Real Estate
Voices from the Home-Loan Bust
Three families cope with rising mortgage payments and declining property values.
By Pat Mertz Esswein, Associate Editor
From Kiplinger's Personal Finance magazine, July 2007
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It wasn't long ago that homeowners across the country were gloating over soaring home values in their neighborhoods. Now there's blood in the streets.
What at first looked like an inevitable downturn in the real estate cycle has turned ugly. Wall Street firms that once eagerly packaged mortgages into securities and encouraged lax lending standards and 100% financing are pressing lenders to tighten up. In response, lenders now require larger down payments or more equity, higher credit scores and closer scrutiny of appraisals.
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Although the vast majority of borrowers still make their payments on time, mortgage bankers report record rates of delinquency and foreclosure. A few high-profile subprime lenders -- firms that granted loans to people with blemished credit or undocumented income -- have declared bankruptcy. The National Association of Realtors predicts that the subprime sector's distress will prolong the housing slump and that the median home price nationwide will decline in 2007 for the first time since the Great Depression.
Even homeowners with the best credit feel the squeeze from falling home prices and rising rates. Toward the end of the boom, the number of adjustable-rate mortgages with cheap initial rates surged as home buyers struggled to get a foot in the door of houses selling for bloated prices. Now ARM payments are ratcheting upward even as home values slide.
True, some homeowners cashed in their equity on goodies such as BMWs and expensive vacations. But many well-intentioned, overstretched homeowners are in payment shock and are unable to refinance because their equity has evaporated. Nor can they find buyers when selling is the only sensible way out.
Double trouble
Kevin Kempskie is not your typical buy-and-flip investor. In 2003, he bought a triple-decker -- three apartments stacked sandwich style -- in Attleboro, Mass., between Boston and Providence, R.I. In Boston, investors had already driven up prices and condo conversions were rampant, but Attleboro had escaped the rush and price run-up.
Kempskie, 33, put 5% down on the $365,000 property. He moved into the first-floor apartment with his wife, Heather, also 33, and collected rent on the other two units. He was confident that prices would rise and planned to convert the units into condos.
Within a year or so, he had accumulated at least 20% equity in the property through price appreciation. He refinanced and disposed of the private mortgage insurance that had cost him $285 a month -- money he could use to beef up his rental-property reserves or his household budget. Following his mortgage broker's advice, he traded in his fixed-rate mortgage for an ARM with a rate of 5.97% for the first year. The loan, known as an option ARM, offered four payment choices, including a minimum payment that didn't include all the interest due.
Like many other risky mortgages, the loan carried a prepayment penalty that would apply if he refinanced within three years. Often, to boost their commissions, brokers would push for the prepayment penalty because it increased a loan's appeal to investment firms issuing packages of mortgage-backed securities.
Making the minimum payment quickly became the norm for the Kempskies. Their first child was born in 2003, and Heather wanted to take a year off from work. In 2004, their second child was on the way. The couple bought a single-family home and began making two mortgage payments.
A year after the refi, the interest rate began adjusting upward -- to 7.9% in April 2007. The $2,650 that Kevin collects in monthly rents is just enough to cover the loan's minimum payment of $2,370 and the building's operating expenses. He's deferring about $800 a month in interest, which is added to the loan balance.
Partly out of pride and partly because he believes the building is a good long-term investment, Kevin is reluctant to sell the property. Plus, paying the deferred mortgage interest would use up his original equity, and any sales expenses would cut into his proceeds even more. And because of the prepayment penalty he doesn't want to refinance until August.
Watching his investment go sour has been stressful, says Kevin, especially because he pushed for the original refi despite his wife's aversion to risk. "She's a 401(k) gal," he says. The family budget has taken a hit. And opportunities are slipping by. "This would be a great time to buy," says Kevin, "but I don't have the means to do it."
Free-falling prices
Mike Franey, a mortgage loan officer in Bakersfield, Cal., saw trouble coming. For years, swarms of investors descended on his hometown, buying and flipping some of the cheapest housing in the state, driving up the area's median home price from $99,000 in 2001 to $280,000 in 2006. Franey, 63, feared that when the investors left for greener pastures, prices would decline and he and his wife, Mira, 60, might lose the equity in their home just as they approached retirement. "I said, 'We need to sell right now and rent until we can buy again cheaply,'" says Mike.