Foreclosed Properties:

Today, the number of homes that are either in default or in foreclosure has reached the highest point ever recorded in American history.  The probable causes for the increased foreclosure problems appear to be consistent from one part of the country to the other.  In the past, we have been able to persevere over adversity, in equally daunting hardships, by indentifying the circumstances pertaining to the root cause of the predicament in order to learn from it.  Understanding why these foreclosures have escalated to historic levels might empower us to take the appropriate steps now so as to avoid such a disastrous market failure in the future.

The first and most obvious reason contributing to the current foreclosure issues is that homeowners are finding it increasingly difficult to make their payments, due to economic instability.  For example, losing one’s job for one or both members of a household will wreak havoc on their ability to make punctual payments.  This is quite self-explanatory; based on the current state of the economy we are witnessing an expanding number of homeowners who are faced with this issue.  Historically, a contributing factor to foreclosures has consistently been economic hardships, but in today’s market we are seeing larger factors entering into the equation.  The current foreclosures are experiencing a new phenomenon in the industry, which stems from the adjustments coming due on the once popular Adjustable Rate Mortgages, or ARM’s. 

There are many types of ARM products available and not all are detrimental or considered the cause of our current foreclosure problems. Subprime ARMS, commonly known in the business as 2/28 or 3/37, are believed to be contributors to the present influx of foreclosures.  These programs were designed to motivate homeowners to refinance their mortgage loans after two or three years.  We often referred to these as “band-aid loans” because they were meant to be temporary. When the adjustment period began these loans would adjust 2% every six months until it hit the market cap rate, which is around 12.5% today.  Many of the borrowers entering into a subprime mortgage could barely afford the payment at its start rate, let alone have the resources to continue the payment when the rate increased.  You can see why these loans have contributed so quickly to our current foreclosure problems.  Homeowners that entered into a 5.5% 2/28 program actually found their loans interest rates increasing after two years, from 5.5% to 7.5%, and eventually to 9.5% by the third year. 

As previously stated, these programs were designed to be refinanced again after two or three years, but something interfered with the borrower’s ability to refinance.  What hindered them was the fact that their homes were not increasing in value enough to meet eligibility requirements for new refinancing opportunities.  Most borrowers who were put into a subprime mortgage for whatever reason should have been preparing to refinance into an FHA loan when their Subprime loan was due to adjust.  In order to qualify for an FHA home loan, the borrower must have at least 5% or more equity in the home to be eligible.  Therefore, as home values began to drop, borrowers who did not have the ability to show the 5% equity requirement (mandatory to qualify for an FHA mortgage) were suddenly in a very serious predicament.  These homeowners began to see their payments increase spontaneously without having any means of putting it to an end.  Homeowners were faced with a difficult decision:  continue to make a payment they couldn’t afford or stop making payments altogether.  If they chose to stop making payments then the homeowner would be able to save the money needed to get into a rental property shortly before the official foreclosures took place.  It is clear why so many people are now electing to go into foreclosures when the only repercussion is that they must find a new place to live. 

Let’s quickly review some of the key points contributing to our increased foreclosure rates:

1. Tough economic downturns have increased unemployment figures throughout the U.S. This is causing many families to experience some type of income reduction.  The decreased family income has caused some homeowners to fall behind on their mortgage payments, and has ultimately caused some families to go into foreclosure.
2. Loose lending criteria put some homeowners into loans they were probably not prepared for in the first place.  Lenders were approving everyone who was willing to buy, ultimately putting people into homes when they had no business qualifying in the first place.
3. Home values were not increasing enough to allow homeowners, who needed to refinance, to garner enough value from their homes in order for it to be logical to refinance.  In some places home values have dropped, causing some people to owe more than they own.

Each of these reason are perfectly sensible explanations for the rapid increase in foreclosures, but none of these reasons specifically assign responsibility to any one person or group.  This is where my final explanation for the increased foreclosure problem in the U.S. comes into play. 

4.  Professionals in the Real Estate industry did not have the home buyer’s best interest in mind; instead, they made decisions based upon the increased profit potential for themselves and the company for which they worked.

It sounds a bit harsh, but simply put, people trusted us and we let them down.  Mortgage professionals had the opportunity to prepare their borrowers, in order for the loan they entered into to be scheduled with their long term financial strategies. Realtors had the chance to ensure that home buyers were getting into the right home at the right prices for the right reasons.  Instead, a number of Mortgage lenders and Real Estate companies chose to utilize unethical business practices to place thousands and thousands of home buyers into transactions that should have never occurred.

I could go into greater detail on a number of blatant violations committed by professionals involved in the real estate markets, but those individuals are already facing some stern repercussions.  Instead, I will walk you through some of the unethical practices that took place at that time but will more than likely never be addressed.  What took place during the housing boom can be simplified by stating that a number of professionals, representing a variety of fields in the real estate market, violated their sense of duty to the clients.  We know this to be a “breach of duty”, and some of the offenses can be punishable by law, but are rarely prosecuted through the court systems. 

Let’s begin with the mortgage lenders.  Several mortgage providers misrepresented themselves and their products to the consumer in order to generate and benefit from additional income.  There was very little oversight happening in the lending world and a large number of consumers worked with mortgage representatives that had little or no knowledge about the products they were selling.  On the contrary, these originators misrepresented available mortgage-related products by hiding product details, lying about terms, falsifying documents, and even negatively influencing service providers to guarantee your loan would be closed in a manner that benefited the mortgage originator.  Obviously, the fallout that resulted from putting borrowers into the wrong mortgage product or a product destined for a negative outcome could only lead to poorly performing loans on Wall Street. 

The best way to illustrate this is to navigate through an example.  I observed several mortgage originators who put struggling borrowers into a one year adjustable rate mortgage, solely for the purpose of bringing their current mortgage up to date.  Lenders would allow a borrower to borrow up to 100% of their home values without requiring verification of income or employment status.  Consequently, it became very easy for a mortgage originator to sell such a loan for people who might have found themselves in a tough situation.  Most of these borrowers were not naive enough to get into a loan like this unless they felt some good would develop out of it.  This is where the misrepresentation took place.  Unethical originators would tell their borrowers that when the rate adjusted that the adjusted rate would normally have a minimal increase—if any increase at all—in the interest rate.

Some borrowers were also led to believe that the loan program they were getting into had no cost to them at all.  This fallacy was perpetuated to the borrowers at closing when no out-of-pocket costs were collected.  Undoubtedly, the closing costs were added to the loan, drastically decreasing the amount of equity in the home.  I can imagine you would think that this is impossible, but I actually spoke to a very nice woman who informed me of the fact that they paid no costs on their previous loan; however, when we reviewed the documentation for the closing she, in fact, paid 3.5% in total loan costs.  What makes this particularly unfortunate is that her loan was for over 400K.

It’s safe to say that there were waves of unethical things taking place, in order to make money in a very hot market.  Many people began to work in the real estate industry during these times. There were many questionable people with equally questionable motives entering into the real estate industry. These individuals had self-serving ambitions and practices that were implemented at the cost of unsuspecting victims.  The amount of foreclosures resulting from poor misrepresentation by mortgage originators is appalling. All that I can say on behalf of any mortgage professional still in the business is “I’m Sorry”.  I hope that as I reference real estate-related topics you will be able to glean the information you need to protect yourself from misrepresentation by anyone out in the market.

Mortgage lenders were not the only culprits involved with the growing problems currently plaguing our industry.  There were also a number of Real Estate brokers entering into agreements with other entities that could be construed as less than ethical.  Some Real Estate agents would establish affiliated business agreements with other agents, builders, title companies, and mortgage lenders, in which additional profits collected by these entities would be shared in a form of a “kickback” to the realtor for manipulating their clients to use any one of the other entities.  A Realtor can not influence your decision on whom to use for your services when buying or selling your home.  If a realtor has an agreement with one or more entities, with the intention of earning compensation by directing their clients to these entities, it can be a defined as a conflict of interest and a violation of their duty to you.  Once again, we see a “Breach of Duty” to represent you in a nonbiased manner.  What would then happen, in a number of these affiliated business arrangements, is that the pricing of the products or services being offered would be overinflated in order to generate sufficient revenue to pay off any party involved in this legal form of “kickbacks.”

The best way to understand my point here is through another example.  I once attempted to do a refinance on a 4-plex owned by a young couple who were entangled with a realtor involved in such an arrangement.  This couple trusted the realtor to provide them with the best price, but because the realtor was also involved with the selling realtor, the couple invariably paid about a 35% higher price for the property than the fair market value on the home at the time.  The appraiser obviously should have discovered this pricing difference, but because of the arrangement set up by him and the realtors the appraiser did not want to jeopardize future business with them; therefore, he appraised the property based on the price that the realtors wanted for the sale of the property.  The appraiser was charging double the normal appraisal fee, and why not? He knew that the realtors would use him.  Needless to say, there were many people involved that could have stopped the transaction dead in its tracks.  However, once the right groups of people join forces anyone involved in this business arrangement can support the next person, in order to legitimize the transaction.  These affiliated business arrangements can be perfectly ethical and legal, but for the most part are formed by professionals that don’t always have your best interests in mind.  People that were coaxed into a group of real estate professionals with these connections find that the majority of them are facing some form of property value issues on their homes. 

Returning to the experience of the young couple, when they went back to refinance their existing loan they were so far over extended on their loan that ultimately the borrowers were forced to default on the loan.

I could write an entire book about the issues that occurred from one professional to the next, but moreover the lesson I want people to learn from this is to trust their selves.  Don’t be afraid to ask questions, and above all else do your homework.