Foreclosures: Blame It on Second Mortgages

by Steve Crossland, REALTOR in Austin TX on December 12, 2006 · 7 comments

I thought this was interesting. Again, people are over-borrowing against real estate and getting into trouble. At our sales meeting this morning a Mortgage person updated us on a few things and then wanted to make sure we knew that they can do so-called 80/20 loans (80% first mortgage, 20% second mortgage = 100% loan) so our buyers can buy property with zero down and no PMI. I have to bite my lip. I want to shout out “quit giving people loans who can’t afford to pay a downpayment to buy real estate!”

The article below backs me up. Unless used purly as a leveraging strategy by investors who know what they are doing (and have the cash on hand to buy out if needed), I can’t think of a good reason for anyone to borrow 100% when purchasing a home, thereby becoming upside down on the mortgage payoff vs. attainable sales proceeds from day one.

From the Wall Street Journal:

Mortgage lenders are tightening their underwriting standards as more homeownership ends in foreclosure, but a new study suggests that the popularity of second mortgages could undermine their efforts.

New data in a research report from securities firm UBS shows that nearly half of all loans delinquent for more than 90 days this year also have second mortgages, while 30 percent of loans that are current have them, according to the UBS report.

“Mortgages that have a second mortgage behind them run a far higher risk of default,” says Zach Gast, a financial analyst in Rockville, Md., for the Center for Financial Research and Analysis, an independent research group. Gast says borrowers’ debt-to-income levels are similar for all mortgages, regardless of whether payments are late or current, suggesting the second mortgages are pushing borrowers into delinquency or default.

{ 7 comments… read them below or add one }

1 Norman Richards December 12, 2006 at 9:10 pm

I definitely agree, though I’m entirely guilty of over-borrowing. I did 3% down on my first duplex. At the beginning I was very strapped for cash since that 3% was pretty much all the savings I had. When a condenser coil on the AC went out early on (on my tenants side) it was off to credit card to pay. Ouch. I was definitely in WAY over my head. Great appreciation these last 2 years has definitely made it a profitable investment, but if had to sell before our recent boom I would have been in serious trouble.

On my most recent property, I did a full 80/20. However, that was not out of desperation. I had funds for a decent down payment, but they were tied up. (stock trading window issues) Rather than wait for cash in hand, I borrowed knowing I would be able to pay down the 2nd in about a year. That’s obviously an exceptional situation, and I would not have otherwise taken out an 80/20 given my past experiences.

Actually, given my experiences, I think having good reserves is more critical than a big downpayment. But, both are very important.

2 Dan K December 13, 2006 at 11:50 pm

Steve,

I have a question. Is there any extra incentives for Realtors to push buyers into 2nd mortgage situation if the buyers are using mortgage brokers referred by the same Realtors? I mean, normally, if your buyer buys a home and financed the home through your reference, you get a bonus from the mortgage broker right? So, the more loan he/she is borrowing, you get more cut? I’ve met several Realtors are like that. One of my friends who had only enough savings to do 10% down was persuaded to do 80/20(2nd mortgage) to avoid PMI. He used his cash reserve to buy a bunch of furnitures and a nice entertainment set.

I wonder if many agents would kindly point out to my friend that the PMI is not such a horrible thing as it is fully tax deductible in 2007 (http://www.msnbc.msn.com/id/16170664/).

3 Steve Crossland December 14, 2006 at 10:15 am

There is no financial incentive that I am aware of that would cause a Realtor to push a certain lender or loan product. It would be inappropriate unless fully disclosed to the Buyer. We don’t receive any compensation at all from a buyer’s loan, nor would I want to.

We do send buyers to certain Mortgage Lenders because those lenders know how to get the loan done and close on time and are competitive on rates, but those are the only things I personally care about when refering a buyer to a lenders.

We discourage low-downpayment loans because I think they are a bad idea (except for eyes-wide-open investors who have plenty of cash on hand). Maybe I’m old fashioned, but I don’t think people who can’t afford to save a downpayment should be buying homes. I know it “feels good” to help young families achieve the “American Dream” of home ownership, but I also know that over-borrowing and foreclosure wrecks the lives and credit of a lot of people who were doing just fine as renters. Too many solvent renters become upside down home owners in homes that can’t be sold because they have no equity.

But I also think it’s not just the renters becoming first-time buyers that get into trouble with loans, but the “keeping up with the Jones” folks who feel like they need to own rental property because all their friends are buying. Or they need to follow friends who have “move up” into a new, better neighborhood. Add to that consumer debt, car payments, etc and we have a lot of Americans living almost entirely on borrowed money while not building up savings for retirement.

Steve

Steve

4 Jim December 14, 2006 at 4:11 pm

In the end, it’s greed that ruins these people, not the sleazy mortgage broker or sleazy realtor.

The problem is very common out in North East Austin. There’s a good mix of first time buyers who could barely afford the house, and excited California investors who bought all they could get their hands on (those people are crazy..they’ll buy anything :). The result? Cash strapped buyers face foreclosure and suddenly all these homes are on the market. Also, investors flood the market with rentals and start renting out to trashy people just to get some tenants. It all combines together to keep property values down, making more home buyers upside down on their mortgage. Really sad.

5 Tony Steve December 20, 2006 at 3:39 pm

Jim… you’re right.

It’s no different than the 1980s and leverage buyouts, the beanie baby craze or dot com bubble. Irrational exuberance. Its amazing how we have more material wealth than any society in history yet we all want more stuff; to the point where we risk losing everything. It makes no sense.

6 Amy Broghamer February 6, 2007 at 7:33 pm

One of my best lenders talks about how you can really manage a 100% second mortgage very well. You’re right Jim… it’s not the sleazy lenders… they are just offering competitive products to people. People just try to stretch their monthly paychecks as far as possible. Some people can manage this, but the majority unfortunately cannot.

7 Steve April 2, 2007 at 6:00 pm

I think this argument is very old fashioned. Not many people, especially on the east coast, have 100K sitting in there bank accounts to put a down payment on a house. The salary increases have just not kept up with the real estate increases. These loans are now necessary for even very well off individuals to purchase homes, especially in the northeast where 400K will get you about 1500 sq feet. If you are educated, informed, and have good money management skills then a 100% financed loan can work. People that think otherwise are very old fashioned and living in the past.

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