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Foreclosure, Home Equity Declines and You! March 10, 2008

Posted by shaferfinancial in Uncategorized.
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There has been much attention to the rising rates of foreclosure of late.  Additionally, the federal reserve issued a press release last week about the decreasing amount of home equity held by Americans.  So I thought I would blog on this with an eye toward you folks out there that are financially responsible.

First of all the overall foreclosure rate has broken the 2% mark.  But let’s look behind these numbers.  The rate of foreclosure for prime loans (loans made to people with reasonably good credit) is still below 1%.  So for folks that had a good history of paying their bills, the foreclosure rate is within historical range (although on the high end).  Sub-prime loans are another story.  For sub-prime fixed rate loans the foreclosure rate is 1.52%, while the variable rate loans rate is 5.29%.  Both are historically high rates.  I have mentioned this many times before, but this is not surprising for two reasons.  First, when you are giving loans to people who have not paid their bills in the immediate past, it is not surprising that they continue that behavior.  What is surprising is that so many of these folks have been able to pay their mortgage, given their history.  Secondly, the industry has used teaser rates and sold the lower interest rate of variable loans to gain a competitive edge over other loan officers and companies that take a responsible approach to lending.  Here is a statistic that should really illuminate the foreclosure crisis.  Currently 42% of the foreclosure starts are folks with a sub-prime variable rate loans.  These loans only make up 7% of the total loans out there.  One more point about the  sub-prime variable rate loans is that the majority of folks went into foreclosure BEFORE their interest rate rose!  And the 6 month LIBOR rate, which most of the  sub-prime adjustments are based on has come down 2.5% lately.

Next is the fact that 18% of the foreclosures are on non-owner occupied properties.  Many of these loans had high loan to value percentages.  So for some, this might be a business decision to get out of a bad investment decision.  If you are upside down on your loan (owing more than the worth of the property), you are cash negative, and you never had great credit scores to begin with why not walk away?  There is even a California company that for $995 will teach you how to do this with as little damage as possible to your personal finances!  Consider this just like companies declaring bankruptcy, a chance to reorganize.

Finally, the foreclosure action is not spread evenly.  California and Florida have the most, followed by Arizona, Nevada and the Midwest.  California, Florida, Arizona and Nevada had the most price appreciation since 2000, so are seeing home values drop the most (still way ahead of 2000 numbers).  Where there was double digit price appreciation there were speculators.  Most of these speculators were amateur investors although the large development companies acted in the same way.  Those states are now paying the price for all this speculative activity just as the tech stocks have been paying the price for the speculative action of the late 1990’s.

Is it surprising that when real estate values go down that home equity percentages also go down?  No.  When the federal reserve last week sent out the information on this the mass media made a big deal of it and tried to tie it to the foreclosure activity.  However, the truth is that home equity has been declining (percentage basis) since 1945 as the Federal Reserve pointed out in their press release, but most media outlets conveniently dropped that line.

As regular readers know, I am not a big fan of keeping home equity inside of homes, so it should not surprise you that I give a big yawn to all this noise about declining home equity and foreclosure activity.  To it I say so what?  Yes, it will dampen real estate values for a time, especially in California, Florida, Arizona, and Nevada.  Yes, the recession will exasperate the foreclosure rate and will probably extend the real estate down cycle.  Yes, if you have to sell your home in the face of this, it will be difficult.  But real estate has always been cyclical and one should know this going in.

So what  does this all mean to you?  Well, as long as  you have a decent amount in an emergency fund to cover …well …. emergencies like job loss, sickness, etc. you should be fine.  Just sit tight and let the down real estate cycle finish.  But, if you live in an area that is suffering job losses and out migration then, you might take a look your real estate investment.  It took Houston Texas twenty years to recover from the oil based recession that started in the late 1970’s.  Like all investments, your real estate should be examined based on fundamentals like population inflow/outflow, jobs, demographics, and neighborhood stability.  Frankly, real estate is a great investment most of the time, but what the realtors and lenders won’t tell you is that there are certain circumstances and geographic areas that it would be best to rent rather than own!

Hope this makes sense and is helpful.



1. Nick - March 10, 2008

Good post, the foreclosure mess is certainly not affecting everyone everywhere, and is no reason to keep investments out of real estate. Owning a home whose value fluctuates in price is still much more substantial than owning a minuscule portion of a hedge fund that specializes in investing in subprime mortgages. Planning for times like this with an emergency fund is essential for people serious about owning a home, either for an investment or just their place to live.

2. Ron Holland - March 10, 2008

From Wolf Laurel in the NC mountains – The housing recession is negatively impacting property sales in Florida and across the south as well as slowing sales in NC mountain resorts that depend on Florida buyers.

Still the downturn in prices and building of inventories is starting to attract second home buyers from Florida looking for cool temperatures in our mountains. Also the dramatic decline in the dollar combined with weakness in American real estate markets are beginning to interest some bargain hunting European investors.

3. Jeff Brown - March 10, 2008

David — You said, >However, the truth is that home equity has been declining (percentage basis) since 1945 as the Federal Reserve pointed out in their press release…

Your reaction was to yawn, and I’m with you there. Because you and I have been telling folks to make use of their home equity, they DO have less equity there.

However, we didn’t tell them to start their BBQs with the cash from their refi’s did we? Of course not.

The same net worth now controls far more assets than before they tapped into their home equity. Every time their real estate investments — acquired with that very same home equity — go up 1%, it’s 1% on a far greater number. This means they’re becoming wealthier not poorer.

As long as nobody told them to invest in Cleveland or to use 100% financing, they’re gonna be far ahead a decade down the road than if they hadn’t listened to you.

Declining equity indeed. Your clients and mine are gonna be living off that so called ‘declining equity’ in retirement — laughing all the way to the bank each month.

4. shaferfinancial - March 10, 2008

Thanks Jeff. Nice job clarifying that point. There is so much misunderstanding and emotional baggage getting in the way of what should be a straighforward analysis.

5. real estate Vancouver - March 11, 2008

Remarkable article! You hardly can find proper explanations on this phenomenon on internet as I`ve been searching for it for a while. The foreclosures become a common thing in Canada as well however it hasn`t been frequent until now. What you can`t calculate is the right time to sell your house that it won`t lose its real value. The Vancouver real estate market is also affected by this recession however the people seem still eager to invest in it which is a good sign.

6. Janetuc - March 24, 2008

favorited this one, bro

7. Mint - May 15, 2008

Thank you for good information~~*

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I’m sorry , If you think this is spam. but may i thank you again.


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