subject: The hard lesson of lacking 20 pecent down [print this page] Highly leveraged investment banks and sub-prime housing lenders took the brunt of the blame and criticism in the wake of the economic recession of 2009. And certainly property foreclosures have been a leading reason and indicator for the recession and slow recover. The United States experienced more than a 20 percent increase in foreclosures in 2009 and a 120 percent increase over two years ago. In all, there were more than 2.8 million foreclosures in the U.S. in 2009. Nevada was the hardest hit by the foreclosure crisis, as one in 10 properties were foreclosed upon during the year, according to RealtyTrac. While subprime mortgages got the bulk of early headlines and heat as the economy faltered, a majority of these bank foreclosures were on prime mortgages. While subprime loans triggered the crisis with their low, teaser interest rates and excessive rate jumps, many prime loans were written during the housing boom of the late 1990s and turn of the century were close to 100 percent loan-to-value. Such a high debt-to-equity ratio makes it difficult for homeowners to recover from an interruption in their careers or income due to job loss or illness. A high debt-to-equity ratio puts enormous pressure on a homeowner and provides little flexibility when circumstances change. Akin to a corporation that has high operating leverage, it can be difficult to switch strategies on a dime with so little liquidity. The consequences of a high mortgage debt-to-equity ratio are many, and include: - Difficulty selling a property. Even if a buyers offer is close to the mortgage, it can be difficult for the homeowner to sell without taking a significant loss from expense such as marketing, sales commissions and transfer taxes. - Lack of flexibility in relocating to a new location. In times of unemployment, its often necessary for workers to relocate to areas where the job market is more accommodating. Being stuck in a highly leveraged or upside-down mortgage makes that kind of flexibility difficult. - Little wiggle room when illness or work shortage creates a loss of income. People who bought highly leveraged homes might have figured they could refinance to a lower payment if money got tight. Being highly leveraged or upside on a mortgage can take that option away. - Difficulty renting a property at breakeven. A highly leverage home is likely to have high fixed costs, including taxes, interest and community fees, which may not be covered by rental income. In short, negative-equity scenarios are wrought with risk, and these factors were largely ignored by conventional wisdom during the multi-year housing boom. People who jumped into homeownership before saving the traditional 20 percent down payment seemed to have history and market trends on their side, and in fact, homeownership has been touted as the best way to accumulate wealth and improve neighborhoods and communities. Easy-to-obtain credit in the 15 years pushed homeownership above 50 percent for the first time. Now the negative consequences of foreclosure and unpaid debt have become reality. The U.S. governments Financial Stability Plan included provisions to entice banks to refinance mortgages from people who were adversely affected by the recession. These programs are designed to support as many as 4 to 5 million homeowners whose mortgages are owned by Fannie Mae or Freddie Mac, or who through a change in income or circumstances find their housing costs are more than a third of their income. These programs have limitations and participation requirements, and homeowners who fall short of meeting the guidelines may find themselves without recourse. In fact, the Obama Administration announced this month that only more than 66,000 of the 850,000 homeowners who enrolled had succeeded in permanently modifying their loans through Making Home Affordable. Representatives from the Housing and Urban Development note homeowners who havent provided sufficient documentation to demonstrate their risk and adverse changes to income remain in the provisional modification stage. Still, the program has only assisted about 12 percent of its target. Many mortgage providers say theyre working with customers, trying to assist them where possible to avoid foreclosures and stay in their homes. Foreclosures are costly to banks as well, and many have agreed to short sales and other terms to help mitigate the hard impact on peoples credit and finances. Theres no conventional wisdom driving assistance desperate homeowners who may fall through the cracks of government programs and their ability to meet their mortgage commitments. Todays homeowners will likely take caution to make a good down payment before investing in real estate, even if the banks forget the lessons of 2009 and start offering no-money-down mortgages.
