Monday, November 9, 2009

Foreclosure Crisis--Drawing down principal

One of the major issues in States such as Arizona, Nevada, and California is the amount that homeowners find themselves "underwater." Even in homes where egregious fraud is not found, homes that sold for $330k not too long ago, can now be worth $160k or less based upon the fraudulent practices around them .

This puts the homeowner in a difficult position. They can't sell their home and they won't be in a position to acquire equity for years to come.

The answer to this issue is simple in theory...draw down the principal to reflect the current market value.


That's not so simple.

Last Spring, part of the Obama plan included a legislative provision that would allow certain homeowners to address their grievances in bankruptcy court. The court would have had the authority to review cases where the homeowner could have their loans modified by the judge, and effectively draw down the principal of the loan to reflect current market value.

This provision was defeated in the Senate, which prompted Sen. Dick Durbin to make his now famous statement:

"The banks--hard to believe when we're facing a banking crisis--that many of the banks created--are still the most powerful lobby on Capitol Hill. And frankly they own the place."

Major Banks are unwilling to address principal reduction. Excuses are made, but effectively the issue revolves around the detail that if they reduce one home's principal, they fear a series of phone calls requesting principal reductions across the board.

Amongst the many plans that have been brought forth to effectively reduce the principal burden on the homeowner such as the "soft second," is an idea that may still be in its infancy, but may have some legs once it becomes more well known and specifics of the plan are worked through.

The concept revolves around short sales. Banks in the southwest region of the U.S. have shown a willingness to approve a short sale at 80, sometimes 70% of the current market value of the home. Banks have also shown the ability to report the homeowners action effectively as a deed in lieu transaction, which would only put the homeowner's credit impact in peril for a year, allowing them to apply for an FHA loan after one year.

The idea would then entail finding an investor who is willing to purchase the home at the 80% of current market value, rent to the original homeowner for one year, and then resell the home to the homeowner at the FHA appraised home value at the end of the year.

In a state such as Arizona, where predatory lending practices run rampant, finding a trustworthy investor poses a problem. The investor must be willing to abide by a pre-drawn contract at time of short-sale, and sell the home back when the time comes. Many of these homeowners cannot afford a trip to court, and the snakes in the grass know this.

What if a municipal, county, non-profit, or church were to be a large-scale investor in the short-sale principal reduction plan? The entity could not only ensure stabilization of homes and families in the area, but they would potentially see a profit of near 20% at the time of sale, along with a modest monthly income from the lease of the homeowner. The homeowner would have to keep their credit clean for the time period they are "renting" and would have to then come up with a down payment to secure a loan at the end of the year. (FHA loans require 3.5% down)

Regardless of which plan is used to draw down principal, one thing is clear--principal reduction is necessary to stabilize the housing market. In some states, (Arizona for one) lenders were responsible or knew of appraisal fraud, steering practices, charging excessive or unearned fees, and targeting vulnerable populations--knowing full well that no attorney would be present at closing to represent the interests of the soon to be homeowner. If the major lenders were not complicit in these acts, they definitely knew or should have known these practices were taking place and rewarded the practices in one form or another (RICO anyone?).

The burden of losses should not be shouldered by a population that was targeted, and ended up losing any and all equity or down payments invested in the property.

At some point, the beneficiaries of the years of incompetence need to pony up.

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