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Where Did My Equity Go?

The mortgage meltdown that sparked The Great Recession had a number of complex issues. Those issues, and how they played out over time, can be demystified.

Your may not want to think about it, but your home could be worth less than what you owe on your mortgage.

If you purchased your home between 2002 and 2008, and if you put less than 10 percent down, it is, in fact, a firm probability.

If you used your home's equity as an ATM during the last 10 years, even if you have owned it for decades, chances are your home will probably appraise for less than the balance of your mortgage.  You could be $50,000 or even $100,000 or more "underwater" on your mortgage.

You may have good or even great credit and yet you still cannot qualify for a refinance of your current mortgage.  Borrowers with 700+ credit scores and six-figure incomes are being rejected for refinance loans.  Interest rates are at their lowest point since the early 1950s, yet mortgage lenders and brokers are having a difficult time finding qualified borrowers.

Walk down Main Street in Reisterstown and you will find evidence of the collapse of the housing market.  In 2008, there were 12 mortgage brokerages with offices along the Main Street corridor.  As 2010 comes to a close, there are only four brokers on Main Street that remain in business.

The mortgage industry provided jobs for many Reisterstown residents from the late 1980s through 2008.  Now, dozens of local mortgage professionals have been forced to abandon their careers and seek employment in a new field and in a difficult job market. The conditions are similar in Owings Mills, where more mortgage brokerages have closed, leaving dozens of offices unoccupied.

The collapse of the housing market has left hundreds of people who worked in mortgage-related businesses unemployed or under-employed within the local community.  The collapse of the housing market and the subsequent closure of mortgage brokerages and related businesses have also left hundreds of thousands of square feet unoccupied within commercial developments.

The collapse of home values has had a ripple effect, devastating the lives of thousands of people within our  community, and millions nationwide.

Some homes lost as much as 30 percent of their value, and most homes lost at least 10 or 15 percent of their value during the period from 2005 through 2010. For example, if you purchased a new home for a purchase price of $650,000 with nothing down, your balance wouldn't be more than a couple thousand lower by now but your home's current market value is probably only around $550,000.

Even if you had made a down payment on the original purchase loan, you would still be seriously "under water." This drop in value is the grim reality facing current homeowners and aspiring owners.

Homeowners, and those who aspire to own a home, have borne the brunt of this crash in property values and resulting credit crunch.  As recently as 2005, a borrower with a 580 credit score, a job, and few other qualifications could get 100 percent financing on a home with relative ease.  A borrower with a 600 credit score could obtain 100 percent financing without even proving his or her income through so-called "stated income" programs. A "stated income" is a declared amount usually higher than the borrower's real salary.

In 2010, those programs no longer exist and most of the lenders that offered those programs are gone as well. Lending to under qualified borrowers who could not afford their mortgages led to the inevitable collapse in value of certain mortgage-backed securities.  In turn, most of the lenders that made these irresponsible loans are out of business. 

Homeowners and potential buyers beware

There has been a radical climate shift in home values and mortgage lending in 2010 as compared to five years earlier.

If a homeowner wants to refinance an existing loan in the current credit market, he or she needs to have some kind of equity, at a minimum 3 percent, usually 5 percent, in order to do a rate and term refinance to a fixed rate in the 4s.  Most homeowners have no equity at all.

Furthermore, a borrower must have 640 credit scores, 620 at the very lowest, to secure financing in the current credit market.  Far fewer homeowners and buyers qualify for refinance or purchase loans in 2010 than did in 2007.  The demand for credit has dropped to some extent, but the availability of mortgage credit has declined sharply from 2007 through 2010.

The question still remains:  Where did my equity go? 

The answers to this question are complex.  I will attempt to summarize those complex answers for you and tell you what to expect over the next few months.

The valuation methods of homes from the mid-1990s through 2007 were questionable at best.  Appraisers were pressured by realtors, builders and mortgage brokers to produce higher and higher values in order to make deals work.  The low interest rates during the last decade, which were driven in part by the post-9/11 demand for Treasury bonds, along with the emergence of sub-prime and stated-income financing, produced a lending environment with loose credit for almost every borrower.

Easy credit and low interest rates, coupled with a governmental and institutional push to expand home ownership to millions of new borrowers, increased demand for real estate.  The increased demand inflated a housing "bubble" of over-valued property.  Cheap money, low rates and skyrocketing home values provided homeowners with an incentive to borrow against their ever-increasing equity.  Borrowers were encouraged to use their home equity as if it were an ATM.  Many homeowners spent their equity on frivolous consumer products, and the mortgage industry facilitated this irresponsible borrowing in collusion with appraisers who were too eager to please.

Eventually, borrowers found themselves unable to make their mortgage payments.  Delinquency increased, as did the rate of foreclosure.  Lending institutions and mortgage servicing companies found that the mortgage notes they were holding were decreasing in value.  The collateral for these loans were over-valued, and the borrowers were under-qualified.  As unemployment began to increase and banks collapsed, the situation grew catastrophic.

From 2006 through 2008, the so-called "sub-prime collapse" took place as a result of these conditions.  The effect of the sub-prime meltdown on the economy was devastating for homeowners, lending institutions and credit markets.  It was like a gigantic financial tsunami whose power to destroy was global in scope and we have yet to recover.

The mortgage lending industry is still reeling from the damage, as are homeowners.  The credit environment is still very tight, and the lenders that have survived have put very conservative guidelines in place.

What can I expect as a homeowner or buyer looking for financing in the current lending climate?   

On the bright side, borrowing is now much safer for the consumer because only truly qualified borrowers are given loans, and also because most of the current mortgage programs available are more conservatively structured.  In addition, interest rates are at historic lows and at secure fixed rates.

The primary obstacle is qualifying for a mortgage loan.  If you have cash, it is a great time to buy property at reduced, bargain prices.  But you must have cash and credit. 

Appraisals, the valuation of your real estate, have become more complex with procedures that are producing lower values.  Appraisal reports are being scrutinized and regulated like never before, which is slowing down the process.  The individual appraisers themselves are receiving less money to do more work, which has also slowed down service.

The new regulations for lenders, both governmental and institutional guidelines, require that a third party vendor – not you, not the borrower, seller, realtor or broker – select the appraiser.  In effect the appraiser is now only accountable to the law and the vendor.  The appraiser is no longer accountable to the borrower, but you are still the person who pays for the appraisal, usually out-of-pocket.

Currently, the average cost for a typical residential appraisal is $400, but they can range as high as $500 in the new, timid lending climate.

The new system of residential real estate appraisals has eliminated most of the potential for fraudulent or grossly inflated values, which is a desirable outcome.  But the new system has also changed the loyalties of the appraisers away from the accountability of brokers, realtors and homeowners.

As a borrower, you have little or no influence and absolutely no control over the appraisal process.  There is a value rebuttal procedure available with some lenders if the borrower is not satisfied with the value on an appraisal, but this process is only moderately and occasionally successful for most mortgage consumers.

Overall, the market for residential mortgage finance has become tougher for borrowers, but if you one of the lucky applicants that can qualify, very low fixed rates and purchase bargains await you.  If you were wise enough to save some money, possess the ability to make the payments, and if you have good credit scores, especially those in the 700+ range, there are opportunities to be had. 

The process is stricter than before, but if you have the grit and qualifications as an individual, if you are a truly safe bet for the lender, credit and real estate are at bargain prices.

Look to this column each week to guide you through the current real estate and mortgage-lending environment.  I will do my best to provide you with a perspective on what you should expect as a borrower, both for refinance and purchase of residential real estate.

FHA and VA loans, the movement of interest rates, home buying tips, new types of mortgage insurance and any significant changes in programs will be examined within this column in the coming weeks.

Please feel free to send me your questions, and I will attempt to provide accurate answers.  Take the information you get here, and seek out a licensed mortgage professional, bank or credit union armed with some knowledge. 

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