You want to buy a foreclosure? Remember, there are both great opportunities and great pressures and pitfalls in this market.

First, you have to decide at what stage of foreclosure you want to buy. There are three options: 1. pre-foreclosure; 2. sheriff’s auction; 3. repossession, called REO (for real estate owned by the bank).

“The safest and best way to buy is when it’s a bank-owned property,” said Rick Sharga, a spokesman for RealtyTrac, the online marketer of foreclosure properties.

Pre-foreclosure: These homes are in the foreclosure process, but they have yet to be sent to auction. Owners are typically trying to unload them because they are “underwater,” owing more on the homes than they are worth.

As a result, potential buyers must negotiate a deal with the lender as well as the owner. That makes buying at this stage of foreclosure complicated and slow. But, you have the advantage of being able to inspect the home before purchase — which isn’t the case in other types of foreclosure sales. Sharga warned, however, that prices are usually higher than at other stages of foreclosure.

Sheriff’s auction: These sales yield the lowest prices, but they are fraught with difficulties. Often the house is unavailable for inspection, leaving buyers with a long list of expensive repairs — and much larger bill than they intended. This stage is usually best left to the professionals, the contractors and investors who regularly bid on these places and know what they’re doing.

Repossession: This occurs after the home has gone through a sheriff’s auction but does not sell and the bank gains possession of the property. Homebuyers may not get the best bargains during this stage, but they can nearly always perform a thorough inspection before closing, minimizing costly surprises. Plus, the property comes with a clear title.

In addition, the banks selling these places may extend preferential financing terms to the buyers and may have made some repairs before putting the property on the market.

Even in this safer stage, though, homes are still usually sold in “as is” condition. “That means the bank won’t pay for cosmetic issues,” said Adam Wiener, a spokesman for the Redfin, the online real estate marketer. “Although, they will often pay for some or all of repairs that are health and safety issues. That makes the home inspection even more critical.”

He also pointed out that, since you’re buying from a corporation, not an individual, the buying process can be faster, so be prepared to move quickly. Many times a listing goes on sale on a Friday and is sold over the weekend.

“The buyers and their agents need to be on top of everything from the inspection to the financing,” said Wiener. “Some banks will even charge a per diem fee for late closings.”

Once you’ve decided which type of home to buy, there are several common mistakes foreclosure buyers should take care to avoid. These include:

Getting caught up in a bidding frenzy: The banks often under-price repossessions, hoping to generate excitement, attract multiple bids and sell them quickly. The problem is, as in any auction-type sale, bidders get excited and pay too much.

“Remember,” said Sharga, “there are 800,000 REOs in the banks’ inventories. There’ll be another home to bid on tomorrow.”

Underestimating repair costs: Take full advantage of the home inspection and don’t delude yourself about much the repairs will cost.

“Take along someone who can give you a good estimate of how much repair costs will come to,” said Sharga.

Redfin coaches its agents to warn buyers to factor in a cushion of 10% to 20% of the purchase price to pay for unexpected repairs. “If you end up not using it, go on vacation after 6 months,” Wiener said.

Not knowing what comparable properties cost: This is important in any market but especially in this endeavor. In high foreclosure areas, prices can be eroding very quickly. You want to have the latest homes sale prices on repossessed properties and try to keep your bid comparable or lower.

Buying in a neighborhood flooded with foreclosures: This is most important for people buying for the short-term. Any neighborhood saturated with REOs and foreclosures may be headed for further price falls. If you’re planning to relocate within a few years or buying a bigger house, that could mean selling at a loss. A better bet, if you can find it, is to buy the only foreclosed home in an otherwise stable community. That’s more likely to hold its value.

Not having financing in place: If you don’t have a pre-approved mortgage, you’re really not in the market. “You have to be able to move quickly,” Sharga said.

Banks don’t want to dilly-dally on sales; they’re losing money every day that homes sit on the market. That means they’ll often jump on the highest bid with the best financing already in place.

Having a loan beforehand carries another advantage: It tells you how much credit you have available. You won’t spend time shopping for homes that are too expensive.

Remember that pre-approved financing is different from pre-qualified financing; it means the loan is ready to go. Pre-qualified is more like an opinion of a loan officer and there’s still work to be done before final approval.

Can rates of car ownership predict mortgage performance?

According to some new research from two environmental groups, the answer is yes.

The National Resources Defense Council, an environmental advocacy organization, and the Center for Neighborhood Technology, a Chicago group that promotes urban sustainability, have completed a study of 40,000 mortgages in three cities over a 30-year period. After controlling for income, the groups found that the probability of mortgage foreclosure increased as neighborhood car ownership levels rose.

In other words, “location efficient” communities – where public transit options are available – can contribute to the financial stability of its residents. The reasoning: If the homeowners don’t need to own a car, they can save money on transportation costs (including lease and purchase costs, maintenance, insurance, gas and parking). They are then better positioned to weather negative financial circumstances – say, a spike in the price of gas or a job loss. (Transportation costs account for roughly 17% of the average American household’s expenditures, the second-largest budget item behind housing, according to 2008 figures from the Bureau of Labor Statistics.)

The report recommends that lenders include measures of location efficiency and borrowers’ transportation costs in their underwriting decisions – “providing proportionally better borrowing terms for purchasers of location-efficient homes,” the report says. But Jennifer Henry, the real estate sector manager in the Center for Market Innovation at the NRDC, says that location efficiency isn’t a determining factor in mortgage default or foreclosure – it’s an additional characteristic that, when taken into account, “makes your ability to predict foreclosure more accurate.”

Indeed, the link between transportation expenses and ability to pay the mortgage is somewhat tenuous, says John Taylor, president of the National Community Reinvestment Coalition, a housing advocacy group. Transportation costs represent “a tangential relationship” to mortgage default, he says. For homeowners who are behind on their mortgage – because of a job loss or an increased monthly payment – getting rid of a car might help only so much. Job loss and unsuitable mortgages with unsustainable terms and conditions are more directly tied to foreclosure, adds Taylor.

Talk of how “walkability” boosts home values isn’t new. A study by CEOs for Cities, a network of urban leaders and corporate executives, published last year found a positive correlation between an area’s walkability – proximity to shopping, services, schools and parks – and housing prices in 13 of the 15 housing markets studied.

“Prices of property around transit-oriented developments – especially new developments – have increased or at least kept their value,” says Sarah Catz, a research specialist at the University of California, Irvine’s Institute of Transportation Studies. Catz says she is currently doing research that shows that property increases in value when you bring transit into a region or area.

A mortgage product based in part on a borrower’s access to public transit has existed. The Center for Neighborhood Technology (in partnership with Fannie Mae) developed a location-efficient mortgage program in the 1990s. Just a few cities experimented with these products, including Seattle and Chicago, but only about 300 of the mortgages were made, says Henry, but none went into default.

Under the program, which no longer exists, a statistical model calculated the monthly savings a typical household would realize based on the property’s proximity to local services and public transportation and how walkable the area was. That amount would be added to their income, which would reduce the borrower’s debt-to-income ratio, thus potentially qualifying them for a bigger mortgage on the theory that with lower transportation costs, they could afford it, says Diane Wasson, a vice president at Home Street Bank in Seattle, who was involved in the program. (Debt-to-income ratio is one of several criteria, including loan-to-value ratio and credit history, lenders use to consider an application.)

Getting lenders to incorporate this into their practices might be a stretch. But last year the House passed a bill that would promote energy- and location-efficient mortgages for home buyers through incentives from Fannie Mae and Freddie Mac. And a spokeswoman from the Department of Housing and Urban Development (HUD) says supporting location efficiency in community development practices is absolutely a priority for the agency. “If we can reduce energy and transportation costs through more location efficient housing, it will make homes more affordable generally, and thus reduce the risk of foreclosures,” she says.

Read more: No Car, No Foreclosure? at SmartMoney.com http://www.smartmoney.com/personal-finance/real-estate/no-car-no-foreclosure/#ixzz0gTAtxV8S

The equity the people did have was artificially inflated due to market conditions and the ease with which people could get money to buy homes as well as the rampant use of homes as ATMs with home equity loans and 2nd (and 3rd!!) mortgages. Of course home prices were going to rise dramatically when people could get loans without downpayments or even proper income documentation – two of the biggest obstacles to home ownership. Not that those obstacles are bad things, they were what had kept the housing market strong until the last few years.

Right now we are going to have to swallow the tough medicine and learn from what happened.

More bad news on the housing bust front: Nearly 25% of all mortgage borrowers were underwater, meaning they owe more on their loans than their homes are worth.

First American CoreLogic, the research firm that monitors housing equity, reported Tuesday that 11.3 million homeowners — or 24% of all homes with mortgages — were underwater as of the end of 2009. That’s up from 23% and 10.7 million borrowers three month earlier.

Nevada was the state with the worst record at 70% of all mortgaged properties underwater. That was followed by Arizona (51%), Florida (48%), Michigan (39%) and California (35%).

For many homeowners, being underwater, also know as negative equity, has few consequences. If they’re not planning to sell and can afford their monthly bills, they can wait out the downturn.

For others, however, plunging underwater can spell disaster. If they become unemployed or have a financial emergency, they have no equity to tap. Or, if they need to downsize or sell their home to relocate for a job, they can’t.

“Negative equity is a significant drag on both the housing market and on economic growth,”said Mark Fleming, chief economist with First American CoreLogic. “It is driving foreclosures and decreasing mobility for millions of homeowners.”

Traditionally, being underwater was one of two main factors in determining a borrower’s likelihood of foreclosure. The other is having sufficient income to pay bills. But, there’s an increasingly important exception: strategic default. As equity gets more and more negative, some homeowners are choosing to quit paying and give the keys to the bank.

As long as negative equity remains a big problem, it will be difficult to stem the tide of foreclosures that continue to plague many local real estate markets around the nation.

“Since we expect home prices to slightly increase during 2010, negative equity will remain the dominant issue in the housing and mortgage markets for some time to come,” said Fleming.

Before it was unemployment, health care or carbon emissions that preoccupied politicians, foreclosure prevention was among President Obama’s top priorities when his term began just over one year ago.

In an effort to “stem the tide of foreclosures,” both the previous and current administrations passed a battery of programs: the Hope for Homeowners Act, the Housing Assistance Tax Act, the Helping Families Save Their Homes Act, FHA Secure, the Hope Now Alliance, the Homeowner Affordability and Stability plan, the Recovery and Reinvestment Act, not to mention the takeover of Freddie Mac and Fannie Mae, all costing hundreds of billions of dollars with the expressed goal of keeping people in homes on which they weren’t actually making the payments.

“There will be a cost associated with this plan,” the president admitted last year when selling the stimulus. “But by making these investments in foreclosure prevention today, we will save ourselves the costs of foreclosure tomorrow — costs that are borne not just by families with troubled loans, but by their neighbors and communities and by our economy as a whole.”

By even the most cursory measure, efforts to prevent foreclosure have failed miserably. This month Bloomberg’s Foreclosure Index tapped a new high of 11.74% — up from 7.94% one year ago, despite the unprecedented effort and cash, from Uncle Sam. The S&P Case-Shiller Home Price Index, a composite of 20 cities around the country, is still down 5.3% from year ago-levels.

Now Washington has morphed its message to job creation, not by stimulating the private sector, mind you, but largely via make-work infrastructure programs. There’s plenty of historical precedent to suggest that efforts to create jobs won’t be any more successful than preventing foreclosures.

Depression-era public works projects, to which the modern-day stimulus is routinely compared, increased federal spending from 3.4% of GDP in 1930 to 9.8% in 1940, according to data from Heritage Foundation. During that period, unemployment rose from 5% to over 20%.

Between 1992 and 2000, Japan launched no fewer than 11 separate stimulus programs, most with a massive focus on infrastructure spending, which rose to 6% of GDP. The net result? The country now boasts the highest debt-to-GDP ratio in the developed world. Per capita income, which had been the forth highest in the world, dropped sharply. Unemployment more than doubled.

Ibaraki Airport outside Tokyo provides a telling example of how the “build it and they will come” fantasy of infrastructure spending doesn’t wash. When the $270 million project was approved in 1996, government officials promised the facility would create jobs, boost the economy and handle up to 800,000 passengers annually.

The airport will finally open next month with only one carrier, Asiana Airlines, offering a single fight each day.

The recent spike in the number of delinquent Federal Housing Administration-insured loans has some people worried that taxpayers will eventually have to bail the agency out.

Seriously delinquent FHA loans, those 90 days or more late, jumped 62.1% in the past year to 558,944, or 9.4% of FHA loans, as of the end of January, according to agency statistics released on Friday.

The FHA, however, insists its finances are sound. Its loan portfolio actually performed better than most mortgage products, according to David Stevens, the agency’s commissioner.

“The FHA default rates are increasing at a slower rate than even prime mortgages,” he said.

But the reason for this increase may be more of a statistical glitch than an actual trend. Loans that go into the seriously delinquent bucket stay there far longer, boosting the numbers and making comparisons problematic, said Jay Brinkmann, chief economist for the Mortgage Bankers Association (MBA).

Many lenders and servicers are overwhelmed by sheer volume of loans and are reluctant to take back homes they don’t think they can sell. As result, they keep the loans hanging out in the 90-day late bin rather than moving them into foreclosure.

Lenders are also trying to modify more mortgages, which can take months to accomplish. Meantime, many of the borrowers sit in the seriously delinquent bucket.

In contrast, loans that are 30- or 60-days late actually declined in the past year, according to the FHA.

Home price drops hurt
Until the mortgage bubble burst, FHA loans made up a small portion of the housing market. Now, the agency originates almost a third of all home loans. That means most of the agency’s notes were issued in the past three years — when prices were plummeting.

“There are a lot of young loans in the FHA book,” said Mike Fratantoni, vice president of Single-Family Research and Policy Development at the MBA. “Mortgages typically hit their peak delinquency rates two or three years after origination.”

Those early years are toughest because many borrowers have struggled to afford their homes and their incomes have not risen enough to offset any setbacks.

Additionally, the price drops pushed many FHA borrowers underwater. These homeowners only had to put 3.5% down to start, so they could quickly end up owing more than their homes were worth in places where values plummeted 20%, 30%, 40%.

Once these mortgages clear the system, the FHA portfolio should emerge in sound condition. Recent FHA borrowers have been of high quality; their average credit score has risen 33 points in the 12 months through December to 694 and is up from the low 600s a few years ago.

No policy change
Some FHA mortgages are simply bad loans. After subprime lending froze in 2007, overly aggressive mortgage originators, who could no longer hook up borrowers with subprime loans, turned to FHA loans for their risky clients.

Commission loan officers and rogue mortgage brokers pushed the envelope of who qualified for FHA loans, according to Allen Hardester, a Columbia Md.-based mortgage consultant. They pushed the edge on debt-to-income ratios, credit scores and loan-to-value ratios.

“They took advantage of lax underwriting by FHA to interpret the guidelines broadly,” he said.

The resultant delinquencies have not persuaded FHA to impose risk-based pricing, in which borrowers pay more if they have lower credit scores. But the FHA does now require that borrowers with FICO scores of less than 580 put down at least 10% of the sale price, rather than the 3.5% minimum requirement for more qualified borrowers.

And the agency has also eliminated seller-assisted down payment programs, which HUD has said accounts for a disproportionately large share of FHA delinquencies.

In these transactions, sellers kick back the down payment to homebuyers, usually through a third party. The result is that buyers have no “skin-in-the-game,” which makes the loans more attractive to risky borrowers.

Commissioner Stevens said the FHA is on a sound financial basis. Its primary reserve fund is at $32 billion, its highest level ever. There’s a secondary reserve that has fallen below its mandated level, but the FHA has taken steps to boost it. It recently asked Congress to increase the monthly fees it charges borrowers to insure their loans.

“Given the environment, the FHA has made very responsible changes to its underwriting,” said Fratantoni.