The Foreclosure Story: What does the Process Look Like?

We all know that foreclosures are on the rise throughout the nation. Most people realize that a foreclosure means that you will lose your home. But how does this process look like? In reality, the foreclosure process is a drawn out and lengthy ordeal. It is a gut wrenching and personal nightmare for most folks. So this article is a story about a couple. A couple who is the poster representation of the housing boom and now bust. In this article, we will examine their profession, income, and monthly budget. Amazingly, folks are very upfront when they are making lots of money but go into clandestine mode when they are having financial difficulties. Below is the couple’s profile:

Joe and Mary

Ages: 29 and 28

Professions: Joe - Senior Account Executive (lender), Mary - Real Estate Agent

Location: Orange County

Yearly Income Combined: $130,000 Gross

Net Monthly Income (After Taxes): $8,200

Automobiles: Mercedes E350 Sedan ($599/33 month Lease), GL 450 Suv Purchase ($56,000)

Monthly Auto Fuel Cost (Filling up Once Per Week): $350

Home Purchase: Costa Mesa 4/2 Home, Bought Late 2004 for $675,000

Credit Card Debt: $25,000

Monthly Food Budget (Including Dining Out): $700

So this should give you a nice snapshot of the couple. Since they were sophisticated investors in the know, they decided to jump into the home with a 2/28 loan, interest only with no money down. After all, someone making $130,000 a year can clearly sustain pretty much anything right? And as we all know, no money down was no longer simply a thing of late night infomercials but a mainstream way of buying a home. Here is the monthly budget below with the teaser rate loan (they had it for 2.75%):

2004 Budget

House Payment (PITI – at 2.75% interest only/2 years): $2,249

Auto Cost (monthly payment/lease/loan/fuel): $1,749

Dining: $700

Credit Card Payment: $500

Total: $5,198

Monthly Net: $8,200

Disposable income: $3,002

Keep in mind we are not factoring in medical insurance, cell phone cost, utility bills, retirement accounts, and many other items. These are things that I am aware regarding their budget since I was privy to the information. Well, more like them showing off to me, but I made mental notes on these items as I would with a past client showing me their monthly budget. So even with that said, $3,002 a month in disposable income is a pretty nice chunk of change to pay the remaining monthly items. But again, this was a teaser 2/28 loan. Unfortunately, they didn’t factor in one of them losing their job, a rate reset, and a slumping housing market. Let us take a look at the late 2006 monthly budget:

2006 Budget

House Payment (PITI – amortized fully over 28 years/full rate of 6.25%): $4,962

Auto Cost (monthly payment/lease/loan/fuel): $1,749

Dining: $700

Credit Card Payment: $500

Total: $7,911

Monthly Net: $8,200

Disposable income: $289

Suddenly the jump in the rate creates a crunch on the household income. Keep in mind the above still doesn’t factor in other monthly cost. In addition, this was in late 2006 before, Joe lost his Senior Account job because the company went under. They were already feeling the pinch since the housing industry was already showing signs of weakness and their income being variable with commissions, was also taking a hit. Joe jumped to another mortgage outfit but they were only able to give him $30,000 a year base plus any commissions. Of course with the tightening of the housing market business is not going so well since both of their careers are tied directly to the housing industry. Their combined income is no longer $130,000 a year but approximately $80,000 a year. So let us run the numbers again with the new household income:

2007 Budget

House Payment (PITI – amortized fully over 28 years/full rate of 6.25%): $4,962

Auto Cost (monthly payment/lease/loan/fuel): $1,749

Dining: $700

Credit Card Payment: $500

Total: $7,911

Monthly Net: $5,804

Disposable income: $-2,107

Now we are running massive monthly budget deficits. It may come to a shock to many people that a household earning $130,000 a year actually may have financial difficulties. But looking above, you can see how easy and quickly someone can go into financial ruin. Statistically, this couple was in the top 10 percent of household incomes in the country. Yet they spent way beyond their means. California living is very expensive. You’ll also notice that being in the industry they are in, they felt that they needed symbols of affluence to keep up with the Joneses. So now that you can see that not only folks that make $14,000 a year purchasing $720,000 go into mortgage trouble, even those that are considered the most affluent also have financial problems. The next phase of this case study is the foreclosure process.

How Does Foreclosure Really Look Like?

Foreclosure has been a somewhat unheard of novel thing in California for the past decade. Any homeowner in trouble was able to put their home up for sale and it would sell quickly before the entire process ran its course. The market was so hot that it covered financial irresponsibility by letting folks off the hook. This all ended last year. Suddenly, the market is declining yet rates are still resetting. Folks are realizing that they are unable to make the payments, sell for their asking price, and losing their homes. So how did Joe and Mary lose their home? This is the next stage of the foreclosure story and a sad one.

The psychology of running massive monthly deficits is a hard one. For one, you are probably wondering about the incredibly high car cost. This is Southern California and having a new model is somewhat common practice. The worst depreciating item you can own is a vehicle. Regardless, they purchased one of the two Mercedes and after a year or so, if they decided to sell they would be selling at a loss. So after Joe lost his job, they decided to put their home up for sale knowing they would be unable to make the payments. At first, they thought that they would be able to make a nice profit on the home. This was not the case. This is how the following months looked like:

Month 1-6 – (Pre-Foreclosure)

Joe and Mary miss one payment. They have their home listed at $790,000 on the MLS. No bites. The bank sends a late notice to their home. Since they’ve been in the industry, they have seen homes sell even before landing on the MLS. They are certain that they will sell the home.

Total Monthly Payment Behind: $4,962

Late Payment: $40

Total to Cure Account: $5,002

Another month goes by and no offers. They lower the price to $775,000 to generate some interest. Nothing. They start getting a bit anxious. They get another payment from the bank but this time, they will need to make two payments. At this point, they make a conscious decision not to pay the mortgage and put in a clause for a future buyer to cure the account when they buy:

Total Monthly Payment behind: $9924

Late Payment: $40 x 2

Total to Cure Account: $10,004

At this point the bank tries to make contact with Joe and Mary. If they couldn’t pay $5,002 how are they going to pay double that? A third month comes along and they lower the home price to $750,000. Still the market is dry and silent. At this point the couple receives letters from the bank and attorney. They now start receiving formal letters:

Total Monthly Payment behind: $14,886

Late Payment: $40 x 3

Legal Fees: $75

Total to Cure Account: $15,081

Forth month comes along:

Total Monthly Payment behind: $19,848

Late Payment: $40 x 4

Legal Fees: $75 x 2

Total to Cure Account: $20,158

Fifth Month:

Total Monthly Payment behind: $24,810

Late Payment: $40 x 5

Legal Fees: $75 x 3

Total to Cure Account: $25,160

The bank issues a demand for full payment including full balance, back interest, plus late charges, and legal fees all at once. The legal notices start. Joe and Mary now have their home listed at $715,000. Still no bites. They did have some people come by but the deals didn’t materialize. Now they need $25,160 to cure the account but the bank has legally informed them that they will accept no payments except a full balance payment on their original $675,000 note. Keep in mind the bank is no place for negotiations. Can you imagine calling up your local Mercedes dealer and saying, “Hello Mercedes? Yeah, I’m not going to be able to afford the $600 this month but would you be willing to take $300 plus a free Dodger ticket?” The bank now sends a certified letter of notice of intent to foreclose. Joe and Mary realize they will not sell their home. The notice and waiting period begins. They stay in the place two more months. Now it will cost $35,000+ to bring the account current plus a full payment on the balance. Of course this will never happen given the circumstances of their finances. No payments are arranged and the house is sold at auction and of course, the bank reclaims the home as REO since they are on the sheets for $675,000.

The home is now officially REO and get this, they have it listed for $750,000! The bank is delusional. Joe and Mary now have a foreclosure on their credit record and rent a much smaller home. They managed to break the lease on the Mercedes but are on the hook for the purchased SUV. You’ll notice how things spiral out of control when you spend more than you earn. I can only imagine households with $60,000 getting into this mess. If anything, it will accelerate ten times faster. They are considering bankruptcy but the new laws are now more stringent in terms of letting people completely off the hook, especially a couple that makes nearly twice the median US income.

Hopefully this article gives you an inside look at the story of foreclosure and how it can happen to anyone. I've seen many blogs talk about foreclosures and the numbers but haven't seen a post detailing the entire process and how it impacts a home owner's bottom line. Not only that, but you should get an understanding that we are in a bubble so large, that missing one payment puts you in arrears for $10,000, or the down payment of a modest home in many states of the US. If this is what happening at stage one of the bubble, what do you see happening in the latter stages?

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Big Ben and the Ministry of the Fed: Housing Doublespeak. NovaStar Shining.

One important rule for investors is don’t chase bad money with good. NovaStar Financial is having a challenging time getting out of the doldrums even after a $150 million booster shot it received from private equity funds. Not only are analyst predicting a future price target of $4.50, much less than the current $5.96 price but the company is also planning on slashing the dividend for many investors. Keep in mind this is a company that once was trading as high as $64 a share. But home equity lines of credit and loans are much more expensive now that rates have shifted. 30 year fixed rates are still doing fine at historical lows, but financially, this was a small sliver of the pie for these subprime players. According to Reuters:

“NovaStar shares were down $1.15 to $5.96 in late-morning trade on the New York Stock Exchange after falling to as low as $5.91 earlier in the session.

As a result of the deal, FBR's Valentin said NovaStar common shareholders will see their dividend slashed to $2.67 a share from $4.21 a share. Valentin also said the $150 million injection is not enough to sustain NovaStar, a REIT, unless mortgage markets suddenly rebound."

Like other subprime lenders, which make home loans to people with weak credit, NovaStar has suffered rising defaults and has struggled to sell the loans it makes to investors. Quarterly results have suffered this year, while rivals were prompted to exit the business or forced into bankruptcy.”

This isn’t something new. I warned about the subprime implosion a few months ago including the challenges NovaStar would face. Although many pundits were echoing that $150 million dollars would keep the company solvent for a while longer, there is no way any amount of bad money would keep over inflated assets high forever. And the caveat in the above quote is “unless mortgage markets suddenly rebound.” Now do we really see that happening?

Big Ben Chimes in Again

Then we move on to Big Ben using his glorious Orwellian Doublespeak. First, Mr. Ben is frustrated that the Yuan is rising at a slow pace:

“"I share your frustration about the slow pace" of China's currency revaluation, Bernanke said in response to a question from the Senate Banking Committee following his twice-yearly Congressional testimony.”

Glad he shares the frustration of the American public. Well that can easily be remedied by raising the Fed interest rate. Of course this will pop the bubble. But why should housing pundits worry? They’ve mentioned that housing rose on its own merits without the crutch of easy credit. When asked if housing could face a hard fall, this is his response:

“"We think it remains a risk, we have an inventory problem,"

An inventory problem? Well isn’t that something! And here I was thinking that it was a pricing problem. The doublespeak gets better in this testimony. When asked about the overall state of the economy, Ben responded:

"The ongoing housing correction could prove larger than anticipated, and energy and commodity prices could continue to rise sharply" and that could "spread to other parts of the economy," said Bernanke. Therefore the "upside risks to inflation is [the Fed's] primary policy concern."

You’ll understand that political operatives love using the word “could.” Well I could make a million dollars tomorrow, or not. Well housing could correct, or not. And they keep calling it a “housing correction.” This is a bursting credit bubble! Call it what it is. All these convenient euphemisms make it seem like we are in a high school band class. So the primary concern is inflation. Excellent, at least we agree on one thing. Then what about the resounding housing inflation we have seen in the last few years? The Fed actually created this monster by lowering rates and creating excessive easy credit. This played perfectly into a society that has a very hard time saving for retirement or anything else. Not only that, it made everything you buy with credit cards easier. Even last year, it was incredibly easy to find 0 percent offers on credit card purchases. Try finding these deals now. Now they include a 3 percent transaction fee. Suddenly people can’t play the mortgage refinancing musical chairs game.

“"The most pressing issue facing the U.S. economy today is excessive and growing inequality,"

Bernanke responded by pointing to other studies that show middle class Americans are generally much better off now than they were two decades ago.

But he also said better education training programs, as well as cheaper access to health care, are some things that could be done to lessen the income gap.”

Basically you are doing better if you aren’t buying your first home, eating food, don’t get sick, and avoid going to college. Aside, from that you are doing fantastic! Amazing double speak in face of the largest housing inventory in multiple decades.

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Sales Drop Their Pants in Southern California. In More News, Median Prices Still Strong Like Arnold Schwarzenegger.

What a shock that housing median prices are still holding strong. In the land of Oz otherwise known as Southern California, June data released today shows housing prices resiliently strong with one caveat; sales are falling off a cliff! So even though Los Angeles County has a median home price of $545,000, a 4.8 percent yearly gain and Orange Country has a median home price of $645,000, a 0.4 percent yearly gain the devil is in the sales declines.

Los Angeles is down 32.5 percent in sales numbers. Orange County is down 31.6 percent. Riverside is down 47.2 percent. San Bernardino is down 50.1 percent. San Diego is down 22.6 percent. Ventura is down 27.8 percent. After each sentence I expect you to say Hoorah! Here is an excellent test of housing sentiment. In July of 2006, only one year ago we were having double digit sales drops but pundits kept hyping the yearly gains in the median income. “Sales drops mean nothing. Look at the tasty yearly median gains! Housing is hotter than a burnt tamale.”

Of course any person who studies housing markets realizes that drops in sales volume are indicators of where prices are heading. Housing is sticky on the way down. But the ironic thing is you don’t hear the housing syndicate jumping up and down for the positive median home prices just released. Why? Because business is horrible and the public is tired of being bamboozled. Just listen to the sentiment of the home builders. The summer bounce isn’t here and we are quickly approaching August. Suddenly visions of infinite double digit gains start to seem more distant. Summer 2007 is a vastly different housing market. For one, the subprime market is imploding. Imploding? Seems abstract to say it that way. How about “no more mortgages for LaLa land investments.” Aside from irresponsible lending and delusional sellers, housing is coming back to Earth from a long vacation to Uranus.

The housing syndicate wants to blame the Fed and anyone championing tighter credit. If it were up to them, we’d be purchasing $2 million dollar homes while inflation goes along at 25 percent and every new buyer ended up in a 70 year multi-generational loan. They wouldn’t care. Sustainability is a word outlawed in the subprime industry. These companies have such little reserves, that a simple credit tightening brought many companies to their knees in a few months. And this on the back of the largest housing bubble in history. They could have easily built up their cash account to weather a storm over the healthy years; but why save when you can make money hand over fist loaning out ridiculous suicide loans? Wall Street ate them up.

Well now, thanks to the transparency of information most people look at the median price and just laugh because they know it is simply absurd and a horrible indicator of the current market. Sellers are still doing baby steps trying to lower prices by $10,000 or $15,000 on a home overpriced by $200,000. So it is in today's market. The great summer standoff. I predicted this many months ago. Call it the summer housing Easter bunny and he ain’t hopping in Southern California and time is running out.

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Viva La Housing Society: Social Security, Savings and Debt, and Retirement.

John McCain has just given the US public a crash course on why debt is not a good thing. McCain raised $11.2 million this past quarter but spent most of it and has very little cash on hand. Seems rather commonplace for many Americans to spend more than they earn. Not only that, the major issues that we should be discussing such as the credit bubble, declining dollar, Social Security, and international conflicts are nowhere to be found in the mainstream political debate. Why isn’t any politician tackling any of these problems head on and discussing them? The only person I’ve heard mention “inflation” is Ron Paul, who by the way is financially better off than Mccain. Maybe basic finance does help those in politics. Either way, I think most Americans are realizing that being able to purchase something on cheap credit does not equal financial independence. On the contrary, many are realizing crippling debt is like jumping into the ocean with an albatross around your neck.

So we close off the first two quarters of the year with the fuse inching along to the dynamite box full of funky credit and Wall Street collateralized debt obligations that are so complicated, even the people that created them have no idea how to untangle them. The big bang is here and the world is realizing and watching morbidly, that we spent way beyond our means. In this article I will discuss three main issues that will impact the entire country. From young professionals starting their career to those in retirement. This credit bubble discriminated against no one. If you wanted a home equity line of credit, you were welcomed. If you wanted a no money down interest only loan, come on in. This bubble is one for the ages and we are starting to see that the public is starting to get the memo that massive credit is not a solid solution for sustainable growth.

Social Security – Shhh! Please be Quite

It has been argued that Social Security is the third rail of politics. We remember Al Gore and his lock box talk. Or Bush and his goal of privatizing Social Security. Both went down in mad Ghostrider flames. Yet the issue still looms. Even Clinton recognized the issue with Social Security but no political will was willing to attack the problem. The buck has now passed from three presidents onto another one that will inherit the problem in 2008. Every expert acknowledges that we have a looming problem with Social Security. But anytime a politician brings up the issue, it gets shot down. Typical of the housing bubble, Social Security is a ponzi scheme heading down a slow but sure road of insolvency.

For one, 44 million Americans depend on Social Security (so guess how they'll vote). Two thirds of senior citizens depend on Social Security as their main source of income. 18 percent of senior citizens rely on Social Security as their only source of income. Income that pays for food and housing cost. Keep in mind, even if you have your home paid off you will still get yearly tax bills. You will also need housing insurance and maintenance costs factored in. Why do you think many senior citizens are victims to reverse mortgage loans that are so financially egregious, you would think that you were dealing with a local bookie or turf accountant.

In 1960, there were 5.1 workers putting in money to the system for each person drawing on benefits. In 2005, the number dwindled to 3.3 workers. The projected number for 2031 is 2.1 workers for each person drawing on Social Security benefits. Why the sudden shift? Well we can thank a population boom phenomenon otherwise known as the baby boomers.

Baby boomers are considered to be folks born from 1945 – 1964. The total number of births during this time is somewhere in the ballpark of 76 million. Currently they are 20 percent of the adult population. An incredibly large number. The term is normally given to those in the age bracket of 44 to 62. The major shift will start occurring in 2008 when we start seeing baby boomers go into full retirement. The system is solvent until 2018, which at the time more will be paid out than paid into the system. By 2042 the system will be dry. So anyone in the 20 to 39 age range needs to start planning for another venue of retirement benefits since the last three presidents didn’t do squat regarding the issue.

With a high cost of living, mounting credit card debt, ridiculous college costs, and entry level salaries how is it possible for young professionals to realize the dream of their parents? Hard work and savings are paramount. But the way mom and dad did it is not going to apply to this generation since the Social Security safety net won’t be there for many and housing costs are much larger in proportion to those a generation ago.

Savings and Debt – How does it Break Down?

I’ve been clipping a few charts from the previous LA Times with fascinating data. After reading how Kobe is still up to his antics with the LA Lakers and David Beckham’s Galaxy salary is larger than many third world country’s gross domestic product, I enjoy heading over to the business section. The numbers are startling and the picture that is painted is that young folks of today consume at a high pace and save very little for retirement. It could be a generational thing where many of us are more comfortable paying with a credit card rather than cold hard cash. This debt mentality is also a contributing factor for the housing bubble. After all, a generation raised at the teat of debt is easily coerced into further spending. Large mortgages didn’t phase many young professionals. I’ve had a close friend purchase a Real Home of Genius condo with his wife for half a million dollars in a regular suburb of Orange County. The condo is slightly over 1,000 square feet and as cookie cutter as they come. Their combined income barely allows them to cover the mortgage, taxes, and association fees but they are following the lead of mom and dad. The only caveat is, mom and dad bought with 10, 15, or 20 percent down and went 30 year fixed. But the need to own a home is so psychologically ingrained that folks are willing to live on Cup-o-Noodles to pay the mortgage.

Let us take a look below at some raw numbers:

Average amount in bank accounts per household
20-29	$15,724
30-39	$22,561
40-49	$29,048
50-59	$43,194
60-69	$63,008
70-79	$70,031
80+	$93,641
Overall	$37,675

This first table looks at average amounts in bank accounts per household. Keep in mind that with averages, a person with $200,000 in the bank will skew the chart higher. But even with that considered, the amount of money in accounts isn’t that high. You may say, “well of course not, these people have them in 401(k)s and retirement accounts.” I’ll get to that in the next section but suffice it to say that folks aren’t really saving elsewhere.

The next chart looks at household debt from the same sample in the survey of 158,000 US households:

Average debt per household, including mortgagages
20-29	$62,786
30-39	$107,525
40-49	$106,027
50-59	$94,224
60-69	$79,493
70-79	$59,358
80+	$47,168
Overall	$90,222

This chart should put a major hole in many housing pundit theories of Americans being okay with large mortgage debt. The above chart includes revolving debt and mortgage debt. The highest average is in the 30 to 39 category and it tops out at $107,525. Now think about a young professional couple buying a starter home of $500,000 with 20 percent down. They’ve taken on $400,000 in debt. Or 4 times the average overall debt of those in the 30 to 39 and 40 to 49 group range.

Another scary factor is many of those hitting retirement are still in debt. As we’ve mentioned, if you are relying solely on Social Security as your main retirement income or a large part of it, $50,000 in debt is a large chunk of change.

Retirement

It is pretty clear that anyone in the 20 to 39 age bracket will need to fund their own retirement and not depend on Social Security. So how are folks doing?

Percentage of households with 401(k) plans
20-29	39.1%
30-39	52.3%
40-49	50.5%
50-59	47.7%
60-69	32.9%
70-79	20.3%
80+	18.6%
Overall	43.80%

Well there goes the argument that the majority of people are funding their 401(k). The 20 to 29 year olds are the one’s who need to fund their 401(k) accounts most aggressively. Those in the 30 to 39 age range seem to be getting the message that Social Security will not be there for them. Is fear of no Social Security the only reason for this shift? We have another reason:

Percentage of households with pension plans
20-29	8.1%
30-39	14.1%
40-49	19.1%
50-59	26.5%
60-69	33.7%
70-79	35.2%
80+	34.9%
Overall	21.50%

Pension plans are going the way of the Dodo bird. Anyone under the age of 40 is most likely to be at the tail end of a generational ending of pension plans. You can see from the numbers above that only 8 percent of household in the 20 to 29 range have pension plans and 14 percent of those in the 30 to 39 age range. If anything, these charts should show you that we are not in the world of our parents.

Let us not even dive into the declining dollar, massive deficits, and the ridiculous shadow government tactics used to calculate inflation. This all ties into the housing bubble because with such a high cost of living and lack of future planning, many young professionals seem to indicate by their buying habits a “screw the future” and live a carpe diem type lifestyle. To keep up with the dream of being equally as successful as their parents, they are mortgaging their present lifestyle to meet a dream that is no longer available. They chase this dream by diving into credit and hyping the monthly payments. Yet this is unsustainable. At which point will folks in the 20 to 39 age range become furious about paying into a system that they will not benefit from? At what point will they realize that inflation numbers are cooked and demand better accounting practices?

Sometimes it seems that the media is trying to create a generation of zombies that will stay away from picking up a book and educating themselves about the true state of affairs. According to A.C. Nielsen Co., Americans watch an average of 4 hours of television a day! Mortgage ads spouting crack pot numbers. Flip this House. Extreme Home Makeover. And all the other housing related shows seem to be the number one source for where people get their housing information. In addition we get this mantra of easy monthly payments and the advent of gorilla marketing making it seem like using cash is for old folks. The credit card commercials tell you two things; the faster you spend the better and don’t be uncool and use cash. God help us if people are using the television to educate themselves regarding the credit bubble, savings, debt, and retirement.

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