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You might want to hold that hug.
The posting with erroneous figures during pre-dinner cocktail time doesn't mean I still don't see flaws in your proposal.
I am absolutely positive there are flaws in my plan, that would be for banks and economists to figure out, but to my limited expertise, I think it would work.
Let me explain something...home values are established 2 ways; approximate value by appraisal, and actual value upon transfer of title. If on the transfer of title the REO is valued at $375,000 then that is the basis (value) of the house. Even if the appraisal comes in much higher, the actual value of the house is what it transfers for. The bank uses the transferred amount to calculate its profits and losses.
The banks would not go into this blindly and hope for the best. Different areas have different discount margins for selling REOs. The banks would probably qualify people on the basis of appraisals of both houses. If the bank assesses that they will probably realize a net gain by the deal, then it goes through. If the average REO discount is 20% for a given area, then it might work. If the average REO discount for a given area is 50% (such as certain areas in LA) then it probably would not work.
The banks would have the ultimate say on who can participate and who can't. People would have to apply for these trades, and through appraisals and economic demographics, the banks would evaluate if it is feasable to realize a net gain from the deal. If they felt they couldn't make enough "net profit", they would probably turn down the applicant.
Forget all that smoke and mirrors. Answer my question in Post #106 if you are serious about your proposal and think it can stand up to review.
I believe I did answer your question, but here goes:
Quote:
Originally Posted by Austin-Willy
Let me just make sure that I understand your reasoning. You believe that the house that the lender gives to the borrower who is "trading up" (i.e. the more valuable house) will automatically and immediately have an increased value once it is in the borrower's hands (presumably because it is no longer bank-owned)? The value will not be increased over what the transfer value is ($375,000). That will be the absolute value once ownership is transferred to the borrower. Value is not established by asking price, value is established by amount on the deed (whatever the buyer paid for it, or borrower in this case). Over time it may go up or it may go down depending on what the market does. The bank is not "giving" it, it will have a $375,000 mortgage on it. If another bank writes the mortgage, the REO bank gets $375,000 cash. If the REO bank holds the mortgage, it gets all the interest and fees associated with it. And you further believe that the house that the borrower gives back to the lender (i.e. the less valuable house) will automatically and immediately go down in value when it is transferred to the lender (presumably because it will become bank-owned). No. The house the borrower gives the lender has already lost value, that is why it is upside-down. It is what it is as determined by an appraisal. Lenders nor sellers establish market value, sales for the area establish market value. The lender, through appraisals and market evaluations can determine what they think the house can sell for, that's what they do. If they think they can't sell the house for enough, they turn down the trade. End of the story for the borrower.BUT, you believe that the increase in the first house will be greater than the decrease in the second house. Yes, in this scenario. It may not be in all scenarios. That is for the bank to determine.
Is that it?
What I said is not smoke and mirrors. It is reality. Ask any appraiser, tax professional, real estate broker (of which I am one), Title and Escrow companies. It's not something I made up. This is really how it works for establishing market values, approximate values, and actual values as well as profits, losses, and capital gains. I do know what I am talking about here, and it is by this criteria that banks will determine whether to make or break the trade.
Let me just make sure that I understand your reasoning. You believe that the house that the lender gives to the borrower who is "trading up" (i.e. the more valuable house) will automatically and immediately have an increased value once it is in the borrower's hands (presumably because it is no longer bank-owned)? The value will not be increased over what the transfer value is ($375,000). That will be the absolute value once ownership is transferred to the borrower. Value is not established by asking price, value is established by amount on the deed (whatever the buyer paid for it, or borrower in this case). Over time it may go up or it may go down depending on what the market does. The bank is not "giving" it, it will have a $375,000 mortgage on it.
The bank already owns this house, so unless someone gives them $375,000 cash, they are giving away the house, which obviously that won't do. So let's assume that someone will loan the borrower $375,000, so the borrower can pay cash to the REO bank... who is going to pay off the borrower's existing $375,000 mortgage on the $300,000 house? Someone will have to pay it off, otherwise the borrower will have 2 mortgage payments.
If another bank writes the mortgage, the REO bank gets $375,000 cash. If the REO bank holds the mortgage, it gets all the interest and fees associated with it.
And you further believe that the house that the borrower gives back to the lender (i.e. the less valuable house) will automatically and immediately go down in value when it is transferred to the lender (presumably because it will become bank-owned). No. The house the borrower gives the lender has already lost value, that is why it is upside-down. It is what it is as determined by an appraisal. Lenders nor sellers establish market value, sales for the area establish market value. The lender, through appraisals and market evaluations can determine what they think the house can sell for, that's what they do. If they think they can't sell the house for enough, they turn down the trade. End of the story for the borrower.For the bank to be able to sell it for enough to retire the mortgage (which is $375,000), it would have to be worth $375,000, plus commissions and other closing costs, and if it was, the borrower wouldn't have wanted to trade up.
If the banks could establish some scheme whereby they transfer properties without the REO discounts and minimizing the cost of the sale they could potential save between 25 and 30% of the value of the home.
This is a scheme of that sort.
The difficulties are practical and probably insurmountable.
First off you need a move up house acceptable to the one moving up. That means practically you need relatively large inventories in each class of home.
In general though no single bank will have such an inventory. Most have a few hundred mostly centered in the relatively low end. So no place to move them too. You could possibly form a joint venture...but then that has to be administered. Practically you could end up in the Real Estate business...with the overheads and requirements of that field. And even having done this there would still be a large problem with the higher end move up houses present in miniscule numbers compared to the low end.
Note that the lenders could accomplish most of the same end by simply moving their properties to market price. The rub then though is they would sell in market timing. Months rather than weeks. The lenders have long since determined that speed is more important than price but they could, I suppose, change their minds.
If the banks could establish some scheme whereby they transfer properties without the REO discounts and minimizing the cost of the sale they could potential save between 25 and 30% of the value of the home.
But then the lender would still have to price in the REO discount on the house it takes back in trade. Not to mention the simple fact that each time the lender trades down they end up with an asset with a lower value than the one they had before the trade, and only when they sell to a buyer who will pay full price in cash (as opposed to part cash and part trade-in) will they be able to book the full loss on the original defaulting loan, and with each trade that loss increases.
The bank already owns this house, so unless someone gives them $375,000 cash, they are giving away the house, which obviously that won't do. So let's assume that someone will loan the borrower $375,000, so the borrower can pay cash to the REO bank... who is going to pay off the borrower's existing $375,000 mortgage on the $300,000 house? Someone will have to pay it off, otherwise the borrower will have 2 mortgage payments.
I didn't bring this up before because it just adds another potentially confusing detail to the discussion. I was told by HUD that the way this would work would be that the borrower's house would be returned to the lender and the loan retired through a banking instrument similar to a "Deed In Lieu Of Foreclosure" but without the credit consequences of a foreclosure. This would retire the loan by returning the collateral. The borrower would then enter into a new loan for the REO with the same lender, thus only one loan outstanding. You cannot actually legally swap collateral on a loan between properties.
For the bank to be able to sell it for enough to retire the mortgage (which is $375,000), it would have to be worth $375,000, plus commissions and other closing costs, and if it was, the borrower wouldn't have wanted to trade up.
At this point, the mortgage would already be retired (see annotation above) and the bank would sell the lesser valued house for whatever a buyer is willing to buy it for (which the bank has already calculated ahead of time) OR go through another trade-up. If the bank got $350,000 for the lesser valued house, they are still ahead by $50,000 over what they would have gotten if they didn't do this program (remember, they were willing to sell the REO for $300,000 and they probably would have gotten less for it).
How? The bank gets $75,000 over their asking price which is what they were willing to accept on the REO ($300,000). The house that had an original loan for $375,000 was sold for $350,000, the bank loses $25,000.
So take the $75,000 they received over what they would have gotten without this program, and subtract what they lost on the borrower's house, $25,000, and they have a net "gain" of $50,000. If the borrower's house only sold for $300,000, the bank would still be ahead $25,000 over what they would have gotten if they didn't do this program.
You seem to think that this program is for the bank to break even between the borrower and the bank. It is not. It is designed to mitigate losses. There will be losses either way for the bank, it will just be less with this program. Without doing this program, the most the bank would get from just selling the REO would be only $300,000 or less, potentially losing the $50,000 that it could have made (or putting it another way, reducing its losses by $50,000) by participating in the program.
Outcome:
Borrower gets a home with a value equal to his loan but keeps his original debt with the bank. He would be less likely to default from being upside-down.
Bank makes $50,000 more than it would have otherwise. Bank can now take borrower's house and offer it for trade up and mitigate (reduce) losses once again. And so on and so on.
The bank mitigates (reduces) losses and also stems more potential foreclosures. That is the black and white of it. Because the REO sells for $75,000 more than it would have otherwise, this helps to stabilize housing prices, therefore stabilizing market values rather than the free-fall it's in right now.
If the banks could establish some scheme whereby they transfer properties without the REO discounts and minimizing the cost of the sale they could potential save between 25 and 30% of the value of the home.
This is a scheme of that sort.
The difficulties are practical and probably insurmountable.
First off you need a move up house acceptable to the one moving up. That means practically you need relatively large inventories in each class of home.
In general though no single bank will have such an inventory. Most have a few hundred mostly centered in the relatively low end. So no place to move them too. You could possibly form a joint venture...but then that has to be administered. Practically you could end up in the Real Estate business...with the overheads and requirements of that field. And even having done this there would still be a large problem with the higher end move up houses present in miniscule numbers compared to the low end.
Note that the lenders could accomplish most of the same end by simply moving their properties to market price. The rub then though is they would sell in market timing. Months rather than weeks. The lenders have long since determined that speed is more important than price but they could, I suppose, change their minds.
I was thinking about banks interacting with each other, thereby creating a larger pool of REOs. They would have to be careful of antitrust laws, however. I was thinking perhaps participating banks with the desired REO could refinance the original loan with the borrower (from a different lender) and close it simultaneously with the close of the REO purchase. Do you think that would work? Or perhaps it could be outsourced to a department created for this program, similar to companies who sell properties through trustees sales.
BTW, the people at HUD did not seem to think the administration of this would be terribly difficult.
But then the lender would still have to price in the REO discount on the house it takes back in trade. Not to mention the simple fact that each time the lender trades down they end up with an asset with a lower value than the one they had before the trade, and only when they sell to a buyer who will pay full price in cash (as opposed to part cash and part trade-in) will they be able to book the full loss on the original defaulting loan, and with each trade that loss increases.
The price of the house has nothing to do with it. This is about what the bank can net in return (or rather how much they can reduce loss). What is part cash and part trade-in?
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Austin-Willy
