Borrowers don't have a clue

It would be an easy fix if we could assign the ultimate blame for the current subprime loan fiasco to a single event or party. Regulations could then be adopted that would correct the problem from happening again. But like other misfortunes, there is never a single event that is totally accountable but a series of happenings leading to the fateful conclusion. Here is a few which contributed to our current subprime fallout:

Investors and their money abandoned the stock market in 2000 seeking higher returns on less volatile and more secure real estate. The Federal Reserve lowered interest rates in an attempt to stimulate a sagging economy. Tax cuts boosted consumer spending which resulted in job growth and historically low unemployment. Builders had a historical low inventory of finished houses and buildable lots since recovering from the last market correction. California real estate and banking regulators adopted legislation that exempted lenders from the formality of having a real estate license. Housing demand drove home values to unaffordable levels.

Borrowers were not exempt from contributing to this perfect storm. Many made poor credit choices or based their housing decisions upon investment expectations rather than lifestyle considerations. Somewhere along this trail, the family home became a discretionary investment tool. Builders, lenders and real estate agents helped facilitated the whole process.

Now that we have time to reflect upon our current circumstances, the loan regulators are attempting to discern what changes need to be made in the lending process by the purveyors of credit. One change that would help future borrowers would be to revise or eliminate the plethora of loan documents into something understandable. Federally mandated mortgage disclosures, forced upon lenders and borrowers for the past 30 years, “are confusing and do not address the variety and complexity of today’s mortgage products,” said Federal Trade Commissioner (FTC) Deborah Platt Maqjoras after reviewing the recent FTC study which demonstrated that most borrowers don’t have a clue about the details of their mortgage.

The report released last month by the FTC, shows how unaware borrowers are regarding the details of a mortgage loan. In the study, 800 borrowers who had recently obtained a mortgage loan, were provided typical loan documents on a hypothetical fixed rate loan and then asked a series of questions. Half the borrowers could not identify the correct loan amount. Nine out of ten could not figure the total upfront cost of the loan. Two-thirds did not recognize a pre-payment penalty and 95 percent could not figure out the amount of the penalty. Eighty percent did not know why the interest rate and the Annual Percentage Rate (APR) of the loan were different. One in five could not identity the interest rate of the loan, monthly payment or the amount of cash due at closing. If a typical borrower can’t figure out the loan amount, how can they be expected to know anything about: indexes, margins, points and neg arms?

The FTC study confirmed what I have been telling readers for years, “More is less.” The more standardized loan papers are provided to borrowers, the more likely they are to become confused and chose the wrong, more expensive loan. Borrowers are buried in meaningless loan papers. Alex Pollock, former president of the Federal Home Loan Bank of Chicago put it this way. “Most of us had the experience of being overwhelmed and befuddled by the huge stack of documents full of confusing language in small print, presented to us for signature at a mortgage closing. The complexity results from legal and compliance requirements. Ironically, past regulatory attempts to insure full disclosure have made the problem worse.” Ah Ha! Finally the problem reveals itself, too much information.

Mr. Pollock, who is now in private practice, has proposed a simple, one-page disclosure document that states in simple English (or national language of choice) the “essential” of the loan. For example: If the loan was an Adjustable Rate Mortgage, the disclosure would say what the beginning interest is, how long it will stay in effect and what the maximum possible rate would be. The form would also show a “fully-indexed housing ratio,” which would show what percentage of a person’s income would go toward a mortgage payment. The greater expense ratio, the riskier the loan.

A simplified, easy to read mortgage loan disclosure will help future borrowers but more needs to be done. Predatory lenders need to be put out of business. Anyone originating a mortgage loan in California should have a state license with some educational requirements. Mandatory educational requirements with regards to financing and owning a home should be a requirement for first time buyers applying for a government insured loans. An unknowledgeable borrower who defaults on a mortgage has no affect on the economy or real estate values. A million defaulting borrowers is a wake-up call. Borrowers need more facts and less paper.

Best places to live

Between appointments yesterday, I stopped in a grocery store to buy a few items and while standing in the checkout line picked up the latest copy of “Money” magazine. This month’s feature was about the 100 best places to live in country. I knew that El Dorado Hills was ranked in the top 100 so turned to the synopsis. Here are a few facts you may not know about El Dorado most popular zip code.

The median family annual income is $116,406. Job growth between 2000 and 2006 was 32 percent, air quality index shows 71.8 percent of the days ranked good, the average commute time is 29 minutes and within 15 miles the magazine found: 13 movie theaters, 1,572 restaurants, 71 public golf courses, 23 libraries, one museum within 30 miles and 18 ski resorts within 100 miles.

The magazine found that residents are slightly older, have completed more higher education and have a higher rate of marriage and a lower divorce rate and take more vacations than in the average 100 best places to live.

The criteria that “Money” used in selecting the best places to live included: populations with less than 50,000, affordable housing, plentiful leisure activities, cultural options, sunny weather, short commute time and good health care access.

The number one best place to live picked by the Money editors was Middleton Wisconsin. I looked at Middleton, population 17,000. There were some nice pictures of green lawns and cute house but then I read that the average property tax on a $300,000 home was $5,000 a year and the average temperature during the winter was 10 degrees with six to eight feet of snow. Maybe the ranking of the 100 best places to live should be done in January rather than in August.

All too familiar

Realtors Bob and Nancy Hunt called to tell me what they heard at a recent Orange County Association of Realtors meeting. Local economist Gary Watts gave a talk where the main message was -- keep news about housing in perspective.


The popular press has called an end to housing for some time, says Watts:
"The goal of owning a home seems to be getting beyond the reach of more and more Americans. The typical new house today costs about $28,000." Business Week, 1969

"The median price of a home today is approaching $50,000 ... housing experts predict price rises in the future won't be that great." National Business, 1977


"The golden age of risk-free run-ups in home prices is gone." Money Magazine, 1985

"A home is where the bad investment is." San Francisco Examiner, 1996

"We want to share some of his other observations," said the Hunts. And they did so by sending me a memo filled with interesting facts and figures Watts gave during his talk.
Among the "gems," say the Hunts, were the following:


· Since the year 2000, Orange County homes have appreciated over 100 percent.
The average Orange County appreciation rate over the past 37 years has been 14.9 percent yearly.
2005 was the peak subprime lending year in Orange County, when subprime loans represented about 23 percent of all loans funded.
Nationally, the delinquency rate on sub-prime loans (13.77 percent) and conventional loans (2.57 percent) combined produces a delinquency rate of 4.84 percent. The record low is 4 percent.
The California delinquency rate is currently 3.25 percent.
In 2006, the California foreclosure rate was 1.17 percent.
Out of 5,680 properties that entered foreclosure in 2006, only 697 were foreclosed upon.
As of July, only 13 percent of properties listed in the MLS were bank-owned.
"Half-full? Half-empty? It depends on who is looking at the glass," say the Hunts. "Just remember, there is another perspective than the one we receive from the news media."

Lawsuits hapen

Even in a good real estate market, housing receives a fair share of negative publicity. Featured newscasts in 2004 and 2005 showed cold, sleep-deprived homebuyers camping out overnight anxiously waiting for the opportunity to place a reservation on a new home. Affordable housing advocates lamented escalating home prices were contributing to an increase in the number of homeless. Economic soothsayers speculated upon when the housing bubble would pop, plunging the economy into recession. Flippers were making excessive fortunes and greedy landlords were gauging renters.

Now that the pendulum has swung, or the axe fallen, depending upon your perspective, real estate continues to get clobbered by the major media. Somehow the housing market is totally responsible for the recent correction in the stock market, tightening credit standards, a drop in consumer spending, job loses, foreclosures, higher house payments, decreasing tax revenues and global warming.

Not everyone is complaining about our market correction. The drop in home sales and property values has been a mini-economic boom to real estate attorneys who specialize in real estate deals gone bad. According to the insurance industry professionals, liability cases against real estate agents, builders and lenders have increased significantly over the past year. So much so that the National Association of Realtors recently completed a random survey of 650 court cases, jury verdicts and settlement reports to determine the most problematic legal challenges facing real estate professionals. The details of the 2007 “Legal Scan” are not released to the general public but a summery report was issued earlier this month.

The leading cause of lawsuits against real estate agents was alleged omissions or misrepresentations about a property’s condition. The most common property defects were: mold, structure defects, zoning, sewer/septic system, drainage, and insect or vermin infestation. Allegations of breach of an agent’s fiduciary responsibility were central to 100 of the 650 cases and agents who represented both the buyer and seller in a real estate transaction (dual agency) had more legal problems than those who only represented one party (single agency). There were also a number of cases alleging illegal kickbacks, undisclosed affiliated business arrangements and inadequate disclosure of settlement costs.

While consumers filed hundreds of lawsuits against their real estate agents, they didn’t win most of them. Most of the lawsuits were settled before trial. Of the 650 cases studied, 315 ended in a judgment either from a pretrial proceeding or a verdict. Of those, 66 percent were resolved in favor of the agent. Most of the cases that went against an agent were jury trials. The highest awards were for deceptive trade practices followed by breach of fiduciary duty and breach of contract. The highest award in the survey was for $4.2 million the lowest was $5,000.

Unfortunately, like with any other business, mistakes and misunderstandings happen. When something major goes wrong with the family home, however, you can’t mail it back for a refund. Buying a home is the single largest financial investment most of us make and that decision is usually based upon our positive emotional expectations. We expect to live happily ever after in our dream home. We visualize a sanctuary of peace and refuge, the nice quiet neighbors next door and appreciating property values. Problems often occur when life’s reality doesn’t meet expectations. The replacement of the central air conditioner, a leaky roof or a backed up septic wasn’t part of the dream of home ownership. When a homeowners dream turns into a nightmare they begin to carefully analyze how they ended up in their situation, occasionally with the help of an attorney.

The number of lawsuits against agents always increases during a downturn in the market. Property defects don’t seem as severe when property values are increasing. A little mold in the bathroom….no problem, planning on remodeling anyway. Overlooking a property defect or an agent’s misrepresentation when values are declining is more difficult.

Like any profession, there are a few unscrupulous and greedy agents who will say or do anything to get a client to the closing table. However, the majority of judgments against agents in the cases studied were not the result of fraud or intentional misrepresentation but negligence misrepresentation and breach of fiduciary duty. New agents who had been in the business less than 3 years and high volume agents who managed 40 plus clients a year were more likely to end up in court.

The California Association of Realtors have been concerned about the increasing number of consumer lawsuits against their membership. Last year they promoted new legislation requiring all licensed agent to complete a 3-hour, Department of Real Estate approved, Risk Management course before agents can renew their 4-year license. The DRE should also require agents as a condition of licensure, to maintain Professional Liability Insurance. Filing a lawsuit against an agent isn’t any guarantee that the plaintiff will be able to collect for damages. Homebuyers and their agents deserve some standard of minimum protection that would avoid cumbersome and costly lawsuits or bureaucratic DRE procedures. Perhaps the California Association of Realtors will make that a legislative priority in the future.