This post is not specifically related to Chinatown. This post is about the housing and credit crisis, which has affected us all in some way or another. While the proximity of Chinatown to the Financial District and the large number of subsidized housing has insulated the community from the worst of the housing problems, the macro-environment continues to affect local businesses. Chinatown restaurants are cutting back, with gas prices still over $3.00 a gallon and the cost of raw goods going up.

For example, restaurants are giving take-out orders in smaller containers. Sushi restaurants are giving thinner slices of fish. The Chinatown Blogger knows of a few people who are struggling. There’s a family who purchased their home at the peak of the market in 2005 and are now struggling to keep up with their mortgage payments. There is another person who had worked at an attorney’s office and was laid-off after Bank of America purchased Countrywide.

The first part of this blog are personal experiences on the impact of the housing and credit crisis. The second part will include commentaries by hedge fund managers and analysts on the macro-environment.

First-hand Experience with the Housing Crisis

Our search to buy a home began in January 2008. The Chinatown Blogger had surveyed the housing market and had started planning in 2007. A list of criteria were established: number of bedrooms and bathrooms, neighborhoods, mass transit, cost, condos vs. single-family homes, year built, and condition of building. After looking for several months and seeing 20 properties, we settled on a condo in a town South of Boston with a population of about 30,000.  The condo passed all of our criteria (including the shoe closet the Missus wanted) and was next to a commuter rail stop. Perfect, we thought! Our realtor informed us that the unit was a foreclosure but this did not deter us because, this was in March and our current rental lease didn’t expire until October. The price was attractive and we had time.

Relatives and friends questioned our judgment. Why buy when the housing market was going down? We knew purchasing a home was taking a risk, but a risk we were willing to take, especially since the foreclosure allowed us to purchase at a fire sale price. Besides, our realtor/friend had been saying every year for the last 3 years that, “It’s a good time to buy,” irregardless if the housing prices went up or down. We thought now was a “good time to buy.”

As first-time home buyers, we hired an attorney to represent us. Our attorney, Paul, did some research on the property. The previous owners of the foreclosed condo, let’s call them the McCains (because their real name does rhyme) purchased the unit in 2006 for $309,000. One year later they foreclosed. So what happened?

Adjustable-Rate Mortgages

The documents showed that the McCains had taken a 3-year adjustable-rate mortgage (ARM) from a national bank. An adjustable-rate mortgage was an option to finance a house at a lower (teaser) interest rate in the initial years before resetting to a higher rate later. ARMs were typically lower than conventional fixed-rate loans.The documents showed that the interest rate on the ARM was 9%. This was the first hint of trouble. Rates for an ARM in March 2008 was about 5%.  A 9% interest for an ARM, even during 2006, most likely indicated that the McCains’ credit were not stellar. The terms of the contract stipulated that once the 3 years passed, the interest rate would reset and be based on whatever the London Interbank Offered Rate (LIBOR) rate was plus 2%. However, the interest rate would never be lower than 9% and would be cap at 15%. The bank also required a 20% down payment, or $60,000 to approve the loan, which the McCains did do.

One can see how there may be problems in the future with the 3-year ARM. The rational for ARMs was based on the assumption that housing prices would continue to appreciate. Based on recent data, national home prices did indeed go up every year since 2000. Yale University Professor Robert Shiller and author of Irrational Exuberance wrote: “Stories have abounded since 2000 of aggressive, even desperate, bidding on homes, of homes selling the first day on the market for well above the asking price, of people buying homes in a rush to beat the market – home that they have sometimes hardly even had a chance to look at. People have been afraid that the price of housing would soon rise beyond their means and that they might never be able to afford a house, and so have rushed to bid on homes.” (Irrational Exuberance, 2005)

But, what happens when housing prices did not appreciate and in fact, went the opposite direction? The national bank that lent the money, the real estate agent, and the underwriters should have known that if the McCains couldn’t refinance or sell the condo 3 years later, a possible 15% interest rate increase to their existing mortgage would have surely meant foreclosure. The reality? The McCains foreclosed on the condo and lost their $60,000 down payment.

Buying a Foreclosed Condo

After selling for $309,000 in 2006, the condo unit was listed for sales through the Multiple Listing Service (MLS) for 35% less, or $199,900. The Chinatown Blogger and the Missus made an offer. The negotiations were excruciatingly slow. The bank had subcontracted out the work to a company in California, which then hired a local realty office to handle the  transaction. Every decision or question would take at least a week to be answered.

After the purchase and sales agreement was signed, then came applying for the actual mortgage and we had 30 days to do so. We had 2 pre-approvals on hand and both of us had over 700 FICO scores. We planned on putting between 10%-20% as down payment and figured that getting a loan would be easy, because after all, wasn’t the whole housing problems contained only to subprime borrowers?

We were wrong.

A credit union that serves military personnel rejected the mortgage loan due to the home being a condo. Their reason for denial: The condo was “a mixed-use development with commercial space on the ground floor exceeding 20% of the total building’s square footage.” We were bewildered. The second lender, also a credit union, serves the employees of a large local university. They also rejected the application. So, despite having 2 pre-approvals from 2 different credit unions, 700+ FICO scores, and 10% down, we couldn’t get a mortgage.

The Chinatown Blogger spoke with the underwriter who said, “We will lend to you, but not for this property…” After a bit of negotiating and convincing (the Blogger had once been a used car salesman), the underwriter relented. We were relieved to get approved for the mortgage.

By September and six months later, we were not able to close the deal due to a defect in the title that was not reconcilable. What was the defect that caused the condo sale to fail? The mortgage lender had hired an attorney (which comes out of our closing costs) to perform a clean title search and discovered that when the developers first built the condo in 2005, the parking deed that the unit we were purchasing was shared with another unit. Who owned the parking space, then?

Obviously, this was the developer’s fault, as they were the ones who wrote the deed. However, the McCains either didn’t hire a lawyer, or their lawyer didn’t catch the mistake and this was not corrected at the time of sale. Due the developers having already sold the unit, the developers were not inclined to sign an easement letter to fix the parking issue. That’s why the deal fell through. Our whole ordeal took 6 months and many back and forth negotiating. We were somewhat disappointed but will move on to look at other properties. In the meanwhile, the condo will continue to sit unsold, with condo fees and taxes accruing, until another buyer comes in.

Our word of advice to the next buyer? Hire a lawyer.