Fixing The Real Estate Mess - Describing the Situation

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Lots of folks have offered lots of different proposals for fixing the real estate markets and the mess we were in (and continue to be in to a less obvious degree). All of the ones I have seen have suffered from one or more of about three problems. First, the majority have been suffering from what I like to call "magic wand" syndrome: somebody waves this magic wand and all of a sudden everything is magically all better. Not gonna happen. Macroeconomics doesn't work that way.

Second, they think that people are somehow magically going to stop doing things in their own best interest. Sometimes I wonder if blunt enough language exists to get through these folks' mental barriers. Any proposed solution that wants to have a hope of being successful is going to have to acknowledge that people will continue to be people, and in the main, act in what they perceive to be their own personal best interests.

Third, they fail to understand that the loan market controls the real estate market. I'm going to be talking about the implications of this fact quite a bit in this article. If the loans don't exist, neither do the buyers, at least not in sufficient numbers. The alternative, waiting for people to be able to afford to buy with cash, would mean either a massive crash in housing prices - to the point where nobody can profitably build - or stagnation until massive inflation takes hold and general price levels catch up, which has the same implications for value in the housing market and much worse implications for everything else. The only way to move away from the loan market controlling the housing market will effectively crash the value of housing much further than it has already fallen. Whether this is done by maintaining dollar cost constant while everything else spikes, or by crashing the actual value, the implications are the same. It takes a certain amount of materials and a certain amount of labor to create an acceptable housing unit, and the costs for those are well in excess of what most people can afford to pay 100% cash for in a unit of housing or anything else. If the people can't afford to pay for it, there won't be any sold, and before too long there won't be any more being built. Yeah, we could go back to one room log cabins and massive unreinforced masonry apartment buildings with no running water or electricity, but I happen to think that the idea of having at least a minimal building code is a good idea. It costs money to comply with building codes - more money than most people are willing or able to save prior to purchasing a home. That's the situation as it would exist without loans. Lest you think the influence of loans is something recent recent, here's entertaining evidence otherwise. 65 year old evidence that most of you will have seen before, if probably not considered in this context, describing a phenomenon that had been widespread in the United States since the 1830s. When you're looking at the real estate market, you're essentially looking at the loan market - the exceptions are damned few, statistically speaking.

So understand that if you want to fix the real estate market - really fix it - what you really need to do is fix the loan market.

This is far from straightforward, and yet the evidence is overwhelming that we have problems. 26.8% of all loans were rejected in 2010. That's 26.8% of ALL loan applications - the data wasn't broken down by loan type, but I strongly suspect it was lower for "rate/term" refinances and higher for both "cash out" and purchase money, as that would be in line with what I know and what's related to me by others in the business. 2010 was a great year for refinancing as rates tumbled - but few could actually qualify. I know I don't want to take an application if I don't have a reasonable idea that this loan should stand an excellent chance of approval. If the values in the neighborhood don't support an appraisal that's going to work, I'll tell the folks, "Look, I will process this if you really want me to, but I think you're wasting your time and about $450 for an appraisal. The highest selling price within the distance and time that appraisers are allowed to consider is 10% less than the value we need - and that was a bigger property well maintained." Similarly, if the debt to income ratio isn't going to work, it's better serving both the applicants and myself to find out as soon as possible.

What are the sorts of things I'm seeing or hearing about as reasons for a decline on an application? Most common is that appraised value of the property is too low, usually on a refinance simply because bargaining power for those willing to actually make a purchase is so great right now. Somebody owes $400,000 on what was a $600,000 property and is now a $440,000 property - a 91% Loan to Value ratio, and that's for those people who don't owe more than the property is currently worth. No lenders want to refinance above 80% loan to value right now (some will, with PMI, but even there 90% is about the absolute limit). Net result: That rate under 4% for a thirty year fixed rate loan you see everyone quoting is no good if you can't qualify for it because you don't have the equity and you sure as heck don't have the cash to pay your loan down that far. If you're in default or in trouble, your current lender will likely work with you in the hopes of avoiding losses. That's not the same thing as a regular refinance. I predicted this problem back in March 2006.

Another reason: Debt to income ratio doesn't work, usually because of a term of low to non-existent income. In plain English, someone has been laid off, or downsized, and it took them a while to find a new job. Even if the income now is as high as the income was before - it usually isn't - due to the way lenders calculate income having six months of missing income can completely kill your chance of a loan until that period is at least 2 years in the past. Stated income is essentially dead, so there just isn't a good way around this. I can get you a hard money loan at 13% or so if your equity is good enough (25% or more; 35-40% if there's "cash out") but that just doesn't help most people.

These ways are pretty much predictable. I can look at the situation before we even complete the application and tell if it's likely to be rejected on such grounds. Yeah, I'm perfectly willing to go ahead and try if the people say to try, but most people get the message when I tell them that in my experience, if they submit a loan application it is likely to be rejected. I can't remember anyone who told me to go ahead and commit them to spending the money for the appraisal when I'm talking about predictable reasons for rejection. From what other loan officers have told me, this tends to be their experience as well.

The majority of the actual rejections are ones that I never would have predicted. This class of failures seems to stem from mortgage investors who have taken losses and are now completely paranoid about losses, to the point of ridiculousness. I think the most egregious was a lender refusing to refinance because there was a private money second that had been originally written to comply with their own specifications when the people bought the home. I was the original agent and loan officer, and the client's parents wanted to give them a loan that would be forgiven in accordance with federal gifting rules so as not to create estate tax problems. So under the lender's instructions, we wrote it up with a given interest rate and payment schedule that did not take into account the planned forgiveness and did include the projected payments in the client's debt to income ratio. Everything worked, everything fit, everything completely above board, legal, verified and copacetic- until the refinance several years later where the bank wouldn't lend because this - much shrunken - private money second was still in place - even though the holders would sign any subordination the lender wanted, or even reconvey the trust deed and convert it into an unsecured personal loan. There was no issue whatsoever with property loan to value ratio, client credit, debt to income ratio or anything else. Just a flat rejection because they owed money to a non-institutional lender. I have yet to tell this story to another loan officer or processor without getting a three word response that most people abbreviate "WTF?", usually with severe emphasis on the last word thereof. (Under other circumstances, it would have been hilarious coming from my processor who is usually quite ladylike). I tried taking the loan elsewhere only to be told it wouldn't be approved there (or there, or there, or ...) either, in large part due to paranoid investor rules about approving loans that had been rejected elsewhere.

Just because the worst I can personally vouch for, but that doesn't mean it's the only one. Refusing to allow the inclusion of rental income for other properties despite extensive documentation of it actually being paid. Slight job title changes due to consolidated duties. Many things that would take way too long to explain, but I (and other loan officers and our loan processors) have been flabbergasted by. Crap that just wasn't on the radar even 20 years ago, well before the Era of Make Believe Loans, but today it's being used as a reason to refuse a loan application.

Now, let me ask "Who is being hurt by the current state of the loan market?" Yes, lenders have taken some real damage, but they are not among those being hurt the worst from current events and going forward. Their pain is mostly in the past, and the ones that have survived this far are pretty much insulated from bad effects going forward. The federal government has assumed the liabilities for the bad loans. They're also still making their usual and customary margin - if not more - on every loan they sell to the secondary market ("mortgage investors" above). In point of fact, lenders - who in my opinion bore far and away the largest non-governmental share of guilt for the meltdown - are doing very well with sweetheart deals from the Federal Reserve and other government agencies, not to mention the hundreds of billions they got through TARP.

Consumers are being hurt far worse. Few people can buy because they can't scrape up the higher down payment necessary even considering the lower prices. As a result, people who need to sell for whatever reason, can't sell.

Another group taking it in the shorts are mortgage investors. A lot of these are pension plans and investor groups who have to invest a certain amount in mortgage securities, because they have traditionally been such a solid investment and there are therefore requirements to invest in them written into their charter documents. The results of this are as obvious as gravity: if you're not making diddly squat on something you're required to have and which you have recently lost a blortload of money on, you're going to be certain you only fund the very safest ones, leading to the paranoid nonsense of underwriting rules discussed earlier and other things that prevent would be borrowers from getting the money to borrow.

Making the entire situation worse are several rules the federal government has passed, allegedly to "protect" consumers, but the net effect is to protect the big lenders with the large bundles of campaign contributions from competition, and even if the politicians in Congress are ignorant enough to believe these rules benefited consumers, the lenders who sponsored them are not. Among other things, these rules prohibit both charging significantly higher rates of interest to compensate for risk and funding loans without having traditional documentation to show the people can afford it.

I'm going to cover the latter item first. Stated Income (and so called "NINA programs, which you may have heard called "ninja" loans) were so badly abused I doubt I can communicate how much damage it did to people who weren't dealing with the situation every day of their working lives. But traditional income documentation was set in place when almost everyone worked the same job with the same company from the time they first went to work as teenagers to the time they retired. I shouldn't have to tell people how rare that is today, or how common disruptions in employment, changes in employer, or even career field, let alone moving to self-employment. The income documentation it requires is inflexible and doesn't take into account the way people work in this modern world. We change jobs, change careers, get promoted, get laid off, go back to school and find new careers, sometimes at intervals measured in months. The response of traditional income documentation to all of these is to cause the loan to be rejected. Pardon me, but I really don't think that someone who can document making $10 an hour in one field, $11 per hour in a second, and $12.50 an hour in a third all within a 2 year window is a larger risk for extended unemployment that anyone who has been solely in any one of the 3 fields. If one field of employment dries up, they still have two others where they have a track record of employment. Traditional lending standards, however, disagree. Such an applicant will be rejected outright for the loan because they cannot show 2 years in the same line of work. Even if the 2 years same line of work requirement here were to be relaxed, lending standards declare that said folks are only able to count the income from the one they're currently in, averaged over a 2 year period even though they may only have been doing it a few months. $12.50 per hour over six months is about like making $3.12 per hour over two years, and the loan is rejected because debt to income ratio is too high.

In regards to the former item, if lenders can't charge more interest to allow for higher risk, then there will be no higher risk loans made, despite the fact that they are good loans and the ability to get those loans puts people into better situations. If Young Couple A can get a loan for $90,000 on a $100,000 condo at 8% - much higher currently available rates - their monthly cost of mortgage become $660, which even with $250 per month for association fees and $100 per month for property taxes means they are paying almost $300 per month less than the $1300 per month rent they were paying for an identical unit elsewhere in the complex, and they're building equity with that money and they OWN the damn thing, which means they are motivated to take care of it. If it is a condo, they get a seat at the table in deciding how to manage the complex. If not, they get to decide all on their own. This also generates all sorts of other good things that I have yet to hear anyone make a single argument against in my time on this planet. Unfortunately, they probably can't get that loan on a condominium, even without this restriction, because of the re-institution of another brain damaged rule: The 60% owner occupancy requirement.

The 60% owner occupancy requirement for condominiums is an old monster come back to life. VA and FHA loans, controlled by the federal government, never dropped this requirement, but every other loan program in the known universe did. When the federal government nominally reassumed ownership of Fannie Mae and Freddie Mac (which had been ruined by political requirements and political appointees, as they were always controlled by politicians), Fannie and Freddie were required by Congress to resume requiring 60% owner occupancy, and so the entire mortgage market in homage to investor paranoia above re-instituted this requirement. Practical effect: Once a condominium complex drops below 60% owner occupancy even once, units in that complex will never be eligible for any of the loans designed to move people into at least fist time ownership ever again, because from that point forward the only people who can buy are the ones with enough cash that they don't need a loan that comes with a 60% owner occupancy requirement. Remember, the loan market controls the real estate market.

Let me also observe that there are a lot of places out there that are legally condominiums even if they may not look like it. A group of detached dwellings on a large lot sharing parking and community recreation? Odds are long they are legally condominiums, and therefore the lender must treat them as condominiums. If it's got a Homeowner's Association and dues, it's most likely a condominium. Many developments in recent years have taken the "legally it's a condominium" route because it makes the property more valuable and means the developer can make more money. But once they drop below 60% owner occupancy, they're still stuck with the rules that lenders have for condominiums, and the questions isn't if it's going to bite a given development, but when.

The fact that these units are not eligible for those loans means that most people can't buy them. Since most people can't buy them, the value drops until some investor realizes that for a $30,000 investment in what used to be a $100,000 condo but is now only worth $60,000, he can make over $750 per month by renting it for $1300 to the poor suckers who can't buy because they don't have the down payment required. Additionally, his equity is increasing every month. All because the renters can't manage to save the necessary down payment because they're too busy paying all their money to investors like this. Overall effect: Transfer of wealth from the less affluent to the more affluent. The people who already own them when such a change happens see a loss of a large portion of their value, quite likely going from having made a significant upfront investment to owing more than the property is now worth - because your average buyer who might actually want to live in it, can't buy it, it's worth far less. I should also mention that in practice this is extremely discriminatory in effect. If it were a private company doing this, it would be probably disallowed by the courts because try as I might to have someone point me at research that shows the 60% owner occupancy ratio means something tangible, nobody has been able to do so. Even if such research exists somewhere, may I point out that Redlining has been illegal for decades? What is the 60% owner occupancy ratio if not Redlining on a smaller scale?

This is the situation we face in the current housing and loan markets. Tomorrow, I will propose some solutions. Not grand sweeping costly solutions that will allegedly fix everything overnight. Solutions like that not only aren't real; they tend to screw the markets up even worse. But incremental changes grounded in accepting the changes in society that have happened in my lifetime. Small touches that make a big difference over time, by allowing the markets to return to a state where the vast majority of those who would like to buy do not face artificially increased barriers to ownership, and therefore, the people who currently own and would like to sell are able to do so.

continued here

Original article here

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About this Entry

This page contains a single entry by Dan Melson published on August 24, 2014 8:00 AM.

Why Is My Rate Higher Than My Lender Promised? was the previous entry in this blog.

Fixing The Real Estate Mess - Proposing Some Small Changes That Would Make A Huge Difference Over Time is the next entry in this blog.

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