Mortgages and Foreclosures in the Subprime Era

Mortgages are valuable tools used by potential homeowners to increase their standard of living, invest in the real estate market, and build/buy a place to call home. Many of us have had experience with either a mortgage or the lending industry. Subprime mortgages are those loans that are riskier than normal, and that is why they carry a higher rate. They are loans that, in a normal market, a bank would most likely deny. However, in a tight, fast-moving market, banks are more willing to play the roulette wheel when it comes to mortgage lending.

Mortgages come in many shapes and sizes. There are fixed rate mortgages and there are adjustable rate mortgages. Fixed rate mortgages are created at a fixed, stable rate for the term of the loan. Adjustable rate mortgages are created at a market rate, and they adjust at a later time. The term of the loan is another way to customize a mortgage. There are loans made with many different terms, including fifteen, twenty, thirty, and forty years. Another new loan is an interest-only mortgage, where the borrower only pays the interest on the loan and does not pay down the principal. While these payments are cheap, the loans are virtually never paid off. While in the past the two most popular loan terms were fifteen and thirty years, there are now many different types of loans, some of them spawned by the flipping industry.

The mortgage offerings were one of the reasons that the housing market began to slow. Adjustable rate mortgages are among the worst culprits. Many financial planners and mortgage sellers have publicly advertised the adjustable rate mortgages as a smart move if the buyer is planning to move within the five year adjustment period. And while many of the borrowers plan on moving within that period, many of them did not for one reason or another. For the past few years, our economy has enjoyed record low interest rates. It naturally makes sense that a borrower should therefore attempt to lock in a low, fixed interest rate for the term of the loan. However, that was not the case for many borrowers. Many of them were seduced by the slightly lower rates given to adjustable rate mortgages and by the relentless advertising of said mortgages.

As they say, hindsight is 20/20, but it still seems as if the borrowers should have known what was coming! As rates began to move in the upward direction, adjustable rate mortgages began to adjust upward, and soon the borrowers were unable to make the payments on their homes. Another type of loan that caused trouble was the interest only mortgage. As previously stated, these mortgages allowed the borrower to pay a very low payment, which often only covered the accrued interest on the loan. Since the payments never paid more than the interest due, the principal was never reduced, which mean that payments would have to continue for an undetermined time to be able to pay off the loan.

In markets such as those in California, where home prices can easily reach into the millions of dollars, forty and fifty year mortgages were introduced. These mortgages allowed the borrower to stretch the term past the standard thirty years, allowing for a smaller payment. However, like the interest only loans, the terms for these loans makes it incomprehensible as to how someone could continue to make payments for that period of time. These mortgages were some of the contributors to the current housing situation.

In the past few years, "flipping" has become a new, relatively popular, phenomenon. Amateurs decide to purchase a property, make few, if any, changes, and resell the property as quickly as possible for a profit. SOURCE This was very popular in neighborhoods and areas where the real estate prices were rising rapidly. A buyer could purchase a property and sell the same property within a month's time for quite a large price difference. Although this process included borrowing up to the maximum allowable limit, uncertain future purchases and sales, and a substantial personal risk, many people still became involved for the potential gains.

Lenders making subprime loans were hit hard earlier this year when the borrowers began to default in a slowing housing market. Homes were not selling as quickly, and more and more of the flippers were caught in between payments they could not make and homes they could not sell. A slow spiral into foreclosure and possible bankruptcy was the only thing waiting for many flippers at the end of the day. Although much has been made of this problem, the housing situation is not as bad off as many would like to believe. For the past few years, the market was riding a wave, and there were many investors that were able to get-rich-quick overnight. Some of them were smart enough to see the slowing market and get off the gravy train, but others plowed full speed ahead. This "crisis" is actually a boon for another segment of the real estate market--foreclosures. Foreclosures have skyrocketed since those adjustable rates began to adjust up (Gandel, 2007). The process was long and hard, and we have yet to see the end of it.

All of the subprime problems could have been handled easily by the borrowers if they had followed some simple guidelines. First of all, a down payment is a necessity. Twenty percent is best, even though everyone tries to make excuses for why they do not have the twenty percent down payment (even me). If the potential borrower does not have a down payment, then they should rent until they are in a financial position to purchase a home. Although many people like to say, "Renting is throwing away money," not being ready for a home purchase will end up much, much worse; just ask those that lost homes and will continue to as a result of their willingness to buy not matching up to their ability to buy.

Renting is a good way to practice before owning a home, it can demonstrate to potential lenders an ability to successfully budget and pay for a place to live, and it can also give the renters a time to save up a nice-sized down payment for their home. If those people were more prepared for the various demands of owning a home, then they would have been better prepared to take this in stride instead of being kneecapped by the current situation. Many economists do not believe, as Danny Schechter (2007) says in his article, that all of this is the fault of the mortgage companies. The borrowers came of their own free will into the bank and signed the note themselves.

I was one of those borrowers. However, I was sure to snag a fixed rate, and I determinedly rejected the bank's suggestions for adjustable rates. When a borrower gets into a loan, the outcome was the borrower's own responsibility. When a mortgage bank or broker looks at a few statistics and facts about a person, that does not mean that they automatically know what is best for the potential borrower. The buyer has the responsibility to be sure of the financial status and solvency necessary for taking out a mortgage to buy a new home. Hopefully this scene will stick with many of those that are considering purchasing a home, and maybe they will wait until they can actually afford a home rather than borrowing too much and losing everything they have.

While the foreclosure market seems like a bunch of sharks swimming around a bleeding swimmer, it actually performs a valuable service in our economy. While the foreclosure industry has not seen this many homes up for sale in quite some time, there are weekend seminars beginning even now that are teaching those who are interested how to negotiate, purchase, and sell the foreclosed homes. This actually sounds familiar. Remember all those flippers from a few years ago? A seminar hosted by Alexis McGee is one of those weekend classes. She teaches her students during the weekend and finishes up the course with "cold-calling homeowners who are behind on their mortgages, getting them to talk the talk and, the students hope, convincing them to sell" (Gandel, 2007).

The foreclosure market is a great way for investors to get their feet wet with real estate investing. The way to look at a foreclosure market is to see it as if it were a sale. Some homes can be purchased at steep discounts by savvy investors. These purchases are also helpful to the sellers. Because many of them are in over their heads, they are looking for a way out of the madness, and an earnest buyer could be just what they need. The sale of a home that is near foreclosure can be a life-saver for many sellers. This illustrates how the foreclosure market can be useful for both buyers and sellers.

It is easy to see how the current housing market is in a tangle. Many different factors are affecting the ways that buyers, sellers, and lenders go about their day-to-day business. Although there have been some problems associated with these factors, there have also been a few positive occurrences to note. These include the bargains on the foreclosure market and the wising up of the borrowers and lenders in this country. This does not address the fact that we are nowhere near the end of the current situation, and no one knows when we shall see the end of all of this.

References

Gandel, S. (2007). Is this a golden opportunity? Money 36 (12) p 110. Retrieved from the ProQuest database.

Schechter, D. (2007). Mortgage blues. Sojourners Magazine 36 (11) p 9. Retrieved from the ProQuest database.