Wealth Tip: Three Reasons Why Foreclosure Rates Keep Climbing
REASON ONE: Changing mortgage underwriting guidelines.
There was a time four decades ago that in order to get a loan to buy a home the borrower needed a 20 percent down payment, strong credit, and stable income that was at least three times as high as the mortgage payments. But the world has changed, and so has the lending market.
Today home buyers can get zero down loans with adjustable rate mortgages that cause their loan balance to actually increase every month (called “negative amortizing loans”). In fact, lenders today have loosened up their requirements on credit standards (witness the explosion of “sub prime” loans) and income levels (with many lenders requiring only twice the income of the total home monthly payment).
As you can imagine, this loosening of the financial requirements means more borrowers will default on their loans. They have less equity. They have a smaller cushion to make the monthly payments. And in many instances they have lower credit scores.
Just to be clear on this, I personally think many of the mortgage industry changes are good ones. I love the idea that more people than ever are able to get access to financing to purchase their home. To me this gives ordinary people the chance to build wealth and enjoy the freedom of owning their own home.
But there is a downside to this too, when you add in the societal push to buy the “most expensive home you can qualify for a loan for”. This influence I think causes many homeowners to get in way over their heads. Hence the need for investors like you and I to be there to bail out many of them for a fair profit.
In many cases the lenders themselves make this profit possible by accepting less than what’s owed (aka: “short sale”). Now don’t go feeling to bad for the lenders since most loans are bundled up and sold on the secondary market (i.e. wall street) in such a way that the risks are spread and investors make a high enough rate of return to cover the cost of the defaulting loans. In fact, this financial flexibility and growth of the mortgage industry to source off the loans in collective bundles is what has allowed the lending world to offer so many more potential loans for would be borrowers. Again, in and of itself I think this is a very good thing—for borrowers, for lenders, for investors, and for the country as a whole. It’s just when you add in the other element I just talked about along with poor financial fluency that so many borrowers get into trouble.
REASON TWO: Toxic Mortgages
A recent Business Week cover asked, “How Toxic Is Your Mortgage?” (September 6, 2006). In the 14-page feature article the Business Week reported on the alarming rise in “option ARM loans”. These are adjustable rate mortgages that offer several payment options to the borrow, including one option, called the “minimum payment” that is less than the cost of the interest so that the loan grows bigger every month. According to the article, up to 80 percent of all option ARM borrowers make only the minimum payment!
In 2005, Countrywide Home Mortgage (the nation’s number one mortgage lender) had a 500 percent increase in “option ARM” loans! According to the article more than 20 percent of all option ARM loans in 2004 and 2005 were worth less than the outstanding loan balance! And if the real estate market fell by just 10 percent that number would double to 40 percent!
Are you getting a sense of why in earlier wealth tips I suggested that prudent real estate investors would be ready to buy with cash? There will be a lot of properties that are in need of saving. Shortsales, as a technique to buy properties in foreclosure where the lender accepts less than what is owed just to get the defaulting loan off its books and make the best of a negative situation, will be one of the most important buying strategies for investors to master.
And if that wasn’t enough, in 2005 lenders gave 43 percent of first time buyers loans for 100 percent of the purchase price (National Association of Realtors) leaving these homeowners vulnerable to the slightest economic quiver.
REASON THREE: A Shift in the Real Estate Market
The headlines are everywhere. The cover of The Economist read, “Has America’s Housing Bubble Burst?” (August 26, 2006). USA Today reports about the declining real estate market. What’s happening?
The answer is that another market cycle is playing out in the real estate market. The huge growth of real estate (from 2000-2005 the total value of American homes skyrocketed from $9 trillion to $22 trillion) was drastically slowed and in many parts of the country, especially the Midwest, is declining in value.
When you add this decline in the real estate market to the loose lending trends of the past decade what you get is a recipe for a massive increase in opportunities for foreclosure investors.
**********************
I hope you enjoyed this week’s tips. Please take us up on the opportunity to join us in January!
My best to you all,
David
P.S. Remember to mark your calendar for January 20-21st, 2007 for the Maui Millionaire Wealth Weekend. This powerful, life-changing workshop is being held in Las Vegas and ALL proceeds—gross not net—go to charity! My suggestion? Come to both this and the “Financially Free” workshop (the events are back to back.)
P.P.S. Don’t miss out on the Financially Free: How to Become Financially Fluent and Build Level Three Wealth Workshop January 22-23, 2007 Las Vegas. For full details and to register, just follow the above link!
There was a time four decades ago that in order to get a loan to buy a home the borrower needed a 20 percent down payment, strong credit, and stable income that was at least three times as high as the mortgage payments. But the world has changed, and so has the lending market.
Today home buyers can get zero down loans with adjustable rate mortgages that cause their loan balance to actually increase every month (called “negative amortizing loans”). In fact, lenders today have loosened up their requirements on credit standards (witness the explosion of “sub prime” loans) and income levels (with many lenders requiring only twice the income of the total home monthly payment).
As you can imagine, this loosening of the financial requirements means more borrowers will default on their loans. They have less equity. They have a smaller cushion to make the monthly payments. And in many instances they have lower credit scores.
Just to be clear on this, I personally think many of the mortgage industry changes are good ones. I love the idea that more people than ever are able to get access to financing to purchase their home. To me this gives ordinary people the chance to build wealth and enjoy the freedom of owning their own home.
But there is a downside to this too, when you add in the societal push to buy the “most expensive home you can qualify for a loan for”. This influence I think causes many homeowners to get in way over their heads. Hence the need for investors like you and I to be there to bail out many of them for a fair profit.
In many cases the lenders themselves make this profit possible by accepting less than what’s owed (aka: “short sale”). Now don’t go feeling to bad for the lenders since most loans are bundled up and sold on the secondary market (i.e. wall street) in such a way that the risks are spread and investors make a high enough rate of return to cover the cost of the defaulting loans. In fact, this financial flexibility and growth of the mortgage industry to source off the loans in collective bundles is what has allowed the lending world to offer so many more potential loans for would be borrowers. Again, in and of itself I think this is a very good thing—for borrowers, for lenders, for investors, and for the country as a whole. It’s just when you add in the other element I just talked about along with poor financial fluency that so many borrowers get into trouble.
REASON TWO: Toxic Mortgages
A recent Business Week cover asked, “How Toxic Is Your Mortgage?” (September 6, 2006). In the 14-page feature article the Business Week reported on the alarming rise in “option ARM loans”. These are adjustable rate mortgages that offer several payment options to the borrow, including one option, called the “minimum payment” that is less than the cost of the interest so that the loan grows bigger every month. According to the article, up to 80 percent of all option ARM borrowers make only the minimum payment!
In 2005, Countrywide Home Mortgage (the nation’s number one mortgage lender) had a 500 percent increase in “option ARM” loans! According to the article more than 20 percent of all option ARM loans in 2004 and 2005 were worth less than the outstanding loan balance! And if the real estate market fell by just 10 percent that number would double to 40 percent!
Are you getting a sense of why in earlier wealth tips I suggested that prudent real estate investors would be ready to buy with cash? There will be a lot of properties that are in need of saving. Shortsales, as a technique to buy properties in foreclosure where the lender accepts less than what is owed just to get the defaulting loan off its books and make the best of a negative situation, will be one of the most important buying strategies for investors to master.
And if that wasn’t enough, in 2005 lenders gave 43 percent of first time buyers loans for 100 percent of the purchase price (National Association of Realtors) leaving these homeowners vulnerable to the slightest economic quiver.
REASON THREE: A Shift in the Real Estate Market
The headlines are everywhere. The cover of The Economist read, “Has America’s Housing Bubble Burst?” (August 26, 2006). USA Today reports about the declining real estate market. What’s happening?
The answer is that another market cycle is playing out in the real estate market. The huge growth of real estate (from 2000-2005 the total value of American homes skyrocketed from $9 trillion to $22 trillion) was drastically slowed and in many parts of the country, especially the Midwest, is declining in value.
When you add this decline in the real estate market to the loose lending trends of the past decade what you get is a recipe for a massive increase in opportunities for foreclosure investors.
**********************
I hope you enjoyed this week’s tips. Please take us up on the opportunity to join us in January!
My best to you all,
David
P.S. Remember to mark your calendar for January 20-21st, 2007 for the Maui Millionaire Wealth Weekend. This powerful, life-changing workshop is being held in Las Vegas and ALL proceeds—gross not net—go to charity! My suggestion? Come to both this and the “Financially Free” workshop (the events are back to back.)
P.P.S. Don’t miss out on the Financially Free: How to Become Financially Fluent and Build Level Three Wealth Workshop January 22-23, 2007 Las Vegas. For full details and to register, just follow the above link!
posted by David Finkel at 1:04 PM
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