Carol H Tucker Passionate about knowledge management and organizational development, expert in loan servicing, virtual world denizen and community facilitator, and a DISNEY fan
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beladona Memorial Be warned:in this very rich environment where you can immerse yourself so completely, your emotions will become engaged -- and not everyone is cognizant of that. Among the many excellent features of SL, there is no auto-return on hearts, so be wary of where your's wanders...
The report came out today - according to CoreLogic (NYSE: CLGX), over 1/5th of the homeowners have mortgages, first and second, that total more than the current value of their property. This is a HUGE problem and a drag on the economy as the mortgage lenders are reeling.
How did this happen? Well to find the root cause, we have to get in the wayback machine with Mr. Sherman and Peabody -- back to Reaganomics.
You see, someone convinced Congress and the President that the middle-class Americans were not paying enough in the way of taxes to finance the bills that were running up the defecit. What to do? Reagan had promised not to increase the income tax after all. So, some smart accountant pointed out that millions of dollars were being claimed in exemptions for interest paid on personal loans [credit cards and auto loans being the two largest categories]. Eliminate that exemption and the amount of taxable income would shoot up without actually raising taxes. In 1986, the the passage of the Tax Reform Act wiped out those deductions as part of the restructuring, It also lowered the highest tax bracket from 50% to 28%, but that is another story, neh?
The elimination of the deduction was phased in over three years -- the only consumer debt where the interest paid continued to be decductable were loans against your primary residence. It didn't take long before the first home equity loans became popular -- pledging the difference between the appraised value of your home minus the principal still owed on your first mortgage. So let's say you bought your house for $250K and let's say your lender stuck to the old 80% LTV, so your house when you bought it appraised at $312,500. After five years, the principal is probably still about $245K -- but back in the day, your appraised value might have shot up to $400K. At a LTV of 80%, you now have an available equity of $75K.
It was like found money! You can afford to get braces for the kids, and dancing lessons too. You could buy a car and deduct the interest again. You could send your kids to a better college instead of taking out student loans. You could go on vacation and take that trip of a lifetime. You could put a pool or a deck on the house. You can pay for the nursing home for Grandmom. You can make the monthly payments. You can actually live a little bit better....
There was a lot of competition amongst lenders to get this business. After all, the car or credit card payment may not be made but people pretty much always paid their mortgages! So you take out a second mortgage for $75K, and now you owe $320K on your house. But wait, if you shop around you can find another lender willing to let you pledge 90% of the current appraised value of your home -- and fold in all the settlement costs so it doesn't cost you a thing -- after all, property values are shooting up -- and you can get a third mortgage for another $40K!
And now you owe $360K on this property
And then all the bubbles burst. The appraised value plummets to $300K. You cannot sell your home because you cannot pay off the liens with the proceeds of the sale. And you are now in default of the terms and conditions of your loans, which require you to have adequate collateral.
The lender in this situation is not at all in good shape either.
Problem #1: according the regs, the LTV on mortgage lending is 80%. If the borrower is over that, then they have to buy PMI [private mortgage insurance] to protect the LTV. [There are all kinds of rules and regulations about having to monitor the LTV so that when the loan amount is below 80%, the PMI is stopped, by the way but that is another topic for another day]
Problem #2: even if you are paying as agreed, the regs say that if the collateral for your loan is insufficient to cover the principal balance, then your loan's risk rating has to be downgraded. The formulas are complicated, the upshot is that the lender will have to take a higher percentage of money out of cash and put it into the reserve account for the life of your loan.
Needless to say, the amount of capital available to make new loans grows less -- and the housing market stutters to a standstill. and the economic recovery stalls with it.
CEOExpress
and the economic recovery stalls with it.
