Risky Loans Leaving Homeowners With Negative Equity


The US economy is now growing at a rate that is less than the rate of population increase. In other words, if it keeps growing at this rate we’ll all go broke.

Housing corrections take a long time. There are now 700,000 new houses for sale…and more houses for sale, overall, than any time in history. It will take years to work down this inventory, because sellers typically resist price cuts…as long as they possibly can.

Money Magazine has done a series of “Scenes from a Bubble,” referring to the housing bubble:

“MONEY has obtained more than 100 emails and faxes sent by loan officers to appraisers across the country. The language varies from asking if a predetermined value was possible to promising more business if a number could be hit.

‘”Many homeowners are finding out that the equity they were led to believe they had in their house is not actually there,’ says John Taylor, president of the National Community Reinvestment Coalition.”

MONEY took an example. Mr. Kim obtained a no-money-down US$642,000 mortgage, based on an appraiser’s estimate of the value of his house. MONEY’s own appraiser judged the place worth only US$580,000.

The result: Kim now owes US$62,000 more than his house may be worth. How many people are in that situation?

How long will it take them to reckon with the negative equity in their home? We don’t know that either. How did they get in that jam? That, we do know. MONEY continues:

“Wall Street’s rocket scientists keep finding more sophisticated ways to repackage and resell mortgages. As a result, lenders stopped worrying so much about credit standards and learned to love risky loans.

“Now a lot of that lending looks foolish. Mortgage delinquencies among so- called subprime borrowers have risen to 13%, the highest in at least 10 years. The market for the lowest-credit-quality mortgage bonds has tanked. And investors in CDOs may be in for a rude shock.”

Meanwhile, yesterday, yields on the long bond – closely linked to mortgage rates – rose to 5.06%. Not good for the housing market.

Bill Bonner
The Daily Reckoning Australia

Bill Bonner

Bill Bonner

Best-selling investment author Bill Bonner is the founder and president of Agora Publishing, one of the world's most successful consumer newsletter companies. Owner of both Fleet Street Publications and MoneyWeek magazine in the UK, he is also author of the free daily e-mail The Daily Reckoning.
Bill Bonner

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  1. The weak link in the industry has been the lowest paid, most pressured, the appraiser.

    Many have been subjected to Classic Conditioning to be cooperative, or even trained to be so, to hit numbers to make the loans work.

    In any given City or County, there is probably less than 5% of the appraisers who are truely neutral, objective and unbiased; although all licensed appraisers certify that they are.

    Most residential appraisal assignments start with a predetermined value promise in recent years. Pushed values 5% to 10% per year, have lead to a 25% to 50% over valued market over the last five years.

    How far will priced go down from the peak, about 25% to 50%. Some areas have already gone down more than 12% since the peak in 2006 and are continuing down, incuding my own Zip Code.

    Anyone who refinanced or pruchased with an 80% or larger loan or a negative amortized loan in the last four years, is subject to having negative equity before it is over. It will be over in about four years.

    Steven R. Smith, MSREA, MAI, SRA
    June 8, 2007
  2. Being an Australian based mortgage broker in this space, a few comments are worthy, I feel.

    FIRSTLY, Valuers in Australia are not easily influenced to over price a property. If something goes wrong with a loan, the VERY first person in the firing line is the Valuer. If it can be proved that they overvalued a property, then they will be sued and sued hard. The mortgage insurers want to recover any lost monies, so the Valuer is an easy target (their PI insurance is astronomical).

    SECONDLY, let’s define a sub prime lender. This is not as easy as it seems, but I would generally classify an Australian sub prime customer as:
    1. Someone who doesn’t have payslips or tax figures to substantiate their income (although Australian Banks are now VERY active in this market … most of my loans to these sort of people are through the banks).
    2. People with Credit issues (Defaults, Judgements etc … although, once again, the Banks are tinkling on the fringes).
    So, the distinction is becoming very blurred as the Banks start diving into the pot in the chase for profits.

    A 100% Home Loan is very definately a PRIME loan these days … Banks are falling over themselves to do these types of loans (one major has just introduced a 100% loan WITHOUT mortgage insurance). Also, 100% customers need to be pretty solid (employment history, earnings etc) before they’ll even get a look in.

    Having said this, as a personal rule I would not be more than 60% leveraged against Real Estate … any more than that and you just may not be abe to weather the storm if doo doo hits fan.

    Keith Jenkins
    June 11, 2007

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