The current administration continues to attempt a myriad of policies aimed at bringing about a recovery in the housing industry. It is not their belief in the importance of homeownership that drives this policy. This administration has openly questioned whether the government should continue to support homeownership as an American ideal. Every policy had one purpose in mind: that stabilizing home prices would help stabilize the economy.

The purpose of the original stimulus package (the homebuyers’ tax credits, the lowering of interest rates by purchasing mortgage-back-securities, different modification programs) was to stabilize housing prices. It had nothing to do with getting families into homes or keeping families in their current homes. The government realized very early on that a recovery in housing would require a stabilization of values. Why? Because a large percentage of homeowners ‘walk away’ from their homes once they fall into a negative equity situation (where their home is worth less than the mortgage on the home). That would create more foreclosures and continue the cycle below:

The administration had to stop home prices from falling. Their ability to control prices would be determined by the theory of ‘supply and demand’. At first, they attempted to increase demand by lowering interest rates and providing tax incentives. They attempted to influence supply by controlling the flow of distressed properties coming to the market with an assortment of loan modification programs. These policies had a short-term positive impact on pricing. However, supply is again skyrocketing and demand seems to be plummeting.

The administration realizes that another drop in house prices will create a new group of homeowners who will fall further into a ‘negative equity’ position. That is why they have introduced the new FHA Short Refinance Option today. The purpose:

The FHA offers help to qualifying non-FHA borrowers who are “underwater” on their home loans. The FHA Short Refinance option is open to those who are current on their existing mortgage—but the lender must agree to forgive at least 10% of the unpaid principal on the original note.

The program’s intent is to prevent homeowners falling further into a negative equity. The Wall Street Journal posted frequently asked questions here.

Bottom Line

Will the program help families? We’re sure it will. If you qualify, jump on it. Will it help enough families to turn the housing market around?  We doubt it.

download the full report

One of the greatest threats to a housing recovery is the months’ supply of housing inventory available for sale. A normal market would have between 5-6 months inventory. We currently have 8.9 months of inventory and most experts believe that number will increase rather dramatically when the National Association of Realtors’ August Existing Housing Report is released today. The supply of inventory is made up of two categories of properties: non-distressed and distressed (short sales and foreclosures).

Part of the administration’s stimulus package was aimed at curtailing the flow of distressed properties coming to the market therefore easing the downward pressure on home prices.

The Home Affordable Modification Program (HAMP) is the administration’s hope for troubled homeowners trying to avoid foreclosure by modifying their current mortgage payments. The original press release said the program was:

“…aimed at helping 3 to 4 million at-risk homeowners – both those who are in default and those who are at imminent risk of default – by reducing monthly payments to sustainable levels.”

The goal was to help prevent 3-4 million distressed properties from coming to the market.

How close to goal is the program?

The administration released the August Housing Scorecard yesterday. The report attempts to convey the successes of the administration’s policies in stabilizing the housing market. The report shows that they have completed only 434,700 permanent modifications to date. The administration also just announced that of those permanent modifications, 19.6% will re-default within 9 months. That leaves over 3 million properties that will probably end up as distressed sales.

Mark Zandi, chief economist at Moody’s Analytics, probably said it best:

“The government program as currently structured is petering out. It is taking in fewer homeowners, more are dropping out and fewer people are ending up in permanent modifications.”

What does this mean?

There will be more and more distressed properties coming to market. Even the Housing Scorecard addresses this issue both in print and with a graph:

“Foreclosure completions also inched upward as the volume of serious delinquencies continues to work through the pipeline.”

Though the numbers of foreclosure notices are stabilizing, the numbers of repossessions are still on the rise.

Bottom Line:

The modification program has not been the answer the administration had hoped it would be. There will continue to be downward pressure on home prices as the inventory of distressed properties continues to mount.

The economy has destroyed the financial stability of many households. More and more families are in fear of losing their home to foreclosure. We feel for these families. Steve Harney, a featured contributor, has shared his own personal story with us in an open letter to this blog where he proclaimed “there is always hope”.

We know it can be difficult but Fannie Mae has just launched a website that helps troubled homeowners realize that they do have alternatives. Click the picture below to ‘know your options’.      – The KCM Crew

The big question about shadow inventory is when this backlog of foreclosures will come to market. Prices will not be adversely affected until these distressed properties are actually put up for sale. Only then will they truly be competition to existing homes for sale. It seems that day may be upon us.

Much of the main stream media are concentrating on two major changes which are occurring in the foreclosure numbers:

1. Foreclosure filings by banks are decreasing
2. Homeowners who are falling behind on their mortgage payments are decreasing

What the media has not concentrated on is that the number of homes banks are actually repossessing (REOs) is up 38% over last year.

According to the most recent foreclosure report from RealtyTrac:

“The pace of properties entering foreclosure slowed as lenders pre-empted or delayed foreclosure proceedings on delinquent properties with more aggressive short sale and loan modification initiatives. Meanwhile the pace of properties completing the foreclosure process through bank repossession quickened as lenders cleared out a backlog of distressed inventory delayed by foreclosure prevention efforts in 2009.”

The reason banks are concentrating on repossessions instead of foreclosure filings is to clear the existing foreclosure inventory from their books. How many properties are we talking about? From the same report mentioned above:

“The midyear numbers put us on pace to exceed 3 million properties with foreclosure filings by the end of the year, and more than 1 million bank repossessions.”

That is 1 million properties the bank will be bringing to market. That number is on top of the number of short sales already in the works.

What does this mean to you?

The banks have sped up the repossession of foreclosed properties in preparation to bring them to market. On average, an REO property is sold at a 34% discount. This wave of discounted properties will become your competition if you are planning to sell this year. Price your house to sell now before the banks release their inventory.

There have been some extraordinary numbers being bantered about when talking about the number of foreclosures that will be coming to market over the next 18 months. Different studies have estimated that number to be between 5-8 million. Let’s take a look at one of these studies today and see how these totals are being calculated.

The Financial Analysis Journal last month posted an article titled Dimensioning the Housing Crisis in which they break down how they arrived at the number of 7.13 million foreclosures about to come to market.

When looking at foreclosures, it is important to realize we are not talking about only those homes currently owned by banks (REOs) but instead the probable number that will be owned. To decipher that number, we must look at two things:

1. The percentage of foreclosures and the percentage of homes in delinquency
2. The probability of liquidation (cure rate)

THE PERCENTAGES

The article breaks down the percentage of foreclosures and the percentage of homes in each delinquency category:

At the end of the third quarter of 2009 (last data available), a staggering 14.1 percent of mortgages in the MBA survey were in some stage of delinquency: 4.47 percent of units were in foreclosure, another 4.41 percent were 90+ days delinquent, 1.67 percent were 60 days delinquent, and 3.57 percent were 30 days delinquent.

These percentages put the actual number of homes in danger at 7.89 million.

THE CURE RATE

Cure rates measure the percentage of loans exiting delinquency and returning to their current payment status each month. These percentages have plummeted over the last several years as the housing market has suffered.

The cure rate is most negatively impacted by unemployment and negative equity. Neither of these are expected to improve in the near future.

THE FINAL TALLY

Below is a table using both the percentages and the cure rates to determine the number of potential foreclosures coming to the market.

The first column shows the percentage of homes in each category of delinquency. The middle column are the current cure rates for each category. The last column is the total percentage of each category that will wind up as a distressed property.

The study estimates 7.13 million distressed properties will come to market.

What does this mean to you?

Whenever there is an increase in supply of an item, there is downward pressure on pricing. The houses coming to the market will be sold by the banks at discounted prices. Home values will be impacted dramatically.

Waiting on a Miracle?

The Home Affordable Modification Program (HAMP) is the administration’s hope for troubled homeowners trying to avoid foreclosure by modifying their current mortgage payments. The original release said the program was:

…aimed at helping 3 to 4 million at-risk homeowners – both those who are in default and those who are at imminent risk of default – by reducing monthly payments to sustainable levels.

HAMP publishes a report each month showing their progress. The May report had some interesting data in it. We want to go over that data in the blog today.

How many modifications have been completed?

HAMP acknowledges that there are over 3 million homes in need of a modification. Thus far, they have offered approximately 1.5 million trial modifications. The results so far: less than 300,000 permanent modifications, which is just a 20,000 more than the number of trials that have been cancelled.

Here is a table which appeared in report:

Will the permanent modifications really work?

The big question is whether the modifications will be a long term solution. One item that jumps off the page is the back end “debt-to-ratio income” (DTI). The report defines this as:

Ratio of total monthly debt payments (including mortgage principal and interest, taxes, insurance, homeowners association and/or condo fees, plus payments on installment debts, junior liens, alimony, car lease payments and investment property payments) to monthly gross income. Borrowers who have a back-end debt-to-income ratio of greater than 55% are required to seek housing counseling under program guidelines.

Why counseling? Because anything over 55% is a re-default waiting to happen. And the report shows a DTI of 64.3%!

Diane Olick of CNBC reported:

The HAMP report puts that at 64.3 percent, meaning you’ve got 35.7 percent of your income to spend once you’ve paid all debt-related bills—not to mention your income taxes! Last month it was 61.3 percent, the month before, 59.8 percent, so it’s getting progressively worse.

“A 64.3% DTI is so far out of scope with the pre-bubble years safe and sound 36% total DTI — and even typical bubble-years full-doc DTI’s of 50% — it is absolutely irresponsible,” says mortgage analyst Mark Hanson. “Servicers are pushing the envelope with respect to getting people to qualify,” he adds.

I have to wonder if any mortgage originator today would even offer a new loan to anyone with those kinds of stats. My guess is no.

What does this mean to you?

I think it is great news that the program has helped almost 300,000 families stay in their homes. Yet, that is less than 10% of the borrowers that need help. Most of the 3 million+ homes will eventually be a short sale or foreclosure. They will enter the market at discounted prices.

The goal of this blog is to create clarity from the confusion in today’s real estate market. We try to take complicated issues and break them down into simpler pieces, and then try to explain how the pieces fit together. There is no situation more difficult to dissect than the current foreclosure numbers.

Yet, understanding this issue is critically important. The number of distressed (discounted) properties entering the market will have a major impact on house values as we proceed through 2010.

Ascertaining an accurate forecast seems impossible at times however. Foreclosure reports consistently seem to be contradicting one another. Take this month’s RealtyTrac Foreclosure Report, which was released last week. The headline screamed “Foreclosure Activity Decreases 9% in April”. News sources and industry heads shouted this news from mountaintops. Things in the foreclosure sector are finally getting better they claimed.

Here at this blog we attempt to go past the headlines and look at the complete story.

It is true that one type of foreclosure activity did decrease:

During the month a total of 103,762 properties received default notices, a decrease of 12 percent from the previous month and a decrease of 27 percent from April 2009 — when default activity peaked at more than 142,000.

However, reading further in the report we find that:

Bank repossessions (REOs) hit a record monthly high for the report in April, with a total of 92,432 properties repossessed by lenders during the month — an increase of 1 percent from the previous month and an increase of 45 percent from April 2009.

The numbers of notices filed were down 27%, but the number of houses taken back by banks was up 45%. That doesn’t sound like such great news to us. And what is the reason notices are down? Could it be that the banks were concentrating their time and efforts repossessing the homes they had already foreclosed on? We already have reported that there are borrowers as much as two years in arrears on their mortgage payments that have yet to receive a foreclosure notice. CNBC reported on this exact point last week:

The fact that fewer loans are going into the pipeline should be our focus, and that’s a positive. That’s what I thought until I interviewed RealtyTrac’s Rick Sharga.

“People are sitting in their houses not paying their mortgages, and the banks are letting those delinquencies extend longer and longer periods of time before they put them in foreclosure,” Sharga told me.

That, he adds, is the main reason we’re seeing lower numbers of new defaults. The borrowers are in default, but the banks aren’t paying attention, so they don’t show up in the numbers.

Let’s take a closer look at all the pieces of the foreclosure pipeline that add up to our current situation:

Just because one element of the foreclosure process has slowed (in this case #2 – “Notices”) does not mean that the other three elements are not continuing on a fast pace.

What does this mean to you?

In order to pick the best option for you and your family, you need someone who truly understands the current housing environment. Find that person, and have them sit down with you and accurately define the market.

As I mentioned in a post earlier this month,  5 Keys to a Real Estate Recovery:

I believe both the increase of distressed properties and the timing of their release to the market will be the biggest real estate story of 2010 … Anytime the supply of an item increases and demand remains flat, pricing is adversely impacted. This supply will come at discounted prices. Its impact could be substantial.

There were four major news reports concerning foreclosures last week. None were good news to an anticipated housing recovery or to home values in 2010.

Let’s go over each news item:

RealtyTrac’s Foreclosure Market Report 1st Quarter 2010

RealtyTrac is one of the leading data resources for foreclosures in the country. Most main stream media see them as the major player when it comes to reporting on the foreclosure situation. In this quarter’s report, they stated:

Foreclosure filings were reported on 367,056 properties in March, an increase of nearly 19 percent from the previous month, an increase of nearly 8 percent from March 2009 and the highest monthly total since RealtyTrac began issuing its report in January 2005.

“Foreclosure activity in the first quarter of 2010 followed a very similar pattern to what we saw in the first quarter of 2009: a shallow trough in January and February followed by a substantial spike in March,” said James J. Saccacio, chief executive officer of RealtyTrac. “One difference, however, is that the increases were more tilted toward the final stage of foreclosure, with REOs increasing 9 percent on a quarterly basis in the first quarter of 2010 compared to a 13 percent quarterly decrease in REOs in the first quarter of 2009.

“This subtle shift in the numbers pushed REOs to the highest quarterly total we’ve ever seen in our report and may be further evidence that lenders are starting to make a dent in the backlog of distressed inventory that has built up over the last year as foreclosure prevention programs and processing delays slowed down the normal foreclosure timeline.”

… REOs also hit a record high for the report in the first quarter, with a total of 257,944 properties repossessed by the lender during the quarter.

A property is classified as REO after a bank forecloses and repossesses it. The banks are beginning to foreclose at greater rates and are actually taking possession of the houses. This is a sign that the banks are preparing larger foreclosure inventories to release to the market.

As a matter of fact it seems Bank of America is already beginning the process of releasing these properties in certain regions. The North Country Times reported last week:

Bank of America, the nation’s largest mortgage lender, ramped up its foreclosure activity in March, sending hundreds of letters warning delinquent borrowers in the region that it could sell their homes at auction in as little as three weeks, according to North County Times analysis of data from ForeclosureRadar.

The bank said the increased activity was a natural consequence of borrowers running out of options … Richard Simon, a Bank of America spokesman, wrote in an e-mail that he couldn’t speak to the sharp increase of notices in San Diego and Riverside counties, but that the bank has expected more foreclosure activity.

“We have reported recently that we anticipate a rise in foreclosure activity through the coming months as homeowners are unable to qualify for loan modifications, fall out of modification programs or go into delinquency due to the ongoing stress in the economy,” he said.

Analysts and real estate agents said the moves by the Charlotte, N.C., banking giant, which controls a large share of the Southern California mortgage market, could signal a final reckoning for homeowners who have been protected by government programs for months or even years.

Fannie & Freddie’s Foreclosure Report

In an article in Housing Wire, it was reported:

The government-sponsored enterprises Fannie Mae and Freddie Mac, like the banking industry, are preparing for a surge in foreclosures to hit already overloaded REO portfolios in 2010.

Freddie holds 45,000 real estate owned (REO) properties in its portfolio as of the end of 2009, according to a filing with a quarterly filing with the Securities and Exchange Commission (SEC).  And while Freddie expects the number of REO to continue to grow in 2010, exactly how much will depend on the pace of the economic recovery, according a spokesperson at Freddie.

Fannie currently holds 86,000 REO properties in its inventory as of the end of 2009, according to its report to the SEC. That number has more than doubled the 33,729 at the end of 2007 and grown another 35% from 63,538 in 2008.

“Although we have expanded our loan workout initiatives to keep borrowers in their homes, we expect our foreclosures to increase in 2010 as a result of the adverse impact that the weak economy and high unemployment have had and are expected to have on the financial condition of borrowers,” according to the SEC filing by Fannie.

First American Core Logic’s Distressed Sales Report

This report qualified the number of distressed sales already coming to market and talks to their impact on a recovery and on home prices:

The report indicates that distressed home sales – such as short sales and real estate owned (REO) sales – accounted for 29 percent of all sales in the U.S. in January: the highest level since April 2009.

Distressed sales are non‐arms length transactions such as REO or short sales. Market sales are arms‐length transactions between a willing buyer and willing seller and they exclude distressed sales. Distressed sales have a very strong influence on home price trends and are an indicator of a housing market’s health.

Lending Processing Services Mortgage Monitor

This report showed the percentage of loans 6 months or more delinquent which have not had foreclosure procedures even started yet. This represents future inventory of foreclosures that will come to market.

Here is a graph showing the percentages:

What does this mean to you?

We have told every seller for months that we believe the best chance you have to maximize the price you will receive for your house is to sell it before the ‘shadow inventory’ of distressed properties comes to market. It appears this is about to happen.

The Foreclosure Ripple

Yesterday, we covered the coming surge of distressed properties that will enter the market in 2010. Today, we will discuss the impact these properties will have on housing values as we proceed throughout the year.  Questions you should be asking yourself are: 1) Do distressed properties sales impact the value of the surrounding homes, 2) If yes, then to what degree are the surrounding home values impacted, and 3) If home values are affected dramatically by distressed property sales, then what is the REO saturation level of my state?

Let’s begin to answer these questions.

Do distressed properties impact home values in a area?

Distressed properties (foreclosures and short sales), by their nature, are priced at a discounted percentage of the values of houses in the surrounding neighborhood. Here is a graph from First American Core Logic showing that percentage over the last four years:

As we can see, today’s average discount stands at about 35% of the non-distressed sales in the area. These distressed (and discounted) properties are included as comparable sales by bank appraisers to establish value of normal resale properties in a community; therefore homes in a neighborhood experiencing a foreclosure or short sale are significantly impacted.

In another graph from First American Core Logic, we can see that as the percentage of Distressed Sales increased, Prices decreased.

To what degree is value impacted financially by a distressed sale?

The Center for Responsible Lending has been studying this issue for the last several years and has actually devoted a portion of their website to this issue. Below is a screen capture of their site:

As we can see by the bottom-left number, (in my state of New York) values are negatively impacted to the tune of over $37,000!!  [You can check your state by going here.]

This situation will continue in 2010.  In a report released this month, Clear Capital stated that:

U.S. quarter-over-quarter home prices fall for the first time in nine months…REO saturation rates continue to rise.

And it occurred throughout the nation as the following visual of Home Prices from Clear Capital shows:

What does this mean to you?

Distressed properties in your area will have a negative impact on values in the community. There are many foreclosures and short sales coming. It has already started to impact prices. If you are looking to sell, do it before prices fall further.

I firmly believe the foreclosure situation will be the main story line in real estate for the rest of 2010. There will be other key factors (unemployment, government involvement, interest rates, etc.). However, no issue will have the same impact as the tidal wave of distressed properties about to come to market.

For purposes of this blog we will always consider distressed properties as those that fit into one of three categories:

1. Real Estate Owned (REOs) by banks currently
2. Houses that are in the process of foreclosure
3. Houses that are 90+ days delinquent on their mortgage payment (the reason we include this category is that recent studies have shown that less than 1% of the borrowers who fall 90 days behind ever catch up. That means that 99% of these homes will turn into distressed properties).

How many such properties are we talking about?

Below is a graph from an article in Servicing Management in February that addresses this point:

As we can see the number is almost 2 million homes and that doesn’t include any homes currently on the market. Many experts see this as a very conservative estimate.

When will this inventory start coming to market?

It already has begun. First American Core Logic released a media alert on April 8 addressing the issue. In the report they stated:

The report indicates that distressed home sales – such as short sales and real estate owned (REO) sales – accounted for 29 percent of all sales in the U.S. in January: the highest level since April 2009…The rebound in distressed sales occurred due to increases in both the REO and short sales shares. The REO share increased to 22 percent in January 2010, up from 19 percent in December but down from a year ago when it was 27 percent. Short sales accounted for 8 percent of all sales in January, up from 7 percent in December and 5 percent a year ago. During the last 12 months, there were 974,000 distressed sales: 740,000 were REO sales and 234,000 were short sales.

Even though delinquencies continued to mount, the number of distressed properties entering the market slowed over the last several months as more and more homeowners attempted to get their mortgages modified. We are now past that point and banks are taking foreclosure action on the homes that did not qualify for the modification programs. There will be a surge in distressed properties over the next several months.

According to the Irvine Housing Blog:

The west coast manager of real estate owned, Senior Vice President Ken Gaitan, stated that Bank of America, which currently forecloses on 7,500 homes a month nationally, will increase that number to 45,000 homes per month by December of 2010.

That is one bank calling for a 600% increase in the number of foreclosures coming to market.

How will this impact prices?

We will cover this point at length in tomorrow’s post.