Housing Crisis - What’s Wrong, Who’s To Blame & What Your Options Are?
By George Chege
AjabuAfrica.com
Lowell, MA
07/24/2008
Many readers have been asking us to comment on what went wrong with the American dream. In this article, we will attempt to explain key factors in simple terms. We will also offer suggestions to those who have been caught up in the housing mess and are threatened with losing their homes. Harvard University has just released its annual report on the status of the housing market and we will comment on both the good news and the not-so-good news.
The key highlights Harvard University housing market report are the following:
1) The current fall in house values and rise in mortgage defaults was last seen 30 years ago. In 2007 1.3 million homes were in foreclosure. This is the bad news – 1 million people losing their homes in a single year.
2) Builders over-built, lenders over-lent and borrowers over-borrowed. This is the reason for the dismal situation in the housing market.
3) However, over the next 10 years, there will be demand for 14.5 million new homes. This is good news. It confirms what we always say – that demand for land and housing will always increase because of population growth.
4) The housing market will eventually recover but it will take longer than other recessionary periods. This is good news.
Let us explain from an economist’s point of view. The banks lent out too much money, too easily. Many people who could not afford to pay for mortgages they applied for got approved and hopped into the bandwagon. Then the law of supply and demand took over.
The huge supply of money created a big demand for houses. The big demand pushed the prices through the roof. Developers too thought demand for new houses would last and they borrowed money to build more houses. But the economy could not sustain the large credit supply and high interest rates as a result of under-qualified borrowers and over-inflated house values. The bubble had to burst. In 2007 it did.
What we are seeing today is the market trying to recover as it seeks a new economic equilibrium of supply and demand. But who is to blame for the mess and the misery.
Banks
The worst culprit in the sub-prime mortgage lending process was the “stated income” loan application. This allowed homeowners to state their income without showing any evidence of the stated income. The stated income process allowed mortgage brokers and borrowers to stretch the truth too far on the loan application forms. For example, it was noted that applicants earning $2,000 per month were able to purchase homes requiring $4,500 payment per month.
Why did the banks allow this to happen? It is because they were able to inflate interest rates for sub-prime borrowers. They became greedy.
Brokers
Mortgage brokers are paid commissions based on the amount of loan the borrower gets. They pushed borrowers to buy houses they could not afford and manipulated the application forms and sourced lenders who could provide the highest and most expensive loan. They inflated their fees. They too became greedy.
Borrowers
When easy credit became available, borrowers borrowed more than they could repay hoping to refinance within a year and cash out home equity. Borrowers were counting on home values rising year after year. They too became greedy.
Government
Federal and state governments assumed the banks knew what they were doing and chose to bury their heads in the sand. The government expected banks to make excessive profits, which would in turn result in massive tax payments to the government. It became greedy and abdicated its supervisory role over banks.
Where are we today?
The government has exercised its supervisory role by creating guidelines for banks and mortgage brokers to avoid predatory lending. The banks are scrapping those 100% financing, no-down-payment, no-closing-cost, stated income type of loans. Brokers will be required to pass exams and be licensed to ensure they follow a code of professional ethics. Borrowers are now understanding that a home is a place to live in and not a get-rich-quick-scheme.
What are your options?
If you don’t have a house and you are contemplating on buying one, watch this space. We will write an article on the most cost-effective way to buy your first house. You can also write to GeorgeChege@AjabuAfrica.com for free guidelines.
If you own a house and you are able to pay your mortgage and you can refinance to a low-interest fixed mortgage within the next 2 years, your concerns are not critical. You can afford to wait for the market upturn in the next 5 years.
If you are among those unfortunate to realize that their house value is now lower than the loan and you cannot afford the increase in mortgage payments, we have some suggestions for you.
- Short sale. Lender allows you to sell the house for an amount less than the loan and they write-off the rest of the loan. Your credit will not show a foreclosure.
- Loan modification. Negotiating with your bank to change your loan payment terms to make it affordable. You may have to prove financial difficulty and provide a hardship letter explaining the cause of difficulty.
- Forbearance. Negotiating with your lender on how to structure repayment of past due amounts within 18 months. This assumes you only have a short-term difficulty.
- FHA/VA one-time payment. If you got your loan through FHA/VA, they can loan you an interest-free one-month payment if you are able to resume normal payments.
- Bankruptcy. If you get a good lawyer you can avoid foreclosure, slow foreclosure or avoid eviction by filing for bankruptcy. Companies and wealthy people commonly use this method.
- Deed in lieu of foreclosure. This means giving your house to the lender and avoiding foreclosure process.
You may need a lawyer and credit counselor to help you with any of the above options. It is also important to beware of scams and bogus companies targeting your money or house yet claiming to help you in the process.
Our advice is that you should start pursuing these options as soon as you realize you are in difficulty of making payments on time. You will then have time to try as many options as possible.
Also understand that the bank does not need your house. Their business is to sell loans not to sell houses. As long as you are making some payment as you negotiate, the bank will be willing to work something out with you.
Giving up your home should be the last resort.
For more details please contact GeorgeChege@Ajabuafrica.com
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