Kauai Real Estate > Real Estate Crisis

Today's Real Estate Crisis

September 2008

Loan-to-Value ratios is a subject which now haunts many homeowners. Across the country there are falling home prices, especially in the middle brackets. "Price reductions” are the norm on listings updates.

We have seen a major correction in the remarkable price increases of the early to mid 2000’s. Millions of people who bought at or near full price during that period have suddenly found that they own a property which is worth less than what they paid. No news here, this headline is everywhere and of course this is not really much of a practical concern for those who stay put, but what about those who move? If you paid $500,000 for a home that is now worth $435,000 (or less) can you sell? Should you sell ?

Price drops of 12% (and more) are being reported everywhere, even on Kauai, this puts enormous pressure on those who purchased with little down and those who bought with high-risk financing.
Over the years the amount of the down payment required to buy a home has fallen dramatically. In the 1970s conventional loans were almost always 20 percent down, FHA mortgages with 5 percent down and VA financing with nothing down.

In the Mid 2000’s down payment requirements were completely random. You could buy with nothing down and you could even buy with 110 or 125 LTV loans, in other words, you could borrow more than the house was worth, enough to finance both the purchase and closing costs. These loans with little or nothing down are of no concern when home prices are rising but a complete disaster when property values are falling, as we see today.

Back to my example, the difference between a $500,000 debt, the purchase price of our model property purchased with nothing down and a $435,000 (or less) gross selling price, before commissions and closing costs. Do sellers have such money? Some might, but many who bought with nothing down or extra-jumbo loans cannot bring such cash to closing. In some jurisdictions the ability of lenders to recover purchase-money loan losses is limited to the value of the property. In effect, the seller cannot be sued by the lender for a loss on the mortgage when the property is sold. However, this protection does not exist in most states and thus a “short sale” option is a case by case situation (up to the lender and the actual sales price he is willing to accept, if offered), but does not apply to properties which have been refinanced or added home equity loans.

This means, many who bought at the top of the market with little or nothing down cannot sell because if they sell they will be bankrupt even if home prices fall just a moderate amount of some of today’s declines. The good news, if there is any, is that the ones who do not sell, hold down supply which will keep prices up. But the problem is that many who have purchased with no money down, with interest-only financing, with stated-income (no-tell) loans, with adjustable-rate mortgages and with option payment financing just cannot stay under any circumstances.

Many of these troubled loans allowed buyers to acquire homes with small monthly payments for the first few years and the buyers thought they would have appreciation to help them “sell out” when payments increased if they couldn’t make the new adjusted payments. However these “introductory years’ low monthly payments” also resulted in "deferred" interest, which means that not only did the monthly payment almost never cover the amount actually needed to reduce the debt, but the debt grew because the low payments also were not covering all the interest, which was then added to the loan balance. This then was a storm of increasing payments, growing mortgage debt and falling values that people with these fancy loans just could no longer take.