The current foreclosure crisis in America has directly impacted thousands of homeowners who have lost or are losing their homes. It has indirectly affected nearly every American, as it is the underpinning of our current economic recession. In order to resolve this crisis, we first need to understand how we got to this point. With that understanding, we can look for solutions, and then try to prevent this from happening again. In regards to a solution, I have come up with three steps that could be taken to repair our nation’s foreclosure problem. We first need to reduce the risk of the loan to the lender, and then we need to increase the consumer’s buying power, and also work to make the foreclosure process more efficient.
To come to any resolution at all we first need to discover how we got to where we currently are. Real estate values and how they are set must be well understood. The value of a home is determined by how much an individual is willing to pay for it at a given time. Since most property is not paid for in cash, individuals finance all or part of their purchase. The cost of the financing is the critical measure. If interest rates are low, you can afford a larger loan and hence, afford a more expensive property. If interest rates are high, the reverse is true.
Here is an example to better demonstrate exactly what I mean. Let’s say that an individual earns a certain amount of income. This same individual already has a certain amount of bills, such as car payments, credit card debt, etc. A lender, based on those figures, qualifies that individual for a mortgage payment of $1,500.00 per month. Currently, interest rates have been dropping, so the individual can borrow $200,000.00 with that payment. Because people can qualify for a large loan, property values tend to rise. Now, let’s say that interest rates are rising. Our borrower in this example can still afford a payment of $1,500.00 per month, but that will not only get him a loan of $150,000.00. Now the borrower, and everyone else, cannot afford as much, and real estate values tend to decline.
What happened in our current environment was that interest rates declined to record lows. As a result, people could qualify for larger loans and, in turn, real estate values rose. Everyone was happy. Real estate buyers could buy more, and sellers could get more for their property. Even those who weren’t selling their property felt that their assets were gaining in value. This was a normal real estate cycle and had it stopped there, all would have been well.
Instead, greed set in. Lenders did not want the party to stop. They got creative and qualified buyers for loans that they could afford right now, but in a certain number of years, that same loan would adjust to a payment the borrower would no longer be able to afford. The loans were sold with the idea that values would continue to rise and when one’s loan came up for adjustment, one would simply refinance back to a low payment, or...