How Rising Foreclosure Rates Affected Your Property’s Value

- Brandon Sternberg

Why are Foreclosures Increasing?

Loans were issued to uncreditworthy individuals:

Government sponsored entities, Fannie Mae, Freddie Mac and Ginnie Mae, were established to provide banks with stable capital for loans. The government sponsored entities would essentially purchase the mortgages from the banks, securitize the mortgages and sell the mortgages- in the form of mortgage backed securities (MBS)- to investors. The transfer of mortgages from the banks to investors also shifted the risks associated with the mortgages (default risk & interest rate risk) to investors. As MBS’s became popular, appraisers, mortgage brokers, banks, etc. were receiving commissions for the mortgages and ultimately did not assume any risk of holding the mortgages. As a result the banks started to issue mortgages to uncreditworthy individuals. Most of these mortgages were in the form of subprime and adjustable rate mortgages and had terms that negatively impacted the borrower. The terms on the mortgages could not be repaid by the mortgage holders and ultimately the borrowers were faced to foreclose their properties.

How does Foreclosures Impact the Value of Real Estate:

Value of the mortgage was more than the value of the property:

As a result of the preceding section describing foreclosures of subprime and adjustable rate mortgages, foreclosures become popular and started to rise. An increase in the number of forecloses on the market, caused real estate prices started to fall. With high foreclosures there was, and still is, excess supply of houses on the market.

Basic economic theory on market conditions states, when there is a surplus (the quantity supplied is greater than the quantity demanded) firms lower price to increase the quantity demanded. This basic economic condition can be applied to the current housing market.

As the price of real estate decreased, the value of the mortgages was worth more than the intrinsic value of the real estate. For example say a homeowner took out a $300,000 mortgage. You neighbor just foreclosed and his house is now selling for $200,000. The price of his house will decrease the value of your property to say $215,000. It is not economical to pay $300,000 for something that is valued at $215,000. Homeowners noticed that this was the case, and as a result foreclosed on their mortgages. As more people foreclosed, the prices of real estate fell even further, and this is essentially how the real estate market crashed.

Other Reasons Why Foreclosures are Rising and Your Property is Decreasing:

Decrease in consumer spending cause firms to lay off employees:

Employers/firms are currently facing difficulty selling products with a decrease in consumer confidence. If consumers are not optimistic on the state of the economy it is difficult for firms to sell products. Firms are having difficulty creating revenue, and as a result they are laying off employees to cut costs. If a household was dependent on the income of the previously employed worker to finance the mortgage, the household might have difficulty making their payments. Eventually the household will face financial distress and default on their mortgage causing them to foreclose their property. As unemployment rates increased in the past few months the number of foreclosures also increased.

Going back to the basic economic theory of a surplus market condition, prices need to fall and stabilize before homeowners are going to enter the market and purchase homes. As more homeowners enter the market, prices will increase and ultimately reach equilibrium. There is optimism in the real estate market, but the number of foreclosures needs to decrease to stabilize prices. As prices stabilize consumers will be more confident in the state of the economy, thus purchasing more products. And as our economy expands, firms will hire more employees and we will be out of a recession.

Our economy has recovered from economic slowdowns in the past, and we will recover from this slowdown as time progresses. Our economy is a machine that is currently a little run down and thus being repaired; once repaired our economy will grow and perform until another break down. The cyclical movements in the economy are common and as a homeowner or commercial real estate tenant, all these factors must be assessed in your real estate purchase. Please consult your real estate broker about the current and future states of the economy. This will help your broker provide appropriate terms to safeguard you against depreciation in your real estate investment.

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