House Worth Less Than Mortgage - Is it really such a bad thing?
There is an area about 45 min east of downtown Phoenix called “Queen’s Creek.” A couple of years ago, developers were going crazy building nice houses out there. My first issue with that is that it’s 45 minutes away when the traffic is moving like it should. When it’s not, add another hour or so of commute time each way.
In my opinion, those subdivisions were doomed just because of that. But, I walk to work, so commute is foreign to me anyway. But this has really gotten a lot of local press as one of the “bad examples” of lender and developer irresponsibility and it got me thinking. Let me ask you, is this really such a bad deal?
The developer sold the house for $400,000 and put $100,000 aside for upgrades like landscaping, a pool, etc. The buyer got a 100% financed house. Upon close of escrow, they got a check for $100,000. Cool! They didn’t just get a no money down house, they got a house PLUS $100,000.
But, how much was the house really worth? It wasn’t just you that got that deal. It was everyone in the whole subdivision. So, the house really is worth $300,000. It’s just that you basically got a low interest loan for $100,000. I’ve got to tell you, as a business owner, I’d love to get a 6%, 7% or even 8% loan to grow my business. AND get it either interest only forever or with a 30 year amortization. I mean, come on, what business owner WOULDN’T love this?
The problem was that people bought the house thinking that somehow they were smarter than everybody else and that somehow they just got a $400,000 house for $300,000 and the $100,000 was their reward for being smart. So, they took the money and spent it.
Now the money’s all gone, and the house is only worth $300,000 (which is what it was in the beginning!) Or actually, it’s only worth about $250,000 now because a few of the neighbors have defaulted and the mortgage companies have allowed short sales that have reduced the neighborhood’s value.
Meanwhile, everyone is blaming the developer and the lender. Well, maybe they should have explained that the “wink wink” when they said how much the house was worth was really meaning “hey, we’re cheating here to get you a great loan and don’t be an idiot about it” but they didn’t.
For me, I’d love to get a $100,000 loan with low interest and interest only payments that counts as a mortgage and NOT a revolving credit line on my FICO score. Anybody got a few of those deals lying around still?
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Isn’t this figure just lending fraud? The bank is tricked into believing they are giving you a loan for a property worth $400K when in reality it is just worth $300K, and then getting the $100K “back at closing”. Is this different because the lender is part of the deal? I can see why lenders would go after the builder for overinflating the appraisal. I don’t see how the property owners could complaint in any way.
I got one just like that offered to me two weeks ago and I decided to pass on that one as I got that impression, that somehow I’d be lying to the lender. So yes, it seems they are still around.
It looks like fraud all around - appraiser, developer and maybe lender.
But, I still think as a business owner it’d be a sweet deal. Now we have a bunch of homeowners complaining.
It sounds like everyone ignored that this business model only works when the market is going up.
Was the $100k supposed to be for planned improvements to the property that would support the $400k appraisal? If so, that’s pretty fuzzy math. This is the part that I find most suspect about the business model and most likely to classify in the fraud category. The value shouldn’t count until the improvements are done. The $100k, then, is an advance loan for the improvements.
Unfortunately, when the market goes down, the note investors, lenders and buyers are the ones at risk with the loan, itself. Everyone else gets their profit at the original sale. The higher the purchase price, the higher the commissions. But also keep in mind, the lenders get some profits, too, in the form of financing points and closing costs/fees that they charge as well. Bigger loans means more interest and bigger profits for the bank. So the lenders have a vested interest in the purchase price, as well.
It’s unfortunate that most of these buyers had no clue what to do with what may be one of the biggest financial windfalls they’re likely to get.
I am amazed that so many people can’t keep themselves afloat with a $100k cash back!
Business model? We don’t need no stinkin’ business model!
Penny, you’re absolutely right - you’ve got to plan for business to continue in a market that goes up, down or stagnates.
And, the $100K question - How much would a payment on a $400K property be? Interest is pretty doggone low. Couldn’t they have just used that for liquidity in case the market went down? BTW very few actually put the money into the property. I think it went for toys.
I agree it smacks of mortgage fraud…when we had one of our houses in San Diego up for sale the real estate agent called and said he had a guy that wanted to buy the house at our high-end asking price but then wanted us to agree to give him back $200,000 after closing - no legal agreement, just a verbal agreement. The agent hemmed and hawed when I brought up mortgage fraud and said “but it’s the same thing developers do.” To me fraud is fraud and I want no part of it.
However, that said, as a buyer in that situation if the property appraised at the higher value and the rest of the loan information they provided was honest then would they actually be considered engaging in fraud if part of the sale was money back at closing? Wouldn’t it only be the mortgage fraud on the part of the seller, appraiser (if they fudged the value on the appraisal), agent, broker, etc. who are licensed and know the laws? Or would “ignorance of the law is no excuse” pull the buyer into it? I would think if they ever defaulted on the loan it could become an issue.
We’ve bought and sold houses with a small amount ($10,000) back at closing for new carpet, etc. How is that different as long as it’s in the closing documents and not just a “wink, wink” deal not part of the contract?
This is an interesting topic…Megan, where does the line get drawn legally????
My understanding is (and I have no law degree or any real knowledge other than my experience in doing RE deals for the past four or five years) that if it is not in the HUD-1 then there is something “wrong”.
If you were the lender, would you agree to such deal? If the lender agrees with the cash back then I am OK doing it. Otherwise I’d leave it alone.
It was in the HUD-1, so that’s the interesting thing. They treated it as a release of escrow funds for property improvements.
Just got an email from my friend Aaron Van Trojen (Morgan Financial) who does all of Richard’s and my loans.
Here are Aaron’s insights into a little bit of the deal:
“The $100K was on the HUD as an escrow hold back, going to a fictitious landscaping company. When the deal closed the $100K went to the buyer. The lender was unaware that happened until they took the property back. The builders keep the values high by selling everything in the development using similar practices. The lender is not committing any fraud because they are unaware that the money ever goes back to the buyer.”
My comment is that if it went to a fictitious landscaping company then the builder and buyer were DEFINITELY aware this wasn’t correct. Again, one of those “wink wink” type of transactions.