I couldn't believe it...I was watching one of the investor type shows last weekend and one of these bozos says, "The economy is doing great; lets just hope the democrats don't screw it up." 

Doing great...don't screw it up?  What color are the clouds in your world ace?  Personal bankruptcies and home foreclosures are at record levels and he says things are great.  Hey chief, maybe a few of your power lunch buddies that have privy to insider info are doing great in the stock market but things don't look good for the average American.  Maybe if you are going to go on national television you should take a look at the whole picture; not just your little corner of the Hampton's.        

THE REAL ESTATE CRASH IS HERE…and going to get a lot worse 

I do not claim to be a financial expert.  But as a contractor I had to pay strict attention to the national and local financial trends if I expected to get paid (when the economy gets slow, so does the work and the payments from people/businesses). 

For the last several years I have listened to the experts tout the strong real estate market backing their opinions up with quarterly sales stats.  What they have not been factoring in is who has been buying those homes.  Using trick finance packages millions of Americans bought more house/borrowed more money than they can afford and now those trick finance packages are starting to adjust.  This article points out the predicament we have put ourselves in.          

When the internet bubble burst the country began sliding into a recession.  To combat this the federal reserve began dropping the interest rate to encourage the real estate market, and it came at just the right time…there was an entire generation prime for buying/building homes. 

Almost 80 million baby boomers were getting close to retirement and with cheap interest rates they realized they could get rid of those 2 week time-shares (in Florida, Arizona, Texas, Colorado) and buy or build a house that they could live in year round.    

This began a chain reaction.  As more people began buying and building their retirement homes it began driving up the property values in these areas. Next it created the phenomenon of house flipping, investors buying these homes not to live in but to sell them in a few years.  This activity got people falsely believing there was a building boom.  True, it was a building boom, but not a traditional building boom.

Traditional building booms are fueled by younger generations coming into an area looking for work and the Orlando area is a perfect example.  When Walt Disney started building Disney World they needed workers.  These were primarily people just starting out in life.  They rolled into town driving sports cars and rented one bedroom apartments.  But as they got married and started having children they needed to change their lives.  They needed more bedrooms and space, so they bought houses. 

They also soon learned it was tough to fit a baby carrier in the backseat of a Camaro so they were buying full sized cars and vans.  As the kids grew so did their needs, they bought them televisions, stereos, and now computers.  The point is, in a traditional building boom people are always buying something to satisfy the needs of their growing families and that is what keeps the economy strong.

But retiring people do this a little different…they purchase things once.  Their family is not going to get any bigger so they buy one house and stay there.  They buy cars, and because they don’t have to drive to work everyday they last longer.  They buy their furnishings (couches, tables, chairs, televisions, computers, etc) one time.  About the only things that increase in a retirement area is medical facilities and restaurants.           

Younger people didn’t realize this and began flocking to these booming regions.  However baby boomers started doing something else that affected the way people lived…they began indulging themselves. 

This generation had worked hard all their lives, scrimping, saving, and doing without because they had learned the value of a dollar from their parents who had grown up in the lean years of the 1930’s and 40’s and now that hard work was paying off.  For many of them this was the forth or fifth house they had bought/paid-off and now they were worth a fair amount of money. 

Rather than living the frugal retirement of their parents they pampered themselves with plastic surgery to get rid of the wrinkles, big screen TV’s, hot tubs, restoring collector cars (for a hobby) and of course, Harley-Davidson motorcycles.  These were the things they did without while raising their families.  Now that they could afford them they went for it.

MISTAKE NUMBER ONE

Naturally the younger generations noticed this and not to be outdone by the old fogies they turned it up a notch.  Instead of a standard 3-bedroom house they went with 4 and 5 bedroom executive style homes with game rooms.  Breast implants and liposuction became common place.  Full sized swimming pools took the place of hot tubs.  Big screen TV’s were not enough…they went with complete home theaters.  And they didn’t buy Harleys off the floor like everyone else, they had custom bikes made.   

Yes things were looking pretty good.  However there was a huge difference between these generations.  The boomers had spent their entire lives building equity and had the cash for their new lifestyles; the younger people hadn’t had a chance to do this yet and the way they were doing it was on credit.  The mortgage lenders contributed to this “life of excess” by allowing (even encouraging) these people to borrow to the limit rather than advising them to live within their means.   

MISTAKE NUMBER TWO

Mortgage lenders, like many companies, were not satisfied with the normal profits being generated by these homebuyers…they needed to post record numbers and they soon came through with packages to fit everyone. 

There were the zero down and interest only programs.  Then 40 year mortgages were introduced and the ARM (adjustable rate mortgage).  But these programs had specific uses and customers. 

·        Zero down/interest only mortgages-These were primarily for people that planned to sell the property within 2 years (the house flippers).

·        40 year mortgages-Long-term loans like this were for those people that were financially borderline for a 30 year mortgage.

·        ARM’s-This was designed for those people whose income would be increasing significantly within 3 years…like a recent collage graduate that just scored a good job with a promising future.  These were really enticing because they offered a ridiculously low interest rate/house payment for the first 3 years.   

When matched to the right person/situation these programs are a positive.  When matched to the wrong person/situation they are a time-bomb.     

MISTAKE NUMBER THREE

It used to be if you wanted to buy a house you needed a solid work history, at least a 10% down payment and you were limited to how much you could borrow by how much your take home pay was.  This was a way to ensure people were not biting off more than they could chew and reduced the number of foreclosures. 

But guess what…there were still millions of potential borrowers out there that were not what you would want to call ideal customers.  But hey, everyone should get a chance to live the American dream of owning a home, right?  So here is where they did something really stupid, they lowered the standards. 

I know this is not going to be politically correct (I have never been one to mince words anyhow) but owning a home is a huge responsibility and there are some people that just aren’t cutout or ready for it.  You know the type; they float from job to job, unemployment to welfare, have bad credit, criminal records, drug/alcohol problems, etc.  These people don’t have the discipline to own a home.   

However age/inexperience is another factor.  Baby boomers grew-up hearing the horror stories about the depression and the shortages of WWII so they were cautious with money; they negotiated when buying a house or a car...they shopped around when looking for toys and often bought used items.  But by the time boomers grew-up and started having their own children, those hard times were a distant memory.  And to their kids, were only a few chapters in a textbook (people never really lived like that).  As a result many boomers did not instill financial values in their children.  Now as that these generations have entered adulthood they had no idea how to negotiate/look for deals or handle debt.  All they know is you sign a paper and send in a check every month.    

If you want to see this theory in action just give a 10 year old kid $100 and let them loose at the mall.  Do you think they are going to buy $10 worth of candy, a $10 toy, $30 of educational materials and save the rest for the future?  No, they are going to blow the whole wad on toys and candy. 

Or let them pick all the items at the grocery store.  Chances are good you wouldn’t find a vegetable or a piece of fruit in the cart.   It would be filled with candy bars, chips and soda.  And this is the way many of these adults are living today…it’s all about instant gratification.  

I met a nice 30-something couple…they seemed to have it all together.  They drove new vehicles, lived in a nice house with all the toys (boats, jet-skis, 4-wheelers) and always seemed to be going on cruises.  Eventually I learned how they were financing their lifestyle (and why they never legally married).  One would start collecting credit cards.  When they had enough they would run them to the limit and file for bankruptcy (she had filed twice, he was getting ready for his second), then the other would start doing it.  Good plan for now…but what happens when they hit their 40’s and 50’s and the system catches on to what they are doing. 

Note: Credit card companies have enabled and incited this behavior.  It used to be you needed a good credit rating before you would be given a credit card.  Now these companies are purposely targeting people with bad credit because they know what these customers are going to do, run their cards up to the limit and pay the minimums.  And because they wield such political power they have for all practical purposes managed un-cap interest rates. 

Credit card companies are legalized loan sharks 

Most people don’t realize what they are paying for the privilege and convenience of using plastic.  Years ago Discover sent me a card promising me cash back.  It was so easy to pay for my gas or lunch, and it made me feel so grown up and professional that I quickly ran up a $2,000 balance.  Cash back or not, I realized this could get out of hand so I decided to stop using it and faithfully made my monthly payments.  Two years later (when I actually looked at the bill) I was shocked to learn I still owed $1,600.  At first I was convinced my wife or kids were using my card or there was a mistake, so I called customer service…nope no charges for the last two years.  When I asked what was going on she gave me an answer that left me even more confused. 

It was then I happened across a credit card payment calculator and what I found out was not only shocking, it downright pissed me off.  For this little $2,000 loan using their plan of making minimum payments, it would take me 18 years to pay it off, and I would pay close to $5,000.  In other words, I was paying more in interest ($3,000 with the occasional late fee) than the $2,000 I borrowed!  What a racket.  Loan sharks have gone to prison for charging this kind of interest…but these companies are doing it legally. 

I scraped together the money and paid it off and made the commitment that when I used the card I would pay it off when the bill came in…no more shylock loans for me. 

But then I found out they had penalties for people like me that didn’t carry a balance.  For one I would have to start paying a yearly fee for this card and second, I was not going to get my full cash-back incentive!  They even have a name for me…a deadbeat.  When you play the game their way there ain’t enough o’s in smoooooth for these people.  Play it your way and they won’t even use any Vaseline on you…they make you take it like a man. 

If people really knew what they were paying these crooks they wouldn’t be using those cards.  But that is the problem; many people are too busy to read the fine print.           

Inexperience + shady lenders = disaster 

Today you have “kids” with bankruptcies working part-time at a fast food joint given a blank check to buy a house.  And because they have no experience buying homes they tend to make critical errors that affect everyone.  They are under the impression that if they are approved for “up to $500,000” they have to buy a $500,000 house. 

Plus when they start getting those offers to re-finance or pull a second mortgage “while the rates are low to buy a new car or take a dream vacation” they almost feel obligated to take it.  Without practical experience they don’t realize that they will have to not only pay it back, but sooner or later that lending well is going to run dry…they will not be able to keep on borrowing every time they needed some cash.        

I was speaking at a community meeting (attended by several local professionals in the housing industry) on the east coast and after the classes were done people stood around chatting.  One group was made up of realtors comparing notes and war stories.  One of them was particularly obnoxious with a loud cackling laugh that went through my head like a nail. 

I couldn’t help but overhear them and what really caught my attention was when she began bragging how she used a little trick to boost the selling price and commission.  She would tell these dumb “kids” that there were 3 other couples putting in offers on the house and if they really wanted it they should offer more than the asking price.  Of course she already knew what they were approved for so she knew how far she could push them. 

She was particularly proud of the fact she did this several times in one neighborhood almost doubling her commissions in one month…”and the houses were all wrecks that should have been condemned.”    

I finally had enough.  I walked up to her and said, “You know when you do that not only are you suckering these kids into buying a house they can not afford to begin with but you are also artificially inflating the property values in that area.  Now when they readjust they are going to owe more than the property is worth.”       

She lost that sickeningly sweet smile she had been sporting and snapped, “What do you know about selling property?”  I said, “I know this much, it’s people like you that give every realtor a bad name.  These kids have placed their trust in you to watch out for their best interests and here you are putting the screws to them to make a few extra bucks.  Well enjoy it now because it isn’t going to last forever.” 

My wife asked me why I care if a few people lose their houses.  I’ve told her I don’t care if a small percentage of homes in an area are foreclosed on…but when you have lots of people losing their homes it creates a domino effect that hurts everyone. 

With too many houses on the market it drives down property values for everybody and that means our house is worth less.  But it doesn’t stop there.  When those people move out it means fewer people to shop in the local stores, now those businesses start to suffer and some will even go under.  Then often those people that lost their homes are forced to go on some type of public assistance…that means my tax dollars are being used to help support them. 

It also means fewer taxpayers to support the local government, fire/police departments, schools, etc.  But those entities still require money to operate, even at a reduced capacity, and that means I will be asked to pay more taxes to make up for those people that are no longer putting into the system. 

Believe it or not it also increases crime.  Some get so desperate to save their homes they start embezzling from their employers, stealing from their neighbors or even committing armed robbery to finance their lives.  And when people do lose their homes they are not what you would want to consider happy…they are depressed and this increases drug and alcohol abuse.  There is a whole chain of negative events that go along with home foreclosures.

THE FREE AND EASY RIDE IS OVER

The fed dropped interest rates to spur the real estate market, however trick finance packages combined with relaxed standards encouraged people to fund excessive lifestyles.  Millions bought far more house than they could afford to start with and then they got caught up in all the trimmings that went with it...gas guzzling SUV's, tricked out pickup trucks, every new electronic gadget on the market, 4-wheelers, jet-skis, vacations to exotic places, etc.  And when they ran their credit cards up to the max they simply refinanced their homes to pay-off that debt, then did it again. 

The problem is, those homes are no longer going up in value which means the endless piggy bank is closed.  And as those introductory offers start to expire people are finding themselves so far in the hole they will never be able to catch-up.  And as mortgage lenders start seeing 10% to 20% of their notes going south they will realize how foolish they were to give blank checks to anyone and everyone that walked in the door start screening their applicants more closely and enforcing stringent approval standards before issuing a loan. 

But this isn't just going to hurt those people that didn't use common sense...it will hurt all of us because with so many foreclosed houses on the market everyone's property value drops. 

WHAT YOU NEED TO DO TO PROTECT YOURSELF

House flippers-If you got into the house flipping business and are holding property(s), get rid of them ASAP.  Don’t hold out for that buyer that is going to make you rich because it ain’t going to happen.  About the only homes that are going to be in demand are those cheaper homes (people will be looking for more realistically priced homes).   

And if you think you are going to cash-in on the glut of executive homes for pennies on the dollar, fugedaboudit.  There will be some good buys but the companies that are holding the paper on them will let them sit empty and take a very nice tax loss before they will give them away for a song.   

Non-conventional mortgages-If you have an interest-only or ARM mortgage, start looking for a conventional 15, 20, 30 or even 40 year fixed-rate program now.  You want to do this right away because:

·        Interest rates are only going to go up.  You may be able to afford a 30 or 40 year monthly payment today, next spring you may not. 

·        Lenders are still fairly lax and may approve you on a 30 or 40 year note; in 6 months they may not.

·        The last thing you want to do is wait until you are forced to make a change because now not only are you limited on time, you are limited on choices.  Think of it like the people that wait until the last minute to prepare for a hurricane.  The hurricane is coming but you waited too long, now all the stores are sold out of the supplies you need.  And those that do have them charge significantly more for those last minute shoppers.        

Buying a home-Buy what you need, not what the lender says they will borrow you.  It may be flattering to learn someone thinks you are worth borrowing a half million dollars.  And it may be tempting to live in a huge house with a pool and so many rooms you wouldn’t know what to do with them all, but you need to be honest and realistic. 

Your monthly payment should not exceed 25-30% of your monthly take home pay.  And when you are married, be careful when using both incomes to quantify your income.  What happens if one spouse loses their job or quits work to raise children.  Will you be able to make a mortgage payment on one income?  What about a divorce; Fifty percent of all marriages are going to fail.  If your relationship is shaky to begin with, financial stress is only going to make it worse.  If you do split an expensive home could be a loss for both parties; a more reasonable home could be an asset.     

You also need to look at your employment future.  If you are fresh in the work force of a stable and growing industry chances are your income will be increasing at a reasonable rate so you can buy accordingly.  But if you are at the top of your pay scale and/or you are in a fragile industry that can be affected by a recession (like construction…when a recession hits construction slows way down) or a service job (many companies are cutting costs by out-sourcing overseas) you will need to be extremely careful.

The clock is ticking on this…

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