Up until the end of 2007 the world of credit was pretty boring. I always tell people that 10 years ago nobody cared about what I had to say. Now, everyone cares. 2010 was the third year of what is generally recognized as the “credit crisis” and this credit expert predicts good – and bad — news for 2011.
This week I’ll discuss what I believe is in store next year for one of the industries that are most tightly intertwined with credit: real estate.
Property values, by and large, will continue to drop throughout 2011 for several reasons, including too much supply, too many bank-owned properties being dumped on the market at well below the original value, and mortgage lenders increasing their lending requirements.
It boggles my mind that there are still new developments going up while we have an enormous number of properties for sale either by their owners or by the banks. As long as local governments continue to issue building permits for new construction, the price and value of homes will continue to drop. There needs to be a moratorium on new construction permits until we’ve worked through the current glut of empty properties. That would be incredibly unpopular for builders, building supply stores, and the trades who act as subcontractors. Still, distressed homeowners significantly outnumber that group and the needs of the many outweigh the needs of the few.
Additionally, mortgage lenders are, rightfully, making it very hard for people to buy homes, and I’m not referring to the tougher FICO score requirements. I’m talking about down payment requirements. Yeah, I know FHA doesn’t require 20% down — but you have fewer options when you go the FHA route than if you went conventional. Unless you’ve got some money to put down, qualifying for a mortgage is very difficult. Lenders want you to infuse equity into the deal, and who can blame them?
Who Else is to Blame?
One of the great mysteries of the mortgage crisis is the lack of criticism pointed at the army of real estate franchises who still command an inexplicable 5%-7% commission of the sales price. And now they’re complaining to FICO about the use of revolving utilization in credit scoring models. That’s right, they want it removed from the FICO system, so more people will qualify for mortgage loans. Nevermind that it’s almost as predictive of credit risk as whether or not you’re making your payments. Let’s go ahead and remove the wings from an airplane so maybe we can fly faster.
We pay a 5%-7% commission for a $17 sign in a front yard and inclusion in the MLS or FMLS systems. Ouch, that’s expensive for a glorified tour guide. Consumers could be more aggressive with their pricing and avoid short sales in many cases if they had 5-7% more flexibility in their price.
“Home Equity? What’s Home Equity?”
Equity in our homes, if purchased in the past six years, is not only gone: we’ve entered the dangerous “negative equity” zone. You owe more on your house than it’s worth. You’re now financing your house like you finance your cars. And just to show you that we’re all in this together: I’m $140,000 upside down on my house… maybe more. Many of us will never be able to sell our homes unless we come up with a boatload of cash at closing or we short sell. Either way, it’s not going to be fun.
If you think you’re going to simply walk away from your home and stick it to your mortgage lender, think again. If you live in one of the many “recourse” states, then your lender can sue you for any deficiency balance left over after they liquidate your home. So to all the people talking about “strategic defaults,” keep in mind that you might have to pay an attorney $300 per hour when your mortgage lender gets around to suing you (and they will).
The downside to having negative equity is significant. Home equity lines of credit (or “HELOCs”) have long been a safety net for consumers who either have too much credit card debt or have lost a job. And, it was a great way to fund home improvements in a tax-deductible environment. Today “equity” is something our parents or grandparents, who’ve lived in their homes for decades, are enjoying. For the rest of us, we have to learn the definition of the term from history books. You can’t have the “LOC” without the “HE.”
The bottom line for 2011? As far as real estate goes, I believe we’re not even close to bottoming out.
Next, Credit Predictions for 2011, Part 2: Credit Cards.
John Ulzheimer is the President of Consumer Education at SmartCredit.com, the credit blogger for Mint.com, and the author of the “credit history” definition on Wikipedia. He is an expert on credit reporting, credit scoring and identity theft. Formerly of FICO, Equifax and Credit.com, John is the only recognized credit expert who actually comes from the credit industry. He has served as a credit expert witness in more than 70 cases and has been qualified to testify in both Federal and State court on the topic of consumer credit.