Lowest mortgage rate on record: investor opportunity?

For lenders and mortgage investors the two cases raise the chilling prospect that the routine ability to foreclose is now less certain. The lever of foreclosure — the traditional way to satisfy an unpaid mortgage — has been bent. The interesting news is that more lender risk translates into increased opportunities for real estate investors seeking marketplace bargains.

The Way It Was

In general terms there are judicial and non-judicial foreclosures. With judicial foreclosures lenders must go to court before they can foreclose; with a non-judicial foreclosure the terms and wording of the mortgage note allow the lender to sell property without a hearing.

So far, so good — for lenders. Even when foreclosures require judicial approval they typically race through the court system in mere minutes, a formality to be observed rather than a barrier of any consequence.

But now we have a growing number of situations where foreclosure defense attorneys have found cracks in the system. Not little chips or minor flaws, but vast fissures which may impact large numbers of loans and billions of dollars in lender equity.

Lawyers and judges are increasingly looking at what the law actually says. Yes, borrowers must pay their debts — but lenders have obligations too. They must own the loan. They must keep accurate accounts to show what's owed. And in a growing number of states they must make a good-faith effort to work with homeowners before moving ahead with foreclosure.

Loan Ownership

If there's such a thing as foreclosure lotto then New York homeowner Olga D. Paredes has won a grand prize. In September she faced off against the PHH Mortgage Corporation in bankruptcy court and federal Judge Robert Drain canceled the mortgage on her White Plains home — that was a debt of $461,263 according to the New York Times.

The issue in the Paredes case was that PHH could not prove it owned the loan, and if it was not the lender then it had no standing to foreclose. How could PHH not be the lender? After the loan was originated it was sold into the secondary market and the wild world of trustees, assignments and electronic ownership, none of which was documented sufficiently for the judge.

The Paredes decision follows similar cases in Ohio, Kansas, Missouri and Nevada. While these cases deal with the issue of who actually owns the loan, a new case takes a different slant, the idea that lenders must negotiate workouts in good faith when required by newly minted state rules.

The States

While mortgages are largely originated under federal rules, the foreclosure process is operated by the states. Because of the foreclosure crisis, many states have enacted new regulations that slow foreclosures by establishing longer periods before homes can be foreclosed, require mandatory meetings between borrowers and lenders and demand that lenders negotiate loan workouts in good faith.

A requirement to have settlement conferences exists in New York state, but according to state Judge Jeffrey Spinner in the case of IndyMac Bank versus borrower Diana Yano-Horoski it was “made clear to the Court that Plaintiff had no good faith intention whatsoever of resolving this matter in any manner other than a complete and forcible devolution of title from Defendant.”

In fact, the homeowner had actually been offered a loan modification and immediately was in default. If the borrower would not make even one payment for a modified mortgage then why not foreclose?

What Judge Spinner determined was that full and timely payment was impossible because the forbearance agreement had been sent to the borrower “after its stated first payment due date and hence, Defendant could not have consummated it under any circumstances.”

Spinner said IndyMac's conduct was “inequitable, unconscionable, vexatious and opprobrious” and ruled that IndyMac's actions had been “been harsh, repugnant, shocking and repulsive to the extent that it must be appropriately sanctioned so as to deter it from imposing further mortifying abuse against Defendant.”

And how should IndyMac be deterred from such behavior in the future? By canceling the mortgage on the defendant's home in Brookhaven, ruled the judge, a total claim of more than $525,000.

“The recent chain of courtroom events suggests that the foreclosure is becoming less attractive for lenders,” says Jim Saccacio, Chairman and CEO at RealtyTrac.com, the leading online marketplace for foreclosure listings and data. “Foreclose on a homeowner today and there's a growing possibility that a savvy lawyer will be able to hold up the process for months — if not turn the tables and force the lender to prove ownership of the loan and fair dealings under new state laws.”

The Investor Opportunity

Let's imagine that you can buy a property today for $300,000 with 30-year financing at 4.8 percent fixed over 30 years. The cost per month is $1,574 for principal and interest.

Let's also say that in 2010 prices fall as they have for the past 12 months, dropping by 3.8 percent nationwide as the government has reported for the third quarter of 2009. The drop next year might be more in some areas and less in others; in fact prices are likely to rise in some local markets. As always, no one knows what the future will bring and no one knows when the marketplace will bottom out or reach new highs.

It seems implausible that mortgage rates can go much lower — rates for T-bills are already negative according to Canada's Globe and Mail. As an alternative, imagine that mortgage interest rates return to 6 percent next year, a rate which is ridiculously low by the standards of the past few decades but an increase from where we are now.

We'll be able to buy the same property for $288,600 next year ($300,000 less 3.8 percent), but at 6 percent the monthly cost for principal and interest (P&I) will rise to $1,730. You can see where this is going. If rates rise to 7 percent — a rate that would have elated most borrowers until recently — the monthly cost for P&I would go to $1,920.

Buying now to sell into a falling real estate market makes no sense, so for short-term investors and outright flippers the near-term attraction of lower rates is zero. That said, for those who see real estate as a long-term investment or who are looking for a home and worry about monthly expenses, today's rates should be seen as very enticing.

Not only is the market now at a point where financing costs are low, at the very same time lenders are holding massive and costly inventories of unsold foreclosures. They're also facing the prospect of even more foreclosures and looking at some very tough court decisions.

What to do if you're a lender? Make deals.

For instance, Wachovia “is offering its borrowers money for selling their houses short rather than going into foreclosure,” according to the North County Times in San Diego. “Homeowners with Wachovia mortgages who are upside down on their property can get 1 percent of the price of their short sale, with a minimum of $2,500.”

The Wachovia program removes distressed properties from the books while avoiding foreclosure issues. The catch, of course, is that to make short sales work you need buyers.

“Right now,” says Saccacio, “foreclosures and short sales represent roughly 30 percent of the existing home market. Given the inventory of unsold foreclosures, the additions which come into the market each month and current interest levels this percentage could go even higher in 2010. It wouldn't be surprising to see increased activity as buyers look through real estate's bargain bins for the right combination of good houses, low prices and cheap financing.”

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Peter G. Miller is syndicated in more than 100 newspapers and operates the consumer real estate site, OurBroker.com.