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I read an interesting story on MSNBC regarding the Sub-prime lender mess. The article tells a sad tale of a family undergoing foreclosure because their mortgage loan ballooned into uncontrollable repayment plans. I have friends in the real estate industry and I can tell you first hand about the cascading scam in real estate; It goes something like this…

It all starts with a person interested in buying a home. Person goes to real estate agent to seek help buying a home. Real estate agent wants to MAXIMIZE commission on sale so he points person to highest priced real estate agent thinks person can afford.

Person settles on home and then the scam unfolds…..Real Estate agent wants to “double dip” by scoring the commission on the sale but why stop there. Real Estate gets buddy mortgage broker to fund loan and gets a little referral kick back on the loan. Mortgage broker wants to MAXIMIZE his profit by suggesting bank with the best referral cash back reward.

The scam doesn’t stop there because the bank loan officer wants to make his cut as fat as possible so he’ll push the terms that MAXIMIZE his commission/bonus. He also wants to “double dip” by “suggesting” which Title company, Appraiser and other services are purchased from so he can get his kick back.

The appraiser wants to MAXIMIZE his profit and he receives incentives from his bank loan buddy to price the real estate as high as possible which serves a three fold purpose:

  1. The higher the appraisal, the higher the amount the real estate agent gets on his commission.
  2. The higher the appraisal, the higher the loan amount (interest) the bank officer (and bank) will get on the loan.
  3. The higher the appraisal, the higher the “Fees” will be on the rest of the services on the loans.

From the perspective of the real estate agent, the mortgage broker, the banker, and the appraiser it’s all a win-win situation. Throw in a developer and contractors and it’s even more money on top of that.

The real loser of course is the home buyer. I ONLY buy a home when interest rates are high. I purchased my first home when interest rates were at 7% and got a great deal. I saw a lot of suckers snapping up properties when interest rates were low and I knew they’d be in trouble. Low interest rates (a.k.a cheap money) bring out the sharks to feast on the fish.

Interest rates are cyclical, when I bought at 7%, I knew that interest rates would cycle back down eventually and that’s when you refinance! You see, when interest rates are high, home prices drop because people can’t afford the higher premiums & payments. When interest rates are low, real estate is high and suckers get in. It’s the old “buy low, sell high” that you need to look out for in real estate like with anything else.

Tomorrow, I’m going to tell you how Financial Advisors, Mutual Funds and the investment industry operate in almost the exact same manner to the sub prime lender mess.