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Why Must We Bail Out?

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Posted On: 02/18/2009

[banner]Q: I have a friend who lives in another state. His income is very good, and he owns an $800,000 home that now has a value of about $450,000. He’s turning it back to the bank. He owes about $750,000 on it but figures he can rent a great condo and not worry about finances as his income can still support his lifestyle. Why do we have to pay for his stupidity with $700 billion in bailout money?[banner]

A: The example you cite is precisely why so many people are vehemently opposed to any government bailout.

It’s easy to understand your friend’s actions and logic, but that’s not the whole story. Imagine that you went to a local bank to rent a safety-deposit box. Imagine also that they took your valuable stuff, put it in a clear plastic bag and then left the bag on an open shelf where it could be grabbed by anyone in the bank lobby.

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We expect the bank to have an impressive, thick, all-steel vault to hold valuables, not a bunch of plastic bags. Why then should we have lesser expectations when lenders make loans?

You have to wonder: Did the lender verify your friend’s income? Did they physically appraise the property? Why did they ask for so little down? Did they have any insurance on the loan? If yes, did the mortgage insurance company ask hard questions?

We don’t universally require lenders to verify loan application claims. Since lenders are paid for loans they originate and then sell to investors, there’s little or no incentive to decline mortgages. Federal regulators could require lenders to verify income and employment claims for all loans but did not, will not and won’t because lenders say such rules would limit their ability to extend credit.

Such lender claims are nonsense. There are any number of local community banks that properly underwrite loans, make profits and have few defaults. Some – like Hudson City Bancorp in Paramus, N.J. – are refusing to take bailout money.

The logic behind the bailout, as expressed by various government officials, is essentially that if the banking sector crashes the damage to us all will be far worse than the cost. But the real issue is different: Had the lending system been properly regulated there would never have been a mortgage meltdown. Until lenders are sensibly regulated we’ll all be left holding the bag.

[banner]Q: I’m renting a home. I send my rent check to a real-estate broker who works for the owner. I just got a letter from the broker saying that the owner of the home is canceling the terms he has with the broker and for me to send the next rent check directly to the owner. What rights do I have? Who will hold my deposit? Do I still have a lease?[banner]

A: Let’s look at each issue individually.

First, the owner is getting rid of the broker. That’s a matter between them.

Second, the broker sent you a letter telling you where to send the rent. You now have written instructions from the broker. That’s proper and appropriate. However, to protect yourself it would be wise to send the first direct payment by certified mail with a return receipt requested so you can show both when the rent was mailed and when it was received. It would also be wise to send it a few days early.

Third, rules for deposits vary by state. Generally, brokers must hold deposits in an escrow (trust) account and not co-mingle with their funds or use the deposit money. The rules for owners may differ. For specifics speak with a local housing office.

In my jurisdiction rental deposits are typically kept in a federally insured bank. Some property owners have separate accounts for each tenant because escrowed funds must pay interest to the tenant. The money must be kept in escrow to preserve the tenant’s money in case the broker or owner is sued or goes bankrupt.

Fourth, the question of whether or not you have a lease can be complicated. Usually, if you have a lease the agreement remains in place whether or not the owner uses a broker. After the initial lease term, say a year or two, is over then you may be allowed to automatically stay on the property on a month-to-month basis.

Notice that the broker did not say you must leave or that the rent is going up. You can ask the broker where you stand with regard to the lease, or you can run the lease by an attorney, legal clinic or community-housing group.

Peter G. Miller is the author of The Common-Sense Mortgage and a veteran real estate columnist. Have a question? Please write to peter@ctwfeatures.com.

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