It seems that the real estate bubble has burst, but how did home prices get so high anyhow?

While visiting San Francisco and the surrounding areas recently (2008), my wife and I were amazed at the prices of houses. A two bedroom home which might sell for $100,000 where we come from in Colorado was sometimes $600,000 or more in San Francisco, Monterey, or Santa Cruz or San Jose. And these high prices were after the real estate bubble burst. At least that’s what we thought. But apparently parts of the San Francisco Bay area were still seeing rising home prices.

Other areas of California have been hard hit of course. Some towns have seen prices drop in half in a matter of a couple years – not surprising to the rest of the country, where we all wondered how such prices could be sustained. Still, how did they get so high in the first place? Homes that average a half million dollars or more for a whole population? Some of those buyers must work at regular jobs, making only $30,000 to $40,000 annually. It didn’t make sense. Or did it?

Several factors lead to high prices. Some of them are still in place, which could mean that prices might not fall much more. Or it could mean that if and when those factors change, further big declines are on the way.

High Home Prices Come From Low Interest Rates

Take out an amortization book or find one of those payment calculators online, and see what the payment would be for your home if you had a 13.5% interest rate. People were paying this much in the early 80s. For example, a 30-year loan of $200,000 would cost you $2,292 for principle and interest each month.

Using that payment, see how much you can borrow at a 5.5% interest rate – as low as my old amortization book goes. Paying the same each month, you could borrow $404,000. If you are following the math here, you can see that the sales price could be twice as high, and yet you would pay about the same each month. Obviously low interest rates allow people to pay a higher price. There is more to it than that, of course, since prices certainly more than doubled in most areas since the 1980s.

Income Went Up

People are obviously able to pay more for housing as their income rises. Those who rent might be interested in owning a house when they start making more, driving demand, and therefore prices higher. Average income in this country was rising for a while. But that still doesn’t quite explain the extremes. How, even with a decent income of $60,000 per year, does one afford a $600,000 house?

Expectations Changed

The real estate bubble seemed to cause people to think home prices could rise faster than inflation forever – something a mathematician could refute in two minutes. They were convinced that homes were a great investment at any price. So while devoting no more than 30% of your income to a house made sense before, buyers started to spend up to half of their paycheck on a mortgage loan payment.

There was a frenzy to get in on the “game” while home prices were rising so fast. A couple might not actually be able to afford a house, but they could buy it with easy credit terms, drain their savings to make the payments for a couple years, and then sell for a profit before they ran out of money. Speculation like this became especially common in California and Florida. The result? Some made money doing this. But with prices falling, there are record rates of foreclosure, and the game is over for now.

High Home Prices – Other Factors

Easy credit allows more people to buy. That helped increase demand, and pushed prices higher. In the past, even those with a decent income had to save for a down payment, but no-money-down mortgage loans changed that. Interest-only loans – half the loans made in California at the height of the bubble – kept monthly payments down. The $2,292 mentioned earlier pays for a $500,000 loan if you need only pay interest.

There’s another factor we discovered while in San Francisco. We were told more than once that people are sharing houses everywhere. A NASA engineer said that when he lived in San Jose, most of the homes in his suburban neighborhood had four families living in them. There might be six or more incomes helping to make the payments on the house.

The latter factor is a cultural phenomenon (most were Asian or Hispanic). Many people born here don’t like the idea of living with other families, or living several to a room. Still, those who are willing to do so have found a way to afford a $600,000 home. These buyers and the additional demand they create may contribute to the high home prices in some areas.

Finally a big part of the answer to how people can afford high home prices is that they can’t really. We’re seeing record after record being set for foreclosures across the country, and if we see interest rates rise in addition, we’ll see those prices drop even more.
About the Author

Copyright Steve Gillman. To see a photo of the house we bought for $17,500, get a free Real Estate Investing Course , and to learn how to find cheap homes, visit: http://www.HousesUnderFiftyThousand.com

The three most frequently used methods to resolve foreclosure are loan reinstatement, forbearance agreement, or loan modification. While there are numerous other specific ways to stop foreclosures, these three are used most frequently.

1.) Loan reinstatement is where a lender has started the foreclosure process and the homeowner finds a way to pay back or “reinstate” the entire deficiency owed. The deficiency amount includes back loan principal and interest payments, accelerated interest costs, attorney’s fees, assorted processing and collection expenses, and late penalty charges. This technique requires the maximum amount of money all at once. Ironically, lenders recently indicated that pre-payment penalties may be included into final judgments in the near future.

When the homeowner’s reason for the delinquency is resolved, he usually asks the lender to take partial payments because he can’t get the entire deficiency amount together. However, the lender will not accept partial payments and the foreclosure will proceed if the full reinstatement amount isn’t paid. The reason for this is simple, the lender knows that the homeowner’s chance of getting out of, and staying out of foreclosure is less than 1 in 8. So the lender does not want to drag out the inevitable, the loss of the home to foreclosure.

2.) A forbearance agreement between the lender and the homeowner stipulates that the homeowner must make additional monthly payments for a specific period to make up the reinstatement amount that he couldn’t pay in full. As simple as it sounds, it may be unaffordable for the homeowner who could barely afford the original loan payment. The lender will usually ask that the homeowner pay the reinstatement amount over a three or six month period. If the monthly loan payment was $2,000 per month and he was 3 months in arrears, the new monthly payment for a three month period would be at least $2,000 + $6,000/3 = $4,000 per month. For a six month repayment schedule the new monthly payment would be $2,000 + $6,000/6 = $3,000 per month. In some instances the lender may ask for an additional cash payment before they will start the increased monthly payments. After the 3 or 6 months, the loan payments revert to the original amount or $2,000 in the above example. The foreclosure does not stop with the signing of the forbearance agreement but simply is put on hold until the homeowner completes making all the increased payments.

When you speak to your lender try for 12 months and don’t accept less than 9 months unless you can truly afford it! Ask them to review your financial statement, which they should readily send you and remember that the lender has already pulled your credit report and knows where you work, possibly how much you make, how many other monthly payments you have, and other information in the public records. They have also done a price analysis on your home and probably had a Broker’s Price Opinion (BPO) completed. Essentially they know what answers you should be giving them, so be forewarned. This method of reinstatement takes as much money as the loan reinstatement except it is spread over 3 – 6 months or, hopefully, more.

3.) A loan modification program was the most common method of foreclosure resolution for decades. It involved the lender issuing a new loan agreement where the deficiency amount was added to the loan balance and paid in identical monthly payments but for many more months, at the end of the loan. The monthly payments remained the same and if the home was sold, the balance of the reinstatement amount was paid from the proceeds of the sale. This method of resolution requires no up-front cash and the same monthly payment as before the foreclosure.

Another type of loan modification was to very slightly increase the monthly payments over the remaining term of the loan. So the homeowner has a choice of either extended but identical payments (as above), or slightly higher payments for the original term of the loan. Either option repaid the lender his money back plus interest. It was an affordable win-win for the lender and the homeowner, but is seldom offered anymore unless the lender knows the property is not worth taking back by foreclosure and he hasn’t sold the loan into a mortgage pool.

Loan modification programs are usually not available unless there is a hardship involved such as a job loss, death or illness. But it is worth asking your lender about it if you are in foreclosure because the market conditions and massive loan defaults puts pressure on the lenders to be more cooperative with homeowners. Your best option is to talk to your lender and as early as possible so you have time to resolve your problem.

In today’s climate of change any one can find them selves short on cash and as a result miss a few payments. This can result in a foreclosure process being initiated by the lender. If you ever find yourself in such a situation you should contact your lender as soon as possible. Banks and other lenders never like to miss payments but would rather know in advance. They also will probably want to know why you’re having a problem and how you are planning to deal with the situation. They may even have useful suggestions. A Loss Mitigation Department might be able to help.

Some times a loan or a second mortgage is an appropriate solution, although under some conditions that might just make things worse. You also might want to consider selling your house before the bank does. That would be a pre-foreclosure sale and although you still have to pay back the loan you will probably be in a better position to do that. Another possibility to consider is what’s called deed in lieu of foreclosure in this scenario you still owe the rest of your loan, but you will avoid foreclosure and save your credit rating.

Bankruptcy is sometimes used to delay a foreclosure this is not always a good idea. You may choose to use either chapter 7 or chapter 13 again depending on your individual circumstances. Bankruptcy may do more harm to your credit rating then a foreclosure and there is no guaranty you won’t wind up with both.

Foreclosure Prevention Services exist that can help you determine which strategy is most appropriate for your state of affairs. When you can’t pay the full amount owed without creating a hardship for your family you can get a legal review of your situation. You do have rights and choices, find out just what they are before making any decision that may have lasting effects on your ability to purchase land in the future.

Many people not facing foreclosure themselves are interested in the subject due to the fact that it may offer them an investment opportunity. In most cases these individuals are more concerned with making a profit than with performing a service and yet it may be possible to do both at once.

Those who are in danger of loosing their property due to foreclosure may actually benefit from an encounter with those seeking financial gain. There are web sites that specialize in bringing such individuals together. Almost any web search including the word foreclosure will yield numerous sites that fall into this category. If you are either about to be foreclosed on or have an interest in investing in foreclosure properties a search of this nature is probably a good place to start.

A “Deed in Lieu of Foreclosure” is when a lender accepts a deed to the homeowner’s property in foreclosure instead of continuing the foreclosure process and incurring more expenses to get the deed anyway. However, this does not mean the homeowner is no longer responsible for a loan deficit if the lender sells the home for less money than is owed.

This legal transaction starts after the homeowner has fallen behind on his loan payments and is in foreclosure. Even if the foreclosure has not started yet, the lender can be approached and asked if they will accept a “deed in lieu of” continuing into the foreclosure process. Sometimes the lenders regulations require the homeowner to be behind on his payments before they will consider accepting the deed, usually 90 days in judicial foreclosure states and 30 days in non-judicial states.

Unfortunately the homeowner is, or shortly will be inundated by people trying to help with his foreclosure because he has become part of the public record and usually he is getting information from well-meaning but uninformed people. However, he will be set upon by professionals looking to sell him foreclosure services or take the equity from his home by buying his home very inexpensively.

As soon as the homeowner notifies the lender of his impending problem or when he is 30 days late on his mortgage payment, the lender orders a BPO (Broker’s Price Opinion) to determine its market value. With this information the lender can immediately determine if he wants to take the home at the foreclosure auction, take a “deed in lieu of” or work with a loan modification or forbearance agreement to stop the pending foreclosure. The lender will make a purely financial determination about what is best for the lender, not the homeowner. By taking the home back though the foreclosure sale, there are higher legal costs, extended loss of interest on the loan, real estate market risk, carrying and closing costs, and increased reserve requirements for the Federal Reserve. However, if there are other open liens on the property, the lender will have to get the junior liens to assign them to the primary lender or extinguish them so they don’t become the burden of the first mortgage lender. In many cases it is simpler to go through the foreclosure process to extinguish these junior liens.

The lender determines if it is quicker to accept the “deed in lieu of” or continue with the foreclosure and sale. The lender may take the deed from the homeowner and continue the foreclosure anyway for the reasons mentioned above. In this case there is no advantage for the homeowner to give the lender the deed, especially if the lender requires the homeowner to sign a personal note for the potential deficit that the lender may incur when he sells the property. It is not entirely uncommon for a homeowner to have junior liens that are larger than the first mortgage and in these cases, the primary lender must continue the foreclosure so the junior liens either buy him out or have their interest in the property extinguished at the auction.

If the lender agrees to accept a deed in lieu of foreclosure, the responsibility for the mortgage deficit is not finished. The lender generally has the homeowner sign an Acceptance Agreement as well as a new deed. This agreement will stipulate that if the lender sells or transfers the property for less than what is owed on the loan (including all penalties, interest, and attorneys’ fees), the guarantor of the loan (usually the homeowner) will owe any deficiency. This deficiency amount can then be pursued in the courts as a deficiency judgment or the lender can issue the homeowner an IRS Form 1099. In this latter case the deficit becomes “Phantom Income” to the homeowner. Federal legislation enacted in December 2007 now allows the homeowner to avoid income taxes on this phantom income under certain strict circumstances.

So is a “deed in lieu of” an ideal solution for a homeowner in foreclosure? The answer is clearly “no” since very little is accomplished by the deed transfer because the homeowner or guarantor, is still responsible for any loan deficiency after the sale. If the homeowner does nothing, he will not have to sign the Acceptance Agreement. By not signing this agreement, the homeowner will not be opening himself to even further liability. The terms of the Acceptance Agreement should release the homeowner (guarantor) from future liability (i.e. deficiency amount). The bottom line is that if the “deed in lieu of” isn’t a better solution for the lender, the lender has no motivation to take back the deed. If the lender readily takes back the deed, the homeowner should be concerned there may be substantial equity in the property that the lender will receive “free and clear”. If there are additional liens on the home, the lender does not need the deed since he has to complete the foreclosure action to extinguish them.

In summary, it is a best questionable whether it makes economic sense to give back a “deed in lieu of” unless the Acceptance Agreement clearly stipulates that the homeowner does not have an obligation for the deficiency amount. You should not sign any documents from the lender or anyone else without having an attorney review and approve your signing.

Foreclosure Overview:

What is Foreclosure?

Foreclosure is a process that allows a lender to recover the amount owed on a defaulted loan by selling or taking ownership (repossession) of the property securing the loan. The foreclosure process begins when a borrower/owner defaults on loan payments (usually mortgage payments) and the lender files a public default notice, called a Notice of Default or Lis Pendens. The foreclosure process can end one of four ways:

1. The borrower/owner reinstates the loan by paying off the default amount to during a grace period determined by state law. This grace period is also known as pre-foreclosure.

2. The borrower/owner sells the property to a third party during the pre-foreclosure period. The sale allows the borrower/owner to pay off the loan and avoid having a foreclosure on his or her credit history.

3. A third party buys the property at a public auction at the end of the pre-foreclosure period.

4. The lender takes ownership of the property, usually with the intent to re-sell it on the open market. The lender can take ownership either through an agreement with the borrower/owner during pre-foreclosure or by buying back the property at the public auction. These are also known as bank-owned or REO properties (Real Estate Owned by the lender).

This process allows for three opportunities for finding bargains on foreclosure homes.

Pre-Foreclosure (NOD, LIS):

Buying a property in pre-foreclosure involves approaching the borrower/owner and offering to buy the property outright. The borrower/owner can walk away with something to show for any equity in the property and avoid a bad mark on his or her credit history. The buyer has time to research the title and condition of the property and can realize discounts of 20-40 percent below market value.

More about pre-foreclosures

Auction (NTS, NFS):

If the loan is not reinstated by the end of the pre-foreclosure period, potential buyers can bid on the property at a public auction. Buyers often are required to pay in cash at the auction and may not have much time to research the title and condition of the property beforehand; however, a public auction often offers some of the best bargains and avoids the unpredictability of dealing directly with the borrower/owner.

More about auctions

Bank-owned (REO):

If the lender takes ownership of the property, either through an agreement with the owner during pre-foreclosure or at the public auction, the lender will usually want to re-sell the property to recover the unpaid loan amount. The lender will then typically clear the title and perform needed maintenance and repair; however, the potential bargain for these REO homes is typically less than a pre-foreclosure or auction property. Bank foreclosures can become government foreclosures if the loan is backed by a government agency such as the Department of Housing and Urban Development (HUD) or the Department of Veterans Affairs (VA). In that case the government agency would be responsible for selling the property.

More about REOs

Before you buy

You’ll need to make sure you’re armed with the resources you’ll need to find and buy foreclosed homes. You can start by searching free on foreclosuredata, which includes pre-foreclosure and auction properties across the country and a nationwide bank foreclosures list.

Find out more about buying resources.

Sheriff’s Sales

Buying foreclosure properties at the Sheriff’s Sale (or Auction as it’s commonly known) is one of the best and quickest ways to make big profits in the distressed real estate business. However, it can also be the easiest way to lose.

The sale of a property comes at the end of the foreclosure process when the defaulting property owner cannot repair their financial problems with the lending institution.

There are 2 types of foreclosure, “judicial” and “non-judicial”. In basic terms, the “judicial” process requires the lender to file a suit against the borrower and the “non-judicial” process does not. The judicial foreclosure is a much more lengthy process due to the restrictions and schedules set forth by the courts. For our purposes, we will focus on the “judicial” process since it is the method used in New Jersey.

The process starts with the mortgage document, a security instrument used to pledge the property as protection against the loan.

When a default occurs, the lender attempts to end the homeowner’s rights of possession. The lender must file suit and prove in court that it has the right to sell the property to recover its loss by virtue of the default and as stipulated in the signed security instrument. If awarded a final judgment from the court, the mortgage company will proceed with the foreclosure process and the property will be scheduled for sale.

The properties are sold at public auction under the direction of the court in the county where the property is located. The winning bidder of this auction will receive clear title to the property (excluding taxes owed and other municipal liens, more on this later). About 80% of the time the successful bidder is the lender, the original mortgage holder.

Attorneys are usually there to represent the lenders in the bidding process. Get to know these attorneys because they can provide you with the judgment amounts and other information before the sale, giving you extra time to plan your strategy. There will also be investors, onlookers and other curious individuals observing the proceedings.

Occasionally, a lien holder of the property will appear trying to salvage what they can from their remaining interests. Rare but certainly possible, the homeowner may show up to bid on their own property. Remember, the owner has 10 days to redeem the property for the full judgment amount. In the event of redemption, all prior liens will become active again. In other words, it’s like reversing the foreclosure process; you’re back to where you started with only the foreclosing lien holder paid off.

find out more about sheriff sales and foreclosures here

Rewards

The biggest reward to buying properties at the Sheriff sale is the high profit potential. If there is a substantial difference between the fair market value of a property and its final judgment amount at sale, you can really win big. Typically, the largest monetary rewards will come from the proper application of this investment method.

Sales are usually advertised 4 – 6 weeks in advance. In some counties, this information may be available 6 – 8 months or more before the sale (tip –information available this far in advance can drastically differ from the properties that eventually end up at sale because the owners are only 3-4 months behind at this point and it is relatively easy to cure the default). By the time they reach the sheriff’s department you have at least 1 month before the sale.

In New Jersey, all owners are entitled to 2 adjournments for a period of 2 weeks each. The owner can take them all at once or in 2 separate intervals, usually giving you 2 months from the publication/release date to do your research.

You will need to research the property, the condition of the loan and the condition of the owner. Why the owner? If you can work out a satisfactory arrangement with them, you might be able to save yourself the trouble of going to the auction. If you meet with the owner and cannot work out a deal, take careful note of the property’s condition while you are there. This will give you a competitive advantage over other bidders at the auction.

You should go to the courthouse and observe the process a few times before going to bid on your property. It’s certainly a good idea to familiarize yourself with the local auction process.

For instance, certain counties do not announce the judgment amounts of their properties and if you are not careful, you might end up paying over the amount necessary to purchase.

Drawbacks

Buying at the courthouse can be very dangerous for those who do not do their research properly.

The large cash outlay required to buy the property is the biggest deterrent for most potential bidders. Certified checks and sometimes cash will be required to bid on these properties (call ahead to find out details).

Generally, you usually have to pay off the sale amount within 30 days from the date of purchase. You may not be able to inspect the property before bidding on it. In this case, there is little chance you will be able to assess the property damage and replacement costs. This ends up hindering your ability to determine true market value, maximum bid amount and potential future profit.

If you happen to be the successful bidder, you may have to evict tenants currently residing in your new property. This could take several months (typically 3-4 in New Jersey). This also interferes with your plans to repair and quickly sell the property for a profit. This delay increases your carrying costs (monthly payments and other bills) and erodes your profits.

At times, there may be land use problems with a property such as zoning or environmental issues like petroleum contamination or toxic waste. A clue to avoiding a problem property is when the lender’s representative fails to appear or bid on the property. If the lender does not want it, then you do not want it either.

Failure to research properties leads to over-biding at the sale. Too often properties are purchased for much more than their value. This, accompanied by the tendency to get caught up in the heat of the moment and over-bid, known as ‘’auction fever’’, results in large over-payments and even larger future losses.

Your most important concern should be the possibility of other liens or judgments. As the successful bidder, you replace the homeowner’s position in the property. Any municipal liens and previously owed taxes will also have to be paid. (The foreclosure process wipes away all secondary liens such as mortgages and judgments except for taxes and specific municipal liens)

Make sure you listen to the announcements being read by the representative for the lender. The announcements typically have all owed taxes and municipal liens that are included with the sale. If a lien shows up that you were not aware of, you might change your maximum bid price at the last moment.

The first mortgage holder is not the only one who is foreclosing properties. If a third lien holder forecloses, the process will not wipe out the first and second lien holders. Buying this property means you buy these liens as well. Typically, first mortgages are the largest liens on properties.

Researching Properties

The only way to be sure that this is a first mortgage holder foreclosing is through a full title search. The cost of the search is minimal compared to the potential loss from not investigating the condition of the title.

Evaluate the properties and determine their profit potentials. Do this by determining the market value using comps, appraisals and brokers’ opinion of price. Call the local tax collector to find out if there are any taxes owed or even tax liens on the property. Find out if the town also provides water/sewer. If so, inquire about outstanding bills. Subtract the final judgment amount, taxes and municipal liens from the market value. If there is a significant difference, you may have a winner.

Inspect the property if you can and assess any damages or repairs you might have to make before re-selling the property. Deduct those expenses from the profit you calculated earlier.

Calculate your profit potential by starting with the price you can sell the property for in its final condition. From this amount subtract any repair expenses, costs you will incur while holding the property (loan payments, taxes, insurance), closing costs you will incur when you sell the property, the broker’s commission if you intend to sell your property through a broker and other taxes and/or municipal liens.

Your sub-total so far, is your expected sale price of the property known as, the ‘”‘net to you’”‘ after you sell.

Deduct the default or final judgment amount from your last sub-total. This is your gross profit potential, hypothetically the most you can make assuming all goes well.

Determine your maximum bid amount. The lowest you can bid is the final judgment amount. The highest you bid is the ‘”‘net to you’”‘ amount. Any amount over that break-even point results in a loss. Determine the minimum profit you want to make and then subtract your desired profit amount from the ‘”‘net to you’”‘ figure. That is your maximum bid amount.

Going to the Sheriff’s Sale or Foreclosure Auction

Prepare for the auction by phoning ahead to find out any details and to make certain that the sale hasn’t been postponed. Determine the requirements for purchasing properties, how much deposit is needed, when the balance is due and what type of payment is required.

Attend the auction and arrive early. Properties are sold very quickly, sometimes within minutes. Pay attention and register yourself as a bidder if necessary.

Listen carefully for your target property to be announced for sale. Observe the bidders. Know your competition. Do not announce your intentions to anyone there. Never bid more than your pre-determined amount.

The successful bidder will receive a deed, the type of which depends on who is conducting the sale and state law. Record your new deed and obtain title insurance as soon as possible.

Remember to research properties and their liens thoroughly. Calculate your expenses and profit margins. If you cannot inspect a property, leave yourself a little extra room and some extra cash.

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