By any measure, we are experiencing the worst housing crisis since the Great Depression. In Las Vegas, one housing price index is down 29 percent from its peak in August 2006. Foreclosures are rampant, new home sales are in the tank and consumer confidence has fallen to historic lows.
Our experience is not unique. Real estate markets across the country are suffering from the same ailments, in some cases much worse than us. As a result, President Bush on Wednesday signed into law a housing rescue package intended to stabilize the market and shore up the finances of mortgage giants Fannie Mae and Freddie Mac.
Now the speculation is focused on whether the approval of this rescue package establishes the long-sought market bottom — the perfect time to buy.
The Housing and Economic Recovery Act tackles the problem with three major components designed to quickly stabilize the market: a mechanism whereby a distressed homeowner can avoid foreclosure while reducing and refinancing an existing mortgage under attractive terms; a limited-time $7,500 tax credit for first-time home buyers; and a financial backstop for Fannie Mae and Freddie Mac that effectively guarantees their survival while providing a reliable source for future mortgage financing.
The foreclosure bailout is a potential boon to lenders and homeowners. Under the program, financially distressed homeowners have the opportunity to reduce their mortgages to 90 percent of their home’s current appraised value. The new mortgage will be a 30-year fixed FHA loan at the prevailing interest rate, currently 6.75 percent. In exchange for this refinancing, the homeowner agrees to share a substantial portion of any future appreciation with the original lender and the FHA.
Now the homeowner has two choices: suffer a foreclosure and all the damage that comes with it, or instead accept a lower payment and share future appreciation. The choice seems obvious.
But what about current lenders? They must consent to the refinancing, and why would they do that?
Because they will save a lot of time and money. Here’s how it works for them: Historically, lenders have lost about 50 percent of the loan amount through the foreclosure process. This 50 percent figure seems high at first, but it makes sense. By the time the foreclosure occurs, the lender has already lost six to 12 monthly payments. Then they pay the costs of the foreclosure itself, any necessary repairs and the ongoing expenses of home ownership (maintenance, property taxes, special assessments, HOA dues, utilities, etc.) while they work to sell the home.
During this time, they still aren’t collecting any payments, and when the home finally is sold, it’s at a significant discount due to the “as-is” nature of the sale and the over-supplied state of the market. Throw on top of all this the sales commissions (6 percent, minimum), incentives, closing costs plus the cost of the lender’s own management of the process, and the 50 percent number starts to look cheap, particularly in light of the market’s severe price adjustments.
Now consider the FHA refinancing option from the lender’s standpoint. They absorb the loss in the value of the home, but avoid all legal, administrative, maintenance, ownership and selling costs related to the acquisition and disposition of the home. Plus, they share in a substantial portion of any future appreciation in the home, and the FHA assumes all responsibility for any future losses that may occur. Effectively, they minimize their current losses, eliminate the risk of future losses and share in any upside the home experiences. Again, the choice seems obvious.
This program is only available on owner-occupied home mortgages, and certain financial guidelines must be met. The government estimates that 400,000 mortgages totaling approximately $90 billion will be refinanced, but has authorized up to $300 billion for the program.
The program has the potential to quickly and substantially reduce foreclosures of owner-occupied homes and significantly reduce the number of homes being offered as short sales (when the proceeds from a home sale are not sufficient to fully repay the loan). Short-sale homes listed on the valley’s Multiple Listing Service represent 27 percent of all homes available. A meaningful reduction in this amount would go a long toward bringing our supply of homes for sale back down to attractive levels, potentially providing support for stabilizing and even increasing prices.
Then there’s the demand-building, first-time buyer tax credit. Under this component, first-time home buyers receive a 10 percent tax credit ($7,500 maximum) on the purchase of any home to be used as their primary residence. The credit is available on home purchases that close escrow between April 9, 2008, and June 30, 2009.
This credit will actually increase the cash flow of many buyers. Let’s say a buyer decides to purchase a home for $175,000. The down payment on this home with an FHA loan is $6,125 (3.5 percent). If the seller is willing to pay the buyer’s closing costs — a common practice in today’s slow market — the new homeowner will come away with the home plus the excess of the tax credit over the down payment, or $1,375. The credit must be repaid at $500 per year for 15 years, and no interest is charged. And if the buyer ultimately sells home at a price that doesn’t fully repay the tax credit, the outstanding balance is forgiven.
It’s hard to imagine that people considering the purchase of their first home will not see the appeal of this program, or that they would think something better is in the offing. Given the limited time frame, entry-level home builder and bank-owned offerings should fly off the shelf and reduce the number of available homes for sale while, in turn, stabilizing or increasing prices. This will be especially true if the foreclosure bailout is successful in slowing the number of homes that come to market.
This may even generate growth in residential construction employment. The home building industry has drastically reduced staffing levels because of the downturn. As a result, new home inventory levels are extremely low, especially for entry-level residences.
What does that mean for first-time buyers? The new home they want probably hasn’t been built. That’s a six- to eight-month process, and the clock doesn’t start until the contract is written. These buyers need to make decisions quickly if they hope to close escrow before the tax credit expires.
The last, and in many ways the most important aspect of this law is the propping up of Fannie Mae and Freddie Mac. The primary focus here is guaranteeing the flow of credit into the mortgage market, rather than to directly stimulate sales and reduce inventories. Even so, the certainty of knowing that mortgages will be readily available as activity increases will help build confidence in the market.
The federal government has decided that the housing bust must end. It has put a tremendous amount of stimulus into the market to make it happen.
Many prospective home buyers have been waiting on the sidelines, looking for signs that the Las Vegas housing market has hit bottom. Those people should listen closely to the local prognosticators, who are now saying that we are at or near the bottom, and keep in mind that those statements were made before President Bush signed all these programs into law.
If they work anything like described herein, the turnaround is likely to be swift — and the opportunity fleeting.
Tom McCormick is president of Las Vegas-based Astoria Homes and McCormick Luxury Homes.