Tag Archives: 1930s

Wall Street’s New Toxic Transactions

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Toxic Real Estate

The National Consumer Law Center released a report, Toxic Transactions: How Land Installment Contracts Once Again Threaten Communities of Color. It describes land installment contracts as follows:

Land contracts are marketed as an alternative path to homeownership in credit-starved communities. The homebuyers entering into these transactions are disproportionately . . . people of color and living on limited income. Many are from immigrant communities.

These land contracts are built to fail, as sellers make more money by finding a way to cancel the contract so as to churn many successive would-be homeowners through the property. Since sellers have an incentive to churn the properties, their interests are exactly opposite to those of the buyers. This is a significant difference from the mainstream home purchase market, where generally the buyer and the seller both have the incentive to see the transaction succeed.

Reliable data about the prevalence of land contract sales is not readily available. According to the U.S. Census, 3.5 million people were buying a home through a land contract in 2009, the last year for which such data is available. But this number likely understates the prevalence of land contracts, as many contract buyers do not understand the nature of their transaction sufficiently to report it.

Evidence suggests that land contracts are making a resurgence in the wake of the foreclosure crisis. An investigative report by the Star Tribune found that land contract sales in the Twin Cities had increased 50% from 2007 to 2013. Recent reports from The New York Times and Bloomberg reveal growing interest from private equity-backed investors in using land contracts to turn a profit on the glut of foreclosed homes in blighted cities around the country.

Few states have laws addressing the problems with land installment contracts, and the state laws on the books are generally insufficient to protect consumers. The Consumer Financial Protection Bureau (CFPB) has the mandate to regulate and prevent unfair and deceptive practices in the consumer mortgage marketplace, but has not yet used this authority to address the problems with land installment contracts. (1-2, footnotes omitted)

This report shines light on this disturbing development in the housing market and describes the history of predatory land contracts in communities of color since the 1930s. It also shows how their use was abetted by credit discrimination: communities of color were redlined by mainstream lenders who were following policies set by the Federal Housing Administration and other government agencies.

The report describes how these contracts give the illusion of home ownership:

  • They are structured to fail so that the seller can resell the property to another unsuspecting buyer.
  • They shift the burden of major repairs to the buyer, without exposing the seller to claims that the homes breach the warranty of habitability that a landlord could face from a tenant.
  • They often have purchase prices that are far in excess of comparable properties on the regular home purchase market, a fact that is often masked by the way that land contract payments are structured.
  • The properties often have title problems, like unsatisfied mortgages, that would not have passed muster in a traditional sale of a house.
  • They often are structured to avoid consumer protection statutes that had been enacted in response to previous problems with land contracts.

The report identifies Wall Street firms, like Apollo Global Management, that are funding these businesses. It also proposes a variety of regulatory fixes, not least of which is to have the CFPB take an active role in this shadowy corner of the housing market.

This is all to the good, but I really have to wonder if we are stuck just treating the symptoms of income and wealth inequality. Just as it is hard to imagine how we could regulate ourselves out of the problems faced by tenants that were described in Matthew Desmond’s Evicted, it is hard to imagine that we can easily rid low-income communities of bottom feeders who prey on dreams of homeownership with one scheme or another. It is good, of course, that the National Consumer Law Center is working on this issue, but perhaps we all need to reach for bigger solutions at the same time that we try to stamp out this type of abusive behavior.

Reiss on New Residential Real Estate Exchange

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NationSwell quoted me in Can’t Afford a Down Payment? Let Investors Help You Buy Your Home. It reads in part,

Enter PRIMARQ, the world’s first residential real-estate equity exchange — a soon-to-launch venture of San Francisco entrepreneur Steve Cinelli. Can’t afford a down payment? Let investors put together the capital you can’t, without relinquishing all your clout as a homeowner. By letting “co-owners” buy shares in your home, you’re able to put down a bigger down payment, which means you end up carrying less debt and can get a loan free of mortgage insurance, which is commonly tacked on for down payments of less than 20 percent. “I think the market is overly dependent on mortgage-debt financing,” Cinelli says. “The application of debt has gone way too far.”

Investors can bet on housing without having to deal with the actual house. They’ll get their money back (plus profits if there are any), under one of several circumstances: when you sell your home, when you decide to buy back your shares, or when the investor sells his shares back to the PRIMARQ exchange itself, which offers a “liquidity guaranteed” 90 percent of their value. So, if an investor puts up $10,000, and then wants to cash out for any reason before you sell your home, they’ll walk away with no less than $9,000 (unless the home price drops) — and it doesn’t affect you either way.

Not all homebuyers and not all houses can qualify for PRIMARQ funding. If there’s a mortgage involved, the buyer has to meet strict credit-score criteria, and the home has to have a certain expected price appreciation — meaning it’s got to be a decent property in a good location. That doesn’t necessarily rule out homes in lower-income neighborhoods, but it does stand to reason that unless those neighborhoods are deemed “up-and-coming,” the homes there might not qualify for PRIMARQ.

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To be sure, the PRIMARQ model involves risks for both investors and homeowners — not the least of which is a gaming of the system by nefarious investors, says David Reiss, a professor of law at Brooklyn Law School in New York who researches and writes about the American housing-finance sector. While Reiss calls PRIMARQ a “supercool idea” for all the aforementioned reasons, he could imagine various ways for unsophisticated homeowners to get fleeced without proper consumer protection regulations (the program has not yet been reviewed by a government regulatory agency). Unscrupulous investors could demand fees or increased equity in exchange for agreeing to help fund a second mortgage, for example. By participating in PRIMARQ as a homeowner, “you are not the master of your own destiny,” Reiss says.

Reiss on Rising Interest Rates

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ABC News quoted me in Small Interest Rate Changes Mean Big Money for Home Buyers.  The story reads in part,

As the economy continues to recover from the worst recession since the 1930s, mortgage interest rates remain at historically low levels.

The Primary Mortgage Market Survey, produced by Freddie Mac, reported in mid-March the average rate for 30-year fixed-rate mortgages was 4.32 percent; 15-year fixed-rate mortgages averaged 3.32 percent and interest rates 5-year Treasury-indexed hybrid adjustable rate mortgages averaged 3.02 percent. Nonetheless, Frank Nothaft, chief economist for Freddie Mac, speculated the Fed’s gradual tapering of its stimulus efforts may prompt a rise in mortgage interest rates.

If mortgage interest rates do rise significantly in the future, what, if any effect will there be on the home buying market? According to Steve Calk, chairman and Chief Executive Officer of The Federal Savings Bank, interest rates have never been the deciding factor for whether potential home buyers actually purchase a home.

“Whether interest rates are 5.5 percent or 7.5 percent, when people are ready to buy, they’ll buy a home,” Calk said.

Price, location, size, appreciation value – these are factors many would-be homeowners consider long before mortgage interest rates enter into the picture. However, once they begin actively searching for a home, interest rates often play a role in their ultimate buying decision.

This is especially the case when interest rates are high, according to David Reiss, Professor of Law at Brooklyn Law School.

“When people think about buying houses, they think about the price of the house. But what they really should be thinking of are the monthly costs. The average 25-year-old might not think about housing rates until they go to a mortgage broker.
“Then they discover that 8 percent interest may mean that instead of a $200,000 home they can only afford a $160,000 home,” Reiss said.

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Tight credit and persistent high unemployment have almost certainly played a role in depressing home buying figures during the recovery, as has the large numbers of home owners who perhaps bought homes at the height of the bubble who now find themselves underwater on their mortgages. However, many underwater homeowners could be missing out on a unique opportunity presented by the present financial climate. In a housing market where prices are depressed and borrowing is cheap, home buyers with solid incomes and good credit can find lenders willing to extend credit on favorable terms, ultimately putting them ahead financially, even if they sell their present homes at a loss, according to Reiss.

“Many people feel stuck in place because they are underwater or the market is bad. But although it may be counterintuitive, it could actually be a smart move to sell in a bad market. It’s a bit more sophisticated strategy, but you could move out of a cheap home into a better home for not that much money,” Reiss said.

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Education and due diligence in maintaining good credit are the most potent tools that potential home buyers can employ, whether they are seeking their first home, a larger home or are scaling down to smaller quarters as empty nesters. Obtaining prequalification can provide home seekers with a better idea of precisely how much house they can afford, Reiss said.