Home Buyers with Foreclosures or bankruptcies on Their Credit: Can They Buy a Home Today

There's an interesting phenomenon happening in the real estate buying cycle.  Now that most of the country is five to seven years out from its real estate peak, and most major cities are actually into the upswing of home prices, distressed homeowners of yesteryear are becoming the home buyers of today.

 

Rules for qualifying for a mortgage vary widely between lenders and loan programs, but one of the most-often used loans today is the FHA mortgage.

Today's FHA mortgage requirements for foreclosures and bankruptcies (see your lender for exact details):

• A foreclosure that was discharged three years ago
• A bankruptcy discharged two years ago

The initial reaction by many to this situation is: Again?  We've certainly all seen enough shoddy lending and lax credit practices during the last boom-bust cycle and, on the face of it, this seems like an invitation to more.

However, the details of how these home buyers must qualify is dramatically different from the way sub-prime home buyers were qualifying for loans in the past.  The new practices, while still generous to the buyer, create far greater protections for the lender and the American public who, in the long run, foot the bill for defaults.

Home buyers with foreclosures and bankruptcies on their records need to show a consistent history of pristine credit since the time of their foreclosure or bankruptcy.

Additional FHA requirements (there are more, refer to a lender):

• On-time bill payment on all credit accounts since the foreclosure/bankruptcy
• A 640 credit score (responsible credit use is absolutely essential to gain this score 3 years out of foreclosure)
• A verified down payment (3.5% or higher, depending on the borrower)
• Upfront and ongoing mortgage insurance (which protects the lender from debts in case the buyer defaults)
• Significantly lower debt-to-income ratios (ensures the buyer has ample discretionary income to make payments long-term)

Underwriters scrutinize these borrowers' loan applications far more than an average home buyer.  In contrast, during the real estate boom, a buyer could be approved for a mortgage with very little credit history to support it.

Sub-prime mortgage approvals at the height of the real estate boom: 

•  580 credit score
• 100% Financing or 80/20 1st/2nd mortgages (no money down)
• Foreclosure 2 years out
• Bankruptcy 2 years out
• No income verification
• Total debt ratios up to 60%

While the changes in lending to borrowers who have past foreclosures and bankruptcies may not satisfy all critics, there are also mitigating factors that underwriters take into consideration.  Remember that even though a home buyer's past foreclosure may have been closed as of three years ago, the banks sometimes take up to a couple of years to push a foreclosure through.  That person may have essentially handed the home back to the bank five years ago and been repairing their credit ever since.  Underwriters can take this into account.

Moreover, there are many different situations that lead to foreclosure.  Certainly some buyers overspent, got in over their heads, and walked away from a bad investment.  Those are going to be viewed less favorably by a lender.  Others have lost their homes due to job loss, divorce, deaths in the family, and a host of other reasons.

When an underwriter can see that home buyers have been responsible with credit in every instance of their lives except for the foreclosure or bankruptcy event due to unforeseen loss of income or spouse etc., there is great reason to believe that these people, under the newer, more restrictive lending guidelines, are a good credit risk.  The lender and the public are protected by these buyers paying for mortgage insurance, and their re-introduction to the housing market in a new economy will allow them to re-establish a long-term credit track record and keep the housing market moving.

Possible 2013 Housing Outlook

At last, most indicators point to a genuine recovery in the housing market. After nearly six years of deflating home prices, the housing market is finally, firmly on the path to recovery. For the year ended September 30, home prices nationwide rose by 4.9%, and the median price for existing homes jumped by almost $14,000, to $185,000, according to Clear Capital, a provider of real estate data and analysis. Buyers turned out in greater numbers in 2012, driven by affordable homes and historically low mortgage rates. Strict guidelines for getting a mortgage, however, continue to hinder the ability of some would-be buyers to close the deal.

All the positive trends for the housing market will drift into 2013, becoming more entrenched as the economy picks up steam in the second half of the year, says Celia Chen, a housing economist at Moody's Economy.com. Market observers agree that home prices will keep rising in 2013, but they disagree by how much. Clear Capital's forecast is at the higher end, with an overall gain of about 5% in 2013.

As the recovery blooms, "sellers will smile more, and buyers will need a more concentrated focus," says Lawrence Yun, chief economist for the National Association of Realtors (NAR). Home buyers can expect to face stiff competition for fewer highly desirable homes.

Correcting the Correction

Home prices rose or remained flat in about two-thirds of the 313 cities Clear Capital tracks and continued to fall in the remainder, mostly by single-digit percentages. Fifty cities experienced double-digit increases in home prices, led by Phoenix, with a gain of 28.4%. Such spikes reflect a "correction to the correction," says Alex Villacorta, director of research and analytics for Clear Capital. The properties had become undervalued when measured by affordability.

The benchmark of affordability (the ratio of median home price to median family income) stands at 3.0—right at the historical average and up a tad from 2011. Another measure, the percentage of monthly family income consumed by a mortgage payment (principal and interest, using a mortgage rate of 4%) is 14%, up slightly from 2011, when it was 12%.

Many of the cities that are doing the best are those that Villacorta describes as "first in, first out," including Phoenix and many cities in Florida and California's Central Valley. The real estate bubble began to burst in those cities earlier than in many others, and the cities have begun to recover earlier, too.

Other cities—including San Francisco, San Jose and Washington, D.C.—are relatively expensive again, driven by strong job growth, especially in technology and defense. Utah's largest cities (Ogden, Provo and Salt Lake City), as well as Denver and Little Rock, Ark., never experienced a huge drop-off in home prices, and as a result they posted gains in 2012 that exceeded their losses since the peak. Several cities have seen steady gains: Austin, Tex., Pittsburgh, and the upstate New York cities of Buffalo, Rochester and Syracuse. They neither boomed nor busted; they just kept plugging along.

The large U.S. cities where home prices remained flat or fell in 2012 suffer from either a surplus of distressed properties or uninspired economies—or both. They include Chicago, Louisville, Ky., Memphis, New Orleans, the greater New York metropolitan area and Philadelphia.

Buyers Get in the Game

For several years, investors armed with cash have been scooping up distressed and undervalued properties, especially at the market's entry level. In 2012, that drove double-digit price spikes in Phoenix, Cape Coral, Fla., and other cities. 

As home prices rise and the economy improves, investor influence will wane. Villacorta explains the process: Investors buy undervalued homes, which are often vacant and in poor shape. They remodel them, and by renting or selling them, attract occupants. The neighborhood revitalizes, and prices begin to rise. A year or so of consistently rising prices instills buyers and sellers with confidence that the bottom has been reached and it’s time to jump in. As that sentiment catches fire and spreads, the market transitions to include more traditional buyers, who pick up where investors left off. 

Meanwhile, as the economy recovers and hiring increases, housing demand strengthens. High rental occupancy and rising rents are encouraging renters to move on to homeownership. Also, as home prices rise, owners who were underwater or nearly underwater—without enough equity in their homes to pay off the mortgage—will emerge from the sidelines and start selling and buying homes, says Molly Boesel, a senior economist at CoreLogic, a mortgage data firm. The company reports that 1.3 million homeowners were lifted out of negative equity between year-end 2011 and June 30, 2012.

Rising Sales, Tight Supply

In the past year, sales of existing homes and condos rose by 11%, to 4.75 million. The NAR expects sales to rise to nearly 5.1 million in 2013. Sales have increased across all regions and all price categories. "That's a reflection of a very broad-based re­covery," says Yun.

In 2011, most activity occurred at the low end of the market, so the number of inexpensive homes for sale dropped off in 2012. "It was like someone switched on the light and half of the inventory disappeared," says Yun. That led to a reduction of sales activity in the very low price range, especially in the West. That also explains why the median home price has risen dramatically in the past year. More transactions have occurred in the middle and upper home-price tiers.

As demand grows, where will the supply of homes come from? That could turn out to be a problem for buyers—one that leads to higher prices and more bidding wars. Many would-be sellers of existing homes have waited for prices to stabilize or improve—but most of them are also planning to move up or downsize after they sell their home. So it's a wash in terms of net inventory. And although new-home building has increased, it’s still half the normal historical average. That's not enough to satisfy demand, says Yun. But builders are constrained now by difficulty finding financing, and many skilled laborers left the industry after the housing bust. 

Distressed properties are still adding to the supply of homes, but in 2012 foreclosure filings dropped to a five-year low nationally, according to RealtyTrac, which monitors the foreclosure market. RealtyTrac vice-president Daren Blomquist expects the number of foreclosures nationwide to continue to decline in 2013, partly because lenders have finally realized that they lose less money on short sales (homes sold with lenders' approval for less than the owners owe on their mortgages) than on foreclosures. However, lenders in some states (notably Florida, Illinois, New Jersey and New York) have a backlog of foreclosures resulting from the robo-signing debacle in 2011 and new state legislation. As they catch up, the foreclosure rate will spike in those states, but only temporarily.

Despite most housing signals flashing green, confidence in the market is still blinking yellow. Chen says it is tied to concerns about the economy—especially lending, hiring and consumer spending. Continued recovery of the housing market also depends on how adeptly Congress deals with the spending cuts and tax hikes looming at the fiscal cliff and whether the mortgage-interest deduction survives the process. Those may seem like big ifs, but most economists say the majority of them will be resolved by the second half of 2013, giving the housing market the shot in the arm it needs to stay on the path to full recovery.

Contributing information: Pat Mertz Esswein

U.S. Farm Bills Fuel Food Price Inflation

The Food, Conservation, and Energy Act of 2008 expired at the end of the U.S. 2012 fiscal year, and covered all agricultural commodities produced in the U.S. during the full crop year of 2012. Congress on New Years Eve approved a nine month extension of the 2008 act, and it is now set to expire at the end of the 2013 fiscal year and cover the full crop year of 2013. American farmers currently have no clue if and when Congress will pass a new 5-year farm bill and what the Federal Government's latest agricultural policies will be.

Food price stability is supposed to be one of the Federal Government's main goals when proposing and enacting their primary agricultural and food policy tool, the farm bill. However, all farm bills enacted by the U.S. government throughout history have always resulted in Americans overpaying for food. The current uncertainties surrounding the farm bill will likely lead to greater food price volatility than ever, throughout the full year of 2013.

If the 2008 farm bill wasn't extended on New Years Eve, the law would have automatically reverted to the last permanent farm bill, which was enacted in 1949 - the year in which the New York Yankees, with the help of Yogi Berra and Joe DiMaggio, defeated the Brooklyn Dodgers in the World Series. The Brooklyn Dodgers have since moved to Los Angeles and were sold last year for a record $2.15 billion, and Brooklyn is now the home of the Nets - an NBA team that was founded as the New Jersey Americans 18 years after the passage of the last permanent  U.S. farm bill.

The U.S. Agricultural Act of 1949 included price support programs covering agricultural commodities, which allow farmers to receive a minimum amount of dollars for their agricultural commodities produced. Its goal is to provide farmers who produce agricultural commodities with a "parity" level of income based on their level of income vs. the rest of the U.S. economy during the years 1910 through 1914, which they considered to be the "golden age of agriculture".

During this so called "golden age of agriculture", the agriculture industry employed 20% of our nation's workforce. Beginning in 1940, a revolution took place in the U.S. agriculture industry that suddenly made American farmers substantially more productive. Inventions of new machines, irrigation methods, and improved pesticides, allowed American farmers to work dramatically less hours, while being able to produce a much larger amount of food. All together, growth in U.S. agriculture productivity increased 5-fold from 0.4% annually from 1910 through 1939, to 2% annually from 1940 through 1996. As a result, only 2% of our nation's workforce works in the agriculture industry today.

The 1949 farm bill included a "parity ratio", which is defined as: the level of prices for articles and services that farmers buy, wages paid to hired labor, interest on farm in-debtedness secured by farm real estate, and taxes on farm real estate, divided by the the general level of such prices, wages, rates, and taxes during the period of January 1910 to December 1914. It also created "adjusted base prices" for agricultural commodities based on the most recent 10-year average prices received for the commodity, deflated by the corresponding 10-year average of the index of prices received for all commodities. The bill then calculated a "parity price" by taking "adjusted base prices" for agricultural commodities and multiplying them by the "parity ratio".

Even though the parity price hasn't been used for many decades, the USDA is still required to spend millions of dollars monthly on calculating and reporting the latest parity prices for each agricultural commodity. The 1949 farm bill mandates that the Federal Government support a minimum sales price for agricultural commodities by directly buying from farmers milk and butterfat products at 75% of its parity price, wheat at 75% of its parity price, cotton at 65% of its parity price, and corn at 50% of its parity price.

The milk parity price as of October 2012 was $52.70 per cwt and the Federal Government under the 1949 farm bill is required to support a minimum milk price of $39.525 per cwt vs. the current milk January futures price of $18.10 per cwt. The wheat parity price as of October 2012 was $18.60 per bushel and the Federal Government under the 1949 farm bill is required to support a minimum wheat price of $13.95 per bushel vs. the current wheat January futures price of $7.83 per bushel. The cotton parity price as of October 2012 was $2.11 per lb and the Federal Government under the 1949 farm bill is required to support a minimum cotton price of $1.37 per lb vs. the current cotton January futures price of $0.77 per lb. The corn parity price as of October 2012 was $12.10 per bushel and the Federal Government under the 1949 farm bill is required to support a minimum corn price of $6.05 per bushel vs. the current corn January futures price of $7.23 per bushel.

The U.S. Agricultural Act of 1949 supports minimum agricultural commodity sales prices for farmers that are above current market prices by 118% for milk and 78% for wheat and cotton. Only corn's current market price is above the 1949 farm bill minimum sales price, with corn currently selling for 19.5% more than what the government is required to pay for it in the 1949 farm bill.

If Congress didn't extend the 2008 farm bill on New Years Eve, milk prices in retail stores would have roughly doubled in recent weeks, with U.S. consumers today likely paying approximately $8 per gallon of milk. Around mid-year when farmers begin harvesting wheat and cotton, consumers would have experienced an explosion in prices of goods containing wheat and cotton. If a new farm bill doesn't get enacted this year, consumers will once again be facing these same threats in late 2013.

Even since the first Agricultural Adjustment Act was enacted in 1933, Americans have been forced by the U.S. government to overpay for food. The Agricultural Adjustment Act of 1933 restricted agricultural production by paying farmers subsidies not to plant part of their land and to kill off excess livestock.

During the Great Depression, the free market was trying to make lives for Americans easier by allowing them to benefit from low food prices. However, the U.S. government ignored the root causes of the Great Depression and decided that farmers were producing too many commodities like hogs and cotton. Late in the Spring of 1933, the Federal Government began carrying out "emergency livestock reductions" and 1 million farmers were paid to destroy 10.4 million acres of cotton. The Federal Government bought 6 million little pigs and other livestock from farmers. All of these little pigs and other livestock were simply killed, many of them shot and buried in deep pits.

More recent farm bills have rapidly expanded the size of the U.S. government by introducing new federal programs, expanding subsidies, and providing more food stamps and foreign food aid. Most farmers support free market principles and prefer honest pay and honest work. Farmers become fearful any time that a new farm bill is up for consideration, because 60% of the subsidies go to just 10% of farms and if a farmer's competitors unfairly qualify for more government subsidies, it could force them out of business. Generally speaking, U.S. farm bills have disproportionally favored large agribusiness at the expense of small struggling farmers.

The farm bill is just another way to make Americans more dependent on the Federal Government. If farmers weren't unfairly given subsidies, competing farmers wouldn't need their own subsidies to stay in business. If the government didn't keep food prices high by continuously increasing the size of the food stamp program, the number of Americans who need food stamps will fall dramatically.

The passage of U.S. farm bills make food prices unstable and help fuel huge food price inflation. The fact that most parity prices for agricultural commodities are well above current market prices, shows that Americans today are still blessed with very cheap food. As the Federal Reserve continues to expand its balance sheet and the U.S. moves closer to trillions of dollars of debt monetization, food prices have the potential to double overnight without any substantial reduction in demand.