Friday, February 20, 2009

Redistribution -- Part 3 of 4

This is Part 3 of 4 on this subject—the proposed “rescue” of people with delinquent mortgages at the expense of other homeowners who have timely paid their mortgages.

Redistribution of Equity— Here’s an illustration of how real estate equity is effectively confiscated and redistributed to others.

Assume that a homeowner bought a house or condo some years ago for $200,000. The bank probably required a 5 or 10 percent down payment, or about $10,000 to $20,000 paid from savings. Suppose that over the years, the owner has been timely paying off the $180,000 loan, and that the house had recently appreciated to about $250,000. Estimate that $150,000 is still owed on the mortgage, meaning that there should be equity of about $100,000.

Under the federal government's “affordable housing” policy, another person could buy a similar $250,000 house or condo for little or no money down. These are called “sub-prime” mortgages because this buyer would not qualify for the same loan as the buyer above, and there is a risk that this buyer will default and walk away because he has invested nothing of substance in the property. (Yet, stockholders, mutual funds and retirement plans owning the banks and holding the mortgages have their capital and savings at risk).

Now assume that for any number of reasons that the “sub-prime” mortgage is currently in default and the bank may have to take the property back. Envision millions of similar situations across the nation. Such properties are dumped on the market for sale in hopes they can be sold before they are foreclosed upon.

But, where will the new buyers come from? Millions who could “qualify” already bought a house for little or nothing down, and banks are reluctant to make any more risky “zero down” loans. So, the asking prices for these houses are lowered in hopes of attracting buyers. After the property sits on the market for a while, the asking price is lowered again. If the properties don’t sell, they may be repossessed by the banks. But what would the banks do with them? Who would the banks sell them to? There are more sellers than buyers.

The values of all houses and condos in the neighborhood are lessened because a property stubbornly listed for more than others in the area would never sell. The true value of any property is determined by a comparison to similar properties in the area.

Meanwhile, the owner who believed he had a $250,000 property with equity of about $100,000 now finds that the “fair market value” has probably diminished to $225,000, $200,000 or $175,000. So, it must be concluded that—

--unsuccessfully trying to provide “affordable housing” for others has cost responsible mortgage payers in the neighborhood $25,000 to $75,000 in lost equity (10 to 30 percent loss); or

--the true growth of equity over the last few years was never that big anyway (so hopefully the property was not re-financed and equity taken out against the inflated value for money to make repairs, pay off credit cards, or pay college tuition); and

--the only way to avoid the “loss” is to not sell the property until the higher values return— if they ever return.

(Continue to next posting on this subject, Part 4 of 4).

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