Part Three: They Get Us Where We Live

In the housing industry, it all comes together – every form of margining, gouging, and fee wrangling takes place in the cavalcade of paperwork and fine print the unwary homebuyer faces.

Here’s how it works.

“Ed” watches some house-flipping show on TV.

He’s fascinated and thinks he can easily pull it off. The housing market is hot, and he’s sure he can fix up and sell a house in a couple months or less. Big dollars!!!

Ed has $50,000 in the bank. He finds a fixer-upper for $150,000. He has to put down 20% to get his loan at 6% and 3 points ($4500), and puts $10,000 into making it sellable. That climbs to $25,000 as the infirmities in the house are discovered.

Now Ed is $9500 in debt and has a mortgage payment on the spec house. He puts it on the market at $275,000, the same price range as other houses in the area. He wants his margin. But, a glut of houses for sale in his neighborhood drive the price down near $200,000 and his is not selling. So he decides to drop the price to $250,000 and rent it in the meantime for market value, almost double his mortgage payment. Tenant after tenant gets behind on the $1400 rent and has to be evicted, often leaving damage in their wake.

It goes on for like this for 6 months.

“Mary” wants to buy a house in Ed’s neighborhood. His is “just right” for her, but she can’t afford it. He was looking for something around $150,000. But she really loves it. Her bank won’t come up, and she only has $20,000 to put down. She can’t afford more than $1000 a month payment, tax and insurance included.

She’s talked to several real estate agents. Many told her there won’t be anything she wants in her price range – that she should lower her sights. One, though, insists that she can afford Ed’s house, even though her bank won’t touch it. He tells her he can recommend someone.

He insists – “we will get you into the house”.

Mary goes to the agent’s chosen mortgage broker, who also assures her that she will get her dream house. The sale price is the full $250,000. She is offered a typical 30 year mortgage at 5% fixed with 1/2 point loan fee. He quotes her $1200 without T/I. She says it’s too much. He says he’ll “come up with something”.

Weeks later, he calls Mary with a solution. He can get the principle down to under $1000 if she puts $70,000 down. She reminds him she only has $20,000 to put down. He says she can borrow the rest of the down payment for an extra $75 dollars a month.

And, he chimes, “you’ll be in your dream house.”

Mary agrees and he puts the loan in to the bank. He sets a closing day for July 1st. Her lease is up at the end of June, and the landlord won’t budge, so she has to move into storage anyway.

The paperwork takes longer than expected, so with her things in storage, Mary has to live in a motel for a 8 days waiting to close on her dreamhouse. When she gets to the pre-closing meeting, she suddenly finds herself in the Twilight Zone, beset with a mountain of new, horrifying contracts and numbers.

She is now looking at 8% interest variable up to 17%, $1320 PI per month, with 3 points down – $7,500, and a second mortgage for the downpayment – 20 years at 9% for $400 a month. Her combined payments with tax and insurance top $2000 a month, and she has to pay almost $29,000 at closing.

So, she has to take it because she works out of her home and can’t do business from a motel room. She rationalizes that she can rent a room, make some cutbacks – she still has $10,000 in the bank. She’ll just have to make it work. She will surely go broke being unable to work and paying for hotels and storage while looking for another house.

You see, Mary had only a $40,000 inheritance in the bank. She was counting on getting a mortgage lower than her current rent, and still having $20,000 security in the bank.

But, the mortgage company required Mary to show them that bank balance, as well as her credit and income. They decided after seeing the $40,000, her income of $30,000 a year, and a good credit score that Mary would be an ideal target for the maximum margin – she could be expected to somehow make the payments at that rate – at least until the $40,000 ran out.

All this time, Ed has seen his debt escalate as his maintenance of the house and tenants continues to worsen. Finally, he’s so far in debt and tied up maintaining the renters that he gets behind on the mortgage.

In the 7 months it’s taken Mary to figure her finances, decide to buy, find a neighborhood, find Ed’s house, apply for the loans and close, Ed has lost it to the bank. They foreclosed on the $120,000 loan and that’s who Mary is buying it from now.

For $250,000.

The agent makes 7%, $17,500, and the bank that foreclosed on Ed nets over $150,000.

Neither the agent nor the mortgage broker suggested offering less money for the house. They both wanted their maximum return.

So, in a years time -

Ed lost his entire $30,000 down payment, spent the other $20,000 and rang up an additional $12,000 in credit debt over the course of the project. Eventually it put him behind in his own home mortgage, and when he was laid-off from his job, he ended up losing his home.

Mary held on until the savings ran out and business slumped. A roommate could only be expected to pay about $500 a month including utilities. Making matters worse, house prices in her neighborhood plummeted farther, below $200,000, leaving her seriously “upside down” at $230,000 in total loans. Losing the house was inevitable.

Well, it shouldn’t have been. This is the kind of mess you end up with when margining rules every step of the way. Had Ed been offered and willing to take $200,000 and the bank willing to give Mary 5% @40 years with a 1 point loan fee, she could easily have made it and Ed would’ve collected $65,000, even after paying the agent. And he wouldn’t be in severe debt causing him to lose his own home.

But, everyone had to have the biggest piece they could along every step. From the mortgage companies to the title brokers to Ed’s credit cards, everyone wanted their maximum profit margin, right now.

Ed was trying to play the casino games, like the big guys on TV. He willingly took the risk, knowing he might lose, but not really believing it. Like many people, he was attracted to the golden apple of big money, portrayed all too often on TV as easy pickings. He got in over his head by rushing in as soon as his bank said “yes”. So many doing it – it must be a sure thing. Turns out, it’s not always so.

Only one person was margining for the right reason. Mary. The consumer. She was budgeting. She tried to increase her chance of maintaining cashflow by reducing her cost without having to charge more for her services. She was trying to obey the marketing rules. This is normal, healthy margining.

But the money monsters had both of their numbers all along. If you want it, you gotta pay for it.

Everyone involved marginalized Ed and Mary to the limit for the sake of immediately collecting cash that “we know you have”.

Gotta keep that margin up.

Ooh! Gotta run. The Casino’s open!

 
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Read Part 4: Epilogue
 

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