You will pay for your neighbor’s irresponsible borrowing and spending
When borrowers and lenders petition the government for relief through debt forgiveness and bailouts for losses, you are the one paying for whatever the borrower did with that money; the government is merely a middleman facilitator of a tax heist.
In a bygone era, lenders lost money if they made bad loans to irresponsible borrowers. With the advent of securitization, much of this risk of loss transfered to investors, and with the economic catastrophe of 2008, lenders learned the government would bail them out for any losses they were unable to pass on to investors. The too-big-to-fail banks no longer attempt to conceal the moral hazard behind their actions; they know they will be bailed out, so they act accordingly.
The worst example of moral hazard for both borrowers and lenders is the attitude toward mortgage equity withdrawal. Borrowers look at HELOCs as free money because they expect the house to pay it off. Lenders look at HELOCs as high-yield investments with little risk because they also believe the house will pay it off. All the manipulations of house prices, loan modifications, and other measures merely embolden both parties to be more irresponsible than ever — the the worst part is that you will end up paying for it either directly through taxpayer bailouts or indirectly through inflated house prices.
Why will you pay your neighbor’s bills?
If your neighbor asked you to pay for the renovations to their kitchen, would you pay it? If they asked you to pay for their vacation, would you pay it? If they asked you to pay for their cosmetic surgery, would you pay for it? Well, if they purchase these items with a HELOC and stiff the bank who then gets a bailout, you do pay for it.
When borrowers and lenders, parties ostensibly entering into a private contract, can petition the government for relief through debt forgiveness and bailouts for losses, you are the one paying for whatever the borrower did with that money, the government is merely a middleman facilitator of a tax heist — dollars move from your pocket, through the government coffers, and to the bank that funded the Ponzi. So how do you feel about that?
Does it give you a warm and fuzzy feeling about a return to unrestricted mortgage equity withdrawal?
After a home equity credit binge during the housing bubble, banks restricted the loans as home prices crashed. But now second mortgages are back in vogue.
By E. Scott Reckard and Andrew Khouri, February 20, 2014, 5:00 a.m.
Retired aerospace engineer Owen Klasen was rejected last year when he sought a second mortgage to paint and re-roof his house.
Home prices hadn’t risen enough, the loan officer told him.
But last month, the same loan officer offered him more than double the credit he needed.
“I told him I needed $25,000” on a home equity line of credit, said Klasen, who lives in Fillmore in Ventura County. “He said we were qualified to go up to $60,000.”
This is the behavior economists and politicians wanted because they subscribe to the belief in the wealth effect, the most dangerous euphemism in economics. The conventional interpretation is that rising house prices make people feel more confident than rising stock prices, so rising house prices have a greater impact on people’s desire to spend, a partially true interpretation because prior to the housing bubble, house prices had never gone down while stock prices had crashed repeatedly. A rising house price appeared more stable; however, that isn’t what’s really going on.
If stock prices go up, people don’t have ready access to that money, as they would have to sell some of that stock and pay taxes on the gains in order to obtain the money. That’s work; that’s a hassle; that’s why the correlation between stock price gains and consumer spending is so weak.
If house prices go up, it’s a different story. When credit is loose, lenders will loan 100% of the value or more of a house with a HELOC or second mortgage, giving homeowners immediate access to cash, and it doesn’t have any tax implications — and the owner doesn’t have to sell the house, so they may be offered even more free money in the future. That’s easy; that’s convenient; that’s why there is a strong correlation between house price gains and consumer spending.
Klasen is among a wave of homeowners in California and nationally who are again putting their homes in hock — despite the costly lessons of the housing meltdown.
After a home equity credit binge during the housing bubble, banks shut off the tap as home prices plummeted. Sobered homeowners stopped viewing equity as free money for cars, vacations and college educations.
Did they really change their views, or were they merely denied access to free money for a time?
But now second mortgages are back in vogue. Homeowners in the six-county Southern California region took out 47,542 home equity lines of credit last year — 48% more than in 2012, according to research firm DataQuick. The median credit line was $100,000. …
$100,000 is not a small loan, and half the loans were larger than that! It’s 2008 all over again.
The most popular use of equity lines is home improvement, followed by debt consolidation, Kockos said. But some borrowers are using the credit to double down on real estate, a popular move during the housing bubble. …
Home improvement is the only use of HELOC money that’s justifiable, but most people do that improperly. A typical renovation project adds about $0.60 for each dollar spent because a homeowner typically is renovating to their tastes rather than renovating only what adds value.
Using HELOCs for debt consolidation is a crutch. Financial advisors condone this because consolidating high-interest short-term debt with low-interest long-term debt lowers a borrowers payments; however, the borrower shouldn’t have borrowed so much on credit to need the consolidation in the first place.
Home equity lines of credit are a type of variable-rate second mortgage. They enable homeowners to borrow up to a pre-defined amount at their discretion.A homeowner with a $200,000 first mortgage on a $400,000 house, for instance, might take out a $100,000 line of credit. If the homeowner borrowed the maximum, the mortgage debt would total $300,000 — 75% of what the house would bring in a sale.
As long as HELOCs are limited to 75% or 80% of the value of the home, it doesn’t become a problem. In fact, Texas largely avoided the housing bubble because it prohibits HELOCs above 80% LTV; with no access to HELOC money, Texans had no incentive to drive up home prices, particularly given the high property taxes there. We have the opposite here in California: we have no restrictions on HELOC lending other than what the banks impose on themselves, and we have low property taxes capped by Proposition 13. Californians have every incentive to drive up home prices to create fake wealth, and no tax disincentive to dissuade them. Our HELOC availability and property tax regime is a recipe for house price volatility.
For lenders, the credit lines are riskier than first mortgages, which would be paid off first in case of a foreclosure. Still, these are no longer the easy-money loans of the housing boom, bank officials assure. Applicants who get approved today have high credit scores, along with ample savings and equity in their homes.
For now, I imagine these loans are being underwritten to more conservative terms, but what will stop the pendulum from swinging the other way? Lenders have little or no fear of losing money as they know they will be bailed out. Rather than a slow creep of loosening standards, we may see a rapid move toward pursuing this business if lenders believe they will be bailed out if things go badly.
During last decade’s housing boom, the standards were quite different — sometimes nonexistent. Banks have lost billions on loan defaults from that era.
They haven’t recognized most of these losses, and now that they know they can successfully manipulate house prices to restore collateral behind these loans, they will have even less fear of loss going forward even if they don’t get a direct government handout, which they probably will get if they want it.
The losses aren’t over. The way the credit lines are structured has created a new problem — payment shock on credit lines issued during the bubble.
That’s because the credit eventually runs out. At that point, often 10 or 15 years later, borrowers must pay back the entire amount or make set payments on the debt monthly, as with a traditional loan.
That can cost borrowers hundreds of dollars a month extra — payment shocks that will reverberate as the credit lines come due. National bank regulators have calculated that the draw periods will end for $29 billion in home equity credit lines this year at the nine largest U.S. banks. Those numbers rise to $52 billion next year, $62 billion in 2016 and $68 billion in 2017.
Officials at Bank of America and Wells Fargo & Co. said they have begun reaching out to borrowers well in advance of the date their credit lines mature, making sure that they are prepared for higher payments and, if necessary, talking about modifying the terms of the credit lines.
Who would have guessed they would modify these loans? (See: Will lenders kick the can when billions in HELOCs recast and payments skyrocket?)
Meanwhile, lenders are wading back into the business of issuing new home equity credit. In high-end markets, which recovered first, some borrowers are using home equity credit lines of $100,000 to $250,000 “as a financial tool” to buy more real estate, said mortgage broker Richard T. Cirelli in Laguna Beach.
Using HELOCs to load up on more real estate? Thousands of Ponzis used the same method to acquire dozens of properties (See: OC Housewife, Ponzi borrower, failed land baron) It will likely end just as badly next time around.
Lenders were bailed out when the housing market collapsed in 2008; they were given direct assistance through government bailout funds, and they were given indirect assistance through a variety of government and federal reserve programs designed specifically to reinflate the housing bubble. The costs of these bailouts fall to you in one form or another; either you pay through your taxes, or you pay through your mortgage on a more expensive house. As with the moral hazard of these bailouts firmly in the minds of borrowers and bankers, I expect we’ll see another even more massive housing bubble again in the future. It’s only a matter of time.
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27481 TIARA Dr Mission Viejo, CA 92692
$750,000 …….. Asking Price
$285,000 ………. Purchase Price
11/7/1997 ………. Purchase Date
$465,000 ………. Gross Gain (Loss)
($60,000) ………… Commissions and Costs at 8%
$405,000 ………. Net Gain (Loss)
163.2% ………. Gross Percent Change
142.1% ………. Net Percent Change
5.9% ………… Annual Appreciation
Cost of Home Ownership
$750,000 …….. Asking Price
$150,000 ………… 20% Down Conventional
4.27% …………. Mortgage Interest Rate
30 ……………… Number of Years
$600,000 …….. Mortgage
$145,739 ………. Income Requirement
$2,959 ………… Monthly Mortgage Payment
$650 ………… Property Tax at 1.04%
$0 ………… Mello Roos & Special Taxes
$156 ………… Homeowners Insurance at 0.25%
$0 ………… Private Mortgage Insurance
$0 ………… Homeowners Association Fees
$3,765 ………. Monthly Cash Outlays
($695) ………. Tax Savings
($824) ………. Principal Amortization
$231 ………….. Opportunity Cost of Down Payment
$208 ………….. Maintenance and Replacement Reserves
$2,685 ………. Monthly Cost of Ownership
Cash Acquisition Demands
$9,000 ………… Furnishing and Move-In Costs at 1% + $1,500
$9,000 ………… Closing Costs at 1% + $1,500
$6,000 ………… Interest Points at 1%
$150,000 ………… Down Payment
$174,000 ………. Total Cash Costs
$41,100 ………. Emergency Cash Reserves
$215,100 ………. Total Savings Needed