How's the Real Estate Market Treating You?
OK, here’s my question – how many people will be selling their houses when they have a 40 year loan at 2% and all of their expenses are added on to their rear end of the loan. This means that if they have $20,000 in extra expenses they can’t afford when the bank works out the loan, the bank will add it on to the back end of the note. While the owner of the house will have to pay interest on this amount ($400 per year), they will not have to amortize it over the 40 years, they’ll simply have to be able to come up with the $20,000 in 2051, when the loan balloon is due and the note is paid in full.
HOW DO I GET THIS LOAN – SIGN ME UP! No, it’s not that easy. This is mortgage modification for people about to lose their house to foreclosure. So, instead of taking a property back at foreclosure, they’ll get to keep their house, and the bank will technically have a performing loan back on their books.
How well will this loan perform for the bank? Well, to most of us, we’d say not so well. Further, if inflation rises at a rate of over 2% per year, this loan will rapidly become very, very cheap. However, before inflation explodes, the loan serves a great purpose: it allows someone who would otherwise have to walk away from a house to stay in it and care for it. The other option is to have the owner walk away, possible have a vacant house with the plumbing and other items of value removed, and something that will sell for 50% of the mortgage amount when it finally goes to the courthouse for auction.
A great example, to make it easy, would be a $1,000,000 loan in foreclosure. Consider the home owner took out the loan made payments for years, but then stopped paying. So, the amount owned we’ll consider to have returned to the original loan amount of $1,000,000. So, if the owner had originally taken this loan for 30 years at 6.5%, their mortgage payment would have been $6,320 per month. At the new rate, the mortgage payment will drop to under $3,700 per month. At the original 6.5 percent, this $2,620 in saved payments would be the equivalent of having borrowed $415,000 less than the $1,000,000, or $585,000.
WHAT IS REALITY? IN MOST MARKETS, THE VALUE OF THAT +/-$1,000,000 PROPERTY IS PROBABLY AROUND $585,000 TODAY. IN THIS WAY, THE BANK IS ACCEPTING THE DROP IN VALUE, AND LOCKING IN THE HOME OWNER.
The reason this loan works is that a homeowner can now most likely own their house and pay a mortgage for a price that is 41.5% below the mortgage that was agreed to with the purchase price.
WHY IS THIS IMPORTANT TO A REAL ESTATE BROKER?
I could write ten pages in explaining how this will have a dramatic effect on business throughout the country, but the following will simplify it: The only reason this house will ever be sold is if a) the homeowner dies, b) they cannot afford the new rate, or c) they have to move and need to sell short or walk away from the property. Since there are millions of houses in some part of the foreclosure process, is should be safe to say that more than one million of these mortgages could eventually be written. As such, these houses will be removed from the market for 40 years. The cascading effect will be tremendous. Transfer taxes will not be paid for many years, and the purchase of new floorings, painting, furnishings, appliances, etc. will all be postponed. This will trickle-down and have a deleterious effect on contractors, Home Depots, city clerks and hundreds of other businesses.
WHAT IS THE SAD/GREAT/AMAZING PART OF THIS EQUATION?
The people receiving the equivalent of a 41.5% discount are those who have stopped paying their loans. Those paying will never be offered this rate! However, at this point in the real estate market, it is unlikely that other solutions would make sense. In addition, it is understandable that a bank would be more willing to accept the 2% rate than a write-down of the principal mortgage amount.
If you need a referral to someone able to help you manage a transition from foreclosure to a workable mortgage, give me a call at 516-741-5960. While I am the broker at Village Properties in Mineola, we have dealt with clients who haven’t been able to perform short sales, but have gotten 2% rates and seen mortgages (more realistic than the sample shown above) drop from $2,700 to $1,570 per month. Yes, the discount is the same (+/-40%), but the payments are more realistic for this part of the world.
WHAT SHOULD THE 2% MORTGAGOR HOPE FOR? INFLATION!
Should inflation hit 10%, this loan would essentially be free money. If the homeowner is, for example, self-employed, and they have to pay this loan, inflation would be terrific. If they are professionals/trade workers charging per hour, and we assume they could earn, say $50 per hour, net, then the loan in the previous paragraph would cost them just more than 31 hours of work per month before taxes.
However, if inflation went up ten percent in a year, and they were able to increase their billing by this 10%, they would earn $55 in year two and this loan would cost them 28.5 hours of work. It doesn’t sound like a big deal, does it? Well, in year 3, they’d earn $60.50 per hour and work just less than 26 hours per month to pay their loan. Well, the value of compound interest is much more profound at 10% than at 2%. So, by year 10, the contractor would be able to charge $118 per hour and spend 13.3 hours per month paying their mortgage. But, here’s where it really gets good: In year 20, they will earn $305 per hour and spend 5 hours per month; in year 30 they will earn $793 per hour and spend fewer than 2 hours per month and, in the 40th year, they will be up to over $2,000 per hour, and spend a whopping 45 minutes per month to pay their mortgage!!!
This may sound impossible, but, 40 year ago yesterday, the gold window was closed. At that time, one ounce of gold could be transferred with the Federal Reserve Bank for $35. While the ‘gold window' was shut by President Nixon, he did it to protect our nation’s gold and protect the value of our dollar. However, today it costs $1,788 (exactly) for one ounce of gold. As such, in 40 years, our dollar has lot 98% of its value based on the underlying value of gold. Now, does my concept seem surreal? At other rates, the mortgagor will work as follows: 5% - 3.8 hours per month in year 40; 4% - 5.8 hours per month in year 40; 20% is great making our worker perform 6 hours of work per month in year 10, .98 hours of work in year 20, and 9 minutes of work in year 30. Yes, and finally, in year 40, should we endure 20% inflation for that length of time, our worker earning $50 per hour today, would be earning more than $61,000 per hour in the 40th year and would have to work fewer than 2 minutes per month.
Is this impossible? Well, consider 1979 through 1981. During that time, inflation never dipped below 9% per year in any given month. Most importantly, all a homeowner needs is for these rates to hit in the first few years. If we get 10% interest for 5 years, and then return to 5% thereafter, that same mortgagor would still enjoy working only the 31.4 hours in the first year, 16.8 in the 10th year, 10.3 hours in the 20th year, 6.3 hours in the 30th year, and 3.2 hours in the 40th year. In any case where inflation markedly exceeds two percent per year, out borrower has struck pay dirt. For once, this debtor falling rapidly out of the middle class, may have a way back into the middle class and an easier life than they can imagine in their present financial condition. They are on the precipice now, but could be in the cat-bird-seat in the years to come.