According to a WSJ analysis of the latest Federal Reserve Bank Data, American home equity is at rock-bottom. “As of March 31, owners’ equity accounted for just 41.4% of real estate values. The levels are the lowest on record, and of course they are far below those which were standard a generation ago.” The chart below, courtesy of the WSJ, shows how in only 50 years, average home equity declined from 75% to the current level.

The implication is clear: it’s still a buyer’s market. “Many potential sellers have a desperately weak hand. And many potential buyers lack enough equity in their current home to trade up.” In other words, sellers don’t have any leverage (in the figurative sense), and competition among buyers is limited, to non-existent. In fact, the decline means that many homeowners now have negative equity in their homes, and they are bound to be the most desperate from considering offers.

Some analysts are using these trends as a basis for encouraging investors/buyers to get back into the market. “If a real estate investor can pick up a property for 55 cents on the dollar, fix it up for another 15 cents on the dollar and sell it to a first time buyer for 80-85 cents on the dollar, everybody is happy. The investor perceives this is a good profit margin.” And some investors are doing just that. For several months now, there have been growing reports of bidding wars, featuring above-list price, all-cash offers for distressed properties.

In a recent article, one columnist even invoked the cliche about how real estate is a more sound investment than stocks/bonds because it is tangible. “Not all investments are the same. You can’t live in a stock certificate or gaze wistfully at a bond (at least most of us can’t). In what is still a time of tumult, there’s something deep inside us that finds the solidity of a home soothing. I think that explains why people moving out on the risk scale are focused more on real estate than on stocks or bonds.” Wasn’t this the attitude that led to the housing crisis in the first place?

It’s arguable a good time to by real estate, given the record decline in prices and mortgage rates that remain temptingly low. But the main rationale for buying should ultimately be based on utility, rather than capital appreciation.

The first part of the above title is the clear consensus of personal finance experts, while the second part represents my own two cents. Allow me to explain.

As a result of both the credit and economic crises, the financial situations for many retirees has become increasingly precarious. The stock market is recovering, but still remains well below its peak in 2008. Meanwhile, the worsening employment picture, combined with stagnating wages, have forced those nearing retirement to dip into their savings accounts. Even worse, many of these borrowers have been unable or unwilling to pay down their mortgages, carrying a significant debt burden well into retirement.

The statistics speak for themselves: “In 1992, 18% of Americans age 65 to 74 had housing debt, according to government data compiled by the Employee Benefit Research Institute. By 2004, that percentage had risen to 32%. And in 2007 — the most recent year available — 43% of 65- to 74-year-olds had a mortgage. The levels of debt have also risen. In 1992, the median amount of housing debt carried by those age 65 to 74 was $24,609; 15 years later, the median amount owed was $69,000.”

The results of this trend, unfortunately, also speak for themselves. “Americans 55 and older have been the largest age group to file for bankruptcy recently, accounting for 23  percent of the more than 1 million filings in 2007, according to AARP. Older seniors are even more vulnerable, with bankruptcy more than quadrupling for those from 75 to 84.” It’s not difficult to connect the dots. Making mortgage payments without a steady source of income is a recipe for disaster. This is especially true in the current lending environment, where banks are increasingly hesitant to facilitate refinancing because falling home values are eroding borrowers’ equity positions.

There is also a common-sense argument for paying down your mortgage early rather than investing it via a retirement account: “In the current environment, your mortgage provides a better return on your money than other risk-free assets. ‘It is unlikely that many retired households will be able to earn a return on risk-free investments, such as bank certificates of deposit, Treasury bills and Treasury bonds, that will exceed the cost of their mortgage.’

For homeowners that qualify, there is an alternative: a reverse mortgage. Reverse mortgages have gotten a bad rap recently, from no less than the comptroller of the currency, who compared them to subprime mortgages. While certainly subject to abuse and scams, reverse mortgages can nonetheless provide a valuable benefit if utilized properly, by enabling borrowers to “extract cash from their home and still live in it.” I’ve explained how reverse mortgages work in previous posts, so suffice it to say that this product will only become more popular as desperate retirees run out of other options.

The Mortgage Calculator’s last report on the status of the federal government’s Home Affordable Modification Program (Banks Represent Main Obstacle to Loan Modification) argued that banks were largely to blame for the program’s failure to get off the ground. In an attempt to jump-start modifications, “The administration on Aug. 4 unveiled the first of what will be monthly name and shame exercises, publishing data on the loan-modification efforts of about three dozen companies.”

Three weeks later, however, it doesn’t look like much progress has been made. “Moody’s analyst Celia Chen…said that the number of modifications ‘will have to step up substantially in the remainder of this year in order’ to hit the 1.5 million to 2 million modifications that her firm estimates can be completed under HAMP by 2012,” which is less than half of the target of 4 million set by the government.

Demand for loan modifications is still running strong according to anecdotal evidence, which suggests that the fault lies primarily with the banks. According to government estimates, “Only 9 percent of eligible borrowers had been offered trial loan modifications through June.” By their own admission, banks remain reluctant to participate in the program. “In the Fed’s latest survey of senior loan officers, about 30 percent of banks said they were still tightening standards for both consumer and business loans.”

In some cases, banks have even acted counterproductive to the modification process, by dubiously suggesting that borrowers should deliberately fall behind on their payments in order to qualify for modification. It’s not clear whether such a strategy can ultimately be successful, but from a cost/benefit standpoint, it’s definitely not advisable. Horror stories abound, whereby “the modifications never came….These borrowers burned through retirement savings, destroyed their credit ratings and suffered mental and financial hardship,” and even foreclosure!

The government also deserves some of the blame for not making the program altogether transparent. One columnist seeking to navigate the process himself, wrote: “I discovered, just trying to access the program put me through a torturous weeks-long battle with red tape that made my previous interactions with the RMV and the IRS seem downright fun.” Unfortunately, his experience seems to be typical, and the relative handful of borrowers who were ultimately lucky enough to secure modifications were only able to do so after months of hard work and persistence.

The most recent Weekly Primary Mortgage Market Survey, conducted by Freddie Mac, revealed a significant drop in mortgage rates. “The average rate for a 30-year fixed-rate mortgage was 5.12 percent, down from 5.29 percent the previous week, Freddie Mac said. At this time last year, the average rate for 30-year fixed-rate mortgages was 6.47 percent.”

Rates are now at their lowest-levels since the week of May 28, when they averaged 5.91%. Moreover, the decline has not been limited to 30-year fixed rates, which is the most popular type of mortgage, and hence the most oft-cited. “The average rate on a 15-year fixed-rate mortgage was 4.56 percent, down from 4.68 percent the previous week…Rates on five-year, adjustable-rate mortgages averaged 4.57 percent, down from 4.75 percent a week earlier.” One-year ARMS and jumbo mortgage rates fell proportionately.

While most analysis/prediction tends to focus on the demand side – implicitly seeking to establish whether mortgage rates are low enough to draw in buyers – it seems that the recent rate declines are a product of supply-side changes. By now, most laypeople are probably at least somewhat familiar with the securitization process (if not because of the pernicious role it played in the credit crisis), which bundles individual mortgages into large pools, in order to dissipate risk and sell them to investors.

Well, it turns out, that these pools of mortgages (known in industry parlance as Collateralized Mortgage Obligations [CMOs]), has been particularly strong in recent weeks. Investors are growing more confident (some would say complacent) about the risk posed by such securities, especially with respect to current prices: “Non-agency home-loan bonds have soared from record lows as investors reduced the yields they targeted amid signs that the deepest housing slump, worst financial crisis and longest U.S. recession since the Great Depression are easing.”

The US government (via the Treasury Department) and the Federal Reserve Bank have also been active. Specifically, there is “speculation that Treasury Secretary Timothy Geithner’s Public-Private Investment Program, or PPIP, will add as much as $40 billion of demand,” while the Fed’s “Holdings of mortgage-backed securities jumped $66.6 billion to $609.5 billion” last week, as part of its $1.25 Trillion plan to boost the housing market.

Going forward, it’s unclear whether these government purchases will continue. Already, the “Treasury and Federal Reserve said in a statement today that ‘they do not anticipate any further additions to the types of collateral that are eligible for’ the central bank’s Term Asset-Backed Securities Loan Facility,” which could make private investors wary of holding mortgage securities. Ultimately, such investments will only remain attractive if the housing market continues to stabilize and the foreclosure crisis is brought under control. Stay tuned…

In a recent interview, Wharton Business Real Estate Professor Peter Linneman, a well-respected authority on the real estate market, declared that the market has bottomed: “If you ask, is the storm over? The storm is over. What’s left is cleaning up the wreckage from the storm.” In other words, while the free-fall in prices may be coming to an end, there is still plenty of work to do rehabilitate the market.

Professor Linneman makes an important distinction in his predictions between single-family homes and multi-family homes: “Single-family housing starts have bottomed and will slowly pick up, [and] single-family housing prices in almost every market have bottomed….The multi-family side has fallen off a cliff. Multi-family starts are about a quarter of their historic norm.” In this regard, his analysis is firmly supported by the most recent data: “The Commerce Department said on Tuesday construction starts for single-family dwellings, the worst-hit part of the housing market, rose 1.7 percent from June to an annual rate of 490,000 units — the highest since October. But a 13.3 percent drop in new multifamily home projects pushed overall housing starts down 1 percent last month to an annual rate of 581,000 units after two months of gains.”

By Linneman’s own estimation, the national data is still pockmarked by significant regional discrepancies. The west – California, Nevada, and Arizona – remain battered, and “Construction of new housing in the Western states, including Arizona, fell 1.6 percent in July from the previous month, the second straight monthly decline, and was off 31.9 percent from a year earlier.”  In other words, it’s probably more useful to look at specific regional markets rather than focusing too much on the big picture.

Linneman is especially critical of the government, both for stoking the crisis and for its counterproductive efforts aimed at alleviating it: “We’ve had a government that for the last year has — under both the Bush administration with Paulson and the Obama administration with Geithner — leaped, then looked.” For better or worse, it looks like the government is going to remain active. Already, the government has moved to stimulate home ownershi, increase the stock of rental housing, limit foreclosures, and regulate the appraisal process. Good news for the housing market, even if Professor Linneman isn’t smiling.

In the wake of the closure of Taylor, Bean and Whitaker – the 12th largest mortgage lender in the US – two weeks ago, many borrowers are still scratching their heads over what to do. Should they continue to make mortgage payments as scheduled? To whom should they mail them to?  What about those who were pre-approved for mortgages and/or in the process of closing on a mortgage? “I’m at the point where, do I still have a mortgage? Or who do I pay my mortgage to? Everything’s in limbo right now,” said one concerned borrower,” summarized one uncertain borrower.

The company itself has not been able to provide any clarity on the issue, since it has already ceased day-to-day operations, although Bank of America has stepped in and taken control over TBW’s servicing operations. From the standpoint of borrowers them, it looks like the transition will be relatively painless, involving little more than writing a check to a different entity at a different address. Ginnie Mae has issued a directive fully outlining this process.

Unfortunately, it looks like potential borrowers that were promised mortgages will have to restart the process with BOA or another lender. However, “If you had an appraisal completed as part of an uncompleted loan application, your loan file (including the appraisal) could be transferred to another lender. FHA appraisals are valid for six months.”

Apparently, most instances of lender closure/bankruptcy are resolved just as easily. Typically, the mortgage servicer “will sell its assets under the supervision of the bankruptcy court to another financial institution and transfer the servicing of your loan to another company.” According to the Federal Trade Commission, you must be notified at least 15 days before the effective date of the transfer by both the old and new servicers. “In addition, you have a 60-day grace period after a transfer to a new servicer. That means you can’t be charged a late fee if you send your mortgage payment to the old servicer by mistake and your new servicer can’t report that payment as late to a credit bureau.”

With regard to escrow accounts, the old servicer must continue to make payments (taxes, insurance, etc.) as usual. “Even if your servicer files for bankruptcy or goes out of business, it is responsible for making the escrow payments in a timely way.” As with the case of Taylor, Bean and Whitaker, mortgagers that have not yet closed will probably be canceled, although it’s important to speak to the lender anyway to confirm the status.

While the collapse of the housing market has been viewed universally as a negative development, there is a silver lining: property taxes. All else being equal, lower property valuations translate into lower property taxes. Of course, the reality is much more complex.

Generally, the burden is on the homeowner/taxpayer to prove that the current valuation is inaccurate. Given that housing prices have fallen across-the-board, chances are that many homeowners will find themselves facing such a problem. In most cases, it seems state and local governments are amenable to adjusting the valuation:”Once a petition is filed, the county Value Adjustment Board sets the case for hearing in front of a special magistrate. Should the magistrate rule to reduce the contested tax assessment, owners who have already paid their taxes will receive a refund.”

Other areas are being overwhelmed with appeals and finding it difficult to process them before the tax bills are sent out. For that reason, one jurisdiction is moving to give homeowners the benefit of the doubt: “If their assessed value jumps five-percent or more in a year, the new law shifts the burden to assessors to prove they got it right.”

Some homeowners will see their tax bills fall doubly, both as a result of a lower valuation and lower tax rates. There are stories of local governments that are contemplating lowering property taxes as a type of economic stimulus. And lowering taxes never hurt politically, either. Unfortunately, it appears that lower rates appears to be the exception. Most state and local governments are facing record budget deficits, and are using property taxes to plug the holes. By tweaking rates upward, they can at least compensate for the revenue that would otherwise have been lost to lower valuations.

A new strategy, practiced by governments most desperately in need, is to sell “their delinquent tax bills to the highest bidder….Private investors step in and buy tax liens, paying governments upfront all or part of the value of the taxes. The investors then get the right to foreclose on the properties, taking priority over mortgage lenders, and to charge interest rates as high as 18 percent on the unpaid taxes.” While a win-win scenario for governments and investors, both of whom stand to reap huge cash windfalls, the program can be extremely detrimental to homeowners, which can see their tax bills (as a result of interest) skyrocket.

Unfortunately, there’s no law protecting homeowners in such situations, since the investors function as collection agencies, only going after back-taxes instead of credit card debt. In the end, if you don’t pay your property taxes (whether to the government or to a legally entitled third party) the result is the same as if you didn’t pay your mortgage on time; you lose your house.

Following up on yesterday’s post (Is it better to rent than buy?), today I thought I’d blog about the switch from owning to renting, in practice. In order to solve both the glut in housing supply and the shortage of rental housing, the government is trying to make it easier for “victims” of foreclosure to stay in their current properties as renters, even after they no longer own the respective properties. “The bill would remove legal impediments blocking federally regulated banks from entering into long-term leases – up to five years – with the former owners of foreclosed houses. It would also allow banks to negotiate option-to-purchase agreements permitting former owners to buy back their houses.”

The idea works as follows: after foreclosure proceedings are completed, the previous owners would be given the option of renting the property at a market rate. After a few years of such an arrangement – assuming that all rent payments were made on time – the tenants would then be given the option to purchase the property back. This might seem familiar, and some of you might recognize this arrangement is a tweak of a traditional lease-to-own option, which are usually used to facilitate the purchase of a house, not after foreclosure.

Under current rules, lenders are permitted to rent to the previous owner (or anyone else for that matter), but since the idea is to sell the foreclosed property, lease arrangements are usually only month-to-month, and the owner-turned-tenant can be evicted at any time, once a permanent owner is found. Under the proposed legislation, “The mortgage holder is permitted to resell the house after foreclosure, but any buyer must honor the existing lease. Rents can be increased yearly, according to the Labor Department’s consumer price index for rents in the area.”

Of course, this idea is not without its faults. First of all, there is the notion that if a homeowner cannot afford the mortgage payments on a house, is it reasonable to expect him to be able to make rent payments as a tenant. There are other critics who insist that the legislation has not gone far enough, by giving banks the option – but not the obligation – to rent foreclosed properties back to the previous owners. Finally, there are some who insist that lenders are not suited to being landlords.

This notion is reflected in a variation to this arrangement, under which a third-party investor is introduced into the equation. “First, the bank agrees to a short sale to a private investor, just as they often do now….The investor is contractually bound to lease back the house on a “triple net” basis – the tenants pay taxes, insurance and utilities – for two to three years…The deal comes with a preset buyout price after the leaseback period. That price is higher than the short-sale price paid by the investor, but lower than the original price of the house paid by the foreclosed owners.” Under such an arrangement, everyone should theoretically emerge satisfied – the lender, investor, and homeowner/tenant.

You can find thousands of websites and associated calculators that purport to tell you definitively whether it makes more (financial) sense to rent or to buy. The Mortgage Calculator Blog also took a stab last month at answering this perennially difficult question and concluded: “This is not to say that it’s better to rent than to buy. Instead, think of it as an exhortation to really think critically before deciding whether to jump into home ownership, since it may ultimately prove more expensive and more stressful than renting.”

It turns out that advice is now being echoed by more and more people, who are insisting that universal home ownership was never economically viable, and not entirely desirable. In a recent Wall Street Journal Op-ed, one historian notes that renting used to be the norm, and buying/owning was the exception: “From 1900…through 1940, fewer than half of all Americans owned their own homes…But from that point on forward (with the exception of the 1980s, when interest rates were staggeringly high), the percentage of Americans living in owner-occupied homes marched steadily upward. Today more than two-thirds of Americans own their own homes.” He points out further that what ultimately catalyzed the change was not a change in culture/values, but rather a shift in government policy: “It wasn’t until government stepped into the housing market, during that extraordinary moment of the Great Depression, that tenancy began its long downward spiral.”

Over the past 50 years and accelerating over the last decade, this policy assumed a grotesque form. An increase in federal housing programs/subsidies/guarantees combined with easy credit to make home ownership easier to achieve, and hence more prevalent. The results speak for themselves: “The collapse of the for-sale housing market has left many low-income people holding mortgages they can no longer afford, becoming victims of skyrocketing foreclosure rates.” Meanwhile, homeowners began to see their homes as vehicles for investment, rather than for their inherent utility. The diagnosis is clear, according to the WSJ: “It’s time to accept that home ownership is not a realistic goal for many people and to curtail the enormous government programs fueling this ambition.”

As if on cue, the Obama administration is springing into action. It recently announced the allocation of more than $4 Billion in stimulus funds to the Department of Housing and Urban Development, with the goal of mitigating the growing shortage of affordable rental housing. “The idea is to pay for the construction of low-rise rental apartment buildings and town houses, as well as the purchase of foreclosed homes that can be refurbished and rented to low- and moderate-income families at affordable rates.” Politicians are also jumping on board, some claiming cynically that they always opposed the Bush plan to expand home ownership. “I’ve always said the American dream should be a home – not homeownership,” said Representative Barney Frank, for example.

In any event, this could be the start of a huge shift in preferences. Ironically, lenders are facilitating this shift by tightening lending standards and making it more difficult for potential borrowers to secure mortgages. Personal finance columnists also appear to be on-board, advising their readers to invest their savings in traditional vehicles, rather than in the dream of home-ownership. Could this be the start of a return to the days when “holding a mortgage came with a stigma?”

The majority of borrowers probably don’t understand the difference between mortgage lenders and mortgage brokers, especially in the practical sense. A google search for the term “mortgage broker” yields mostly stories related to scams and fraud. While this is helpful in one sense – by making potential borrowers aware of the potential for unscrupulous behavior – it does little to clarify what exactly mortgage brokers do.

In a nutshell, mortgage lenders originate (and often underwrite) mortgages directly, while mortgage brokers work as intermediaries, connecting mortgage lenders with borrowers. If that’s the case, those of you unfamiliar with this dilemma are probably scratching your head and asking yourselves, “Who would be dumb enough to voluntarily pay for the services of a middleman, when he could go just go directly to the source?” According to the most recent data, the answer is two-thirds of all borrowers.

In fact, the system is not as straightforward as you would think. In fact, most lenders operate on two levels: retail and wholesale, with corresponding prices and rates. An individual borrower, such as yourself, would be offered retail pricing, while a mortgage broker would be offered wholesale pricing. For their part, mortgage brokers naturally exact a healthy commission, which would more than eliminate the savings from buying wholesale, all else being equal.

Of course, using brokers offers certain key advantages. While lenders, especially regional or community-based lenders, only offer a handful of different mortgage products, a mortgage broker should have access to the complete spectrum. Of course, a resourceful borrower could certainly search out a lender that offers the type of mortgage that he is looking for, but this naturally assumes that he already knows what kind of mortgage he wants. In fact, most borrowers wait to make such a decision until further along the process. In addition, it could involve significant legwork to find a lender that has what you’re looking for, and is competitive in pricing.

Another advantage of working with a broker is that they can potentially save you time and energy, by helping with paperwork, gathering documents, and generally facilitating the process. A good broker should protect you from lender “abuse,” by negotiating down/away any junk fees. Borrowers with special circumstances (i.e. can’t document their income, need to close immediately) would also do well to consider engaging a broker, as certain lenders might not be amenable.

Before you accuse me of being a shill for the mortgage broker industry, let me also point out the disadvantages. The main disadvantage is price. While it’s impossible to say definitively that brokers are more expensive than lenders, common sense suggests that all else being equal, they are. Brokers that are most competitive on pricing tend to be smaller (less overhead), which could be considered a disadvantage, since it doesn’t offer the same sense of security that bigger firms tend to project.

For those caught in the middle, there is another option that represents a sort of compromise. It involves finding a broker that is willing to act as your agent, rather than as an independent contractor. The difference is largely semantic, but if negotiated properly, it could result in significant savings. Whereas most brokers earn money from charging a spread on the wholesale rate they receive from the lender, a borrower’s agent will work for a fixed commission, such that you will pay the actual wholesale rate. Sounds like the best of both worlds!