Ready for the Second Wave of Foreclosures? - by Bill and Kim Cook
Posted by: Bill Cook Real Estate Investor
Posted on : 12/23/2009 7:16:57 AM
Ready for the Second Wave of Foreclosures?
The government is reporting lots of rosy real estate news. They claim the mortgage meltdown is behind us, foreclosures are beginning to level off, real estate values are rebounding and it?s clear sailing ahead.
But just hang on there a dang second, Baba Looey! Are you sure you want to believe this government forecast?
Wasn?t it the government, when they lowered lending standards to a point where almost anyone with a pulse could get a loan, that caused this mortgage meltdown in the first place?
I recently read a report on the housing and credit crisis written by T2 Partners, LLC. It sure opened my eyes. Here?s a little of what I learned.
The wave of sub-prime mortgage resets is behind us, but we?re only in the middle innings of the bursting mortgage bubble! The second wave ? the wave of defaulting Alt-A and Option-ARM mortgages ? is bearing down on us like a runaway freight train!
Beginning in January 2010, Alt-A and Option-ARM mortgages start resetting (i.e. monthly payments begin adjusting ? upwards!) These adjustments will peak in February 2013 and finally fall back to normal levels in October 2013.
It?s my guess that the news media will finally report on this second wave of defaulting mortgages and pending foreclosures sometime around May 2010. Until then, guess we?ll keep listening to the sunny forecasts coming out of Washington.
An Alt-A (Alternative A-Paper) mortgage is given to a borrower who has a good credit score. At the same time, the lender doesn?t require the borrower to provide full documentation. In other words, the lender possibly didn?t verify the borrower?s income, employment history or asset reserves. Some Alt-A mortgages are called Stated Income Loans (aka Liar Loans).
An Option-ARM (Adjustable Rate Mortgage) mortgage is a doozie of a loan. The lender, in order to approve the loan, typically relies on the property?s appraised value and the borrower?s good credit score. Each month, the borrower has the option of making either: 1) An ultra-low, negatively-amortizing, teaser-rate, interest-only payment ? usually at about 2% to 3% interest; 2) a full interest-only payment; or 3) a fully amortized interest and principal payment.
Most Option-ARM loans were made between 2005 and 2007 ? when real estate values were at record-high levels. To boot, since getting Option-Arm mortgages, about 80% of these borrowers are only making the ultra-low, negatively-amortizing, teaser-rate, interest-only payments. This means that their mortgage balances have been INCREASING since the day the loan was made!
Now comes the BIG problem: Most Option-ARMs reset after five years. This means the loan payments on many of these stinker loans will begin adjusting on January 1, 2010.
When these mortgages begin resetting, it?s estimated that the average monthly payment will jump by more than 50%!
Moving forward: When the homeowner bought his property in 2005, it had a FMV (Fair Market Value) of $200,000. He got a stupid Option-ARM mortgage. He probably didn?t put any money down, so his mortgage balance was $200,000. For the past 5 years, he?s made 2% interest-only payments. This means his mortgage balance, because it was negatively amortizing, has RISEN to $210,000 or more!
Now comes the problem: In 2010, his mortgage payments reset. This causes his monthly payments to jump by more than 50%. In addition, he?s now paying off a $210,000 mortgage on a property he bought for $200,000 that?s now only worth $145,000!
What do you think a lot of the folks who find themselves in this situation are going to do? Will they keep making their much higher mortgage payments on a property that?s worth significantly less than what they currently owe, or will they simply walk from the property?
Do you think these borrowers? actions will lead to an increase or decrease in the number of foreclosures? When foreclosures increase, which way do you think property values will be pushed ? up or down?
The sub-prime mortgage meltdown only cost $450 billion. The losses stemming from the coming Alt-A and Option-ARM mortgage meltdown are estimated to be $795 billion ? a good bit more than the sub-prime fiasco!
And here comes the big kicker: The federal government is in debt up to its eyeballs. It can?t keep printing money and not have inflation ? accompanied by interest rates ? skyrocketing through the ceiling!
There is a bright spot. Today, while discussing this information with a banker friend, she pointed out that there is a big differenced in the integrity between sub-prime borrowers and Alt-A borrowers. Alt-A borrowers are far more likely to hang on to their property, make their mortgage payments in a timely manner and weather the storm.
After reading this, you?re probably wondering whether investors should avoid buying real estate. Just the opposite. We continue to think that, because people will always need a place to live, this is a great time to buy investment real estate. Just make sure you are getting a great deal ? it should be well below market value and the property must cash flow, cash flow, cash flow!
In addition: Don?t get trapped into any short-term loans that will reset in a year or two. The longer the loan terms, the better.
What types of creative deal structures are working best in this market? Owner Carry-Back Financing, Subject-to deals, Deed-for-Note deals, Short Sales, and Rentals or Lease/Options.
Bill and Kim Cook live in Adairsville, Georgia and have been successfully investing in real estate since 1995. They write a weekly real estate investing newspaper column.
Bill Cook
www.REIoutpost.com
