my loan daily based on that new price. If my neighbor loses his job and sells his home at auction, does that mean my home is now worth less two years from now. Maybe an even better analogy, if I am renting that home to a very good tenant, does my neighbor's price impair my income?

I was, and am, a fan of mark to market pricing. But we need to think through what a market price is. Not all things can be easily marked to market. This is doubly true when "market price" is a nebulous index of mortgage securities which may or not have a fundamental relationship with an illiquid security on the books of an institution which has no intention of selling, especially in a time of credit crisis.

It is one thing to require that you mark your stocks or bonds to market values. It is another thing entirely to require all mortgage backed securities, which are extremely complex things, can be very different one from another and which require a lot of time and effort to value, to be priced as though they are all the same.

FASB 157 needs to be amended this week. If Congress can create a new Resolution Trust Corp in a week, the surely the accounting board, with the suggestion of Treasury, can figure out a better way to price illiquid securities.

This Too Shall Pass

I know that you probably are reeling from all that has happened the past few months and especially the past two weeks. Lehman and Mother Merrill gone? We the people own AIG? Fannie and Freddie? A new housing bailout which will cost hundreds of billions? The Fed creating whole new programs to provide liquidity? Did you notice they loaned some $250 billion this last week to banks all over the world? Stopping short selling?

Want to see in graph form how bad it got and what spooked Paulson, Bernanke and company to act so quickly? Look at these graphs from my friends at Casey Research (http://www.caseyresearch.com/crpmkt/crpSolo.php?id=119&ppref=JMD119ED0908A). 30 day commercial paper went to 5% from 3% a week ago. The market was literally freezing. And the amount of paper issued is in free fall. Commercial paper is the life blood of the financial and business world. Without it commerce will soon grind to a halt.

It simply takes your breathe away. As President Bush said today, it does not help to find who is at fault today, we have to figure out how to get out of this mess. It is going to cost the taxpayers a lot of money. While I think the losses on AIG will be rather minor in the grand scheme of things, if you add up Fannie and Freddie and a new RTC, coupled with the stimulus package, you can easily get to $500 billion, and that is probably a low number.

For such a price, we had better get a new regulatory scheme which requires reduced leverage. Want to get really mad? Up until 2003, all investment banks were allowed only 12 to 1 leverage. Then in 2004, the SEC basically gave five banks (and only five banks) the ability to lever up 30 or even 40 to 1. Bet you can guess the five banks. Bear, Lehman, Merrill, Morgan and Goldman. Three down.

As Barry Ritholtz wrote: "So while the SEC runs around reinstating short selling rules, and clueless pension fund managers mindlessly point to the wrong issue, we learn that it was the SEC who was in large part responsible for the reckless leverage that led to the current crisis."  (Don't get me started on blaming the short sellers. Let's not blame the people who leveraged up their companies 40 to 1 with bad investments.)

We absolutely must move credit default swaps to a regulated exchange, no matter how much investment banks and hedge funds scream. Must be done. Do it now. Real rules about writing mortgages, although now that losses are in the hundreds of billions, underwriting rules are already becoming quite restrictive.

And while we are at it, a thorough revamping of the rating agencies and the rules they use should be at the top of someone's list.

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Is down-payment gift taxable income?

 

Is down-payment gift taxable income?

Mom taps retirement account to help daughter buy condo

 

By Benny Kass, Monday, August 4, 2008.
Inman News

DEAR BENNY: In January I lent my daughter $20,000 so she could use it as a down payment on her condominium unit. She gave me a promissory note. I took the money out of my retirement account (I am retired). My tax person said this will be added to my yearly income and I have to claim it as my income. I have a friend who works as a loan officer at a bank; she said I just have to claim the interest. Who is right? --Linda

DEAR LINDA: From the facts that you have given me, I believe that your tax person is correct. If you withdraw money from your retirement account, normally that is taxable income to you. The theory of retirement plans is that you are able to exclude from your annual income moneys that you put into these accounts (such as a 401(k), and let it grow tax free while you are still working. But when you start withdrawing (and there is mandatory withdrawal when you reach age 70 1/2) this money is ordinary income to you and you have to pay income tax on that money.

You should also discuss this with the trustee of your pension plan. Perhaps the moneys can be considered a loan from that plan in which case it might not be considered a "taxable withdrawal." I am not an expert on pension plans so you should investigate this further.

In any event, the interest that your daughter will be paying you is ordinary income, which must be reported to the IRS on a yearly basis. Unfortunately, unless your daughter also gave you a deed of trust (mortgage), and has it recorded among the land records in the jurisdiction where the property is located, she cannot deduct that interest from her tax returns.

So unless her lender objects, you should consider having your daughter give you a deed of trust for $20,000 and have that document recorded. This way, she can deduct the mortgage interest.

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Housing and Economic Recovery Act of 2008 

 

Housing and Economic Recovery Act of 2008

President Signs Housing Bill into Law

 

H.R. 3221, the “Housing and Economic Recovery Act of 2008,” passed the House on July 23, 2008, by a vote of 272-152. On Saturday, July 26, 2008, the Senate passed the bill by a vote of 72-13. The President signed the bill on July 30, 2008. The bill includes the following provisions:

• GSE Reform – including a strong independent regulator, and permanent conforming loan limits up to the greater of $417,000 or 115% local area median home price, capped at $625,500. The effective date for reforms is immediate upon enactment, but the loan limits will not go into effect until the expiration of the Economic stimulus limits (December 31, 2008).

• FHA Reform – including permanent FHA loan limits at the greater of $271,050 or 115% of local area median home price, capped at $625,500; streamlined processing for FHA condos; reforms to the HECM program, and reforms to the FHA manufactured housing program. The downpayment requirement on FHA loans will go up to 3.5% (from 3%). The effective date for reforms is immediate upon enactment, but the loan limits will not go into effect until the expiration of the Economic Stimulus limits (December 31, 2008).

• Homebuyer Tax Credit - a $7500 tax credit that would be would be available for any qualified purchase between April 8, 2008 and June 30, 2009. The credit is repayable over 15 years (making it, in effect, an interest free loan).

• FHA foreclosure rescue – development of a refinance program for homebuyers with problematic subprime loans. Lenders would write down qualified mortgages to 85% of the current appraised value and qualified borrowers would get a new FHA 30-year fixed mortgage at 90% of appraised value. Borrowers would have to share 50% of all future appreciation with FHA. The loan limit for this program is $550,440 nationwide. Program is effective on October 1, 2008.

• Seller-funded downpayment assistance programs – codifies existing FHA proposal to prohibit the use of downpayment assistance programs funded by those who have a financial interest in the sale; does not prohibit other assistance programs provided by nonprofits funded by other sources, churches, employers, or family members. This prohibition does not go into effect until October 1, 2008.

• VA loan limits – temporarily increases the VA home loan guarantee loan limits to the same level as the Economic Stimulus limits through December 31, 2008.

• Risk-based pricing – puts a moratorium on FHA using risk-based pricing for one year. This provision is effective from October 1, 2008 through September 30, 2009.

• GSE Stabilization – includes language proposed by the Treasury Department to authorize Treasury to make loans to and buy stock from the GSEs to make sure that Freddie Mac and Fannie Mae could not fail.

• Mortgage Revenue Bond Authority – authorizes $10 billion in mortgage revenue bonds for refinancing subprime mortgages.

• National Affordable Housing Trust Fund – Develops a Trust Fund funded by a percentage of profits from the GSEs. In its first years, the Trust Fund would cover costs of any defaulted loans in FHA foreclosure program. In out years, the Trust Fund would be used for the development of affordable housing.

• CDBG Funding – Provides $4 billion in neighborhood revitalization funds for communities to purchase foreclosed homes.

• LIHTC – Modernizes the Low Income Housing Tax Credit program to make it more efficient.

• Loan Originator Requirements – Strengthens the existing state-run nationwide mortgage originator licensing and registration system (and requires a parallel HUD system for states that fail to participate). Federal bank regulators will establish a parallel registration system for FDIC-insured banks. The purpose is to prevent fraud and require minimum licensing and education requirements. The bill exempts those who only perform real estate brokerage activities and are licensed or registered by a state, unless they are compensated by a lender, mortgage broker, or other loan originator.

For more information, visit http://www.realtor.org/governmentaffairs.

 

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Imagine housing without a secondary market

Opinion

Imagine housing without a secondary market

Perspective: 10 predictions

By Bradley Inman, Friday, July 11, 2008.
 
Inman News

In 1974, the United States was reeling from Watergate and the Vietnam War and stuck in a vexing recession. Inflation was out of control and President Gerald Ford was struggling to get control of the country and its economy. A collectible from those days is a "WIN" button, which stood for "Whip Inflation Now" -- a promotional device that the desperate Ford administration ginned up.

At the time, I was fresh out of college, living in Peoria, Ill., and working as an urban planner. One distinct memory I have was passing the downtown office of Peoria Savings with a sign on the window that read "No Home Loans."

A moratorium on home loans -- can you imagine?

Get ready.

In the early 1970s, the housing market had no meaningful secondary mortgage market. When passbooks savings -- which capitalized most mortgages -- shrank, money for home loans dried up.

In 1968, Fannie Mae and Freddie Mac were re-chartered by Congress as shareholder-owned companies funded solely with private capital raised from investors on Wall Street and around the world. But it was not until the 1980s that they found their footing and their growth mushroomed. Mortgage-backed securities got traction in the early part of this decade with the national push for home ownership. New mortgage instruments were invented to capture global interest in U.S. home loans.

In this period, a secondary market came onto the scene with brute force. By 2005, the size of the market had ballooned to $3 trillion.

And today? It has collapsed. Even Fannie Mae and Freddie Mac are poised for a government bailout. Today, Fannie Mae's stock has tumbled 45 percent and Freddie's has fallen 20 percent. This is after steep declines all week.

So, imagine a return to a housing market without a robust and functional secondary housing market. In other words: a severe credit crunch.

Here are 10 things that I predict will flow from its collapse (many of which have already hit the beleaguered housing market):

1. The capital that exists from direct lenders such as community banks, savings institutions and large commercial banks will fall short of potential demand and focus on bread-and-butter loans, leaving most borrowers out in the cold.

2. Exotic loans of any kind will be completely out of favor, leaving many borrowers and many properties unfundable.

3. Home sellers will become active lenders, but only those who have equity. Seller financing will help some transactions.

4. Second homes, expensive houses and certain types of investment property will be penalized and difficult to fund.

5. Small boutique lenders will enter the business, capitalizing on market voids, funding specialized but secure niches.

6. Investment banks will take care of unleveraged high-net-worth customers, but terms will be unfavorable so this market will further shrink.

7. Sovereign wealth funds are not the solution, because many were burnt on mortgage-backed securities.

8. Those that do lend will revert to back-to-basics underwriting: perfect credit, large down payments, proof of income, personal character and good family upbringing.

9. Housing industry lobbyists will make the mortgage liquidity problem their number one policy issue in the next two years. They will argue that the sky is falling and it is.

10. The trend will keep the housing market starved for capital, prolonging the slump.

Like so many parts of our American culture, the accessibility to unlimited and poorly scrutinized debt helped turn Americans into a sloppy group of consumers, which spawned greedy Wall Streeters, out of control lenders and starry-eyed investors.

Brad Inman is founder and publisher of Inman News.

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Six Signs of a Housing Recovery  (Part 1 of 2)

Six Signs of a Housing Recovery  (Part 1 of 2)

 

By: Shelly K. Schwartz, www.rismedia.com

 
The housing market these days can best be described as a moving target.  Some metros have gone from white-hot to ice-cold in just a year, while other cities are just now hitting their stride.   There's so much going on and so many different trends across the country that, when you net them all out at the national level, it really doesn't capture the wide variety of experiences going on in local markets, says Rachel Drew, research analyst for Harvard University Joint Center for Housing Studies in Cambridge, Mass.

Indeed, the yo-yo performance of residential real estate makes it tough to take the pulse of the nations housing market, let alone determine where your own neighborhood falls on the recovery curve. 

But for those looking to buy, sell or renovate, there are a handful of signs that may indicate whether a recovery is just around the corner in your neck of the woods. 

Fewer for sale signs Perhaps the biggest indicator of housing market health is the inventory of available homes.

Your number-one compass is inventory‚ says Denny Grimes, a longtime real estate agent in Ft. Myers, Fla.  Drive around your neighborhood to get a sense of whether there are more signs going up for sale or fewer; that'll give you the best indication of where your market is turning.

If inventory is growing, your neighborhood is becoming a buyers market, which is broadly defined as an area with inventory of six months or more.

If inventory is shrinking, it's leaning toward a sellers market.

A local real estate agent can also provide valuable insight on inventory trends, especially if you're new to an area.  Once inventory begins to shrink, it's a sign that things are moving back in favor of sellers -- and the overall real estate market.

Job growth

Job growth is another important factor affecting home values, says Walter Molony, spokesman for the National Association of Realtors.  If you are in an area with growing population and rising jobs, the picture for you is quite bright he says.

Around the country today, that's the common denominator among markets doing well.

For example, underlying strength in the local economy is helping neighborhoods surrounding several cities to produce solid year-over-year home-sale gains.

Such cities include: Salt Lake City; Salem, Ore.; Farmington, N.M.; Beaumont/Port Arthur, Texas; Spokane, Wash., Austin, Texas; and Raleigh, N.C.  Markets near Denver and Boston are also in better shape than before Molony says.

However, job growth alone does not dictate the direction of residential real estate.  Las Vegas and Miami are oversupplied Molony says.  Some of those have good fundamentals, but they're in a temporary situation where they are overbuilt, so that affects prices.  If you live near those cities, particularly in less desirable towns, it may be a while before home-price appreciation on your block returns to historic norms.

So, even though local job growth does not always guarantee a strong housing market, it certainly helps.  Keep a close eye on the unemployment rate and other indicators of economic health in your community.  The brighter the picture, the more likely it is that a real estate recovery is on the way.

Increased affordability

Part of the reason the housing bubble burst, at least in the most overheated markets, is that average home prices grew disproportionately faster than average salaries, pricing many first-time buyers out of the market.  That, in turn, reduced demand.  Many of those would-be buyers continue to wait on the sidelines, hoping for a bargain and watching for signs that the market has reached a bottom.

If housing in your area has become more affordable to the average buyer, you're likely to see property values rebound sooner.  A few key reports can help you determine whether the dream of homeownership is becoming more attainable for local buyers.

 
By: Shelly K. Schwartz, www.rismedia.com

 

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Evaluating Market Psychology in Real Estate
 

 

Evaluating Market Psychology in Real Estate

By Inman News, Monday, January 28, 2008.

 

 Watch this video with Michael Shermer about the Market Psychology

 

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Watch the Midyear Housing Market Update Video

 Watch the Midyear Housing Market Update Video

2008 NAR President-Elect Charles McMillan and Chief Economist Lawrence Yun provided Midyear Legislative Meetings and Trade Expo attendees with news on the housing market and when we can expect a recovery.

Watch The Video

 

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What baby boomers want in next home

 

What baby boomers want in next home

Differences between today's seniors and their parents loom large

By Ilyce Glink, Wednesday, May 21, 2008.
 
Inman News

Are you a baby boomer? Statisticians consider anyone born between 1946 and 1964 to be a full-fledged baby boomer.

The oldest of the baby boomers are 62, and just old enough to start collecting Social Security and qualifying for a reverse mortgage.

But for this group of Americans, retirement looks a whole lot different, according to Gene Warren, president and CEO of Thomas, Warren & Associates. Warren, an economist who specializes in the economics of retirement, helps developers and communities figure out how they're going to attract future retirees.

By 2029 those baby boomers born in 1964 will turn 65, notes Warren. But this group of individuals looks at retirement in a different way. For example, boomers are much more likely to move when they retire than their parents were. At this month's annual meeting of the National Association of Real Estate Editors, in Dallas, Warren said that typically just 10 percent of retirees relocate. He expects 20 percent of boomers, or approximately 18.2 million individuals, to relocate.

Another difference: Boomers are activity-driven, he notes, unlike their parents who are from what he calls the "silent generation."

"Boomers are much more active than their parents were. They are amenity-migrants, not sun-migrants. They're not necessarily going to buy a house on a beach, but will look at all the amenities in the area."

Deborah Blake, a vice president of Pulte Homes, who works extensively with the Del Webb-branded senior communities, says that today's seniors are looking for "a purposeful life."

"They're not looking to play golf for 10 years. They're asking themselves, 'What's next?' " Blake says.

Del Webb has found that seniors living in their Sun Cities developments (the average age of a Del Webb buyer is 62) are fans of lifelong learning, social networking and active volunteering.

"We provide classes on Internet safety at many of our communities," Blake explains.

Del Webb has begun shifting the designs of its houses to meet the needs of boomer seniors, including building larger kitchens to accommodate computer technology, dual master suites (for sandwich-generation boomers), and creating spare bedrooms that can function as craft studios.

Blake says that looking for a purposeful life has turned seniors onto the idea of leaving a legacy. For them, volunteering "doesn't mean holding someone's hand in a hospital." Instead, Del Webb residents are writing business plans for local nonprofits and working with communities to stimulate growth.

Each Del Webb community has an online bulletin board, and local nonprofits and community organizations are invited to post the needs that they have on the "volunteer" tab. Over time, Blake says, they've learned that if they ask for a specific skill set, say "event planners," and offer seniors flexibility so they can continue to work out and enjoy local amenities, they'll get a larger response.

Staying mentally and physically fit, "so that the mind and body hit the finish line at the same time," Blake quips, is also a key concern. Developers and builders who aren't paying attention to the wide and varied needs of today's boomer population risk building a community no one will want to live in.

Finally, 50 to 80 percent of Del Webb community residents continue to work, Blake says, reflecting a widespread concern about financial security. There is a growing concern that many boomers won't have the resources to fully retire and will have to continue to work at least part-time.

Architect Carl Malcolm, an associate with James, Harwick and Partners, says that even boomers on a limited budget want an amenity-filled lifestyle on a budget.

"These folks have the same cell phones, e-mail and Internet habits," he explained. "They are time-starved seniors looking for places they live in to take care of what they don't want to do," he explained, adding "but the economy overlays it all."

In some of the Atlanta-based projects his company has designed, Malcolm says they have been able to cut corners by increasing space flexibility ("the dining room also functions as a ball room," he notes) and designing buildings with economical floor plans.

"But we're learning," he says. In the first building, seniors parked their scooters in the hallway and used the landlord's plug to charge up their batteries. "In the second generation, we added a scooter parking area."

To get even more valuable advice from Ilyce, visit her Personal Finance and Real Estate Center.

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 Mortgage Insurance Cheaper Under New Plan

 

Mortgage Insurance Cheaper Under New Plan

Part 3: Fixing the housing finance system

By Jack Guttentag, Monday, May 19, 2008.
 
Inman News

(This is Part 3 of a five-part series. Read Part 1, "Lenders wise to beef up default-risk reserves," and Part 2, "Borrowers, insurers would save with new mortgage insurance.")

Last week, I described a new type of mortgage insurance called mortgage payment insurance, or MPI. MPI covers cash-flow risk as well as collateral risk, as opposed to traditional mortgage insurance (TMI), which covers only collateral risk.

Cash-flow risk is the risk of an interruption in the scheduled payments from the borrower to the investor. Collateral risk is the risk that proceeds from foreclosure sale will not be sufficient to pay off the loan balance and reimburse the investor for foreclosure expenses.

Under MPI, the insurer would guarantee timely receipt of the payments, so that the investor continues to get the payments after the borrower defaults. If the default is not corrected, the payments continue until the foreclosure process is completed, at which point the investor is reimbursed under the collateral-risk insurance part of the policy.

The incredible thing about MPI is that it will cost the insurer little more than the cost of TMI, and in many cases it would cost less. Here is an example based on wholesale price quotes covering two loans as of Nov. 27, 2007, when the market was less unsettled than it is today. Both loans were for $400,000 with 10 percent down on a single-family home in California, to a borrower with a 700 FICO score.

The prime loan was to purchase the home as a primary residence with full documentation. The interest rate was 6 percent and the TMI premium at 25 percent coverage was 0.67 percent. The risky loan was a cash-out refinance on an investment property with no documentation. The rate was 9.875 percent and the TMI premium at 25 percent coverage was 1.29 percent. The risky loan thus paid a rate 3.875 percent higher, and a mortgage insurance premium 0.62 percent higher.

We assumed the risky loan went into default followed by foreclosure and calculated the loss to the insurer with a TMI policy. We then used the same default/foreclosure scenario to calculate the loss on an MPI policy with the interest rate reduced to 6 percent. Since the insurer assumes all the default risk with MPI, the rate-risk premium should disappear.

We found that the insurer's losses were actually lower with MPI than with TMI. While the insurer made payment advances, the advances simply prepaid the amount due at foreclosure dollar for dollar. And because of the lower interest rate with MPI, the loan balance and the unpaid interest due were lower, reducing the loss. The insurer did lose the interest it could have earned on the payment advances, but this was much smaller than the reduction in the amount due.

The potential of MPI to reduce the cost to borrowers who are less than prime, which is most of them, is mind-boggling. Assuming the TMI insurance premium of 1.29 percent in my example is properly priced to meet losses under that policy, it is more than adequate to meet the lower losses under an MPI policy. Hence, the 3.875 percent rate premium, which investors require when they are protected only by TMI, is redundant if they have MPI.

Further, with all borrowers eligible for mortgage insurance paying prime rates, the potential for predatory practices would be sharply reduced. Elimination of risk-based pricing would eliminate opportunistic pricing of mortgages at the point of sale, which is one of the most important sources of abuse.

With default risk covered by MPI, rather than by a combination of TMI and rate-risk premiums, vulnerability to financial crises would be substantially reduced. Today, only TMI premiums are placed in reserve accounts to protect against future losses. Interest-rate risk premiums, if not needed to meet current losses, become investor income. With MPI replacing rate-risk premiums, the process of reserving for contingencies would be extended to cover all default risk, not just collateral risk.

In addition, risk underwriting would shift into more dependable hands. Mortgage insurance companies already offer underwriting to lenders as a service, but with MPI they will do it for all loans except those that don't qualify for MPI.

Lenders and investment banks tend to extremes, becoming excessively liberal when market sentiment is euphoric, and then excessively tight when sentiment shifts. This tendency is encouraged by their ability to pass along most default risk to the next party in the chain. Insurers, by contrast, have a long-term orientation because they are on the hook for a loan until it is repaid or the insurance is terminated.

In addition, by keeping mortgages in good standing until they are paid off, MPI would block the contagious erosion of investor confidence that stems from increasing numbers of nonperforming loans. This has been a central feature of the current crisis.

Next week: What is needed from government to make MPI work?

The writer is professor of finance emeritus at the Wharton School of the University of Pennsylvania. Comments and questions can be left at www.mtgprofessor.com.

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 Homeowners React to Falling Real Estate Values

 

Homeowners react to falling real estate values

Many struggling after losing access to HELOCs

 

By Ilyce Glink, Wednesday, May 14, 2008.

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