Scarlet Letter Zones

It’s not bad enough that we have to put up with all of the local, Detroit political scandals and bad news about plant layoffs and closings in Michigan’s automotive industry; now we have to walk around with a big red “L” on our heads – “LOSER”. We live in a “Scarlet Letter” zone. "Scarlet letter" refers to the growing number of local market areas now designated by major lenders and Fannie Mae as "soft" or "declining." Guess who is leading that pack.

Under a policy that went into effect last month, mortgages on properties in any of hundreds of counties and Zip codes around the U.S. now require an extra 5 percent up front in equity investment. For many leverage-conscious buyers and small investors, that sort of additional money out of pocket can be a deal killer -- or could send them back to the negotiating table to demand a lower price or concessions from the seller. I’ve hit that response on several deals now. Just about all of the southeastern Michigan zip codes are likely on that list (with the exception of the Ann Arbor area).

In late January, Countrywide Bank informed its national network of brokers that properties located in approximately 100 counties rated by Countrywide as higher-risk -- "Category 5's and 4's" on a five-level scale -- now require an extra 5 percent down up front. Another 975 counties are rated Categories 1 through 3, and may require 5 percent bigger down payments if a local appraiser rates the area as "declining," or if properties are taking more than six months on average to sell (note: we are averaging well above six months locally). This sounds a lot like how the weathermen rate storms (hurricanes and tornadoes), with the higher numbers being the worse storms.

Among the areas immediately affected are dozens of prime rental and vacation areas in Florida -- Miami-Dade, Naples-Marco Island, Sarasota and Broward (Ft. Lauderdale). In Arizona, all the counties in the Phoenix-Scottsdale-Mesa area are rated highest risk. The same is the case for all of Las Vegas and Reno, Nevada. We’ve actually been in this class for some time, so this is not new for us.

Other large lenders have instituted similar systems-some using letter designations for elevated risk such as "C" and "D" -- and rating every Zip code in the U.S. One lender, giant GMAC-ResCap, even created a dedicated website allowing brokers to type in a Zip anywhere and get an immediate letter designation rating local risk, and requiring a 5 percent higher down payment.

All of the designations were prompted by Fannie Mae, which mandated the 5 percent rule for all loan types. If you had figured on leveraging your property purchase with a 5 percent down payment program, now you'll need to double that if the area has a high risk rating. The upshot: Even if you're intentionally buying real estate in a soft market because prices have dropped and look attractive for the long term, you may have to pay a new penalty -- 5 percent more up front -- just to get into the game. For conventional mortgage buyers, this may mean a longer wait, while you save for that increased down payment.

This is also increasing the use of FHA backed mortgages, since the FHA doesn’t look at the declining market rating to make its decisions. FHA loans are not risk-based, as are those of conventional mortgage companies. We expect the FHA market to boom this year locally, especially if the FHA Modernization Act gets passed into law and the FHA limits are raised to be more in line with Fannie Mae and Freddie Mac limits.

If you’re a first-time buyer, you don’t need to walk around with a big scarlet “L” on your head if you’re ready to buy. Let’s get out there and find some good “Scarlet letter” houses. The prices are great and I can hook you up with an FHA mortgage. With an FHA backed mortgage you can get by with as little as a 3% down payment and there are even some programs to help with that.