Foreclosures are a normal part of life. They happen in good times and bad, whether credit is easy or difficult, but a large amount of foreclosures in any particular market has the ability to send a market crashing out of control in a downward spiral. The reason is when banks take homes back they do not want them on their books and want to sell them as quickly as possible. This is usually not an issue, because buyers looking to purchase foreclosures are usually a limited segment of the home buying market and search primarily for foreclosures.
In a typical real estate market, there are a limited number of foreclosures and that number balances with the number of foreclosure buyers. In good economic times, foreclosures do not affect the price growth of homes because there are more buyers than foreclosures. This causes foreclosure buyers to either drop out of the market or compete against each other for lower priced homes.
Banks and real estate agents will typically price a foreclosure slightly below market value for several reasons. First, they want the home to sell quickly, and a lower price allows for a faster sale.
Second, people face foreclosure for a variety of reasons, but the most common reason is a lack of money. If a person does not have money, it makes upkeep and maintenance on the home very difficult. Homes in a dilapidated state of repair fetch far less money and buyer attention than well-maintained homes.
Third, banks and real estate agents want these homes off the market quickly to avoid costly maintenance and upkeep. In the summer, who pays to keep the grass cut, or in the winter, who pays to winterize the house and keep the pipes from freezing.
Usually real estate agents pay these expenses out of pocket and then submit the receipts to the banks for reimbursement. This is why banks and the agents hope for a quick sale to keep these expenses to a minimum.
Another cost that can quickly create problems for banks is property taxes. If the homeowner did not pay the property taxes on their home, which is likely since they probably have had financial difficulties for some time at that point. The bank must pay these or risk losing the property to the city, township, or state. State tax liens will supersede a mortgage, and if the taxes are not up to date, the bank can lose their rights to the home as well. Therefore the longer a home sits vacant and under bank ownership, the greater the tax bill becomes and the greater the chance of the bank losing ownership to the property.
During a slow economy, foreclosures can send property values spinning out of control, like a downward spiral. This happens because as banks acquire more property the lower they make the prices to try to sell these properties. The problem is in difficult times less people have money to invest in foreclosures, causing the amount of foreclosure buyers to decrease while the amount of foreclosures increases. Supply and demand dictates that when there are fewer buyers and a greater inventory the price must go down.
When the price of these foreclosures fall enough they begin to attract typical homebuyers, people who will handle the repairs to a home before moving. This then hurts the common seller because not only do they have less buyers, the buyers are looking at different homes than they would in a normal market. In response to less buyers and not selling their home, the common home seller must lower their price to compete with the foreclosures.
The downward spiral then begins, because banks then lower their prices to sell their homes. In turn, the common seller then lowers his price again to compete with the foreclosures. This process then repeats itself several times and the real estate market of an area crashes. This cycle played itself out from 2007 to 2009 and many people are still waiting for signs the market could recover.
Unfortunately, the crash that began in 2007 resulted from lending money to people with less than stellar credit histories or from putting people into payment based mortgages, interest only or negative amortization loans. Not a one of these products was exceptionally good, and the people who sold these loans were not heartless criminals from Wall Street. These were simply honest salespeople trying to earn money to support their families. Unfortunately, these products had a catch. Over time, the payment would increase and make the home unaffordable.
The idea with the less than stellar credit individuals was they would work on fixing their credit and refinance into a conventional loan before the payments went up. The problem with this idea is that if people have a history of money trouble with a good income, they will continue to have these issues. This made refinance for these people impossible, and when the payments went up they could not pay, resulting in a massive wave of foreclosures.
The negative amortization loans and the interest only loans became a problem when these foreclosures began to hit the market, and prices stagnated. Since these loans saw no reduction of the principle or in negative amortization loans, an increase in the principle, many people decided to quit making payments. The reason these people quit making payments was they did not buy a home, they bought a house.
A person buying a home should never worry about short term market corrections; it is their home, where they live. The person buying a house on the other hand worries because he is looking at his house as an investment, which if you own multiple houses they are. However, you should consider the house you live in a home. Since they viewed their home as an investment, the smart business decision is to cut your losses and sell. Unable to sell they simply walked away, causing another huge wave of foreclosures.
Now that most of these loans have cleared the banking system, the worst of the foreclosure nightmare appears near. However, with credit remaining restrictive and unemployment remaining high, another wave of foreclosures could devastate a real estate market that is barely stable at best. If this happens, it would destroy consumer confidence in the real estate market and send the market spinning out of control even faster than the last wave of foreclosures did.
All information within this article came from the writer’s personal knowledge and experience from working in the real estate and mortgage industry for several years.
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