Indiana Realtor blog by James P Wells. Discussing Real Estate topics concerning Central Indiana and the US. Focusing on Boone and Marion County.

This Thursday, Treasury Secretary Paulson and President Bush announced the details of a plan to freeze the interest rates on many subprime ARMs (Adjustable Rate Mortgages). While this spurred the stock markets and initially the idea sounds good, it’s like putting a band-aide on a gunshot wound.

Many of the subprime loans that were closed during the mortgage and real estate boom were “stated income” loans. These loans don’t require much, if any, verification of income and are often called “liar loans” within the lending industry. Unfortunately, the outcome of many of these loans will be the fact that borrowers are unable to pay the needed mortgage payments and will end up in foreclosure.

The current year has seen drastic increases in foreclosures across the nation with the south and mid-west leading the pack. The Mortgage Bankers Associations National Delinquency Survey for the 3rd Quarter of this year places the US average default rate at 19.6% (mortgage payments past due at least 1 month). Indiana is towards the top of the list at 22.3%, but the states in serious trouble are: Mississippi (30.2%), West Virginia (27.5%), Michigan (26.2%), Missouri (25.7%), Tennessee (25.3%), and Alabama (25.1%).

When the plan to freeze ARM rates is really evaluated, most experts agree that it will only help between 10-20% of the ARM borrowers facing serious problems. Combine lost projected income for mortgage investors, the increased amount of vacant homes, and the added foreclosures to the existing housing inventory, I believe the housing slump will extend well past the end of 2008; which is when many industry leaders state the upturn will begin.

I’m not going to sugar coat things. I see the current market as a strong buyers market. Several options to choose from and heavy listing competition put the negotiation power in the hands of the buyer with one big exception: Many sellers CAN’T reduce the amount they are requesting, due to the amount owed on the property. The refinance boom has effectively made the real estate market stagnant with no money down mortgages and home equity loans (2nd mortgages). Add in depreciation and many current homeowners have little to no equity in their home, or even worse, owe more than the property is worth. I speak with other Realtors on a regular basis and it is well know that we are in a bad market with no sign of change in the near future. I read a recent news article that talked about avoiding a recession, but then later in the article it was implied that we are already in a recession. Call it what you want- the overall current US economy is not good and several signs point that this is just the beginning.

I  don’t have a answer our current problems, mainly because I don’t have the authority to make the necessary changes. All I can do is try and educate people and identify some of the causes to these issues in hopes that I can help some people avoid costly mistakes. The best solution I can suggest is to begin teaching real life (practical) skills in our educational systems (and not just in colleges). Many people will say that learning about getting a mortgage, property ownership, obtaining insurance (car, life, auto, liability, etc.), managing a budget, paying taxes, and stocks (trading, options, IPO’s) should be taught in the home, but I disagree. My parents knew little about these matters and I have had significant obstacles to overcome to obtained my desired level of education on these matters. Mistakes in many of these arenas can have drastic and life-long effects for the average individual. The best way to avoid the problems we currently face is through education.

Short Sales have been around for a long time, but recently they are being discussed and utilized more and more even though many people do not fully understand the entire process. Having been on both sides of a short sale- representing the bank in some situations and representing the homeowner in others- I felt a review would be helpful to you.

Basically a short sale is an agreement by the lender (or mortgage company) to allow the homeowner to sell the home for less than the mortgage owed on the house. This is not a decision mortgage companies take lightly, and is normally utilized to avoid foreclosure and even further losses.

Mortgage companies are in the lending business, not Real Estate, and foreclosure is one of the last recourses available to recover the funds they loaned. A short sale can provide reduced losses for the bank in many cases, and is the reason more short sales are occurring in todays heavy foreclosure market.

Let’s review a hypothetical short sale situation:

A homeowner approaches a Realtor to try and sell their home to payoff the mortgage (or mortgages). Unfortunately, a sale of the home will not produce enough funds to fully payoff the loan. This can occur due to many different factors:

• The homeowners borrowed more than the property is worth
• A depressed market lowered the property value
• The property condition has deteriorated and lowered the property value
• The homeowner has been in the property for a short period of time and paid a minimal down payment during the purchase of the home.

In order to approve a short sale, the mortgage company will require specific information to determine whether a short sale is their best recourse (if foreclosure will provide for a higher net amount- don’t expect a short sale to be approved). Each lender is different, but here are common examples of required information:

• Hardship Letter - States the reason for default, normally the sadder the situation the better
• Appraisal or CMA of property - Helps determine an accurate value of the proprty and prove it’s not worth the loan balance
• Proposed HUD statement or settlement sheet - Provides the lender with an estimated net amount after the sale
• Authorization Letter - Allows your Realtor to discuss the details of your loan with the lender
• Bank statements and W2’s - The bank will want to verify that the borrower is actually unable to re-pay the debt
• Listing agreement and any Purchase agreements - Be prepared for the lender to disallow certain items such as home warranties and they often try and reduce Realtor commissions and other fees

As you can see, a short sale can have significantly more paperwork than a normal Real Estate transaction and a homeowner would be well advised to seek the assistance of a Realtor experienced with short sales.

Once an offer is accepted and the property is sold, there is normally a deficiency balance. Please contact an attorney regarding the implications of this balance- some states allow for the lender to seek legal action to continue to collection of this debt, while others may not.

There are also potential tax ramifications of a short sale. The IRS considers the forgiveness of a debt as income and the amount can be taxed. Seek advice from a professional CPA regarding your individual situation.

Another issue involves your credit after the sale- contact the lender to try and obtain the best possible credit rating after a short sale, but understand the lender is under no obligation to avoid reporting a negative credit rating.

While there are advantages to a short sale over a foreclosure, many homeowners do not understand all the requirements and potential loopholes. Another option to consider to avoid foreclosure is a “Deed in Lieu of Foreclosure” or “Quit Claim Deed”. Look for a future post regarding the different aspects of this approach.

I have received several requests in the past few weeks to contact my congressman and request support of this bill. These requests have been sent from several different sources but the most recent was from Pat Combs, President of the National Association of Realtors.

I’ll admit that I haven’t reviewed this bill with a fine tooth comb, but I have looked thru it. I do see benefits from changes made to this bill including tighter requirements on mortgage broker (required surety bonds), but my concern is more about the attitude and some of the other significant changes proposed like:

• Eliminate the 3% down payment currently required
• raise single-family FHA loan limits to 125% of area median home prices
• allows Secretary of Housing and Urban Development to make even further increases if required by market conditions

I may go on a rant here so I’ll apologize up front, but this bill is being sold that it will modernize FHA for current market conditions. I loaned money for 10 years and was deeply involved in sub-prime mortgages. The main reason I chose to leave the industry was because I saw things were getting out of control.

Indiana has been at the top of the foreclosure list for many years and I believe a big reason for that is because we have made it extremely easy for people that should not be homeowners, become homeowners. Indiana homeownership rates for 2005 put us at about 78.5% compared to 68.9% for the US. What does this have to do with foreclosure you ask? I own rental property and can honestly tell you that there are people in our society that are not able to successfully own and maintain a home. The question becomes- What percentage of the population can effectively own and maintain a home?

I guess I just don’t understand how making it even easier for a 1st time buyer to buy a home will help us in our current market slump. The slump has been created via several different factors, including low down payments (reduces the buyers vested interest in the property), High loan to value percentages (if you owe $125,000 on a $100,000 house and making the payments becomes tough, what incentive do you have to retain the property), stated income loans (people don’t have to prove what their income actually is for loan approval), and most importantly a huge swing in the supply/demand cycle.

Loan approvals are becoming tougher to obtain and homeowners stuck in bad loans may end up losing their homes if they are unable to refinance, but revising the FHA guidelines in this manner doesn’t agree with my opinion of a solution. The real estate market needs this adjustment (the current slump) to bring home prices down so they are more affordable to the average buyer. Reducing down payments and and increasing LTV percentages only makes it easier to afford in the short term, not for the next 30yrs when the buyer will need to make those mortgage payments.