May302013
HELOC Abuse Grading System (redux)
HELOC abuse is one display in many of the properties I profile each day. I made my point about HELOC abuse years ago, and I originally wrote today’s post back in early 2010. No matter how many of these I profile, many readers, including myself, find these stories interesting. It’s one thing to know HELOC abuse happened, but it’s much more entertaining and educational to see every manifestation of the disease. The thinking behind this behavior is flawed, es evidenced by the legions of people who lost their homes this way. Recognizing the mistakes of others can be very helpful in avoiding them in our lives.
There is a simple truth about the housing market; people are going to buy and sell homes when is suits their life’s circumstances. Unlike many of the readers of this blog, few base their decisions on market dynamics, and even when they do, each sets their own risk parameters.
The main factor separating those who benefited from the housing bubble from those who did not was a Simple Twist of Fate; for some it was time to sell or buy, and Fate either enriched or destroyed them.
I have often wondered if I had made different decisions during the bubble if I would have been caught up in the frenzy. Although I don’t believe I could have fully ingested kool aid, I probably would have behaved like most of my cohorts and increased my loan balance. I consider those who did this with fixed rate financing and still managed to lower their payments as the sly ones. That is as far as I would have gone, but I probably would have taken some of the free money.
The conditions that spawned the rally of The Great Housing Bubble are gone, and we will not see rapid appreciation and a HELOC-fueled economy for decades. I believe we are embarking on a 20-30 year cycle of slowing rising interest rates as we stay one step behind inflation the entire journey. In an environment of increasing financing costs, mortgage equity withdrawal is rare because there is little equity available, and the cost of accessing and spending that equity is high — the opposite of what people have become accustomed to over the last 20-30 years.
It is important to me for people to realize HELOC spending is not coming back. Many buyers operative today are basing their decisions on poor information, they believe that if they can just get into a home, they will get to live off the HELOC money like everyone did in the 00s — they may have to wait a few years, but most buyers are certain HELOC money is on its way. It’s not. As long as buyers are making buying decisions based on poor information, they will likely overpay and be unhappy with the results later on.
HELOC Abuse Grading System
I was looking back on the abundance of HELOC abuse stories from last year, and since I know we are going to see many, many more of these disasters over the next several years, I have developed a simple grading system that will tell you at a glance information about the borrower. By devoting this post to the grading system, in the future when you see a small graphic that labels the owner a “Grade D HELOC abuser,” you will know a great deal about how they lived and how they managed their debt.
As I contemplated a grading system, I wanted something visually intuitive so I developed the graphic above. The origin point to the left represents the total loan balance on the day the property was purchased. The lines emanating from the origin extend to the right with an angle of trajectory that either pays down a mortgage or adds to it.
Each HELOC grade is separated by a psychological or behavioral threshold, and each one has observable results — you can compare the current mortgage balance with the original one and see how quickly the debt went up or down.
HELOC Abuse Grade A
Most people who borrow money do so because they need it. There is a limitation to how quickly they can repay the money, and the limit at the bottom of Grade A is the pinnacle of borrower prudence.
I probably shouldn’t call this HELOC abuse at all because in order to earn an A, a debtor must pay off a mortgage faster than a 30-year amortization schedule. This should not be a difficult hurdle to jump over; in fact, prior to the housing bubble, most borrowers were forced to toe this line by conservative lenders.
The major difficulty in earning an A comes from deferred maintenance and renovation. People tend to borrow for major improvements with the justification it adds value to the property. Added value is debatable, but added debt is certain. Few people pay down their mortgage faster than a 30-year rate, and fewer manage to maintain that trajectory. Kudos and special recognition are in order for those who accomplish this difficult task.
HELOC Abuse Grade B
Earning a B in this system requires a debtor to at least hold the line on the total debt. Anyone who does better than treading water — which puts all interest-only borrowers on the line — can earn a B. As previously noted, prior to the bubble, few borrowers were near this threshold and most of the market earned a B for debt management.
Since lenders lost billions allowing copious amounts of mortgage equity withdrawal, since prices are no longer rising (in 2010), and since the cost of money (interest rates) is likely to rise, borrowers of the future will be forced to earn a B as lenders drop their C, D, E and F customers.
[Which they did. See: New mortgage regulations will prevent future housing bubbles)
Earning a B is a badge of honor; the scarlet letters are coming next….
HELOC Abuse Grade C
I hate to give borrowers in this category a “passing” grade, but this is the reality for most Americans. Growing credit card or mortgage debt slowly generally can be compensated for through home price appreciation, and although I consider this a bad idea, I can’t really call it HELOC abuse, just foolish HELOC use. Is there a distinction there? I will let you decide.
Financial planners will tell you that most people fail to budget properly for unexpected expenses (they don’t save), so when they fall behind a little each month, they put the balance on a credit card and hope they can pay it back with a tax return — or during the bubble with a visit to the housing ATM.
People are still going to manage their bills this way going forward, and there will be pressures to “liberate” this equity to pay for these expenses. The money changers will continue to peddle this nonsense as sophisticated financial management. It is a stupid way to manage debt, and I give it a C.
HELOC Abuse Grade D
The transition between a grade C and a grade D is somewhat subjective, but it is hinged to an idea; once borrowers start knowingly increasing their loan balance to spend appreciation as a matter of habit, once they start expecting appreciation and HELOC money as a reliable source of income, they have moved from what some may consider legitimate use of HELOCs to Ponzi Scheme financing and ultimately a foreclosure implosion. This Ponzi borrowing limit is an invisible threshold borrowers do not realize they have crossed, but once they accept using debt to pay debt as a concept, they have crossed over to the Dark Side.
The top of the range of D graded HELOC abusers is the limit of each borrowers self delusion when it comes to how much appreciation they feel comfortable spending without losing their homes. People who earn a D still planned to keep their homes, they were merely misguided by their own ignorance and the incessant Siren’s Song of kool aid intoxication. These are the sheeple; like the rats St. Patrick cast into the sea, each borrower followed the Piper to their underwater mortgage and a watery foreclosure.
HELOC Abuse Grade E
Most of the HELOC abuse posts I have done have been Grade E abusers because they are entertaining. When someone borrows and spends a $1,000,000, it is dramatic, and as an outside observer, you have to wonder what they spent all that money on.
Somewhere beyond the limit of self delusion, a borrower makes another psychological leap, they no longer worry about the consequences of their actions and they spend, spend, spend. This grading category spans the continuum from thoughtless spending to foolish and reckless spending where the borrower exercises no restraint at all.
HELOC abusers who get an E had to make an effort to spend. It takes time and effort to really spend beyond ones means one small transaction at a time. How many dinners out, trips to Vegas and other indulgences does it take to consume $1,000,000? I don’t know, but grade E abusers try to find out.
HELOC Abuse Grade F
Grade F HELOC abusers are the creme de la creme of their craft. These people are not maxing out their debt to spend recklessly — although I am sure much reckless spending occurred — grade F HELOC abusers are openly gaming the system to flip properties or strip equity while passing the risks on to lenders.
Another group that falls in this category are the Land Barons, as they are described at the Coto Housing Blog (no longer active). People who stripped the equity from one property to acquire others build a massive Ponzi structure. Back in February of 2009, I profiled the holdings of one such land Baron in Everybody Wants to Own the World.
The upper limit of this boundary is determined by lender greed as reflected through their underwriting standards. During the housing bubble, this line was pushed so far as to create categories C, D, E and F. Since most of these people are going to lose their homes, expect to see lenders lower the trajectory of this line significantly.
Grade F HELOC abusers are the ones who benefited the most from the housing bubble. All Grade D, E, and F borrowers either have or will lose their homes. The grade F borrowers got to extract the most value out of their equity before the market collapsed. Any borrower who had any psychological restraint — even the clueless ones who get an E — are worse off than those who spent with the greatest abandon.
Peak buyer with cash out and four years squatting
With so few foreclosures being processed due to the loan modification can-kicking, finding really good HELOC abuse stories is more rare. Perhaps after six years most of the best ones already imploded. Although I suspect there are many more to come.
The former owner of today’s featured property bought right at the peak, but they may have had previous Ponzi living experience because after a year and a half after buying the property with no money down, they managed to refinance and extract $30,000. They may have been disappointed not to have extracted more.
It appears they were counting on that HELOC money because a year and a half after getting their fix — right when the probably needed another one — they quit paying the mortgage. They were served an NOD in August of 2008, and they were allowed to squat until July of 2012 when the lender finally foreclosed.
$30,000 in free money plus four years of free housing. It worked out well for them.
[raw_html_snippet id=”newsletter”]
[idx-listing mlsnumber=”PW13098155″ showpricehistory=”true”]
2401 South RAITT St Santa Ana, CA 92704
$317,100 …….. Asking Price
$901,000 ………. Purchase Price
6/12/2007 ………. Purchase Date
($583,900) ………. Gross Gain (Loss)
($25,368) ………… Commissions and Costs at 8%
============================================
($609,268) ………. Net Gain (Loss)
============================================
-64.8% ………. Gross Percent Change
-67.6% ………. Net Percent Change
-17.0% ………… Annual Appreciation
Cost of Home Ownership
——————————————————————————
$317,100 …….. Asking Price
$11,099 ………… 3.5% Down FHA Financing
3.77% …………. Mortgage Interest Rate
30 ……………… Number of Years
$306,002 …….. Mortgage
$81,513 ………. Income Requirement
$1,421 ………… Monthly Mortgage Payment
$275 ………… Property Tax at 1.04%
$0 ………… Mello Roos & Special Taxes
$66 ………… Homeowners Insurance at 0.25%
$344 ………… Private Mortgage Insurance
$0 ………… Homeowners Association Fees
============================================
$2,106 ………. Monthly Cash Outlays
($216) ………. Tax Savings
($459) ………. Principal Amortization
$14 ………….. Opportunity Cost of Down Payment
$99 ………….. Maintenance and Replacement Reserves
============================================
$1,544 ………. Monthly Cost of Ownership
Cash Acquisition Demands
——————————————————————————
$4,671 ………… Furnishing and Move-In Costs at 1% + $1,500
$4,671 ………… Closing Costs at 1% + $1,500
$3,060 ………… Interest Points at 1%
$11,099 ………… Down Payment
============================================
$23,501 ………. Total Cash Costs
$23,600 ………. Emergency Cash Reserves
============================================
$47,101 ………. Total Savings Needed
[raw_html_snippet id=”property”]
This change is not due to the housing market getting better. Banks just simply stopped foreclosing in April and May due to some rule change.
Report: Foreclosure Inventory Falls 24% from Year Ago
By: Esther Cho
Foreclosure inventory continued to shrink in April, with the number of homes in some stage of the foreclosure process down 24 percent year-over-year, according to data from CoreLogic.
About 1.1 million homes sat in foreclosure inventory in April compared to 1.5 million properties a year ago, CoreLogic reported. Foreclosure inventory also dipped month-over-month, falling 2 percent from March to April.
At the same time, the overall share of mortgaged homes in foreclosure inventory declined to 2.8 percent in April from 3.5 percent in March.
The data provider also reported the number of homes lost to foreclosure decreased 16 percent year-over-year in April to 52,000. Compared to March, the number of homes lost to foreclosure remained unchanged.
Prior to the crisis, completed foreclosures averaged 21,000 per month between 2000 and 2006.
“The shadow of foreclosure and distress continues to fade, with the annualized sum of completed foreclosures having declined for 17 straight months,” noted Dr. Mark Fleming, chief economist for CoreLogic, in a release. “Six states have year-over-year declines in the foreclosure inventory of more than 40 percent, and in Arizona and California the year-over-year decline is more than 50 percent.”
“The shadow of foreclosure and distress continues to fade”
Is that really true? Or have we simply changed one form of distress for another? The loan modifications which ostensibly are “curing” this problem fail at a very high rate. These owners are arguably in another form of shadow inventory.
Look at what el O posted two days ago.
Keeping The ‘Recovery’ Dream Alive; 3 Big Banks Halt Foreclosures In May
What is the only thing better than Foreclosure Stuffing to provide an artificial supply-side subsidy to the housing market? How about completely clogging the foreclosure pipeline, by halting all foreclosure sales, which is just what the three TBTF megabanks: Wells Fargo, JPMorgan and Citi have done in recent weeks. Under the guise of ‘ensuring late-stage foreclosure procedures were in accordance with guidelines’, the LA Times reports that these three banks paused sales on May 6th and all but halted foreclosures. Perfectly organic housing recovery – as we noted earlier… and guess what states the greatest number of ‘halts’ are in from these banks – California, Nevada, Arizona – exactly where the surges in price have occurred.
http://www.zerohedge.com/news/2013-05-28/keeping-recovery-dream-alive-3-big-banks-halt-foreclosures-may
Ok, the culprit has been identified. In cavalier terms, so what? Is there any reason to think the lenders can not and will not continue postponing loss recognition? Why should they? Have you noticed? The Federal Reserve will act in the best interests of the banks, it’s shareholders. And politicians will act in the best interests of those who contribute greatly to their campaigns.
I don’t think anything will change, but buyers, both investors and owner occupants, should be made aware of the risks from ongoing market manipulations. This is not an organic recovery built on fundamentals, and although the banks will probably succeed in what they are doing, there is still significant hidden risk in buying in today’s market. We have a duty to expose this truth to those willing to learn it.
I am glad you are calling attention to the injustices. Not being sarcasic.
My speculation is the banks will succeed; for awhile.
Which bank gave a $900k loan for a house in central SA?
They deserve to take the loss!
Taxpayers will now guarantee loans to borrowers with over 43% of their income to mortgage debt
The Consumer Financial Protection Bureau (CFPB) announced Wednesday it has finalized amendments to the Ability-to-Repay rule first handed down in January this year.
The rule, set to take effect January 10, 2014, establishes basic requirements designed to ensure consumers don’t take on loans they can’t pay back. Those guidelines require stricter monitoring and verification by lenders; they also prohibit no- or low-doc loans. Loans issued as “qualified mortgages” are presumed to comply with those terms.
According to CFPB, Wednesday’s amendments are the result of months of input offered by industry groups and the public at large.
“Our Ability-to-Repay rule was crafted to promote responsible lending practices,” said CFPB director Richard Cordray. “Today’s amendments embody our efforts to make reasonable changes to the rule in order to foster access to responsible credit for consumers.”
The new amendments exempt certain nonprofit and community-based lenders who work to help low- and moderate-income consumers get into affordable housing. Generally speaking, the exemptions apply to designated categories of community development lenders and to nonprofits that make no more than 200 loans per year and that only lend to lower income consumers.
On the same token, mortgage loans made by or through a housing finance agency or through certain homeownership stabilization and foreclosure prevention programs are also exempt, CFPB announced.
Another new amendment adjusts the Ability-to-Repay rule in order to facilitate lending by small creditors (including community banks and credit unions that have less than $2 billion in assets and that make 500 or fewer first-lien mortgages annually).
Application Volume Down as Refi Volume Freefalls
Mortgage refinance applications continued to suffer last week as mortgage rates climbed to their highest level in a year, the Mortgage Bankers Association (MBA) reported in its Weekly Applications Survey.
The survey’s Market Composite Index, a measure of mortgage loan application volume, declined a seasonally adjusted 8.8 percent for the week ending May 24, MBA reported. Unadjusted, the index dropped 9 percent week-over-week.
The Refinance Index decreased 12 percent, the largest single-week drop in refinance volume so far this year (just beating out the previous survey’s drop). The refinance share of total mortgage activity fell 3 percentage points to 71 percent, the lowest level since April 2012.
“Refinance applications fell for the third straight week bringing the refinance index to its lowest level since December 2012 as mortgage rates increased to their highest level in a year,” said Mike Fratantoni, MBA’s VP of research and economics. “Rates rose in response to stronger economic data and an increasing chance that the Fed may soon begin to taper their asset purchases.”
Meanwhile, the seasonally adjusted Purchase Index rose 3 percent from the last survey. The unadjusted index was up 2 percent week-over-week and 14 percent year-over-year.
The average contract interest rate for a 30-year fixed-rate mortgage was 3.90, an increase of 12 basis points, according to MBA. Points were unchanged at 0.39 (including the origination fee) for 80 percent loan-to-value ratio loans.
It’s almost time get out that affordability/purchasing power chart again. In fact, I think you posted it last week.
It will take a month or two for the new rates to really show their effect. If they are all the way up to 3.9% when the government takes it’s new reading at the end of the month, it will have an immediate impact on the numbers.
That’s the really good one based on real data, I’m looking forward to that one. I realize that one will take time to adjust.
I wish I had the link, one I’m talking is used to show a hypothetical situation. It’s the one chart showing reduction in purchasing power different mortgage rates. It demonstrates what loan dollar amount a buyer can qualify with the same income, but at different mortgage rates. I think this week we hit a new peg.
Survey: 59% of Young Americans Not Interested in Buying a Home
A new poll commissioned by Mortgage Marvel shows younger Americans are as interested as ever in buying a home this year—but whether or not their finances can take it is another matter.
According to an online survey conducted by Harris Interactive, 41 percent of Americans aged 18-34 display an interest in buying a home (46 percent of men and 36 percent of women in that age group). Of that group, 17 percent of men and 6 percent of women see their finances as “shaky” but still think they can afford to buy a home soon.
Across all age groups, 30 percent of respondents said they are interested in buying a home during the next year. Of that group, men were more than twice as likely to risk buying with shaky finances; 10 percent of men and 4 percent of women said they still think they can get a home in the next year, even with an uncertain financial situation.
Overall, only 5 percent of people who have or had plans to buy a home this year said they can’t afford it after reviewing their taxes and finances.
“It’s heartening that young Americans haven’t let go of the American dream of home ownership,” said Mortgage Marvel COO Rick Allen. “It is important, however, that anyone looking to buy a home is very clear about what it takes, knows the impact of monthly mortgage payments on current finances, and has access to lenders who can provide the best terms possible.”
Among other findings: Separated, divorced, or widowed respondents were less likely to say they have an interest in buying a home this year. Only 20 percent of tax filers in that group expressed in interest in buying compared to 31 percent of married respondents and 38 percent of single (never married) respondents.
Of those displaying an interest in buying this year, those in households with children under 18 years old are were significantly more likely to say they can’t afford to buy a home this year (24 percent versus 14 percent without young children). However, they were also more than twice as likely to say that, after reviewing their taxes, they believe they can swing a purchase despite their financial situation (11 percent versus 5 percent in households without children).
The survey was conducted among 2,064 American adults ages 18 and older from April 18-22—after the tax filing deadline, “when Americans generally have a clearer picture of their financial health,” Mortgage Marvel said.
Extend and Pretend. This will keep the supply off the market.
Obama administration extends Making Home Affordable Program until 2015
By Christina Mlynski May 30, 2013 • 8:30am
The Department of Housing and Urban Development teamed up with the Treasury Department on Thursday to announce an extension of the Obama administration’s Making Home Affordable Program through Dec. 31, 2015.
The new deadline was determined in coordination with the Federal Housing Finance Agency to align with extended deadlines for the Home Affordable Refinance Program and the Streamlined Modification Initiative for homeowners with loans owned or guaranteed by Fannie Mae and Freddie Mac.
The program deadline was previously set to end Dec. 31, 2013.
The Making Home Affordable Program is a critical part of the Obama administration’s efforts to provide relief to families at risk of foreclosure and help the housing market recover from the housing crisis, HUD explained.
“The housing market is gaining steam, but many homeowners are still struggling,” said Treasury Secretary Jacob Lew.
He added, “Helping responsible homeowners avoid foreclosure is part of our wide-ranging efforts to strengthen the middle class, and Making Home Affordable offers homeowners some of the deepest and most dependable assistance available to prevent foreclosure. Extending the program for two years will benefit many additional families while maintaining clear standards and accountability for an important part of the mortgage industry.”
Since its creation in March 2009, roughly 1.6 million actions were taken through the program to provide relief to homeowners and, consequently, nearly 1.3 million homeowners were helped directly by the program.
As of March, more than 1.1 million homeowners received a permanent modification of their mortgage through HAMP, with a median savings of $546 every month — or 38% of their previous payment.
This program will be extended endlessly for the borrowers who bought during the bubble. Until each and every one of them can sell without a loss, the government will offer them the ability to amend-extend-pretend.
“The major difficulty in earning an A comes from deferred maintenance and renovation. People tend to borrow for major improvements with the justification it adds value to the property.”
Borrowing for major improvements is a great tool to get things done, but I think a lot of people tend to apply the same thinking for all situations, when many things can wait. “No” or “Not now” was removed from the collective vocabulary while HELOC money was being thrown out bank windows.
What’s striking is to remember just what the money was really used for.
I remember a neighbor putting in granite countertops, a swimming pool with rocks and a water fountain, new truck and taking vacations to Maui. I wondered how in the hell he did it all given his position and salary.
The home improvements that add value can at least be justified, but how does taking a vacation to Maui and paying for it over thirty years make any sense?
Institutional
investorsspeculators shifting from net buyer to net seller status + influx of the ”stupid money” signals the beginning of the end for the latest bounce (charade). Especially in the bubble counties.————————————————————————————-
Big Investors Quietly Slip Out The Back Door On Housing As “Stupid Money” Jumps In
Last September, one of the original institutional investors in the housing-to-rent strategy, multi-billion hedge fund Och-Ziff called it quits on the landlord business. The reason: “the New York-based hedge fund is looking to sell now because the returns it is generating from rental income are less than expected.
Today, another one of the original “big boys” has called it curtains: “We just don’t see the returns there that are adequate to incentivize us to continue to invest”, according to the CEO Bruce Rose of Carrington. Rose’s assessment of the market? “There’s a lot of — bluntly — stupid money that jumped into the trade without any infrastructure, without any real capabilities and a kind of build-it-as-you-go mentality.
http://www.zerohedge.com/news/2013-05-29/meanwhile-big-investors-quietly-slip-out-back-door-housing-stupid-money-jumps
It really feels like we’re rounding the corner here, watching mortgage applications fall off a cliff, big money beginning their exit, and rates beginning to edge upwards. Is this just a blip, or is reality finally “up to bat”?
Your guess is as good as mine – with the shenanigans we’ve seen over the last couple years (QE, etc.) nobody can say for sure, and anything can happen.
What I DO know for sure is it would have been nice to have cashed out in 2006-2007 and put the equity in the bank. We aren’t missing the boat this time around, and our listing hits the MLS today.
Our realtor thinks rates will be around 5% by the end of this year. I think that is a bit optimistic (or pessimistic depending on your POV). If rates are anywhere near 5% 6 months from now, RE prices will be in freefall.
“You can’t time the market”, but we’re giving it our best shot. Perspective – you are next. 🙂
We talked to Shevy again yesterday. We’ll be listing in a couple weeks to take advantage of this selling opportunity. Our neighborhood had a lull for a few weeks with just two listings available on average. Now more are popping up every few days, but we’re not sweating that because everything is selling within two weeks.
We’ll list for ~10% less than our early-2007 price (which is a reasonable price in this market) and hope for multiple offers exceeding list. This is a shocking turn of events for me.
Good Luck. It’s still a feeding frenzy. I think you’ll be pleasantly surprised. Like the piggyback article.
“You can’t time the market”,
My experience is that that statement is untrue, a prevarication, and just plain stupid. My first experience with real estate market timing was in 1990 when I believed all the hype that So Cal real estate never goes down. I bought at the peak and was underwater within a couple or three or four years after having put down 20%. In 2000 we sold that home and bought a more expensive home using a mortgage that was beyond our means to pay back betting that we were buying with leverage at the beginning of the next hot market. We speculated correctly and sold in 2005 when everyone thought we were nuts to sell and rent. You can time the market, but you have to be willing to bet your own mind and forget what anybody else tells you, especially real estate agents.
I’ve often thought about writing a post about you — anonymously of course. It’s a very rare person who identified the housing bubble, sold their property near the peak, bought gold, then sold gold to buy a property for cash near the bottom. What you did is remarkable. Not just were you right, you were right for the right reasons, and you acted on being right in a way that hugely benefited you financially. Unfortunately, you are the rare exception rather than the rule.
Piggybacks have returned!
“One Good Loan, Two Loans Better
MortgageOrb, May 29, 2013–Caley, Nora
The piggyback loan has returned, albeit in a different form than a few years ago.”
http://www.mortgageorb.com/e107_plugins/content/content.php?content.13859
“When home values dropped during the mortgage crisis, second-lien lenders suffered losses when the equity disappeared.
“Lenders are hesitant to take on this risk again,” Walzak says.”
Piggy-back loans? What could go wrong?
awgee,
When is the next down turn coming?
Thanks!