The Foreclosure Slump

The Foreclosure Slump

The rich get richer and the poor get poorer. The banks, mortgage companies and investors, among others, reaped the benefits of the housing boom and the low interest rates, while lower income families suffered the consequences. For example, in Charlotte the numbers of the less fortunate suffers of the foreclosure disaster look like this. From July 2007 to September 2007, Mecklenburg County reported 2,254 foreclosures, 527 more than a year ago. Statewide, there were 8,762 foreclosures, 3,342 more than last year. Nationally, 635,159 homes went into foreclosure, almost double last year (Charlotte Business Journal). Foreclosures seem so harmless if you are not personally involved in it. This is not true; the affects are felt throughout the in the economy of the surrounding area.

Is greed the biggest contributor to this crisis? Looking back to the beginning of the emanate demise, how did all this get started? In 2003, the interest rates dropped to 5.28% for a 30 year fixed mortgage, a 46 year low and 2% for the discount rate, which is what banks are charged (Lewis). With the interest rates so low the real estate market began to boom, and housing prices soared, in most areas housing prices doubled. Lenders suddenly found they had extra capital to loan. This gave them a greater desire to accept higher risk to enhance their returns on their investment, so they opened the flood gates on the subprime market (Barnes). Subprime Lending- A mortgage made to borrowers typically with a 620 or lower credit score. A credit score in this range is given to someone who has had problems paying their bills on time or not at all. They could have a repossession or a charge off, this puts the borrower at a higher than average risk of defaulting on the loan. They are in turned charged a higher interest rate to offset the risk of them defaulting on the loan; this is usually 2 to 3% more then a conventional mortgage (“Subprime Lending”). With the rates so low a subprime mortgage was still a great rate for a loan. Subprime mortgages were given at a phenomenal rate jumping from $213 billion in 2002 to a record $665 billion in 2005, an almost 300% increase.

Home buyers were able to purchase homes they could scarcely afford to buy. To do this, lenders used non-conventional loans, typically a 2/28 or 3/27 ARM or an interest only loan (Petroff). Adjustable-Rate mortgage or ARM- A mortgage loan where the interest rate changes over the life of the loan the change is based on an index set by the lender. Typically, the rate is adjusted up 2% a year which also increases the monthly payment amount. 2/28 the rate of the loan stays the same for the first 2 years and then fluctuates every year for 28 years. 3/27 is the same, but changes at the 3 year mark and is adjusted for the life of the loan. Interest only loan is where you only pay the interest for the first 15 years (“Adjustable Rate Mortgage”).This makes your payments low at first but at the end of 15 years you still owe the original loan amount.

Lenders made the prerequisites for receiving a mortgage much easier, they often over looked basic requirements such as proof of income and down payments. Buyers were offered loans with little or no money down, and low payments for the first couple of years, lulling them into a false sense that they could afford this home. If anyone wondered about being able to make the larger payments, they were comforted with the idea that in two or three years, surely they would be making more money (Petroff).

With little or no initial investment, and the low payments this was enough to entice anyone into buying, remembering the old adage, it is better to buy then rent. People were buying homes and gambling that in two years, when their payment went up, they could refinance for a lower rate, have lots of equity in their home, and use the money to catch up on the mortgage, or pay off other bills.

With the hot housing market lenders were able to sell more of the subprime loans on the secondary mortgage market (Barnes). Secondary mortgage market- A large percentage of mortgages are sold into the secondary market, where they are packaged and sold to investors and insurance companies among others. The secondary mortgage market helps to make credit equally available to all borrowers ( Secondary mortgage market. ). Investors or insurance companies buy the mortgage for the full amount of the loan plus the origination fee. Origination fee- The fee that the borrower pays to the bank to make or “originate” the loan it varies from .5% to 2% of the loan amount (“Origination Fee”).

The investor gets the loan for a small fee, the origination fee, and in return gets the loan paid back to them and the interest is how they make their money. Once the loan is bought from the lender he can then have the money available to loan again. Investors were quickly buying the loans seeing them as a great investment thus helping to drive the subprime market. Lenders were making money selling the loans so this prompted them to make more loans. With the busy competitive mortgage market the mortgage broker became more popular (Petroff). Mortgage Broker- Someone who acts as the go between with a borrower and a lender. They are licensed by the state they work in. They meet with the borrower and find out their needs and then search for the loan that best fits their needs and budget. They are also to help protect the borrower and help them through the mortgage process. (“Mortgage Broker”). A mortgage broker’s fee is paid by the buyer as a certain percentage of the loan amount.

With the booming market came the need for new homes, bringing home builders into the mix. They were building houses as fast as they could, barely able to keep ahead of the demand.

The larger home builder companies also are able to lend money adding more mortgages to the market. To help push new home sales they offered real estate agents incentives to bring buyers to see their homes. The incentives ranged from large screen, high end televisions and all inclusive tropical vacations, to extra commission like 10% to 12% instead of the usual 6% or cash that ranged from a thousand, on a one hundred thousand dollar home, to over one hundred thousand dollars, on multi-million dollar homes. This is given in addition to the usual commission. Buyers are given incentives as well; ten thousand dollar kitchen up grades such as granite countertops, stainless steel appliances, tile floors and 42 inch wood cabinets. Some builders opted to finish the basement and garage. Most pay closing costs and any other buyer costs. They may pay the Home Owners Association dues for the first year and add in a one year home warranty. Some have even given