As foerclosures start to appear in your neighbor hood the crime rate goes up. In our suburban neighborhood houses have been broken into and stripped of everything of value.
Empty houses do not have the grass cut or snow cleared off the sidewalk either. Property values drop quickly.
There are severals reasons people would take teaser loans like these. What you described is one type, a speculator. One in which they know exactly how the loan works and is banking on future equity or profit potential, and effectively lost when homes values sunk. There’s no free lunch with speculation. It’s no different then buying a stock with leverage and it tanking 40%. Now you gotta come up with the cash once the margin is called. A lot of people can’t, so they foreclose.
Others may have been enticed by the “deal” thinking they could afford it now, but might have been hoping for a high salary in a few years to cover it, or refinance once their credit was better later on. If their income didn’t increase, or their credit still stunk, they now have to deal with the new, higher rate.
Others may have gotten them when they could afford it now, but lacked the education to actually know the terms of the loan. This is where the predatory part comes in, and is quite a shady practice. Preying on people that don’t know any better, and getting the loan sold as quickly as possible for a banker to get his bonus for the made loan, and defer the cost of the loan to someone else later on when said loan would “reset” and the owner couldn’t pay (your “high-yeild” bond fund is an example as to where it ultimately gets packaged).
And of course, others may have gotten them, in which they have bad credit, and/or are horrible with managing their money. And that’s usually a case for disaster, but loans were made anyway for a banker to get his bonus on the sale.
I think our collective mindset is automatically equating “balloon payments” (or “teaser rates,” etc.) with subprime loans.
In the most basic sense, your credit rating and risk assessment is what qualifies you as a prime borrower or subprime borrower. Subprime, of course, is higher risk and demands a higher interest rate. In theory, subprime demands a higher investigation into your ability and willingness to repay a loan.
Programs like PMI, VA, and FHA exist mainly to assist subprime buyers, and buyers with little to no money down. These can aid people with subprime credit and people with excellent credit.
Then there are the loans themselves. Just because a loan has a three year balloon doesn’t necessarily qualify it as a subprime loan. Doing 80/20 splits doesn’t render them so. Teaser rates don’t render them so. There are traditional loans out there that were given to subprime people that are in trouble, too. There are gimmick loans out there that are effecting prime people who made bad decisions as well.
So then to address the question, this whole thing isn’t just about the ease in procuring the loan in the first place, but whether or not the loan should ever have existed – under any structure-- notwithstanding the means of procurement.
Oops, meant to add that another thing to consider is that the VA funding fee can add another 2% to the price of a house with that program, and FHA can be about 1.5%. There’s a real cost save to avoiding them if you have the means. “Have the means” being key.
And then there were people like me and my husband, whose credit scores were quite good (around 720 at the time), and could absolutely afford the home we bought, but got taken in by a greedy, scummy mortgage broker* and greedy, scummy banks that realized how much more money they’d be making if they forced us into an interest-only mortgage 1st and an adjustable 2nd mortgage.
It was such a seller’s market (houses were sold and off the market before the listings even came out!), and with multiple offers on the house, we had to move quickly or risk losing the house. We got quotes from a couple of different lenders, but we didn’t have the luxury of time to really shop it around and submit those arduous application forms to a bunch of different places. And then the broker we went with pulled a switcheroo one day before closing, claiming he couldn’t get us the loans he’d originally quoted us! At that stage of the process, we had not choice but to take what we were offered, deciding we’d just have to refinance sooner rather than later.
Luckily we didn’t have any trouble refinancing into a “jumbo” conventional loan a year and a half later (though we got screwed by yet another sleazy mortgage broker again on that one, too), which combined our 1st and 2nd mortgages into a single, fixed-rate loan. But for those who couldn’t, I can see first-hand what a nightmare that could turn into.
*This scuzbucked pulled a bait-and-switch, quoting us a conventional loan with no points, then taking a full point at closing, not to mention that he gave us a “Good Faith Estimate of Closing Costs” that turned out to be $10,000.00 off! Had we not been able to reach my boss that day to secure a loan from him for the extra closing costs, we’d’ve lost the house and our $20,000.00 earnest money deposit. After this, and the 2nd bait-and-switch theft by the 2nd mortgage broker, I will never, ever do business with a mortgage broker again unless there is absolutely no other choice, and then, only if every single conversation is done in writing. I’ll never speak to another one of these crooks over the phone again. I think these guys played a HUGE role in this crisis.
This was not strictly true. For personal savings, something like the first £2000 was fully guaranteed and the next £31,000 90% guaranteed. Cite. Still, I don’t believe many people knew that.
As a result of the Northern Rock affair, Alastair Darling announced that the first £100K would be fully covered. I’m not sure if that’s been enacted yet.
It seems to me that there were many people who were effectively a combination of these two. That is, they were speculators, but they didn’t realize it. I can’t even count how many people I’ve spoken to who understood exactly the terms of the loan, but didn’t seem to understand that there was even a small chance that their house wouldn’t go up in value.
Even otherwise smart people would just repeat mantras like “rent is throwning money away” and “housing always goes up” when talking about their house purchase. In fact, this kind of thinking is still prevalent. Just go look at any of the “should I buy a house” threads here.
The aftermath of subprime lending is slowly eating away at my neighborhood, an inner ring suburb of a poor Rust Belt city.
Because banks lowered their lending standards, people who normally couldn’t afford to buy houses could now qualify for a mortgage.
I live in an inner ring suburb of Cleveland that is dominated by well-maintained houses that range from $130K to $200K. ARMs and interest-only mortgages made these houses very affordable to lower-income families; $600 a month got you out of the ghetto of East Cleveland, and into a nice middle-end house in a safe middle-class suburb in a decent school district, not unreasonably far away from the old neighborhood.
The problem: interest rates were adjusted, property taxes rose, and in a few short years those those $600 mortgage payments became $1,000 mortgage payments. Also, many of the new homeowners were renters who had no idea how to maintain a house. They didn’t have the expertise in day-to-day maintenance, and they lacked such basics as lawnmowers and snow shovels. No longer being able to afford their houses, they foreclosed on their mortgages, and left. What they left behind was a poorly maintained house with neglected landscaping, in an already slow real estate market. My neighborhood is otherwise considered “nice”, but blocks are littered with empty houses sitting on overgrown lots.
Anecdote story from AP I read in the newspaper today:
Jefferson County, Florida did not pay its utility bills so it could afford to pay $500,000 in salaries to its school teachers. It seems their long term investment strategy is now in a shambles because the county invested in the mortgage market.
See http://www.washingtonpost.com/wp-dyn/content/article/2007/12/07/AR2007120701001.html
How many other local government entities did what Florida did? If the defaults start occurring at this local level, how far will it spread?
Oddly, I saw a news story on BBC America the other night that said a Norwegian city had done the same and now has no city budget. If anyone has more information on how widespread such things were, I’d like to know.
If you make a bad loan, you only care whether they can pay if you don’t expect housing prices to go up. If they can’t pay, you forclose and have a house that’s worth more than the loan they defaulted on.
If housing prices drop or stay stagnant at the same time that lots of bad loans are made, the houses are forclosed on, but the value of the house is no longer enough to cover the amount of money you lost from the defaulted loan.
Somthing that I don’t see mentioned, but I think is relevant, is that at the beginning of last year the minimum payment on consumer credits cards was doubled, with an eye toward forcing people to actually pay off their credit cards. So folks that were already living close to the edge of their budgets and relying on credit cards during shortfalls (always a bad thing), suddenly had double the credit card bills. I have a feeling that for many people, this helped push them over the edge from just barely making it to sinking in debt. It was a laudable goal - the previous minimum was barely more than the interest payment, but people parlaying all their available credit - credit cards, home equity loans, etc. - to finance their lifestyles found that they just couldn’t manage the balancing act any more. Just one more straw on the camel.
StG
It’s not a problem at all. Dick Cheney is exactly right when he says that the market should be allowed to sort itself out.
I’ll add a few things:
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Housing is ultimately a commodity just like anything else, and a commodity that everyone needs in some form or other. Since the US economy is not reliant on exporting housing, a collapse in prices can only mean a good thing - more cheap housing for everyone! Transactions always have a willing buyer and a willing seller, it just so happens that the people who were speculating on price increases have miscalculated, and they have the biggest bullhorn in the public discussion. After all, it is the general consensus that more ownership = good (I don’t really agree with that, but whatever), then if home prices collapse by 50%, that means more, usually younger people who were not able to afford a house now can. How could this be a bad thing? Young people in the US should be celebrating in the streets - the market in the US will become more friendly to them, sooner than markets in Europe, for example.
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The people who were speculating on price increases largely have no “skin in the game”. It’s a fact of the American entitlement society that “homeowners are losing their homes” is an acceptable description of the current phenomenon. Anyone who even has a basic understanding of what a mortgage is can see that it is incorrect - you only “own” something when you pay for it. REAL “homeowners” of course, cannot “lose their homes”. People who were able to get a secured loan on which they are now in default have not “lost” anything, since they never actually owned anything to begin with. Why should anyone shed a tear for them? They are no worse off than they were before, and if the market corrects itself, maybe they’ll actually be able to buy a house for real in the near future.
Related question;
What happens if you can’t make your full payment? Is it automatic foreclosure?
If your mortgage goes from $1,100/mo to $1,700 and you can only afford, say, $1,400 and you make (and are willing to continue to make) that payment what will the banks likely do?
Isn’t it better to get most of the money than (presumably) none?
And, are you just throwing that money away if you can’t make the whole payment? IOW, would you be better off banking that $1,400/mo for when you eventually get tossed out?
I sort of agree with Throatwarbler Mangrove on this too. Too many people were caught up in the hysterics and now the market will be reset for the average person to get a decent property with an average loan and good credit. Like it should have been all along.
Well, duh, they’ll be stepping on our grass all the time. And if it’s the wrong type of young people (“financially young,” as in poor), home values will be further depressed. So, white people (I mean people with money) will leave those neighborhoods, chop down more farms and woods, pay money for that housing, and leave the economically depressed people to rot in their own stink. The new ring houses will appreciate, causing a real bubble, and when it bursts, it’ll start all over again. But mostly, it’s the stepping on my grass thing.
I do have several friends who are now hoping to be able to afford a house for the first time–one just moved in to a house. It’s really nice for them, and I’m not unhappy to see the ridiculous housing prices going down.
It’s not clear whether this is supposed to be a spoof or not, but I’ll treat it as serious just to address the issues raised.
Housing prices do not exist in a vacuum. They are part of the overall economy. Changes in housing prices have ramifications beyond the individual sales involved.
And, more specifically, rises in housing prices cannot be divorced from the overall change in the credit economy.
I want to touch on that first. That people do not technically own their homes until they have paid off their mortgages is true, but in a very limited sense. Mortgage owners cannot treat the property as theirs until the contract they have with the payee is violated. It is essentially a license of rights and in such cases the licenser can treat the rights as theirs to do with as they like. In an economy in which 99% of all home loans are paid off the distinction is meaningless in practice. People don’t own their cars either until they are paid off, yet they can treat them as owned for every purpose, and just as importantly, the rest of the world treats them as owners. You might as well say that everything bought on a credit card is not yours until it has been paid off, but that’s not meaningful either.
The notion that payment by credit is somehow different than payment by cash is not very much different from the notion that electronic transfers aren’t the same as cash, and we’re crushed that one pretty thoroughly in a recent thread.
If you remove that untenable notion, the rest of the argument crashes down. Once people move into a home, they and the rest of the economy treats it as theirs. They buy furniture and insurance and lawn maintenance and siding and all the other things that renters seldom purchase. This provides huge stimulus to the economy. In a rising market, people increase their purchases, both of essential and luxury items, and that provides an even greater boost, indeed the exact boost to the economy that has offset the hits that the economy has taken from other sources, like the war, so that the economy has been more or less stable at a time when logically it should be tanking. Currency is printed but value is created by perception out of thin air. All modern economies run on value, which is an economic notion that seems to not be well understood.
Homeowners also tend to be more stable than renters, pay more attention to security and safety, require less police presence, are more active in their communities, etc. There is a large social component to homeownership that renters do not provide. That’s why homeownership is considered to be a general good, and why a downturn in homeownership is considered so dangerous right now.
What happens if value is no longer being created, or even being destroyed? A general decline in housing prices hurts the entire economy and benefits only a small subset of the population. Younger buyers may have more houses in their price range, but they are few in number, liable to be the ones most hurt by more general downturns in the job market, and least likely to be given credit to buy. And they would only benefit if the housing market were equally affected everywhere, rather than being selectively decimated by foreclosures. Younger buyers have no more incentive to move into neighborhoods with large numbers of foreclosures than anyone else, and the mortgage holders have little incentive to sell the houses at huge losses. They can write them off just as easily and get a better return for tax purposes.
In short, and this is the short version, you have no viable argument at all. Homeowners who have mortgages do own their houses and get to treat them that way. That is currently a bedrock principle of our economy. You can devise imaginary other economies, I suppose, but you can’t impose one on our real world without enormous dislocations. And I’m absolutely positive that the results wouldn’t be anything like what you imagined.
This is not the same thing as saying the housing bubble was rational, that greed didn’t make people stupid, or that returning to sensible credit requirements isn’t good in practically every way. Just that the economy is a complex whole and you can’t expect to make enormous changes without enormous effects. Especially not to something as central as homeownership.
I’d disagree with you on the VA loan. There may be a 2% funding fee, but there are cost savings elsewhere, including reduced closing costs when the vet has a down payment of 5% or more. It also does not require PMI and some of the closing costs may actually be cheaper than with a private loan. Finally, if the vet has a temporary financial issue and can’t make the payments, the VA will give assistance for that. (From here.)
In any event, many servicepeople, particularly those who have retired, may never have had the opportunity to buy a house due to frequent transfers; the VA program is designed to overcome some of those obstacles.
Robin
But remember I said “There’s a real cost save to avoiding them if you have the means. ‘Have the means’ being key.” I bought my first house with zero down payment, financed 102%, seller paid all closing costs, and I walked away with a refund check at closing. Luckily 2% of the value of that house was relatively little, even given what I earned at the time! That was a VA-backed loan, as I’m a proud veteran having served during a time of war.
The current house, though, would have cost me 2% for nothing. I still had the motivated seller pay all the closing costs, throw in some of goodies in the garage (like the tractor), and I walked away from closing with a check. Rather than paying PMI, wasting savings on a down payment, or paying the VA 2% of the sale price, I did an 80/20 split loan. Closing costs were all fully disclosed on the exact, same FHA form that you use for FHA and VA loans, and nothing was out of bounds, and the interest was good. The true closing costs were less than 2% of the price of the home. No way would VA have been a good idea for me.
By the way, the checks are result of refunds from pre-pays, like insurance and such, which are rolled into the closing costs, paid 100% by the sellers.
So, like I implied, the VA is a valid option, but like I said, if you have the means, there’s a cost-save in not using them.
A mortgage is a SECURED loan, credit cards are UNSECURED loans. This isn’t meaningful to you? If you think a 1% default rate (in your example) is “not meaningful”, you must work for Countrywide Financial.
Your comparison is ridiculous. Paying by credit is paying with someone else’s money. Paying by cash is paying with my money. I would say that’s a little different from paying with bills or debit card, as both of those, last time I checked, would be considered “my money”.
Whose argument? Mine? I made two points about why a collapse in real estate prices is a good thing. Do you have me confused with someone else?
All rental accommodations that I have ever been in have furniture, insurance, maintained lawns, and sidings. Most of these are required by law, and people generally need at least some furniture. These are provided by either the renter, or the landlord. Maybe you need to move to a better part of town. I’m not aware of any American neighborhoods that have property insurance and lawn maintenance as the cornerstones of the local economy.
I see, so logically, pets.com should never have been allowed to fail, because the fact that they never actually added any value to the economy is irrelevant - only PERCEPTION matters. So of course, house prices must be propped up at all costs.
You read my first post, right? Here it is again:
Again, I note that I don’t really agree with your assertion that ownership is always good, but that’s a much more complicated question. Unless you are advancing the odd position that in order to stimulate demand for an item, one should RAISE (or prop up) the price, then it would seem that we are in agreement.
Is this the new Bush Economic Paradigm? How does sitting on a house “create value”?
Ah yes. Real Estate == the entire economy. Everyone should just quit their economically meaningless jobs, with all that actual work bullshit and live by extracting equity from their houses.
I would say “price” would be a bit of an incentive. There’s that pesky free market thing again.
The mortgage holders can do whatever they want. If I were a shareholder, I would not look kindly on the holding of large amounts of real estate that produced no income, but again, the free market will figure out what’s best.
I guess the short version on my side would be that you either didn’t, or refuse to, understand what I wrote.
Something else that the real estate industry likes to do is draw your attention away from the real issue with red herrings like “credit requirements”. As if “credit requirements” were some kind of societal ill, like pedophiles, or drunk driving. As an individual, everyone benefits with looser credit requirements, because it means MORE MONEY FOR ME, and I like free money. It’s a little different for whoever it is that is suppose to be giving me the money, I imagine that guy probably wants some kind of return on his investment, but that’s his problem. If he wants to give me money for nothing, who is the government to stop him? The “other guy” in this case are the mortgage firms, and I’m generally against government subsidies for large corporations. Why not let the free market sort them out?