It may take more than four years to clear the “shadow inventory” of distressed homes lurking on the sidelines in the U.S., a factor that’s likely to undermine real estate prices as the backlog clears, analysts at Standard & Poor’s Ratings Services say.

At 49 months, the estimated time needed to clear shadow inventory at the end of the fourth quarter of 2010 was up 11 percent from the previous quarter and 40 percent from a year ago. With the lone exception of Miami, the months’ supply of shadow inventory grew in almost all of the nation’s 20 largest metro markets.

But much of the increase in the estimated months needed to clear shadow inventory is due to the fact that it’s taking longer for lenders to liquidate distressed homes — not because the number of distressed properties is growing, analysts said.

Standard & Poor’s defines shadow inventory as properties with borrowers who are 90 days or more delinquent on their mortgage payments, properties currently or recently in foreclosure, or properties that are real estate owned (REOs).

Although shadow inventory peaked in the first quarter of 2008, loans that are 90-plus-days delinquent and foreclosed properties are taking longer to become REOs. That’s once again lengthening the overall timeline for resolving troubled assets, Standard & Poor’s analysts said.

At the current, slower rate of liquidation in the New York metro area, Standard & Poor’s analysts estimate it will take 130 months to clear $116.7 billion in shadow inventory there — 2.7 times longer than the average for the U.S. as a whole.

That’s despite the fact that the Los Angeles metro area has a larger “overhang” of troubled mortgages — $173.1 billion, or 31.5 percent of all outstanding mortgages.

The good news is that the overall level of distressed loans continues to decline, and loan-cure success rates — often the result of loan modifications — have been improving since the second half of 2008.

Although 45 to 50 percent of loans modified or cured in the fourth quarter of 2009 redefaulted within the first year of modification, that’s an improvement from the nearly 80 percent redefault rate on loans modified or cured during the first quarter of 2008.

Homebuyers relying on FHA-insured financing will still be able to buy homes that have changed hands in the last 90 days, thanks to a decision by the Federal Housing Administration to extend a temporary waiver of its “anti-flipping” rule through the end of the year.

The anti-flipping rule — a 90-day waiting period implemented in 2003 to protect the FHA’s mortgage insurance program from losses — already included an exemption for homes repossessed by Fannie Mae, Freddie Mac, and state- and federally chartered financial institutions.

But last year, FHA took the additional step of waiving the waiting period for all resales — including homes purchased and rehabbed by private investors.

Since the broad waiver went into effect on Feb. 1, 2010, FHA said it has insured 21,000 90-day property flip loans worth more than $3.6 billion that would otherwise not have qualified for financing.

The Obama administration believes the waiver may be helping stabilize home prices and neighborhoods that have been heavily impacted by foreclosures.

An analysis of property-flip loans suggests they carry no more credit risk than others insured by FHA, although they were often missing documentation needed to support valuations, the government said in a notice announcing an extension of the waiver until Dec. 31, 2011.

“This action enables our borrowers, especially first-time buyers, to take advantage of this opportunity and buy a home that has recently been rehabilitated,” said FHA Commissioner David Stevens in a statement. “It will also help to move more foreclosed properties off the market and reduce the number of vacant homes in neighborhoods throughout this country.”

To protect FHA borrowers against predatory flipping — resales of properties at inflated prices — the waiver continues to be limited to arms-length transactions, and does not apply to the Home Equity Conversion Mortgage (HECM) for purchase program.

In cases in which the sales price of the property is 20 percent or more above the seller’s acquisition cost, lenders must justify the increase with a second appraisal or supporting documentation verifying that the seller has completed renovation, repair and rehabilitation work to substantiate the increase in value.

The lender must also order a property inspection and provide a copy of the report to the purchaser before closing.

In analyzing 17,114 90-day property flip loans insured between Feb. 1, 2010, and Oct. 31, 2010, FHA found the early payment default rate was 0.03 percent — less than the 0.15 percent rate for the 1.2 million purchase loans insured during the same period. Borrower debt ratios and credit scores were also nearly identical.

But a further review of a subset of those loans found they were more likely than other purchase loans to have problems with valuations. Nearly half had unacceptable valuation reviews, with a majority of the problems that were discovered related to documentation compliance issues, such as a missing inspection report or second appraisal.

Borrows have some weapons for keeping closing costs down, the result of recent guidelines requiring lenders to disclose certain fees, but perhaps the most underutilized consumer tool simply involves old-fashioned haggling.

Good-faith estimate rules, part of a tougher Truth in Lending Act that emerged from the mortgage crisis, mean that lenders must provide a clear picture of the costs involved in buying or refinancing a home. Yet consumers may not realize that some of those numbers are actually negotiable, mortgage experts say.

“There’s a lot of room for negotiation in the costs of closing,” said Barry Zigas, the director of housing policy at the Consumer Federation of America, a consumer advocacy group, “and consumers should examine every charge and not hesitate to challenge them and try to bring them down.”

Closing costs can run a borrower 3 to 6 percent of the price of a property, according to the Federal Reserve. In 2010, the average cost for a $200,000 purchase rose by nearly 37 percent, to $3,741, according to Bankrate.com, a financial data publisher; the average in New York State was $5,623.

Most borrowers pay less attention to closing costs, focusing instead on the interest rate offered by a lender. But because many of the fees associated with closing are not set in stone, mortgage experts say, consumers should review the line-by-line estimates with a view toward challenging them. Lenders are required to outline all the estimated closing costs within three days of receiving a loan application.

The standard good-faith-estimate form used by lenders makes it easier to compare the terms offered by lenders, and it lists the services a borrower can shop around for, versus those selected by the lender.

John T. Mechem, the vice president for public affairs of the Mortgage Bankers Association, said borrowers should “simply ask the lender which fees are negotiable and which are fixed.”

“Sometimes a borrower can shop for individual services and find a cheaper alternative to the provider that the lender uses,” Mr. Mechem said.

Mr. Zigas agreed. “Ask, ‘Who is getting paid this fee, and why am I being asked to pay it?’ ” he said.

The good-faith-estimate rules say that certain charges cannot increase at closing, including those for loan origination and points paid to the lender to reduce a locked interest rate, with 1 point equal to 1 percent of the loan amount. But borrowers can negotiate those charges.

Some other charges can rise up to 10 percent, including title services and appraisals, regardless of whether the borrower chooses providers listed by the lender or shops around. In general, charges for any required services that the lender selects or that the borrower shops around for, using companies selected by the lender, can rise 10 percent.

For a $200,000 home with a 5 percent down payment, the settlement costs of that $190,000 loan, not including reserves for property taxes and down payment, typically range from $6,235 to $19,930, according to the Federal Reserve. The loan origination fee can range from $2,130 to $3,105; the application fee, typically from $65 to $640; and points can add $5,700.

While regulators discourage lenders from overestimating costs, they don’t penalize them for doing so.

Therefore, borrowers should understand that “it’s not a time to be polite,” said Kathleen Day, a spokeswoman for the Center for Responsible Lending, an advocacy group. “You have to have a strong stomach and a stiff spine and not bow to pressure from the other side of the table to close the deal,” she said, even in this tight credit environment.

For a refinancing of your primary residence, you can generally cancel your mortgage application for up to three days after closing, with fees refunded.

Back around the beginning of December 2010, there were a number of notifications in the press exclaiming Federal Housing Administration condominium requirements for recertifying projects were going to expire, which did nothing but cause a lot of people, including me, to scratch our collective heads, wondering what that was all about.

That deadline was to be Dec. 7, 2010; except when that date rolled around the FHA decided to extend the various recertification deadlines on a rolling basis through the end of 2010, most of 2011 and even into 2012.

Those who understood what was going on — a group that admittedly didn’t include me — breathed a sigh of relief; everyone else was still picking at their scalps with their fingernails.

“There were 26,000 condominium developments that would have had to have been recertified by Dec. 7, 2010, and, in fact, my office sent out letters to almost every single one of these developments across the country telling them they were going to lose their approval. Most of them didn’t even know,” said Orest Tomaselli, CEO of White Plains, N.Y.-based National Condo Advisors LLC.

As I was also to learn, this is an important bit of knowledge for condominium managers and HOA (homeowners association) boards because it could affect individual condo sales going forward.

Condominium projects can be FHA-approved for the purposes of making FHA financing easier. Unfortunately, the process has always been a wee bit paper-intensive, and because, up until 2007, private lenders were throwing money at condo purchasers, many projects eschewed the FHA’s offerings.

However, if you as a purchaser did want or need FHA financing there was something called a spot loan, which was a way to get FHA approval for the one condominium unit targeted for purchase.

Then as the mortgage crisis/economic recession rippled through the land and mortgages became more difficult to obtain, spot loans began to rain down on the condominium market and the FHA felt it was losing control of the process as it was its old certification program, so at the start of 2010 changes were implemented.

“With a spot loan, a letter went out from the mortgage company or lender to the homeowners association, and the HOA would fill out the basic information and send it back. If everything was compliant, a lender could give someone an FHA mortgage,” Tomaselli explained.

“In February 2010, the FHA ended the spot loan — replacing it was a process where every single condominium development had to have project approval, which was to be given by HUD (the U.S. Department of Housing and Urban Development), which administers the FHA, and lenders that were delegated FHA lenders.”

There was another key change. In the old days, FHA approval was pretty much forever, but then it concluded projects checkmarked many years ago were probably not up-to-date in regard to compliance and needed to be recertified.

“What HUD effectively declared was the projects it approved 10 or 15 years ago were no longer compliant so it was going to rip away the approvals (any project approved before 2008 was stripped) and force the developments to go through a recertification process,” Tomaselli said.

All of the condo projects that ever received FHA approval were going to have to have those certifications expire as of Dec. 7, 2010, but there were so many projects seeking recertification that it created a crush on FHA’s resources to deal with it,” said Kevin Britt, a Seattle attorney specializing in condo and homeowners association representation.

“The FHA extended the deadline based on when the projects originally received approval. The earliest projects were circa 1972 and had to be recertified by Dec. 31, 2010; the other projects (using five-year increments) had longer deadlines.”

Now, here’s the catch for homeowners associations.

“In the old days, all you had to do to was get your project approved once and it was good for life,” Britt said. “What the FHA has since said was it wants to keep a closer tab on these associations. ‘We want to look at you right now — the recertification process — and again every two years.’ It’s an ongoing obligation that the association has to be willing to sign up for.

“Every two years the HOA will have to go through this and the question is: Does it want to take on the obligation and ongoing expense?”

The onus had always been on the development to be compliant with FHA requirements, but in the past those necessities were minimal. Guidelines have since been considerably augmented.

For example, condo developments now have to have a reserve in the budget for maintenance and repairs equal to 10 percent of the budget. Also, new or established projects with more than 20 units are required to carry fidelity bonds/insurance for all officers, directors and employees of the association and all other persons handling funds.

There are some developments where it would cost too much money to be approved just because of the due diligence that would have to be performed in order to be compliant, said Tomaselli.

FHA-insured loans were not a huge factor in the condo market until relatively recently — and then they became “the” major factor, Britt said. “Associations were not used to thinking about the FHA as being the only game in town. If you aren’t FHA-certified, it’s now something that makes your condo less attractive in terms of individual owners trying to sell a unit.”

Look at this way: If you have two condo developments next door to each other and one is FHA-approved and the other isn’t, the latter is at a severe disadvantage as far as marketing (and, by extension, value).

“When those condo owners want to sell their units and no one can finance,” said Tomaselli, “when buyers can’t get a mortgage because the development is not FHA- or Fannie Mae-compliant, that’s when the pain will rise and everyone will start to scramble to become compliant.”

The possibility of eliminating the mortgage interest deduction on primary residences continues to draw interest in the nation’s capital. While most housing analysts believe the chances this will happen are remote, consumers have been interested in knowing the most popular alternative to the present plan.

Under present law, homeowners with a mortgage may deduct the amount of interest paid on a first or second home (interest allocable to up to $1 million in mortgage debt) plus interest paid on up to $100,000 of home equity loan debt. The proposed new plan offers a 12 percent mortgage interest tax credit.

With the help of the National Association of Home Builders, let’s look at the basics. The amount of the home mortgage interest deduction is added to other permitted itemized deductions, such as expenses for real estate taxes, charitable contributions, and state and local income/sales taxes.

However, if the sum of these itemized deductions is less than the permitted standard deduction, then the standard deduction is used in lieu of these itemized deductions because it offers a better deal. In 2010, those standard deductions were $11,400 for married taxpayers filing a joint return and $5,700 for single returns.

First, let’s assume that a married couple has sufficient non-mortgage-related itemized deductions such that they would itemize their taxes even without a deduction for mortgage interest. Hence, they would not claim the standard deduction. The couple owns a home and faces a 25 percent marginal tax rate. They paid $6,000 in mortgage interest in the year.

In general, the deduction for mortgage interest will reduce their final tax liability by $1,500 ($6,000 multiplied by 0.25). The actual amount would depend on other itemized deductions and how close they are to the next tax-rate bracket.

Alternatively, if the deduction for mortgage interest were converted into a 12 percent tax credit, the taxpayer would calculate the credit instead of claiming the deduction. The value of the tax credit would equal $720 ($6,000 multiplied by 0.12). This tax credit is then used to reduce final tax liability.

This example assumes all other tax rules are held constant. Obviously, if other tax provisions are changed so would a taxpayer’s overall picture.

The present mortgage interest deduction is not a dollar-for-dollar tax deduction; it reduces taxable income. The 12 percent credit proposal would be for mortgages only up to a certain limit, say $500,000. Under the 12 percent proposal, not only would interest on home equity loans no longer be tax-deductible but taxpayers would also lose deductions for state and local property and income taxes.

If the mortgage interest deduction goes on the chopping block, most analysts believe it would start with second homes. Now, consumers may deduct mortgage interest on two residences. Some consider that to be a luxury — something the nation cannot afford in these economic times.

Others believe any incentive — perceived or real — that would rekindle the housing market is dearly needed. Many second-home owners already rent out their homes for at least a few days a year, so making the conversion from a “qualified” residence to a rental would not be a major transition.

The National Association of Home Builders (NAHB) and the National Association of Realtors (NAR) are vehemently opposed to dropping the mortgage interest deduction. The two huge organizations employ influential lobbyists who have hounded legislators since word of an alternative surfaced.

“While we commend the hard work of the president’s deficit commission to improve the nation’s fiscal situation, this is simply the wrong approach to the problem,” Bob Jones, chairman of NAHB, said in a press release.

“It would put a huge tax increase on millions of middle-class homeowners by eliminating or devaluing the mortgage interest deduction. The consequences would be devastating for housing and the economy. This would further depress home prices, putting countless more homeowners underwater and triggering a new wave of foreclosures.”

Before 1987, mortgage interest on all residences could be deducted without limit. Since then, consumers with more than two residences are required to choose two “qualified” residences where mortgage interest could be deducted, but the selected residences are allowed to be juggled into the “qualified” category from year to year.

The failure of government to fix the deep-seated problems of the home loan market raises the question of whether there is a private initiative that would work better. I believe there is and will spell it out in a series of articles. This is the first.

The challenge

One major problem facing mortgage borrowers is finding the best price for which they qualify. The product and the process are complex and vulnerable to all manner of deception. Some deceptions are so widespread and ingrained that they are part of mortgage banking culture.

It is equally difficult to find competitive prices on required third-party services, including title insurance and mortgage insurance. These and other third-party providers are usually selected by the lenders, who base their selection on the services they receive from the service provider, rather than on the prices paid by the borrower.

The second major problem is the lack of knowledge and understanding by borrowers faced with the need to make critical decisions, including the type of mortgage and mortgage options that best meet their needs. Efforts to address this problem by education are complicated by the wide diversity in borrower capacities.

Extensive efforts by government, including mandatory disclosures and regulation, have largely failed to help borrowers. Whatever help has been provided by mandated disclosures of information useful to borrowers has been nullified by the increased confusions arising from the torrent of mandated disclosures that are useless and misleading.
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The proposed approach for dealing with these problems is a third-party network that would certify participating lenders and other service providers. The network would attract borrowers because of the information and protections they offer, which gives the network the clout to set the operating rules required for certification.

Early private networks

In 1997 and 1998, Intuit and Microsoft as well as three smaller firms moved to stake out positions in what was then seen to be a market ripe for massive growth: the origination of home mortgages on the Internet by independent third parties hosting multiple lenders. These sites allowed potential borrowers to shop prices conveniently among lenders competing for their business.

I was an enthusiastic proponent of these new sites, extolling their advantages to borrowers in published articles. The software company I started, GHR Systems Inc., developed the technology used by Intuit. It was state-of-the-art at the time.

The premise underlying the shopping sites was: “If we make it easy and convenient for borrowers to shop, they will come.” They did come, attracted by the up-to-date market information the sites provided — prices on the Intuit site were updated every 10 minutes, which was mind-boggling at the time. However, very few borrowers stayed to transact. All the sites failed and were terminated except one, which converted to a single-lender site.

One obvious explanation for their failure is that the sites were premature in the sense that consumers had not yet become comfortable transacting online. This is much less the case today, which substantially improves the prospects for the next generation of sites.

In addition, the earliest sites did not assure potential borrowers that they would receive competitive pricing, even though that was the intention. Displaying price quotes of multiple lenders online is not enough to assure that transactions will be competitively priced, an important point I will discuss next week. The borrowers who viewed the first-generation sites as a convenient source of price information that could be used just as effectively shopping offline were probably right.

Lead-generation sites

The next generation of sites focused on giving borrowers what many borrowers seemed to want: multiple lenders soliciting them for business. The sites ask borrowers for much less than the shopping sites, which qualified borrowers. Lead-generation sites collect just enough information to add up to a marketable lead, which is then sold to three or four loan providers who contact the borrowers.

Lead-generation sites have been commercially successful because they ask little of the borrower, the technology they require is relatively simple and cheap, and they offer a service that some borrowers find appealing. These borrowers buy into the slogan, “When banks compete, you win,” not realizing that they are equally likely to lose. The leads are sold not to the lenders who will offer the best prices to the borrower but to those who will pay the most for the lead. Price lowballing — the practice of quoting a price the lender has no intention of delivering — is endemic on these sites, and the sites provide little or no decision support.

A successful private network would actually deal with borrower problems, as opposed to pretending to deal with them as lead-generation sites do.