Weekly Kick-Off

Monday, March 1st, 2010 | Uncategorized

This Week’s Topics:

• Volcker: Hybrid Public and Private Mortgage Control a Bad Idea
• Underwater Homeowners Have Another Reason to Dread Tax Season
• Mortgage Rates Top 5% Mark
• Shadow Inventory Leads to Foreclosure Flood
• Can a Code of Conduct Counter Appraisal Corruption?
• 10 Things to Know About the HVCC
• No Short Sale on an REO, But Profit Potential Still There

Volcker: Hybrid Public and Private Mortgage Control a Bad Idea
Former Federal Reserve Chairman Paul Volcker recently asserted that the nation’s home mortgage market is too heavily dependent on government participation, and that’s not a good thing. He believes it will have to be restructured. As it stands, the government (Freddie Mac, Fannie Mae, the FHA and VA) is responsible for about 95% of all new home mortgages. A few years ago, that number was just 40%. Combined, Freddie and Fannie control $5.5 trillion, or half, of all home mortgages. The amount of private mortgage-backed securities in 2009 was a “mere” $5.5 billion, down from $613 billion just four years prior.

Volcker maintains that the key to decreasing the government’s position in the mortgage industry is to attract more lenders and investors back to the mortgage game, without the promise of a government guarantee. He went on to say that Freddie Mac and Fannie Mae were “not a good idea in the first place. This hybrid public, private thing sooner or later was going to get you in trouble – and it sure got us in trouble.” Experts agree that, unless the private securitization market returns, it will be hard for the government to pull back on its involvement.

Underwater Homeowners Have Another Reason to Dread Tax Season
When a homeowner is faced with foreclosure, they’re in a tough situation to begin with, financially. But they’ll often have to brace for a second hit via tax consequences of their foreclosure or short sale, after having to walk away from their home when their adjustable rate mortgages were reset to a higher rate. These homeowners are often underwater already, and when the lender moves to foreclosure or a short sale, the result may be a taxable gain for the homeowner. The type and treatment of the gain will depend on whether the mortgage is considered a recourse or non-recourse debt. For a non-recourse debt, the homeowner is considered as having sold the home for the amount of the outstanding debt. The difference between the debt and the homeowner’s adjusted basis in the house is counted as a gain or loss on the sale of the home. If the mortgage is a recourse, any foreclosure may result in a gain on the sale of the house and/or cancellation of debt income. The difference between the fair market value of the house and the homeowner’s adjusted basis will result in a gain or loss on the sale of the home. The portion of the sale that is treated as cancellation of debt income is taxed and is subject to ordinary tax rates.

Tax on this “phantom” income is due whether the home goes to foreclosure or is sold at a short sale. Relief of debt is considered income because the bank gave the buyer cash to purchase the home when it issued the mortgage. The cash was not taxable because it was a loan, and the buyer promised to repay it.  Once the homeowner can no longer pay their loan, it is forgiven or cancelled, and becomes income. Often those homeowners are left with two options – bankruptcy or insolvency.

Mortgage Rates Top 5% Mark
Rates for 30-year home loans rose above the 5% mark for the first time in three weeks, but remained near historically low levels. The average rate on a 30-year fixed rate mortgage was 5.05 percent this week, up from 4.93 percent a week ago, according to Freddie Mac. Rates hit a record low of 4.71% in December, due in large part to the government’s attempt to reduce consumers’ borrowing costs. Analysts fear that rates could go on the rise again once the federal government’s program to buy up mortgage securities ends due to a lack of willing buyers. This could damage the housing market’s recovery efforts and the economy overall.

Shadow Inventory Leads to Foreclosure Flood
Standard & Poor’s, the credit-rating agency that tells investors what mortgage-backed securities are worth, predicts that we’re about to see an influx of new foreclosures that will cause real estate values to plummet. The reason behind this? A shadow inventory of 1.8 million homes that are almost in foreclosure, but for some reason aren’t there yet. Mortgage services and courts are backlogged or overwhelmed. Add that to high unemployment rates, mortgage modification and foreclosure moratoriums, and you have about $425 billion worth of mortgages that are ready to go into foreclosure at any time. They’re lurking in the shadows.

The shadow inventory equals half the size of the entire market of homes for sale. The current number of bank-owned, foreclosed homes on the market is holding steady, so once the shadow inventory hits, we can expect home prices in areas with a high concentration of foreclosures to take a nosedive. At this rate, it will take nearly three years to sell the inventory of foreclosures.

Can a Code of Conduct Counter Appraisal Corruption?
Death threats on public officials, sting operations, multi-million dollar schemes. Sounds like a story line for a late-night crime drama, right? Surprisingly, it’s all happening in the world of real estate appraisals. Greedy appraisers played a large role in the housing bubble, due to high property valuations to please lenders and line their own pockets. Now of course not all appraisers are looking for a fast buck. Recently 11,000 appraisers banded together and signed a petition against unethical practices and pressure from lenders. But, the few bad ones give the others a black mark. We continue to see cases in the news of corrupt appraisers trying to profit off of innocent homeowners. This has led to the creation of Appraisal Management Companies (AMCs), whose job it is to act as a middleman between the lenders and appraisers. The repeated stories of corruption also gave way to the creation of the Home Valuation Code of Conduct (HVCC – see related article, below), adopted by Freddie Mac and Fannie Mae to guard against corruption and abuse by appraisers. “The code says that appraisal management companies, which are paid by the lender out of the appraisal fees collected, must act as a liaison to keep appraisers and lenders from having direct contact on Fannie and Freddie-backed loans.” The issue is that many AMCs are owned by banks, but the code allows for banks to be involved in the appraisal process. Lenders can use in-house appraisers, and are “responsible for selecting, retaining and providing for payment of all compensation to appraisers.” AMCs also can lead to appraisals being conducted by appraisers unfamiliar with a local market, which can lead to more erratic valuations.

10 Things to Know About the HVCC
Established in May 2009 by Freddie Mac and Fannie Mae, the Home Valuation Code of Conduct (HVCC) was designed to set up a “firewall” between lenders and appraisers, in the form of Appraisal Management Companies (AMCs). The goal was to prevent inflated housing appraisals. The code is quite controversial (see previous story), but what does it mean to the homebuyer?

1. It only applies to loans backed by Freddie Mac and Fannie Mae.
2. A lender can still use an in-house appraiser.
3. Mortgage brokers can request an appraiser.
4. A broker can reject an appraiser.
5. Expect higher fees.
6. The homeowner can pay for an appraiser indirectly
7. A non-local appraiser can de-value a home.
8. Appraisers can talk with a real estate agent, who can provide information about the property and surrounding area to the appraiser.
9. Homeowners can receive a copy of the appraisal prior to three days before closing.
10. The appraisal report is transferrable if a homeowner changes lenders before closing.

No Short Sale on an REO, But Profit Potential Still There
An REO (Real Estate Owned) property is simply a bank-owned property – it has not sold at the foreclosure auction, therefore goes back into the possession of the mortgage company. Sounds like that might be the right condition for a short sale, right? The answer is no – a short sale cannot be done on an REO. The whole point of a short sale is to catch the process before the bank takes possession of a house and kills the homeowner’s credit rating, in other words, before it goes into foreclosure. Short sales can’t be done until the homeowner starts missing payments. After all, if the lender is still getting their money, why would they discount the loan? Lenders will only approve a short sale when they know the loss will be less than it would be to foreclose. REOs cost lenders approximately $80,000, according to the Federal Reserve. That money is then tied up in their bad asset division, and they can’t lend on it.

As a real estate investor, REOs still present an opportunity for profit through rehabbing. Often REOs need a lot of work – they may have stood vacant, been neglected by the previous homeowner or have been vandalized. They can be purchased for a price that compensates for the condition of the property. If an investor is willing to take the home and rehab it for resale, there is an opening for a profit.

Hope your week is filled with real estate investing success.
Until next time… ~Josh

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