In trying to stem the foreclosure crisis, the government has enlisted the help of lenders, servicers, investors, and of course homeowners, themselves. Conspicuously absent from this list of participants, however, are the courts.

Thus far, the only meaningful involvement by the courts has seen renegade judges unilaterally challenge the authority of lenders on a case-by-case basis. Sometimes, they have eliminated mortgages completely for homeowners facing foreclosure, but these stories remain the exception. For the most part, they have merely rubber-stamped the foreclosure petitions of lenders, since the law is the law.

According to experts, it is unfortunate that bankruptcy courts haven’t been vested with enough power to really help homeowners work around foreclosure: “A big advantage of bankruptcy over government-subsidized modifications is that bankruptcy is a difficult process that does not entice anyone to purposely default in order to get better repayment terms.” In other words, government programs are currently structured such that homeowners must (deliberately) default before they become eligible for relief. If the courts were involved, however, this incentive would disappear.

Under current laws, courts don’t have the power to modify primary mortgages, unless the borrower has first declared bankruptcy. Even then, the lender will still probably be successful in foreclosing on your home if it is determined that you can’t afford to continue making mortgage payments. [Thanks to aggressive lobbying, mortgage debt and student loans are basically "exempted" from the bankruptcy process].

If the borrower files for Chapter 7 Bankruptcy, then he can usually achieve a temporary stay of foreclosure. While this will give you automatic relief, the lender can usually petition to have the stay lifted within 3-4 months, which means that at best, this is merely a stopgap measure. If the borrower instead files for Chapter 13 bankruptcy, he can usually work out a repayment plan for the missed mortgage payments. Unfortunately, this procedure won’t do anything to reduce the size of one’s primary mortgage. (Second mortgages may be eliminated, but bankruptcy courts are barred from meddling with the primary mortgages). Rather, it will help those suffering from “temporary” financial distress that still have enough income to remain in their homes.

However, common sense dictates that those who could still afford to pay their primary mortgages probably wouldn’t go through the hassle of filing for bankruptcy, except in rare circumstances where their other debt was crippling, which means this avenue is basically useless. Fortunately, some institutions have started to lobby the government to think about changing bankruptcy laws, for the sake of creating an end-all solution to the foreclosure crisis. Let’s hope that they succeed!

During the height of the bubble, most of the savvy housing watchers were urging their readers to rent, arguing (correctly, in hindsight) that buying a home was far less economical than renting. Fast forward a few years, where housing prices have fallen by more than 30% in some areas, mortgage rates are still near record lows and the government is writing checks for $8,000 to encourage home-buying; as a result, the math is much less clear-cut. In short, it’s probably time to re-examine the choice that exists that exists between renting and buying.

Unsurprisingly, the relationship between rent rates and housing prices is highly regional. According to an analysis by the New York Times, “In South Florida, Phoenix and Las Vegas, house prices — relative to rents — are as low as in places that never experienced a bubble, like Indianapolis and St. Louis. But in a handful of other areas, including San Francisco, Seattle and Portland, Ore., house prices remain significantly higher than they were before the bubble began.” The author concludes that while the former cities offer some great bargains, buying property in these latter markets makes zero financial sense.

Without listing every market and which way the corresponding calculation is currently tilting, it probably makes sense for you to run the numbers yourself. Generally speaking, there are a handful of factors that need to be taken into account. In terms of buying, the purchasing costs, annual costs, lost opportunity costs, and selling costs, need to be weighed against the expected home-price appreciation. In terms of renting, these same costs should likewise be weighed against the expected rent price appreciation. Then, the economy of renting should be compared against the economy of buying.

If this kind of calculation sounds daunting, don’t worry! The New York Times Rent/Buy calculator has done all of the hard work for you, with 7 basic inputs (and 16 additional advanced inputs). After crunching the numbers, it will determine whether buying is more economical than renting, and if so, how many years you will have to remain in your home before this is the case. It will also compute your cumulative savings, and display this in graphical form against the number of years that you expect to live in your home after buying it.

In the end, the biggest variables are home price and rental price inflation, and unfortunately, no one can accurately predict how these will change. Thus, it’s probably wise to be conservative when estimating these variables, and assuming that they will be somewhat similar. As for most of the other inputs, setting them should be within your control or fairly easy to predict.

If you’re feeling lazy and/or don’t place a lot of stock in overly complex complications, you can do a back-of-the-envelope rent ratio calculation, by dividing the purchase price for a house that you are looking at by the annual cost of renting a similar one. According to experts, “When you do the math, you discover that a ratio above 20 means you should at least consider renting, especially if you may move again in the next five years or so. When the ratio is well below 20, the case for buying becomes a lot stronger.”

On April 5, the federal government officially inaugurated another acronym: HAFA, which stands for Home Affordable Foreclosure Alternatives and represents the latest attempt to deal with the housing crisis. As implied by the name, this program aims not to make mortgages more affordable for struggling homeowners, but simply to avert foreclosure. Towards this end, it will encourage short sales (a sale that is expected to net less than the unpaid mortgage balance) as a more palatable alternative.

Just like with its predecessor programs (HAMP, etc.), lender participation in HAFA is completely voluntarily. Instead of forcing participation (which would be unconstitutional), the government instead will try to encourage participation through incentive payments. Lenders will receive $1,500 for processing a short-sale, investors will receive up to $2,000, and second mortgage holders stand to get $3,000, a pittance relative to what they are owed in most cases, but better than the $0 that they would probably get in the event of foreclosure. Even borrowers (who in most cases require no incentive) are eligible for up to $3,000 in “relocation assistance.”

Before a homeowner can qualify for HAFA, he must first apply for a HAMP loan modification. Those who are rejected outright or miss payments (doesn’t this create a perverse incentive?!) will then become eligible for a HAFA short-sale. The borrower must also demonstrate that the mortgage is unaffordable (i.e. exceeds 31% of gross income) and that without lender intervention, loan default would be imminent. (In addition, the unpaid mortgage balance cannot exceed $729,500, the property must be a primary residence, and the mortgage must be owned by Fannie Mae or Freddie Mac).

Within 30 days of being denied a loan modification, the lender MUST make a short-sale offer to the borrower in the form of pre-approved terms and a minimum sale amount. The borrower, then, has 14 days to agree. Once the home is put on the market, buyer offers must be submitted to the lender within 3 days, and the lender, in turn, has 10 days to respond. This latter provision is crucial to the success of HAFA, since the main complaint prior to its implementation was that short-sales took too long to process. This deterred many buyers from even making offers, because they knew it would be many months before the respective lender would even deign to respond.

Under the terms of the program, borrowers are relieved of all obligations after the completion of a short sale, and lenders are forbidden from seeking deficiency judgments. In fact, even if the short-sale cannot be completed, the lender is still required to accept a deed-in-lieu-of-foreclosure, which likewise eliminates all debt obligations. Because of the incentive payments, then, it is in lenders’ best interest to try to complete a short-sale.

It looks like this program has a pretty good shot as succeeding, and more than 100 lenders (covering 89% of all outstanding loans) have already signed up. Let’s hope that this is the last time the government has to announce a new program…I think they are running out of acronyms.

Fannie Mae recently conducted a nationwide survey on home ownership, and the results were somewhat surprising: “65% of the homeowners and renters believe there is still value in owning a home.” Moreover, a similar proportion believe that now is a good time to buy a home, and 1/3 believe that now is a very good time to buy a home.

Frankly, this is pretty amazing, considering the current state of the housing market. To be fair, these figures have declined steadily over the last five years, because homeowners have been chastened by the housing crisis. Still, 70% of respondents believe that housing is a “safe” investment, and that a comparable percentage believes that home prices will either remain flat or appreciate this year. This is a real testament to the optimism (some might be inclined to call it naivete) of Americans, who remain committed to home ownership in spite of the simultaneous realization that homes are becoming less and less affordable.

At first glance, one (myself included) might be inclined to dismiss this kind of mindset as ignorant. According to a recent academic paper [Can Owning a Home Hedge the Risk of Moving], however, buying a home now is still financially beneficial, because it enables home owners to hedge against price increases that can potentially occur if they wait until the future to buy.

The rationale here is actually quite sophisticated, and is based on the notion that housing prices in comparable regions tend to be highly correlated. In other words, home prices in Philadelphia and Boston tend to rise and fall in relative unison, and the same goes for prices in rural Alabama and Arkansas. To be sure, there is (probably) only a weak correlation between housing prices  in Philadelphia and Alabama, but this isn’t important, because the majority of homeowners in Philadelphia will never contemplate moving to Alabama, and vice versa. For the majority of homeowners, which tend to move within the same region and to comparable regions, they can effectively hedge against changes in housing prices by already owning a home:  “If a new house in a new city has…gone up in price by $10,000, a homeowner can cover that higher price with the capital gain. A renter would be out of luck.” If prices in both regions fall (as a result of the current housing crisis, for example), current homeowners would be equally unaffected, since any loss in equity on their current home would presumably be offset by paying a lower price for a new home.

The authors also point out that housing is different from other types of hedging instruments, in that it has real utility, since the owner gets to live in the house in addition to owning out. Finally, “Homeownership seems to induce saving on the part of households because they will pay down the mortgage, and by the time they are in their 70s they have no housing debt anymore. People are willing to put equity into a house, but wouldn’t be disciplined to put it into the stock markets.”

On the other hand, the authors concede that this notion is not as cut-and-dried when the home was purchased with borrowed funds (aka a mortgage): “The real cost of house price declines come from leverage. That’s the real risk of owning a house.” This is especially true when home prices decline precipitously to the point that the borrower owes more on the mortgage than his home is worth, a condition known as being “underwater” and that currently applies to about 25% of borrowers. In such cases, “The homeowner cannot afford to move because there is no equity left to form a down payment on another home.”

This is a crucial oversight on the part of the authors, since the vast majority of homes were financed, rather than bought outright. In fact, according to the latest American Housing Survey, which was last published in 2008 by the US Census, the average homeowner owes $100,904 in mortgage debt, which on average, represents 55% of the value of the mortgage property. When you consider that since then, housing prices have fallen 20-30%, that means the average borrower lost close to half of their equity, or $50,000. You can see from the chart below that as home prices have risen over the last couple decades, so did the amount of mortgage debt, which means the home price gains weren’t necessarily captured by the homeowners.

When you factor in the mortgage, then, the financial benefits of home ownership are much hazier.

What better way to follow up on my last post (”New York Fed: Housing Boom/Bust was Regional“) – which examined the housing boom and bust – than with a post that looks at the nascent recovery in housing prices!

Since bottoming in May 2009, housing prices have unequivocally stabilized, and are even rising in many areas. (As I pointed out in the last post, there are even several regions which never experienced a bust, and, thus,where housing prices have never stopped rising). This is even true for some of the epicenters of the housing crash. For example, “The median price paid for new and previously occupied houses and condominiums in Southern California jumped 14% in March to $285,000 from the same month a year earlier.” In addition, housing starts have reached one of the lowest levels on record, which combined with demographic trends, suggests that a recovery is inevitable.

At this point, the main issue is whether this stabilization is a temporary aberration or the beginning of a long-term trend. Unfortunately, the data (as well as common sense) seems to imply that this trend is only temporary. The most recent S&P/Case-Shiller Index, considered to be the most accurate indicator for housing prices nationwide, “reported that the non-seasonally adjusted Composite-10 price index declined slightly since December…The 10-city composite index declined 0.04% as compared to January 2009 while the 20-city composite declined 0.70% over the same period.”

Yale economist Robert Shiller (after whom the index is named) also has serious doubts about whether this recovery will continue. Mr. Shiller argued in a recent New York Times Op-ed piece that housing prices are strongly connected with the national conversation (dictated in part by the media and housing forecasters), and that in this particular case, there’s no evidence “that the fundamental thinking about housing has shifted in an optimistic direction.”

As further support for his case, he cites The National Association of Home Builders index of traffic of prospective home buyers, which accurately predicted the boom, bust, and subsequent (modest) recovery. He points out that, “The index’s current signals are negative. After peaking again in September 2009, it has been falling steadily, suggesting that home prices may have reached another downward turning point.”

Meanwhile, the Fed has stopped buying mortgage securities, and mortgage rates could soon begin rising. An enormous shadow inventory of foreclosed properties has yet to hit the market, and in fact foreclosures are still rising. As The Atlantic pointed out,”The Obama administration’s mortgage modification program has slowed foreclosures, but has failed to permanently prevent most.” Finally, the expiration (for the second time) of the homebuyer tax credit on May 1 is expected to have a significant dampening effect on demand.

In short, the national picture is pretty unambiguous. Still, if anything can be said definitively about the national housing market, it’s that there is no national housing market, but rather a collection of very distinct, regional housing markets. Unless you are planning to buy a house in all 50 states, then, it’s the regional forecasts that are ultimately more useful.

A new report by the New York Federal Reserve (Bypassing the Bust: The Stability of Upstate New York’s Housing Markets during the Recession) has drawn some interesting conclusions, namely that the housing boom and subsequent bust have been marked by wide regional disparities, and that there was/is a strong correlation between subprime lending activity and the degree of boom/bust.

The first claim is not wholly surprising. It has already been established that the areas characterized by the wildest booms also saw the most violent busts: California, Florida, Arizona, and Nevada. You can see from one of the report’s excellent pictorial graphs that New Jersey, Massachusetts, Connecticut, and New Jersey also fall into this category. On the other hand, most of the non-coastal US experienced neither boom nor bust, while the Pacific Northwest, and much of the east coast (excluding the aforementioned states) boomed and didn’t bust. Michigan, Ohio, as well as parts of Indiana and Illinois inhabit the worst of both worlds, having experienced the bust without the boom.

There are a few prima facie conclusions that can be quickly drawn from this. First, the majority of big boom / big bust regions are in tropical/arid areas, and are commonly associated with retired people. The two main exceptions to this rule were Honolulu and Virginia Beach. In addition, most of the country’s largest and most populous cities experienced at least at least a mild boom and bust. On the other hand, areas where land is inexpensive and wildly available (as in much of non-coastal experience) have experienced neither boom nor bust, since increased demand can be easily be met with affordable, increased supply. This is also true of the handful of states that experienced bust without boom, as housing supply has been consistently plentiful, but demand has been hit by the economic recession. The absence of major recession in some ares, meanwhile, perhaps explains why they have continued to boom in spite of what’s been happening in the rest of the country.

These conclusions are largely intuitive, and without the report’s careful analysis, that’s all that we would have. Fortunately, the authors didn’t stop here. Their next step was to map the “penetration” of non-prime loans, along with the corresponding rates of delinquency and foreclosure. Unsurprisingly, delinquency and foreclosure appear to be somewhat correlated with the penetration of non-prime lending. However, this correlation is weaker than one would expect, due to the superseding effect of economic recession.

What is more interesting, is the very strong correlation (64%) between non-prime loan penetration and boom & bust. In other words, the regions where housing prices rose quickly and fell steeply were the very same regions that experimented with unconventional types of mortgages and were most able to provide financing for all borrowers. “Metropolitan areas with a higher penetration of these loans by 2006—when activity peaked—experienced faster home price appreciation, but also saw a relatively rapid decline in values once the reversal began. Accordingly, a larger number of the nonprime loans that originated in these areas have entered delinquency or foreclosure.” Still the authors point out that these two trends were self-reinforcing: non-prime lending activity fueled housing price appreciation, which in turn fueled more non-prime loans.

From a practical standpoint, there are two take-aways from this report. The first is that there is no free lunch: if housing prices are rising due to speculation (rather than economic fundamentals and demographic drivers), there is a high probability that a correction will follow. Second, if ever it is too easy to obtain a mortgage (in a particular region), again, there is a high likelihood of boom & bust.

Bank of America is the first (large) mortgage lender to officially agree to incorporate principal reduction into the loan modifications that it processes. “The bank estimated that 45,000 customers will qualify for principal reductions averaging more than $60,000.”

Under this seemingly extraordinary program, eligible borrowers could see their loan balances decline by up to 30%. As usual, the devil is in the details; in this case, that means defining who is eligible. “The program is also limited to customers who have missed at least two consecutive payments [aka 60+ days delinquent], who can demonstrate that a financial hardship prevents them from making payments at the current level, and whose loan balance is at least 120% of the estimated home value.”

This final requirement underscores the purpose of the program, which is to address the growing contingent of underwater borrowers. In fact, it is estimated that already 1 out of every four borrowers falls into this category. Bank of America is not aiming to make whole all underwater borrowers, but rather only those that are at serious risk of default. Those contemplating “strategic default,” then, will probably have a difficult time qualifying.

In other words, the BofA program is merely an extension of its ongoing loan modification efforts. Anyone positing a connection with the recent White House overall of its HAMP program is surely mistaken. In fact, Bank of America only acquiesced to principal reduction as part of settlement agreements with the various states that were suing it, and only then to avoid a protracted legal dispute.

In addition to the requirements listed above, eligible borrowers must have had their loans originated by Countryside Financial (now a subsidiary of Bank of America) in a few specific states. As a result, only a handful (5% of the total) of borrowers that are also eligible for BofA loan modifications (itself, a small fraction of the total loans that are serviced by Bank of America) will receive principal reductions.

In short, this initiative does little to change the status quo (Says Bank of America, “Our customers do not need to take any actions at this time.”), and the majority of underwater borrowers (whether serviced by Bank of America or another lender) will remain, well, underwater. It’s understandable that Bank of America wouldn’t want to commit to reducing principal for more of its borrowers, or even more of its underwater borrowers, because it would set a dangerous precedent and create a moral hazard.

Should all underwater borrowers receive principal reductions? Should all borrowers receive principal reductions? Should only those in danger of defaulting receive reductions? What about those that choose to default? Ultimately, the Bank of America program fails to address any of these questions in a meaningful way. For its part, the Federal government also has yet to address them. Personally, I don’t have much of a stake in this issue (only as a taxpayer, that is), and I’ll decline to offer an opinion. Still, I hope that a final decision can be made soon, so that at least, everyone will know where they stand and can then start to move on.

A recent editorial (”The Case for Ending the Mortgage Deduction“) in the NY Times caught my eye the other day for both its logic and its candor. As the title suggests, the focus of the article was on the elimination of the mortgage tax deductions, whereby mortgage interest and property taxes would no longer be deductible from one’s annual income tax liability.

The editorialist’s argument is twofold: first, the tax deduction is very expensive from the standpoint of the government as it results in Billions of Dollars of lost revenue every year. Second, the deduction is not effective in encouraging home ownership, because only the wealthy are able to qualify for it (and they would likely buy homes anyway). Ultimately, it succeeds only in stimulating home price inflation by enabling borrowers to pay more for homes than they could otherwise afford.

On the other hand, the author concedes that even without the mortgage interest tax deduction, the housing bubble likely would have inflated anyway, since UK home prices have risen just as fast over the last decade despite the fact that the deduction was long ago phased out there. But, she writes, this could also be seen as an argument in favor of ending the tax deduction, since it proves that the housing market wouldn’t be adversely affected.

Personally, I am inclined to agree. Even putting aside the fact that the federal government is broke and can’t really afford this loss of tax revenue, this program is clearly ineffective. Only those borrowers with exceptionally large mortgages can claim the tax deduction, since in most cases it doesn’t exceed the standard deduction (for married couples). Moreover, the tax deduction is essentially regressive, since the more you borrow, the more you can deduct. One would think that under our progressive income tax system, the opposite would be true!

Worst of all, the tax deduction (and the entire mortgage finance system, for that matter) is bad for homeowners. Not only does it create an opportunity for borrowers to take on bigger amounts of debt, but even worse, it punishes those who don’t. Anyone who pays for their home using a higher ratio of cash to debt (i.e. a larger down payment) is essentially subsidizing those who paid for their home using mostly debt. Think about it: if two borrowers with equal income are in a bidding war for a house, the person who is willing to finance the home entirely in debt (at greater risk to himself) will win every time! The borrower that makes a higher down-payment, meanwhile, will be punished both by the government and by the housing market, in the form of having to pay more for the same home in order to compete with the heavily mortgaged borrower.

Given that the housing recovery has yet to take hold and that we are still in the midst of a foreclosure crisis, it seems unlikely that the tax deduction will be eliminated just yet. But once the housing market returns to long-term levels, the government may come to its senses and realize that there are more effective, economical, and equitable ways to spur affordable home-ownership.

By now, the proliferation of subprime mortgages during the housing bubble is common knowledge. These loans, we learned, were offered to those with poor credit, few assets, and/or low income – basically anyone who couldn’t qualify for a prime mortgage. But what about those that couldn’t even qualify for subprime?

Many of these borrowers were instead referred to so-called hard money lenders, which are basically the mortgage industry equivalent of loan sharks. These loans are conducted entirely in private (although the contract still must be publicly notarized). There are no underwriters or asset-backed securities or FDIC insurance in hard-money lending. Occasionally, there are middlemen, but for the most part it seems money is lent directly from one party to another.

Since the loans are often extended to borrowers with very shaky credit, the terms tend to be tilted heavily in favor of the lender. For example, interest rates are very high (12-20%), terms are short (6 months – 3 years), with relatively Loan-to-Value (70%) levels. In addition, the loans are fully collateralized by the property, in order to mitigate against the risk of default. Some loans are even cross-collateralized, which means that the mortgage is secured by another (more valuable property). When you factor in the borrower’s minimum equity cushion of 30% (1 – LTV), most lenders would still profit from foreclosure. In fact, high interest rates insure that the lender profits either way.

This is something that you, as a borrower, should understand prior to obtaining a hard-money loan. It’s possible that you can break even (when compared to a conventional mortgage) or even come out ahead (if you can successfully identify an undervalued property), but know that either way, the lender should profit handsomely. That being the case, you should be especially wary of making a large down-payment on a hard-money loan, because in the event of default, you could potentially forfeit your equity. For that reason, hard-money loans are especially attractive for undervalued investment properties, and you can sometimes get a hard-money lender to advance you the cost of repairs, such that the net risk to you is zero.

But these situations are rare, and for borrowers trying to finance the purchase of a primary residence, hard-money loans probably aren’t appropriate. If you are having trouble qualifying for a mortgage through an established lender, it might make sense to hold off and (continue to) rent until your income, assets, and credit score reach the required thresholds. If you are still determined to go this route, try speaking to local real estate agents and title companies in order to get references. Even in “loan-sharking,” there is still a difference between reputable and disreputable.