As with many government programs, it started with good intentions.Â
In 1977 Congress passed the Housing and Community Development Act of
1977 better known as the Community Reinvestment Act (CRA) to reduce
discriminatory lending practices in low to moderate income neighborhoods
and increase lending to minorities. There have been several
modifications to the original act over the years.
Among these modifications were provisions that allowed Fannie Mae and
Freddie Mac to securitize mortgages and sell them to investors. These
securities were insured or guaranteed by these entities. Lenders would
originate loans and sell them to Fannie and Freddie who in turn would
bundle them into securities and sell them to investors all over the
world. This created a ready market for the mortgage backed securities
and encouraged lenders to make more loans. If the asset underlying these
loans remained strong, then the security would also be strong.
Some have charged that the regulations forced lenders to make loans
to people who would not have, under previous credit standards, qualified
for the loans they were getting. Many lenders created new types of
loans, primarily negative amortizing adjustable rate loans as well as
loans of up to 100% of the value of the home. Many did not require any
proof of income for the borrower. All of this was done to increase
lending among low to moderate income borrowers and in many cases to meet
As the supply of money increased, due to relaxed underwriting
standards, more people were able to purchase homes. When there are more
people with more money chasing a limited supply of homes, prices will
rise. Some of the people who purchased homes in the early stages of this
boom were able to sell their homes for 20-50% more than they paid for
them in a short time, often in 3-6 months. Many took the equity and
repeated the process. Some refinanced and remodeled the home, bought
cars and TVs or used the money for their childrenâ€™s education.
Eventually the bubble burst and people were not able to turn the
homes over as quickly as they had just a few months before. Now people
had mortgages of 100% or more of the value of the home and also were
faced with a mortgage payment that was going to increase. Many of these
borrowers had initial interest rates as low as 1% and now were facing
rates of 5-8%. A loan of $150,000 at 1% had a payment of $482 a month.
Now when the interest rate adjustedborrowers were faced with a payment
of $805 a month or more. Many could not afford this new payment and had
to sell their home.
Now we were in a reverse situation from what we had been in before.
The supply of homes on the market increased and prices started falling.
Many borrowers walked away from their homes and the lenders foreclosed.
As prices fell on these homes that the borrowers could no longer afford,
other homes in the neighborhood also fell in value and equity
evaporated. Many people tried to keep up with their payments but after
seeing the value of their home fall 50% or more in some cases, they made
the decision, often called a strategic default, just to stop paying the
mortgage. Sadly the ones hit hardest are the ones that the law was
created to help.
So now our real estate market is dominated with short sales, homes
selling for less than is owed to the lender, and foreclosed properties,
called REOs for Real Estate Owned. Only time will cure the problem but
meantime now is a great time to purchase a home for your own use or as
an investment. Interest rates are at all-time lows for both personal
residence and investment properties.