Incentives are inflating existing-home prices

The downturn in home sale prices may be worse than statistics show.
NEW YORK (AP) -- Buyers latched onto mortgages with all kinds of exotic teaser rates to be able to afford the soaring home prices that sellers were demanding during the boom years.
Now that the situation is reversed, buyers are demanding cash payments and other incentives that may be artificially propping up sales prices -- suggesting the market downturn could be even more pronounced than has been reported.
Gonzalo Sotelo, a licensed real estate agent in Salinas, Calif., said that three times in the last few months, buyers' agents approached him about securing cash back at closing without informing the lender.
In the most expensive proposition, an agent from the nearby San Francisco Bay Area proposed having a home with a 539,000 asking price reappraised and sold at 600,000, with Sotelo's client paying back 60,000 in cash to the buyer. Sotelo, of Prudential California Realty, said he turned down the deal and hasn't heard from the agent since.
The type of offer Sotelo received prompted his boss, Jose Palma, to devote a recent staff meeting to a discussion of how to avoid potentially fraudulent deals, since giving cash back without telling the lender creates legal liabilities for the broker and seller.
"Because the market is changing right now, I think people are trying to be a little bit more creative," Palma said. "We tell our agents: 'There's a black area and a gray area.' I tell them to stay away from the gray area."
What's happening
Offers abound from sellers willing to pay closing costs, several months of mortgage payments and, in some cases, cash. Giving cash back allows a seller to sweeten the offer without having to lower the actual stated value of the home.
Buyers are taking the incentives, and economists say the practice could be inflating reported prices and distorting our view of a market already suffering from higher mortgage rates and a sense that the market is enduring a significant correction.
Fears that overextended homeowners would default on mortgages led banking regulators last month to direct banks to explain the risks to borrowers from interest-only and other nontraditional mortgages, which had helped many homebuyers buy expensive homes during the boom. The Government Accountability Office told Congress last month that from 2003 to 2005, nontraditional mortgages rose from less than 10 percent of all mortgages to about 30 percent.
Inflated prices potentially cause harm to banks, which could take a hit if the mortgage holder defaults and the home turns out to be worth less. It also could affect buyers of neighboring homes, who may be making decisions based on faulty data.
When sellers use incentives to reduce the actual price without cutting the reported price, "then the reported prices are an overstatement of the true net selling price," said Lawrence White, Deputy Chairman of the economics department at the Stern School of Business at New York University. "So that very likely means that the real drop in home prices is greater than what the standard sources, like the National Association of Realtors, have been reporting."
The Realtors association reported that prices of existing homes fell in August for the first time in a decade. The median price of a home sold in August fell to 225,000. That was down 2.2 percent from July and down 1.7 percent from August 2005. That marked the first year-over-year drop in home prices since April 1995.
In calculating the much-watched home price statistics, cash and noncash perks are left out, implying that true prices are even lower than the statistics indicate.
Noncash incentives, such as improvements paid by the seller, also have an effect since any add-ons change the quality of the houses but aren't reflected in the prices -- or for that matter, the statistics.

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