There are many good reasons to read C-VILLE. Among them: to find out if your landlord is facing foreclosure and you may have to move out in a month.
Lauren Frick, a graphic designer at C-VILLE, was perusing the latest issue of the paper last week when she stumbled across a notice of a trustee sale on Augusta Street, where she lives in the Rose Hill neighborhood. Augusta is not a big street—which of her neighbors is facing foreclosure?, she idly wondered.
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Doug McGowan bought 1216 Augusta St. for $304,500 in 2005, and refinanced the next year with a pay option adjustable rate mortgage. Now, the property is in foreclosure, just like another property owned by McGowan. |
Turned out, it was her—the notice was for the house she lives in, 1216 Augusta St., and the person in foreclosure is her landlord, Doug McGowan, a real estate agent at RE/MAX. Also turns out, McGowan has another property, this one at 332 Minor Ridge Rd. in Albemarle County, in foreclosure.
McGowan’s tale—as told not by him but by court records—is a glimpse at a small piece of the larger story of the real estate bubble and mortgage meltdown that led to the recession of today.
The larger story, in brief, dates back to the early part of this decade, when swaths of investors around the globe sought safe ways of investing their money, particularly after the dot-com bust cooled the ardor for stocks and mutual funds. Wall Street money managers offered investors what seemed to be as safe a bet as could be made: mortgage-backed securities, financial thingamajigs that are essentially a bunch of mortgages bundled together. Since American home prices were constantly rising, and since few of those gosh-darn hardworking American homeowners went into foreclosure, those mortgage-backed securities seemed awfully safe. Better yet, their rate of return paid off much better than did U.S. Treasury bonds. So those global investors bought a lot of them.
So many, in fact, that investors ran out of gosh-darn hardworking American homeowners who traditional mortgage lenders thought could repay loans. Around the same time, however, Fannie Mae and Freddie Mac lowered documentation standards on some loan qualifications—people could get lots of money without proving they made the income to repay. Driven by the rabid demand from Wall Street for mortgages to bundle, mortgage brokers created mortgage options with higher interest rates for people who traditionally wouldn’t have gotten a loan. With ready access to such cash, more speculators got into the housing game, further inflating housing prices by flipping properties.
Here we return to McGowan: In 2005 and 2006—the height of the housing bubble—he bought and refinanced the two properties now in foreclosure using some of those exotic new mortgage “products.” Previously, homebuyers would have to put down 10 to 20 percent typically. But by investing only $15,225 of his own cash, McGowan was able to buy two local houses at the same time.
On May 31, 2005, he bought 332 Minor Ridge Rd. for $237,500. McGowan didn’t make any down payment to buy the 1,800-square-foot house. Instead, he got the money from Virginia-based* Resource Bank in the form of two deeds of trust (Virginia’s way of doing mortgages), one for 80 percent of the price ($190,000), the other for the remaining 20 percent. His interest rate? 7.625 percent.
A few days later, McGowan bought 1216 Augusta St. for $304,500. Presumably because this one was clearly an investment property, he put down 5 percent for the four-bedroom house, financing the remainder with two deeds of trust from now-defunct Lehman Brothers Bank. Interest on the loans was initially 8.125 percent. But this one also had an adjustable rate rider that meant that in five years, his rate could go up to as high as 14.125 percent.
The interest rates on these properties were high even for the time, according to Matt Hodges, principal of Compass Home Loans. But no-money-down loans, he says, weren’t uncommon then.
Thanks to rising assessments, McGowan might have been able to escape without foreclosure on these properties had he not refinanced both houses in October 2006 with now defunct American Brokers Conduit, using a product called a “pay option” adjustable rate mortgage. Under this deal, McGowan got loans of $321,000 for the Augusta property and $263,250 for the Minor Ridge house—$42,250 more than their sale prices combined. But the first month after refinancing, his interest rate would jump to 8.1 percent and fluctuate monthly up to 10.35 percent. More disturbingly, his minimum monthly payment didn’t even have to cover the rising interest—meaning that even by paying the minimum, the amount that he owed could grow every month. The principal owed on the Augusta house, for instance, could go up as high as $401,250.
“I never liked that product and I never offered it,” says Hodges, who didn’t do business with McGowan. “I was disturbed that our industry even offered the product.”
It’s unclear what McGowan was thinking in entering such a deal. A clause in the contract prevented him from reselling the property for two years without paying a huge penalty. Perhaps he thought he would make enough income to cover the loss while at the same time believing, like most people did, that housing prices would continue rising at such a clip that he could break even when he sold the properties in a couple years.
Regardless, that same week, he purchased a 4,200-square-foot McMansion on five acres off Garth Road for $962,750, financing the purchase (once again) with no money down and an adjustable rate rider that put him paying between 7.375 percent and 13.375 percent in interest.
McGowan would not comment on his actions for this story. “Can’t help you,” said McGowan, who asked that his name not be used. “It’s a very, very difficult thing to go through. And mentioning somebody’s name in a story like that is detrimental.”
A little more than two years after McGowan refinanced, the Minor Ridge property will go to the highest bidder on December 11. The Augusta property comes up for auction January 6. If a bidder doesn’t offer more than what McGowan owes, then whichever bank that now owns the first deed of trust will likely keep the properties.
The foreclosures are not only bad for McGowan. Likely, they will drop home assessments in the Rose Hill and Wynridge neighborhoods where his properties are located. That means less money for local government. If the neighborhoods are seen as distressed, it could make it harder to get loans to buy in those neighborhoods, creating a vicious cycle of declining value.
On a macro level, those foreclosures hurt as well. If bundled, the bad loans decrease the value of the mortgage-backed securities they’re pooled in. If enough other mortgages in those pools sour like McGowan’s, financial institutions lose assets and fail.
That is, unless U.S. taxpayers come to the rescue. Hence the bailout of both some of the banks that own the shaky mortgage-backed securities and, through bailing out Fannie Mae and Freddie Mac, some of the homeowners who took out the loans they now can’t repay.
“It’s not fair to you and me,” says Hodges. “But it’s justified because it helps support property values.”
Since McGowan doesn’t live in the homes he owns in foreclosure, he’s unlikely to receive help lowering his monthly payment from his lender. Since he is not “too big to fail,” he is allowed to fail. His tenants will likely have to move on. And all of us will be a little poorer.
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*Corrected 12/10/2008: The article originally misidentified Resource Bank, of Virginia, as an Illinois-based bank with the same name. The Virginia-based Resource Bank was acquired by Fulton Bank of Lancaster, Pennsylvania.
