November 22, 2006

Caught In The Housing Bubble

By Jennifer Wheary

Toward the end of October, the Federal Reserve Board finally took a break after steadily raising interest rates for the last two years. Yet mortgaged homeowners haven’t had a chance to catch their breath. In October, new home prices took their biggest plunge in 35 years, according to the Commerce Department. If that wasn’t enough to give home-owners pause, the National Association of Realtors also said last month that we’ve hit the sharpest year-over-year drop on record for the median sale price of existing homes.

Perhaps the sky is not completely falling, but it sure looks threatening.

This is because the housing boom of recent years has fueled some dangerous financial strategies, ones that leave the middle class weaker and hanging onto economic security by a thin thread.

Since 2001, homeowners have been tapping into their home equity at a record pace. Households cashed out $715 billion worth of equity between 2001 and 2005. In the three years between 2003 and 2005, owners extracted $150 billion more in equity from their homes than they did in the previous eight.

About half of the families refinancing have used the money to make ends meet, paying down credit cards and covering basic expenses. In a reasonable housing market, this could be a reasonable trade. But the realities of the current situation make it much less so.

That is because this refinance boom, which families have been using the escape falling salaries and rising health costs, has a shaky foundation. We’ve seen a dramatic rise in riskier home loan products over the last few years. Adjustable rate mortgages—which charge borrowers a lower rate at the outset and then are subject to change over time—made up 31 percent of mortgages in 2005. Interest-only loans, which were uncommon just two years ago, made up about 20 percent of loans.

As the housing bubble deflates and interest rates on risky adjustable rate mortgages have risen, more and more home-owners are feeling the pinch. The interest rates on $400 billion worth of adjustable rate mortgages will be reset to higher levels this year, and $1 trillion will reset next year. The resets are leaving many homeowners facing monthly payments that are 25 percent higher.

Refinancing for a second or third time is becoming a common band-aid. Industry experts predict a spike in refinancing next year as homeowners seek relief from much larger payments.

The danger in this “re-refinancing the American dream” strategy is two-fold. Refinancing has been used to bridge a gap between declining wages and rising living costs. It hasn’t closed this chasm, only given families a way to traverse it in the short term.

The rise of appraisal fraud has also fueled inflated home prices over the last several years and could leave many homeowners owing much more than the market value of their home. Appraisal fraud is the practice of using false home appraisals to complete a mortgage transaction or refinancing. In most cases, appraisal fraud is the result of direct pressure on the appraiser from the loan originator, broker or realty agent to inflate home values. If appraisers do not inflate home values during the appraisal process they risk losing repeat business from the broker or others involved in the transaction. This practice results in households borrowing amounts that, in some cases, are much greater than their home’s worth.

Even though it is underreported, appraisal fraud was the fastest growing type of mortgage fraud reported by major lenders in 2000, and there is no end in sight. In 2005 more than 22,000 cases of mortgage fraud were reported to the FBI, a sevenfold increase since 1999.

Rising foreclosures signal that many homeowners are already buckling as interest rates rise and home values drop, trends that will continue as more mortgages adjust. According to RealtyTrac, foreclosures in the third quarter of 2006 were up 17 percent from the previous quarter, a 43 percent increase from the third quarter of 2005.

Our newly elected Congress can take action to help families out of this mess.

Where can they start?

Eliminate the need to dip heavily into home equity to make ends meet by controlling health care costs and guaranteeing a living wage to anyone willing to work for it.

Create legislation to protect borrowers from the excessive credit card rates and fees and capricious terms which are legal but which end up strong arming honest families trying to make ends meet into financial peril.

Support hard working families in severe economic distress by re-examining and, where appropriate, reversing the sweeping changes to bankruptcy laws passed by Congress in 2005 which removed many protections available to average Americans.

Protect Americans from real estate appraisal fraud by ensuring that brokers are prevented from coercing or intimidating appraisers in order to receive a desired property appraisal value.

It’s time to send a clear message to our political leaders. They should help Americans achieve the American Dream, not sit around idly while we continue to refinance it.

Jennifer Wheary is a senior fellow at Demos (http://www.demos.org/home.cfm), a public policy research and advocacy organization.

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