WEIRD TALES FROM THE DOT-COM ERA

It’s not easy to buy a home these days. It seems like nearly every house that goes on the market is quickly snapped up, fielding as many as 20 offers, most over the asking price, and many with cash.

I recently spent a Saturday sitting with a Realtor during an “open house” at his new listing in Cupertino, a home I would charitably describe as a dump: cramped, worn, and outdated. I couldn’t imagine anyone meeting the asking price of $1.2 million, but it sold (to an all-cash buyer) for more than $1.4 million.

It seems unprecedented, but one need only go back to the late 1990’s (the “dot-com” era) when thousands of newly-minted millionaires were eager to spend their stock-option windfalls on Bay Area housing.

I had a client who was lucky enough to be one of the first software engineers hired at a now-huge high-tech company that went public a year later. Although he had a modest salary, his options made him an instant multi-multi-millionaire. On his first attempt to buy a home in Palo Alto, he offered $850,000 more than the asking price. But someone beat him with an even higher offer!

Stung by this rejection, he was determined to make a winning offer on his next attempt. So he then offered $1.5 million over the asking price of a Palo Alto home (He got that one).

At about the same time, there was talk among Mid-Peninsula Realtors about another jilted prospective homebuyer who went to even greater lengths. Although I have no personal knowledge of this transaction, this is the way it was related to me:

A married couple made an offer on a home in Woodside. They lost out to a man who had made a higher bid. When the husband gave the bad news to his wife, she was outraged and not to be consoled. She instructed (ordered?) her husband to find the people who had outbid them and do “whatever it took” to get that house.

Miraculously, the husband located the successful bidder, whereupon he offered the man $1.5 million dollars to WALK AWAY FROM THE DEAL.

I want you to ponder that for a minute. Imagine you were offered $1.5 million to do nothing! Merely back out of a contract, allowing another person to take your place.

But this was Silicon Valley during the dot-com era, and everyone was seemingly playing with Monopoly money. So, of course, the man refused the offer!

Perhaps there are similar stories unfolding during this latest housing frenzy. If you’ve heard any, feel free to pass them on to me for mention in future newsletters!

 

  “Stated Income” – The good, the bad, and the ugly!

Why are “stated income” loans like Obamacare?

Depending on who you ask, they’re either the greatest thing since night baseball or the worst thing that ever happened to this country.

What is a “stated income” loan?  Simply put, it’s a loan for which the lender asks you to STATE your income, but doesn’t ask for PROOF. The idea started with savings and loans as far back as the 1980s, gained widespread popularity in the years leading up to the mortgage meltdown in 2007, but completely disappeared from the marketplace since.

Now, there are signs that these loans may be making a limited comeback, a surprising turn of events given the fact that they are largely blamed for fueling the worst financial crisis since the Great Depression.

So, why would a bank loan money without proof of income? Isn’t that foolish?

Not necessarily. There are many factors to consider when loaning money - credit history, cash reserves, and equity in the property to name a few. A borrower who is very strong in some categories may still be good risk even if weak in another.

Let’s take an example: CLIENT BOB buys a new home of $1,000,000, puts $500,000 down, and wants to borrow the other $500,000. Let’s assume he’s retired with only a small monthly pension, but with perfect credit, AND another $10 million sitting in a variety of accounts. He could easily pay cash for the home, but for a variety of tax and liquidity reasons, chooses not to do so.

CLIENT FRANK is employed, but puts 20% down, borrows $400,000 on a $500,000 house, has average credit, and has enough reserves to cover about 3 months of payments.

Who’s the better risk?

According to standard underwriting guidelines, FRANK is as good as gold, while BOB shouldn’t be touched with a 10-foot pole.

But wait a minute! BOB has $10 million in reserves! Even with no monthly income at all, he could draw payments from his accounts for more than 200 years. Does that sound like a risky proposition to you? DO YOU REALLY THINK BOB WOULD WALK AWAY FROM A $500,000 INVESTMENT RATHER THAN DIP INTO RESERVES? Isn’t BOB a better risk than FRANK, who could lose that “steady” job tomorrow and would be in real danger of defaulting if he can’t find another one in three months?

And here’s another situation that always has me scratching my head: Let’s suppose BOB wants to refinance. He’s had no trouble making a $3,000 payment every month for 10 years, but by refinancing, he can cut the payment to $2,500. However, the bank denies his loan because, according to the guidelines, HE CAN’T AFFORD TO PAY $2,500 PER MONTH!  He can afford $3,000, but not $2,500!? Sound crazy? It happens all the time!

BOB is the type of borrower for whom STATED INCOME was invented! These loans performed very well for decades, as long as lenders insisted on 20% minimum equity, good credit, and good cash reserves. The problems started when competition and greed spurred lenders to relax the credit and equity requirements until there were virtually no requirements at all – a recipe for disaster.

That’s when the reputation of stated income loans became tainted. Some referred to them as “liar’s loans,” while Congress pretty much mandated them out of existence.

But babies too often get thrown out with bathwater. Instead of eliminating these loans, lenders could go back to the earlier standards. Then legions of self-employed and retired borrowers like BOB, with good credit, equity, and cash reserves, could participate in a real estate market from which they’ve been virtually shut out for the last seven years.

There’s a big demand for this type of loan. It’s just a matter of time before more lenders rush to fill the void.

 

 

 

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