Tragedy of mortgage foreclosures
It was sad and regrettable to read the court case facts last week involving the collapse of a mortgage, a possible devastated business, the pending foreclosure on a family home, the original intention of helping a friend, a trusted relationship probably shattered, while embarrassing details all aired in public.
Realistically, in the best of times, this scenario would have never been noticed, or even have reached such a devastating end point. Instead, it would have been just one of thousands of ordinary transactions that have been employed by individuals and businesses (and their banks) over the years, and it would have had a successful outcome.
I will state here that Moneywise has no personal knowledge of this particular case or of the individuals and businesses involved. All parties have my sincere sympathy.
Nor can one simply look at the case to make assumptions or start assigning the “should have” blame all around.
In normal circumstances, almost everyone who purchases a home intends to make all mortgage payments with the ultimate goal of outright home ownership. Just you at the end of the term, the bank is out of the picture.
Sometimes, these scenarios can evolve sideways into failure. It is useful for anyone wanting to own property in future planning to understand what can happen.
So, let's just walk through the basic process, keeping in mind that there can be many outlier arrangements.
When a property is purchased, certain financial provisions come into play.
We all are somewhat familiar with the real estate home acquisition scenario — we will keep it simple, no closing costs, commissions, etc included.
A property comes on the real estate market, in a current boom with the seller's advantage. After numerous offers, and negotiations,
The seller accepts the following offer from our illustrative family.
• $700,000 purchase price for the family's new home
• Less $140,000 down payment that the family has rigorously saved — for years!
• The remaining purchase price is funded as fixed-rate mortgage from a local bank
• $560,000 @ 7 per cent interest for 20 years
• $4,342 a month for 20 years, or $51,776 a year
The patriarch and matriarch of the family are regular people, in their middle 50s. Mortgage will be fully paid at aged 75.
• Both have good jobs: in retail, and construction, but not at high executive level salaries
• Adequate savings, small pensions
• Most of their current savings were seriously depleted for down payment
• Two almost adult children
They have been totally disciplined in making every single mortgage payment for the last seven years.
They started with equity in the property of $140,000 (their down payment), and with increasing principal payments in an amortised mortgage, the equity has increased to $248,600. The mortgage principal balance outstanding remains at $443,900.
Everything going along in life smoothly.
They have decent equity build-up, or collateral, in the home, they are in their 60s now, but significant progress is being made.
Further mortgage principal reductions (and a larger build-up in equity) may be complete just around the time that they will want to help their children acquire their homes.
Down the road a couple more years, the equity in their existing home has been used as collateral down payment for a new property mortgage for their children — both equal owners. Neither adult child had the resources to fully fund the new mortgage.
When the loan for financing the son and daughter's property, or say providing significant cashflow for a business, or even purchasing a business property, the equity that has accumulated in the original property of the parent is used up.
The original property now has new, more debt accumulated on it, the monthly payments are increased, and possibly the term of the original mortgage is extended.
Sometimes, rather than rewriting the original mortgage terms, another mortgage is attached to the home, an equity line of credit.
However, along with the happy outcome of helping their children, they would be amiss if they did not at least consider the scenario of a comfortable life experience that may be affected by the what-if uncompromising reality in future planning for themselves and their now adult children.
Adverse, abrupt changes in financing, careers, health, and economic conditions can affect the terms, repayments, real estate valuation, and the best of plans.
How can they anticipate, plan or even just react to any of the following?
• Business and economic downturns, out of their control
• Rising finance interest rates do not affect their current fixed-rate mortgage, but their children may have taken out an adjustable-rate mortgage
• Job redundancies, in some ways controllable, and in country economic conditions, not
• Retiree incomes substantially reduced from investment/pension drawdowns or investment market volatility — difficult to plan adequately for, except to continue to fiercely save
• Tenant scarcity or inability to collect rent, a difficult situation in best of times. They elected not to invest in a rent situation
• Property destruction from natural disasters, out of their control
• Debilitating illness, an incentive to stay as healthy as possible
• Political and/or business interference, out of their control — to an extent
• Outright fraud by undue influence requires their very careful assessment of any outside investment offers
• Property value devaluation in recessionary times, out of their control
• Pandemic, a once-in-a-lifetime unforeseen event, out of everyone's control
• Every single one of these singly, or collectively, can absolutely torpedo dreams of success
What does all this mean?
No one individual can successfully manage every life situation for a positive outcome, but, we cannot forget the power we humans have to problem solve and effect determined change.
Life can be startling awful, and wonderfully brilliant.
Part two, next week: Thoughts on how the family can manage some of these financial situations and move forward.
• Martha Harris Myron CPA JSM: Masters of Law — international tax and financial services, dual Bermudian/US citizen. All proceeds from these columns are donated to The Bermuda Salvation Army. E-mail: firstname.lastname@example.org