All Strung Out and No Place To Go

Lately there has been much made of the increase in home foreclosures. When questioned by homeowners as to how I go about evaluating their home, I tell them that I look at it from the perspective of a typical buyer. This has occasionally resulted in a statement that they do not intend to sell their home, but just to borrow some money on their equity. They do not realize what they are doing by taking out the loan.

A foreclosure action results because when someone borrows money on their home, they sell the lender the right to the property minus the equity retained by the homeowner. A mortgage deed is filed, and it allows the lender to obtain a judgment and then sell the home for the amount that is still owed if the homeowner defaults on the payments before the loan is completely repaid. The lender thus becomes a co-owner of the property as long as the money is still owed.

It used to be that the "bank" issued the loan and held the mortgage deed. After the savings and loan bailout in the 1980's, the number of "banks" holding such "paper" decreased, because the regulators realized that for an increase in lending to occur, more partners had to be found to provide capital. The rate of securitization of such loans increased, and today, very few "banks" keep residential loans in their portfolios. The loans are made in conformance with specifications set out by the Federal National Mortgage Association (FNMA, aka Fannie Mae) which is a Government Sponsored Enterprise (GSE) that guarantees, or insures, loans made under their underwriting criteria. The appraisal requirements in those criteria are Supplemental Standards to USPAP, and violations are subject to prosecution under Federal law.

The loans are sold by the "bank" to Fannie Mae, which charges an insurance fee, then resold as securities to investors, many of which are pension funds. Fannie Mae has the ability to force a "bank" to buy the loan back if fraud or negligence can be shown.

The result has been that in the past few years, more and more lenders are coming under the gun due to failing loans being proven to result from bad appraisals or lender fraud. Huge numbers of home equity loans were made during the refinance boom of 2003-2005, many of which were adjustable rate loans with low initial teaser rates. As interest rates have gone up, so have the monthly payments on those loans, and many people are finding out that the "equity" that they borrowed out of their houses either did not exist, or cannot be afforded at today's interest rates.

Fannie Mae securities are not guaranteed by the US Government like FDIC deposits; they are insured based on the fee charged to the "bank". When the number of foreclosures rises, the money available to reimburse the investors decreases. As a result, there is considerably more risk involved to the investor (which is natural, considering the higher rate of return). Because Fannie is stuck with many more non-performing loans now than before, the pressure is on the "banks" to take such loans back. Congress does not appear to be willing to "bail out" Fannie Mae in a repeat of what happened in the '80s. The "banks" are becoming more creative in trying to find ways of avoiding foreclosure when the borrowers cannot pay at today's rates.

The following news article explains how some lenders are approaching the problem.

Lenders Seek to Modify Rather Than Foreclose Mortgages

The bottom line is that Fannie Mae, the lenders, and the loan servicers are all nervous about the current economic situation. If the median home price continues to decline, some of the pension funds may take hits to their earnings. As the article states, if a person's mortgage payment is starting to become unmanageable, the best thing to do is to contact the lender immediately and try to work out a modification to the loan. I believe that we may also see more consumer lawsuits developing over inflated appraisals as both the consumers and the "banks" look for someone to blame for their discomfort.