Thursday, February 19, 2009

First-hand Report from the Mortgage Default Trenches

As a housing counselor for a HUD-approved Housing Counseling Agency, I see first-hand the problem of home foreclosures. Unfortunately, we can continue to expect high rates of mortgage defaults for sometime to come. It is estimated that one out of five subprime loans issued since 2002 will fail. In addition to the people with subprime loans who are at risk, many other borrowers are also at risk due to the declining economy. I personally counsel about eight people a week who are on the verge of losing their home and I supervise other housing counselors so I see a lot of people who are in default. While my experience is not a scientific sampling, I observe five categories of clients who are at risk of losing their home and the people I serve are about evenly split between the five categories. There is some overlap in these categories and often a client fits in more than one category.

(1). Good people to whom bad things happen: Illness, lost of job, divorce, and reduction of income or unplanned increases in expenses cause many people to become late on their payment.

(2) Homeowners who bought too much house. Many customers took out loans they could not afford. People in this category often could have qualified for a $100,000 house with a good loan, but instead got an adjustable rate mortgage or some other "creative financing" so they could buy an $180,000 house. Many times they were steered into a bad loan by a realtor or a loan officer, nevertheless the homeowner should have exercised due diligence and educated themselves before signing on the dotted line. Often the house payment on the $180,000 mortgage, during the period that the loan had the introductory teaser rate, is no higher than the house payment would have been for a $100,000 mortgage with a good loan. During the introductory teaser rate period the buyer is fine, but as soon as the loan resets the homeowner is in trouble. The customer did not think ahead about what would happen when the interest rate reset.

(3) Clients who should have kept renting. This is similar to the case above but instead of buying too much house, these are people who should not have bought any house. Since they were poor credit risk, the only loan they could get was a loan with a high interest rate. These clients are also often “house payment burdened.” They are spending too large of a portion of their income on housing. They often have poor money management skills and when the loan resets or they have any other financial difficulty they default.

(3) Clients who have poor money management skills and make poor decisions. Many people fail to build any saving, live payday to payday, and live beyond their means. A little bump in the road puts their home at risk. They feel entitled to a nice home and a new car. They may not be able to pay their house payment yet they spend $100 a month for cable and $250 for cell phones and eat out often.

Recently I had a couple come see me who was three months behind on their house payment. The wife had had a problem pregnancy and had missed several months work. The couple had exhausted what little saving they had. While working with them on their budget, I noticed that just a couple months before the wife had had to take unpaid sick leave from her job that they had purchased a new car and had taken on a $465 car payment. I asked them why they had taken on such a large care note. The new mother explained to me, “Well, I got pregnant, and we had to have an SUV.”

(5) Clients who are victims of predatory lending or poor lending practices. I have witnessed inflated appraisals, phony "gift letters", falsified income, and people having their loan product switched the day of closing and then being pressured into closing.

I recently had a client come to me, who had inherited a house in the Belmont area of Nashville about eight year ago from her aunt who passed away. The house was paid for but was in bad need of repair. The new owner borrowed a little over $40,000 to repair and upgrade the home. Despite having credit that would have made her eligible for a good loan, she was giving an adjustable rate mortgage and a loan with high closing fees. About a year later, the same loan officer called her and told her she had a bad mortgage that was going to adjust to a higher payment and he offered to refinance her to a new loan that would keep the payments from going up. She refinanced, and again the same thing happened about a year later. All together, in eight years, she got the original loan and was "flipped" (refinanced) four times, each time losing equity in her home. After the fifth loan she could not be refinanced anymore and her gross annual income was actually less than the total of her annual house payments. Unfortunately, this lady lost her home.

Part of the problems that caused the flood of foreclosures has already self-corrected. Investors are no longer buying subprime loans so few new borrowers will find the same easy credit available as did the homeowners who got the bad loans. Nevertheless, there may be a need for reform and greater regulation so this does not happen again. We may also need new laws against some predatory lending practices. More than new laws however, we need vigorous enforcement of existing lending laws and prosecution of offenders. A lot of people need to go to jail. Mortgage lending needs to become a profession with licensing and a code of ethics. We also need basic financial literacy taught in schools and we need policies that encourage savings.

More than anything, we need a change in societal attitudes so that people don’t feel ‘entitled’. No one owes you a new SUV just because you are pregnant and if you can only afford a $100,000 home, you are not entitled to an $180,000 home. You can't have it all.

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  1. Your point #2 (bought too much house) covers more financial ground than most banks, Realtors, and real estate owners think because most real estate, residential and commercial, actually have a negative value instead of a positive one, like everyone thinks when the loan is made.

    You see, most real estate today causes its owner(s) all kinds of problems. explains that real value in real estate is found if and when it helps its owner to create good fortune for his or her self.

  2. My brother fell prey to #5 (switched to adjustable but told he could refinance after a year and then was denied) so his house went into foreclosure. While in the process of moving into a rental home, he had the old house broken into by someone posing as a bank official and had several pieces of furniture stolen including family pieces left to him by our mom! Sleazy people left and right out there!

  3. Well, thank God as Republicans we had nothing to do with creating this awful mess. I mean it's not like we voted for some mentally retarded monkey to run the country or handed the keys of power to a bunch of egomaniacal despots who looted the treasury for their cronies as if it were their own personal automated teller.

    Yep. Our hands are clean.

    I think I now know how Lady Macbeth felt.

  4. Must be diffcult (and sometimes annoying) to hear those stories all day. I worked as real estate agent during the hey day a couple of years ago and each week there would be new, unbelievable loans advertised on brightly-colored paper in my Inbox. What were these people thinking? Whenever any of my clients got one of these bizarre loans, they always shrugged smugly and said "Ill refinance to a fixed in 5 years when it adjusts." Not so easy...

  5. You hit so many nails on the head in this post - not surprising since you're on the ground in this little "war". One thing that a lot of people don't recognize is how many of these subprime loans were not first mortgages. They were second and third mortgages aggressively marketed to homeowners with the blithe promise that "in two years (or five years) when the mortgage resets, you'll have no trouble refinancing the loan because your house value will have gone up and you'll have almost doubled your equity and..."

    It's easy to say that people "should have known better" - but many of them trusted the "experts" who were selling them a castle in the clouds.