Why is America in Foreclosure? Print
Written by Dwan Bent-Twyford   
Monday, 01 March 2010 18:24

Why Foreclosures Will Mean Even More Money for Savvy Investors


Why has the real estate market changed so dramatically over the past few months?  Is it still a good idea to invest in real estate?  When is the market going to turn around?  Should I sell the properties I own before the prices drop again?  Have questions like these been on your mind lately?  For most of us, they have.  It’s important to understand what has been happening and why, so you can ride the wave.

We believe the biggest reason for so many foreclosures and bankruptcies has been “interest only” or “exotic loans.”  These exotic loans are very appealing.  They allow homeowners to purchase a larger house with a smaller initial payment.  The problem is that when the payment changes, most folks cannot afford the larger payment and end up in foreclosure.

Let’s take a look at several of these loans:

•    Teaser Adjustable Rate Mortgages: This loan entices borrows by promising an initial period of very low interest (typically around 1% to 2%) which later resets to market rates.  Over 1 million borrowers will be jolted back to reality this year when their introductory periods begin to expire.  Payments on a $200,000 loan at 2% are approximately $725 a month; at 7%, the payment is $1,340.  If the property was purchased based on the affordability of a $725 a month mortgage payment, what happens when the payment climbs to $1,340?

•    Subprime Adjustable Rate Mortgages: Because many of these loans require no income verification, they attract low-income, minorities, and people with bad or marginal credit.  These folks assume that they can't qualify for a more reasonable rate so they take what they can get.  Many are in questionable financial positions to begin with and are therefore in greater danger of defaulting.  Subprime (also called nonprime) ARMs start with a lower interest rate that continues to climb each year.  Homeowners can find themselves paying 13% interest in just a few short years.  If the initial interest rate of 7% was the maximum payment they could afford, what do they do now?

•    Option Adjustable Rate Mortgages: This is initially the most appealing loan.  It gives homeowners the choice each month of paying the principal and interest, just the interest, or an even smaller minimum amount.  If the mortgage payment is $1,000 a month and the homeowners decide to pay $450, the balance of the payment goes on the back of the loan, causing negative amortization.  Eighty percent of homeowners pay the bare minimum.  Because the amount paid does not cover the amount due, the balance is added to the back of the loan increasing the total amount owed.  Once the loan balance has increased to a certain point, the bank demands that the homeowners begin to make full payments on the now larger amount. 

Why are these loans so popular?  Everyone wants the American dream … a house, a family, a white picket fence, to be successful, and so on.  When homeowners see a chance to buy a larger, more expensive property that comes with a low payment, they jump on it.  The homeowners know that the payment will increase in a few years and assume that they can sell their property for a profit or refinance it for another low interest rate.

If you have been following the market since the first of the year, you know that property values and sales have fallen nationwide.  These same homeowners can no longer sell their properties because they owe what the property is worth, if not more.  The enticement of exotic loans is that most require a very low down payment, if any, and the promise of a low monthly payment.  This is fine if the market is going up, but when it takes a dramatic drop, they can’t sell or refinance so they end up in foreclosure.

In the year 2000, 19% of all new loans were exotic; so far in 2006 over 81% are.  This tells us that most of America owns a property they can’t afford.  In addition, the income verses debt ratio has taken a dramatic swing:

2000:    93% of mortgage payments consumed 28%-36% of a homeowner’s paycheck.
7% of mortgage payments were 36% or more of the homeowner’s paycheck.

Now, let’s take a look at what’s happening now.  We think you’ll agree with us that these numbers are scary:

2006:    33% of mortgage payments consume 28%-36% of a homeowner’s paycheck.
20% of mortgage payments consume 36%-58% of the paycheck.
47% of mortgage payments consume 58%-69% of homeowners’ paychecks!

Almost half of all homeowners use up to 70% of their paycheck just to make their mortgage payment.  This leaves very little left over for emergencies.  In addition, when that payment changes, they can’t afford it resulting in a foreclosure.

What does this mean to investors?  It means there are unlimited properties available right now if you know what to do with them. As a landlord, buy as many properties as you can afford.  With the changing market, buy low and plan to hold for the long haul. 

Since most of America is in a buyer’s market (meaning there is more than six months of inventory available), rehabbers need to offer incentives to get properties sold quickly:  sell below market, offer no payments for 12 months, offer to pay all closing costs, offer new appliances, offer cash back at closing, and so on.  Any property will sell if it is priced right, even in a buyer’s market.  Remember, 90% of the marketing is done when you set the price on the home. 

Wholesalers must hone their short sale skills in order to get good deals. USA Today recently said that short sales are becoming commonplace.  As more and more properties go into foreclosure, banks are being forced to short sale in order to get rid of properties.  With 70% of loans maxed out, banks no longer have a choice.

The bottom line is that there has never been a better time to be a real estate investor.  Foreclosures are going to skyrocket over the next few years because of exotic loans and our cup will runneth over.

Dwan has been a real estate investor for over 15 years.  She has purchased and sold over 1,000 properties, totalling well over $200 million in real estate transactions.  Her niche is cornering the market in foreclosures and teaching people to become investors - without damaging the people in distress.  As a believer in Christ, she feels that the golden rule should apply in all situations.  In a world dominated by men - she has certainl