How Loan Modification Benefits The Real Estate Markets

Okay, I'm excited about this subject, which is why two articles back to back on Mortgage Loan Modification. There's a reason. For the first time ever, I am getting access to a tool that will enable me to keep sixty to ninety percent of the people in trouble from losing their houses. This article will talk about what effect it will have on the overall market, even those who aren't in danger of losing their property.

First off, there's the individual angle. If these folks are forced out of their property while the market is down, it turns a paper loss that doesn't really mean anything into a hard loss which has real financial consequences. If they bought for $500,000 and sell for $300,000, or are foreclosed upon, that's $200,000 in real wealth that has disappeared. Split it between the lender and the borrower however you like; it still doesn't do either one of them any good. If they are able to keep making their payments until the market comes back, they will have an opportunity to at least break even. Lots of folks were upside down on our mortgages in the early nineties. We didn't have idiots on the world wide web telling us to "just walk away" as if there were no consequences to doing so. There are very real, very long term consequences. For one thing, the tax forgiveness for short sales sunsets at the end of 2008, and it's the date of the final dispository sale that controls everything. In other words, with about 75 days left in the year, you're probably not going to make it under the deadline if you start right now. How would you like to get a bill for taxes on $200,000? Congress may still take action before the end of the year, but I wouldn't bet on it with the election coming.

Because they are still in the house, they have not converted an unimportant paper loss which doesn't really mean anything to a hard loss that has long term financial and credit effects. Furthermore, they're not homeless, or further straining an already impacted rental market. Finally, by keeping the folks in ownership of the homes, it is giving them a chance to participate in the recovery of the market. We've seen a tiny bit already in some ZIP codes in San Diego county. Furthermore, inventory is dropping in many areas of the county as well. Back in August, there were 107 homes for sale in La Mesa below $500,000. This morning there were 80. San Carlos, El Cajon, and Santee are all showing similar inventory numbers to August, but those numbers are themselves down from earlier in the year. Furthermore, the number of sales in September were up 56% over a year previously locally. Higher demand, lower supply means higher prices coming. If these folks hold on long enough - and you might be surprised at how short a time that will be - they won't be trying to sell while upside down. They'll be a normal, everyday sale, and they'll walk away from closing with money - maybe enough for the down payment on another property. Possibly even enough for the down payment on a better property. Isn't either one of these better than the consequences of a
short sale or foreclosure, to say nothing of the fact that they don't have the humiliation of having to talk about a negative event for the next seven to ten years, especially with their own kids.

By modifying the interest rate, term, or amortization characteristics of the loan, it keeps folks in their houses when the market is glutted with inventory, and buyers are still below expected averages in number. Supply and demand. High supply, low demand. But if we don't add to the problems, the market will work itself out and prices will recover.

Now let's look at the aggregate effect: every time we add a new seller unmatched by a buyer to the marketplace, the price falls. When you're not doing that anymore, the prices stop falling. Maybe they even start recovering. There's only going to be so many buyers over the next year. Every time we avoid adding excess inventory to the market because they absolutely have to sell, we end up ahead of the game. If we can avoid adding more sellers until the excess inventory is gone, prices will start to rise. Supply and demand.

Now let me ask you what happens when prices start recovering? First, a bunch of new buyers that have been holding off for three years now decide it's not going to get any better, and off the sidelines they come. The very fact that these people come off the sidelines, thereby boosting demand, means prices will rise more. And here's the kicker: Once the lenders see prices rising again, they will relax lending conditions a little bit, meaning more people now qualify for a property, and they come off the sidelines also, because the mortgage market controls the real estate market. This is a positive feedback effect - our old friends fear and greed take over as even more people come off the sidelines so they can participate in the resulting orgy of buying. A million people selling for $300,000 when they owe $500,000 is a personal and national tragedy. A million people who used to be upside-down selling for $600,000 when they owe $500,000 is business as usual, and making a profit after the lender and everybody else gets all of the money they are entitled to.

Now to be fair, it also slows the recovery after a certain point, as people who were upside-down can now sell for a profit, and individually, some of them will decide to do just that as soon as it happens. Having been upside-down, particularly upside-down and helpless, is a life changing experience. This will have the effect of a light tap on the brakes upon values just when, if people had not been able to stay in the homes, prices would really be taking off. I think that's all to the good. Anything that helps avoid a repeat a mess like we're working our way out of right now. There is always a substantial portion of the populace driving with their eyes closed, assuming that because a type of investment gained 20% last year, it will do the same thing this year (or because it lost 20% this year, it will do the same thing next year. As anyone over the age of eight should know by now, that conclusion does not follow from the premises.

Caveat Emptor