I recently had a pleasant Christmas dinner with a friend. We were discussing the current economy and the profits that can be had from “being the bank”. He asked a very reasonable and poignant question: If an investor can get upwards of 36% annual interest on their money, why isn’t everyone doing it?
We pondered this thought. WHY ISN’T EVERYONE DOING IT?
At first, you have to admit that even the thought of 36% sounds completely astronomical, usury, and there just HAS TO BE something ILLEGAL about it. At least that is the common thought. But as we delved further into the subject I came up with at least a few likely reasons. The most common, prevalent, and customary reason is:
a) of the unknown
b) of appearing the fool
c) of appearing greedy
d) of work
I want to break down these items and try to zero in on what is stopping people from prospering in this economy.
FEAR of the unknown. If it is sooo easy to make money what has changed?
Just as recently as 10 years ago anyone could walk into the standard conventional bank and if you could cast a shadow, you could get a home loan for upwards of $650,000 and possibly more. All you had to do was be able to sign the loan document with just an “X” and witness, someone who could vouch that you were a living breathing entity and the same person who appeared on the identification.
Whether you actually had the means to repay the loan was unimportant. Documentation was scanty and often not verified. Banks even fabricated documents just so they could make the loan, package the loan with other acid assets and sell it to gullible investors. This went on for a number of years until nearly everyone was suckered into the idea that the housing market could never crash and the bubble would expand indefinitely.
While we all know what happened:
1) Many people bought homes that were too expensive and borrowed far more than they could repay.
2) Even when they bought reasonably priced homes, they took out home equity loans, spent that, and when the crash occurred were left owing far more than their homes were worth. The home equity loans that seemed like free cash at the time are now coming due and have to be repaid.
3) Adjustable rate loans inched up in interest and thus in monthly payments outstretching the income of many individuals.
4) People who had to sell for various reasons could not sell because their home finance was upside down.
5) It was not in the interest of the banks to work with sellers on short sales. The bank would have to eat the loss. If, however, the bank took the house into foreclosure, it could profit even in a foreclosure by getting the government and the mortgage insurers to pick up the tab on the difference between the sale price (at auction) and the loan price.
6) In addition, homeowners who were able to secure a short sale on their home were charged by the IRS as receiving a “payment” or “income” from the difference between the sale price and the loan amount. Practically the only thing a seller could do was either to declare bankruptcy or find a way to “wrap” their loan into a sale to an anxious buyer which sometimes had its own disastrous outcomes, or just hold onto the house, rent it, and hope the market went up eventually.
7) Add to the mix the rapid deterioration in the labor market, the number of layoffs and the general downward spiral of the US economy as well as the world economy, and you had the economic sinkhole that was going to swallow the US economy and many US dependent countries to an unknown depth.
It was only at this point that the US government went into action to try to stem the crisis in confidence, the vision that the US economy was being sucked into a tar pit that might take years and years to exit, if it didn’t in fact send us into complete anarchy.
1) As discussed in my blog--SHORT SALES AND FORGIVEN DEBT—the government passed the Mortgage Forgiveness Debt Relief Act in 2007. (see: http://flippinginrealestate.blogspot.com/) This law basically “forgave” the loan amount between what the home sold for and what was owed and did not count it as “income” for federal tax purposes. This law expires December 31, 2013. Congress has not extended it. A recent Boston Globe article discussed how some states will continue to waive this “income” on the state tax returns (i.e. http://www.bostonglobe.com/business/2013/12/28/underwater-homeowners-could-face-extratax-shocker/sHIpvhEnyrkaVqe5QOVw2H/story.html)
2) The US Congress passed the Emergency Economic Stabilization Act of 2008. While there is a lot to be debated on how this bailout package was structured, and how it has evolved, the fact remains that the US economy was in a freefall and something had to be done. You can find quite a lengthy discussion on the topic in Wikipedia (i.e. http://en.wikipedia.org/wiki/Emergency_Economic_Stabilization_Act_of_2008. If you don’t have confidence in this “free” encyclopedia, you may find it useful to read the discussion in The New York Times article (i.e. July 24, 2011: Adding Up the Government’s Total Bailout Tab) which provides a running total on the costs of TARP as of July 24, 2011. The Economist added depth with their article from Oct. 24, 2012—The Bank Bailout Crisis Mismanagement.
3) July 21, 2010 Congress passed the Dodd-Frank Wall Street and Consumer ProtectionAct. This law ushered back into use some of the many regulations and restrictions that had kept the federally controlled banks in check, but had been eliminated during earlier congressional sessions. Here again there is debate on whether the laws went far enough or were too restrictive. That is a topic for another time. But here we need to recognize that the new enhanced restrictions are preventing the banks from lending to people and businesses which may have suffered significant losses during the last recession. If you declared bankruptcy, lost any property to foreclosure, or in other ways suffered significant hits to your credit score, you won’t be considered by most banks or credit unions for loans.
4) New global banking regulations are discussed in Bloomberg News Dec. 12, 2013—Global Asset Managers to Consolidate in 2014, Moody’s Says.
The bottom line is that with renewed stringent regulation of the financial industry, and the low returns from savings, cd’s, and bonds, those who want to borrow have moved their search for funding to the private sector which is less regulated and flush with cash.
This is not to say that a private lender should be careless and unconcerned with a borrower’s history, but merely to say that the private lenders can demand high rates and get them. The private lender can look at other factors regarding the borrower, and accept collateral such as motor homes and second properties that the regular banks are not permitted to accept.
It is a win, win, win for everyone. The seller who might not otherwise be able to sell, the borrower who might have a foreclosure in their history, and the private lender who is sitting on a 401K with $400,000 and low returns can all benefit.
Enter the Hard Money Lenders such as COGO CAPITAL, and SECURED INVESTMENT CORP and Transactional Funders such as Cameron Dunlap. Many of the principals in the new wave of real estate gurus are actually big money boys (and girls) who are looking to partner with people to get more borrowing going. They are sitting on wades of cash with no where to invest it. There are not enough borrowers or at least enough who understand that a good deal will always find the money.
We are kind of in a catch-22 situation right now. There is plenty of money available, and more and more investors are starting to enter the private money lending arena every day. There are plenty of borrowers who have been discouraged from borrowing because they keep getting turned down by the traditional banks. The trick or skill is to get the well-organized borrowers together with the right lending source so that both can come out ahead. Secured Investment Corp provides loans that have no prepayment penalty. The borrower can take out a loan in as little as 48 hours for 6 months with a 15 percent annual interest rate, but if the borrower takes the loan, works quickly and efficiently to complete the rehab or purchase and resale, then the loan can be repaid in less than the 6 months. The borrower shows that he/she is a good risk, rebuilds his/her credit rating and can eventually get cheaper funding through the traditional bank.
Many borrowers, however, have found that working with the private sector may appear to be more costly, but the flexibility and speed with which the private sector can move has sometimes saved a project from foreclosure and allowed the borrower to use unconventional assets for collateral and finish the project for a positive outcome.
This blog is getting a little long so I am going to carry the topic onto a second blog.
(Disclosure: I am working with COGO CAPITAL and SECURED INVESTMENT CORP as an independent mortgage loan broker bring borrowers and lenders together.)