NOT going to do it!

As many of you know, I have mentioned several times that things have gotten quite a bit slower. I think this story pretty much sums it up, especially this part:

“How would you characterize the housing market right now? MOZILO: The market has turned. The psychology of the buyers for single-family homes has clearly changed. We are seeing it from the flow of loan applications. If I had to pick a time, I would have to say it turned in January.”

There you have it, from the CEO of the largest mortgage origination company in the country. If the largest originator in the country is being hit by the slowdown, what do you think is happening to all of the other companies?

Look at the stock price of ECR (Encore Capital Corp). This chart does not surprise me in the least. That is what happens why you try and “buy the market” with crazy rates and guidelines that most other companies wouldn’t touch. Encore is known for using the “high” FICO score, not the middle of 3 or lower of 2 like the rest of the industry. Some other companies would do it, but with an add-on to the rate. Encore did it with no add-on. They were also very liberal with pricing for several months there. Maybe that is why they are in the predicament they are in. I’m sure their customers and brokers love them…but at the end of the day, they are taking some large losses on their portfolios.

That said, I have seen the writing on the wall for quite a while now. As things have started slowing down even more, I have began working-on and looking-at other options in and out of the mortgage industry. Just bear with me as I’m working on my plans B, C and D at the moment. It takes quite a bit of time to write 5 completely new posts a week. I really enjoy doing the blog, replying to e-mails, and helping people out…but blogging doesn’t exactly pay the bills at this time…I wish it did though!

The forums are becoming an excellent resource. There are over 200 topics, 1300 posts, and almost 250 members. If I don’t have a post up, spend some time over on the forums. There are a lot of FB stories, as well as other posters that have a lot of good information to share.

Thank you for your understanding, patience, and support!

BTW…San Diego inventory is now sitting at 17,225 per ziprealty.com.

I look forward to your questions, comments, and feedback!

SoCalMtgGuy

Whew…I’m tired! The horse is down, but no matter how much we beat it with data, facts, math, inventories, etc. ‘the horse’ will just not believe it one bit that real estate can go down.

I have covered most of the popular mortgages….from 2/28, 3/27, 5/25, 3/1, 5/1, 7/1, 10/1 ARMs, interest only ARMs, option ARMs, fixed rate loans, even 40 year mortgages on up to 100 year mortgages. We have looked at HELOC’s (home equity line of credit), seconds, 125% loans, sub 500 FICO score loans, stated loans, NINA loans (no income no asset), no doc loans, and more.

We have looked at the data for ARMs and option-ARMs. We have seen that in many ‘bubble areas’ ARMs are used well over 70% of the time. It doesn’t matter if the option-ARM is tied to the COSI, COFI, MTA or LIBOR…it is going to adjust or recast sometime. It doesn’t matter if the I/O period is 1 year or 5 years, it is going to adjust. When these loans adjust, people better have equity to refi, or the income needed to support the payment. When I see things like THIS, I think people just might be a little too comfortable with 50-100k in equity.

I have looked at the data, and compared it with my personal experiences, and nothing surprises me based on what I have seen. I have seen the option-ARM become 80-90% of the business at some of my broker shops. I have seen the way they are sold, and how many clueless borrowers fall for the ‘low payment’.

We have looked at income, inventories, and housing statistics. If I were in Vegas, I know where I would put my money on the direction I think things are headed…and I think many of you feel the same way.

That said, no great long post from me tonight. There are now over 160 active topics and over 1000 posts in the forums. Use the comments here, or the forums to chat back and forth over the weekend. Lots of good posts in there. It is worth checking out if it has been a while since you last stopped by…it has grown a lot!

As usual, I look forward to the comments and feedback!

Have a great weekend!

SoCalMtgGuy

I have received several e-mails from readers that are feeling like this thing is never going to end because there is talk of a 50 year mortgage coming out. My thought is not to worry. It will only delay the inevitable slightly, if at all. Here is an article about the possibility of a 50 year mortgage.

Let’s look at a few choice comments from the article:

The longer-term mortgages would lower monthly payments. No, really?!?!?

“To the extent more consumers have more products available, it will be a help for affordability,” said Douglas Duncan, chief economist at the Mortgage Bankers Association.

And you all though I was kidding when I have told you that all ‘most’ borrowers care about is “LOWEST PAYMENT”. Instant gratification rules in America. Why worry about tomorrow when you can have something today…at a ‘low’ payment. Just stretch the payment out long enough, and everything can be ‘affordable’. At what point do we quit looking for ways to artificially inflate the ‘price’ of assets?!?!?

Keith Gumbinger of HSH Associates, which tracks the mortgage industry, believes lenders will likely generate some borrower interest with the 40-year loans.

Where has Keith been lately? Most of the subprime lenders are pushing the 40yr loan. There are several lenders that have a 40-year option-ARM already. From what I have seen, brokers want lowest payment possible, and naturally, this is the 40-year mortgage term. Finding a 40-year loan is about as hard as finding porn on Google.

I don’t know what percentage of loans will be 40 year loans, but I can tell you that the 2/38 and 3/37 are quite the popular subprime loans now. The payment is about the same as the interest only payment, and the rate ‘add on’ is usually less for the 40 year loan than for interest only. I’m not in capital markets, but I can only attribute this change to the performance of the loans in the secondary market. If the investors want a higher return for interest only (I/O), then look for the lenders to push the 40 year. The lenders will ’sell’ whatever they can make the most money on.

Lets get back on track here. Lets see how much of a difference a 50 year mortgage makes over the 30 and 40 year mortgages. I have done a similar post before where I even looked at 100 year mortgages…but since many of you seem to be into animal cruelty, I will continue to beat this dead horse ….just please don’t tell PETA!

Let’s look at some NUMBERS and do some MATH. I know, I know…doing math, thinking, and using logic really sucks! …but hey, somebody has to do it. It can either be me, or one of the great “Appleton-economists” of the California Association of Realtors….you choose.

$400,000 loan at 6% 30yr fix = $2398.20 . . . . .total pmt = $863,352
$400,000 loan at 6% 40yr fix = $2200.85 . . . . .total pmt = $1,056,408
$400,000 loan at 6% 50yr fix = $2105.62 . . . . .total pmt = $1,263,372
$400,000 loan at 6% 100yr fix = $2005.04 . . . . .total pmt = $2,406,048

$400,000 loan at 7% 30yr fix = $2661.21 . . . . .total pmt = $958,035
$400,000 loan at 7% 40yr fix = $2485.72 . . . . .total pmt = $1,193,145
$400,000 loan at 7% 50yr fix = $2406.75 . . . . .total pmt = $1,444,052
$400,000 loan at 7% 100yr fix = $2335.50 . . . . .total pmt = $2,802,600

At 6%, the 30 year mortgage payment is $292.58 more than the 50 year mortgage payment. That is 13.9% higher. In the long run it costs $400,020 or 46% more to do the 50 year mortgage than the 30 year mortgage. It is interesting to note, that at the 7% interest rate, the difference between the 30 and 50 year payments is only 10.6%. So as rates rise, the benefit of the 50 year mortgage appears to decrease. You can also see that there is very little difference between the 40 year mortgage and the 50 year mortgage payment. The $80-$95 bucks a month saved isn’t going to help people that much financially. It will only stretch the amount of property you can buy over the 40 year mortgage by about 3-4%. That is not going to send the market ‘off to the races again’. People are speculating on real estate for 20-30% returns, not 3-4% appreciation (not inflation adjusted…but we can save those arguments for another day). Heck, I’m getting over 4.3% in my PayPal account!!

Let’s say you can afford the $2398.20 payment for the 30yr fixed, but you decide you want to ‘buy’ more home. For the same payment on a 50 year mortgage, you could buy a $455,600 home. How much more home can you really get for 55k?!?!? Is it worth an extra $400,000 in excess payments to have an extra 55k of home today? Heck, if you are buying from a builder, I don’t think you have ANYTHING to worry about. You haven’t seen that much slashing since Friday the 13th. I leave it up to you to decide. I’m not here to tell you what to do, just to try and give you some info so that you can make an informed decision.

Don’t forget, that at this time, they have not applied interest only to the 40 year mortgage. There are several 40 year option-ARMs out there, but there are extra fees charged, or adds to the rate. I’m looking forward to a stated income, no doc, 1000 year, option ARM, with no pre-pay penalty, and taxes rolled into the loan….there is a sweet house on the coast I have my eye on, and I think I can work the payments if the loan term is long enough… (Yes, I’m joking…just like this site)

I was going to leave things simple by using the same rate for all mortgage lengths as it ‘errs’ on the side of showing the ‘benefit’ of the longer term mortgages, but after reading some of the comments, I feel that I should make another comparison. When you go for the longer term mortgages, there is an ‘add’ to the rate. This add fluctuates between companies, and with monthly specials (usually .10 to .40 bps) but a .25 add to the rate is relatively common, so I will use that. This extra .25 would be added to the 40 year term. I assume an even larger add would be made to go to a 50 year term (.35-.45 maybe??…I don’t know). So to ‘err’ on the low side, I will show a .10 and .25 add for the 40 year mortgage, and a .25 and .35 add for the 50 year mortgage. Now let’s have a look at the savings when these rate ‘adds’ are included:

$400,000 loan at 6.00% 30yr fix = $2398.20 . . . . .total pmt = $863,352
$400,000 loan at 6.10% 40yr fix = $2228.80 . . . . .total pmt = $1,069,825
$400,000 loan at 6.25% 40yr fix = $2270.95 . . . . .total pmt = $1,090,060
$400,000 loan at 6.25% 50yr fix = $2179.89 . . . . .total pmt = $1,307,934
$400,000 loan at 6.35% 50yr fix = $2209.80 . . . . .total pmt = $1,325,880

Now if you look at things, the ‘more realistic’ .25 add for the 40 year mortgage only saves you about $128 a month on payment, but costs an extra $226,000 over the life of the loan. Basically, the rate adds chip away at the benefit of the longer term mortgages, and makes them more expensive in the long run.

Here is what many brokers will tell you. “I have a loan where the payment is about $300 bucks a month less, do you want that loan?”. Uh, what do you think ‘most’ people will say? Do you think they will do the long term math? …or heck, ANY math for that matter?!?!?

One of the things that really cracks me up, is when I’m in an office and one of the loan officers slams the phone down and says “@#$%&!!!! the mother$#@&* wants to run it by his financial planner before we move forward!!!” This is usually followed by the lead being balled up and tossed into the trash can. I smile on the inside knowing that at least the borrower is smart enough to run major financial decisions through some sort of an ‘expert’. It is even funnier to hear the brokers try and talk the borrowers into doing something their financial planner or accountant told them not to do. Total comedy!

That said, if the only way you can afford a home is with a 50 year mortgage, I would suggest you wait a little bit. There is more to life, than making a mortgage payment for 50 years of one. With the average life expectancy in the high 70’s, you had better start making mortgage payments when you turn 18 so that you can have your house paid off before you kick the bucket. Yeah, I know…people move every 3-5 years now, so who cares about paying off your mortgage….real estate only goes up! YAWN….fundamentals are soooo old fashioned.

On a side note, San Diego inventory is at 17,058 today…another 30 properties added in 1 day. We are closing in on 1000 posts in the forums! I think that is great considering they have only been up, along with this new site, for about 3 weeks.

I look forward to the comments and feedback!

SoCalMtgGuy

San Diego inventory passed 17,000 on Feb 21st, and is officially at 17,027 per ziprealty.com…but don’t be surprised if it is higher when you check it. On Jan 23rd, the inventory was 15,568. That is a 9.38% increase in the last 30 days. Don’t wait for the Union Tribune to tell you that though. Take the initiative to check it out yourself, or use the resources of this blog and others. If you depend on the media to tell you what is happening, you will be behind the power curve. Don’t forget that during the ‘good times’ in 2004 the inventory was in the 2900-3000 range.

Take for example this article in the OC Register. I’m sure some of you saw it yesterday, but it was called “Is median price drop a blip or an omen?“. It is worth reading if you haven’t read it. I just don’t get why nobody will touch the ‘inventory’ issues that are being seen in every major bubble area. Check out this excellent site that does nothing more than track the inventory in the bubble areas. One other point I want to make here:

Fact: In January, 72 percent of Orange County’s homebuyers chose adjustable-rate loans to finance their deals. That’s the lowest use of these loans since May 2004.

Only a blip: Lower adjustable mortgage use means fewer buyers who’ll be subject to payment shocks if interest rates rocket higher.

72% of the people used an ARM mortgage to finance their deals in January, and that is the LOWEST rate in 20 months?!?!?!? So it is save to say that 75% or more of the loans the past 2 years have been ARMs, and nobody sees a problem with that?!?!? The fixed rate mortgage is all but dead for many of these people because they can’t afford it in the long term!!! Yes, I know it is Orange County, and there are some sophisticated people there that are leveraging their money, managing their cash-flow, and making investments in and out of real estate, but those are not the majority of people in Orange County. If you look at the affordability numbers, it is no secret why 3/4’s of the people are not getting fixed rate mortgages…they can’t afford it!! If you look at PIMCO’s research, they said that from Nov 2004 to Nov 2005, that 82% of the purchase loans were either interest only, or neg-am (option-ARMs).

Back to the inventory numbers….

This is simple supply and demand. I know that people still think they are entitled to the ‘appraised’ value of their property, but they are going to have to realize the important fact that property is worth what somebody will pay for it, not what a 10-20 page appraisal says.

I think prices will be sticky for a few more months. I have talked to quite a few people who are still holding out for things to ‘pick up’ in the spring “like they ALWAYS do”. Once all of the ’spring sellers’ get their spring ’surprise’, watch for the media to start covering the issue. I don’t think it is a secret that real estate has become very popular because it has been associated with ‘easy money’ in books, infomercials, and the news. The increased inventories will eventually lead to falling prices (yes, I know it is already happening so some extent), this will eventually lead to media coverage that will inevitably include a realtor ‘expert’ who will rationalize things, but the end result will be a change in the market psychology. Throw in a few trillion dollars of adjusting ARMs, some foreclosures (which increase inventories), and more media ‘piling on’ the coverage…and you will finally have your widespread price declines as the masses realize they have been bidding up overpriced assets with funny money. The problem is that the bank and the IRS doesn’t think the money is all that funny. In fact, it is quite real to them.

Making an interest only mortgage payment that is 2-3 times what you could be paying in rent gets old extremely quick when your property is not appreciating at double-digit rates of return. Look for the fundamentals to return to not only the real estate market, but the mortgage market as well.

Sorry if I sound like I’m beating a dead horse. Sometimes I just feel that I’m saying the same things over and over. Let me know what you think.

I look forward to the comments and feedback!

SoCalMtgGuy

I have been out of town and pretty busy the past few days…so I don’t have time to hammer out one of my long posts, so here are some random thoughts and impressions on the housing bubble, real estate, mortgages…among other things.

- At 11:31 PM on Monday night, there are: There are 16,981 active homes in San Diego, CA. per ziprealty. At what time this week (give day and time), do you think that San Diego will go over 17,000 properties? I would do Orange County, but ziprealty hasn’t split OC/LA up…so the number sits at over 72,000. I’m going to say Tuesday at 3pm, we will go over 17,000.

- I was ‘out and about’ quite a bit this long weekend. Made it down to the Gaslamp in San Diego. On one corner there were 4 sign ’spinners’ peddling condos. I saw 2-3 others on various downtown corners. Has anybody ever bought a condo because of one of these guys? Maybe it’s just me, but a condo starting at 300k is not an ‘impulse purchase’. If somebody was spinning a sign for a $2.50 slice of pizza, I think it might work. Condo’s….not working for me. Not to mention the fact there is a real estate office on every block, and condo’s going up all over “East Village”. Even if I did want to buy a condo….those signs are merely pointing me in the direction of about 10 places where I could ‘buy’ one.

- Why is there a silent ‘T’ in the word MORTGAGE???? (let me clarify…this is more of a ‘joke’ than a real question. Back in a training class a while ago, the instructor asked if there were any questions…somebody raised their hand, and asked that question. It was much funnier if you were there.) Thanks to all the people who e-mailed me, or posted the correct answer about the french origins of the word.

- Read this piece of work that was e-mailed to me by a broker. I think they got the roles reversed….what do you think?!?!?

CONTRARY TO POPULAR BELIEFIT PAYS TO BE A CONTRARIAN. Sir John Templeton was known as the Dean of Investing, and he was a classic contrarian. Mr. Templeton said to buy when things looked most pessimistic and sell when the masses felt most optimistic and his attitude paid off. He began his Wall Street career in 1937, created many of the worlds largest and most successful international investment funds, and is now a full time philanthropist at age 92.

And when the housing bubble hype began four years ago, many individuals refused to base their decisions on hypeand have seen sizeable gains with their real estate investments. On the other hand, those who put off purchasing real estate based on the fear induced by the media most probably regret their decision. If you have been putting off the purchase of your dream home, dont base your decision on fear and hype, meet with your trusted mortgage professional and get the facts about your local real estate market.

Uh…maybe I missed something, but I thought the popular opinion was that you “can’t lose” with real estate? I had no idea the media has been saying there was a housing bubble for the past 4 years. Heck, the stories are JUST starting to roll in over on Ben’s blog. Remember, the media is a lagging indicator…and many brokers will say anything to get a commission. The fundamentals in this story are correct, but they are having an identity crisis and they got their roles mixed up. The contrary people would be ’selling’ into all the ‘buying’ frenzy.

I know there is quite a bit of e-mail for me in my inbox, just bear with me, and I will get replies out. The forums are doing excellent! We hit the 200 member barrier! There are almost 150 topics and 900 posts! Lots of good info in there. If things are slow on the blog, be sure to check out the forums. Comments, feedback, and donations are always welcome and appreciated!

I look forward to the comments on this one. Don’t forget to make your guess on San Diego going over 17,000 properties!

SoCalMtgGuy

Here we go again. Some more analysis of that great 33 page data set that I started talking about yesterday titled “Mortgage Payment Reset - The Rumor and the Reality“. Let’s get right to it…after all it is a Friday!

The author starts off trying to minimize the affect of ARMs adjusting and mortgage payments increasing. There are a few things I want to point out though as we move along.

“By definition, fixed-rate loans do not face payment resets, while adjustable rate
loans do. A small increase in a monthly mortgage payment – say from
$1,500 to $1,600 – is unpleasant, but is usually not enough to ruin a
family’s finances and force them to let go of their home.”

I honestly can’t think of a realistic way that the mortgage payments would jump from $1500 to $1600. To get mortgage payments in this range you are probably looking at a 280-320k loan. To get $100 separation between the payments, you are talking about a 50 basis point adjustment in rate. I guess it COULD happen, but rates are way more than 50 basis points higher in the past 2-3 years. Heck, even a 1 year ARM is going to have rates over 50 basis points. You are probably looking more along the lines of a 1-1.5% change. Most subprime loans have a 1.5% cap on each adjustment. The author goes on to discuss a ‘large increase’ in payment.

“A large increase – from $1,500 to $3,000 – may be too great for a household to handle.
Try as they may, a family facing that sort of increase could be forced into
default if they have no equity and are thus unable to sell or refinance.
It is important to note that a household facing a doubling of mortgage
payments will be in difficulty, whether that increase is applied in a single
month or in a series of incremental steps spread over two years.”

Mortgage payments doubling is going to hurt whether it takes place over 1 month, 6 months, or 24 months. This next part made me shake my head in disbelief:

“Additionally, an interest-only feature makes little difference, since the first few years of a
mortgage loan are almost entirely devoted to interest in any case; including
or omitting principal payments doesn’t change the monthly terms much
for the first few years of a mortgage.”

Are you kidding me??? If the interest only feature made little difference, then 82% of the purchase loans in California last year would not have been interest only or option-ARM mortgages. Sure, on an 60k loan, the I/O payment is not going to save much. But look at the numbers for a $550k ‘median’ priced California home. At 6% on a fixed rate, you are looking at a payment of $3,297.53. If you get an interest only (I/O) payment at 6%, the payment is $2750.00 a month. That is a monthly savings of $547.53. I don’t know about you, but I think 550 bucks a month makes a difference. Not to mention that the interest only loan would probably have a lower rate than a fixed rate loan to begin with. I know that you only pay about 1% of principal per year in the first few years of a 30yr fixed mortgage, so it only stands to reason that the larger the loan amount, the more that interest only is going to help. The author is correct about that point, but he is not applying it to the large loan amounts that are necessary and commonplace in the ‘bubble areas’.

“The primary driver of reset sensitivity
is the magnitude of the interest rate change. An initial interest rate of 5
percent that adjusts to a market rate of 6.3 percent will lead to higher
monthly payments, but the increase will not be catastrophic. On the other
hand, a loan with an initial interest rate of 1 percent that resets to a market
rate of 6.3 percent will experience a substantial increase in payments, all
the more so if negative amortization has increased the total principal
amount subject to interest. That type of loan will experience reset payment
sensitivity. An option-payment loan with a minimum payment below that
of a 1 percent loan will face even greater reset sensitivity.”

Nothing to argue with there, some pretty solid information. In the next part, you will see where this guy is using ‘old school’ ratios. I say ‘old school’ in the sense that it is not the standard I see most companies using. I think it is a good rule to abide by, but it is by no means the norm in high cost areas of this country.

“From Table 10, we see that an adjustable loan of $300,000 that resets from
5.0 percent to 6.5 percent has a monthly payment increase from $1,610 to
$1,896, a rise of $286, to about 18 percent higher than it was before. If the
borrowing household was devoting 30 percent of their income to mortgage
payment, the increase is 18 percent of 30 percent, or 5.4 percent of their
income. This level of strain upon family finances is definitely unpleasant, and
might require cutbacks in personal spending or other lifestyle adjustments.
But normally this level of pain would not be enough to force default. To
look at an example from another part of the economy, the late summer
and early fall of 2005 saw a dramatic increase in gasoline prices, in many
places to above $3.00 per gallon. This price rise led to changes of choice
and to lifestyle adjustments. The sales of large sport utility vehicles (SUVs)
declined. But the national economy did not enter into a tailspin. Yes, there
was pain; but life went on, and life still goes on.”

Is this guy funny or what!?!? First off, if you look at the statistics, very few people can get a $300k mortgage and only spend 30% of their income on the payment. Take the $1610 mortgage payment…remember this is just the mortgage, no taxes or insurance included. If you take that amount and divide by .30, you need a monthly income of $5,366.67 or $64,400 a year. Remember, I’m not adding in $350-400 for taxes and insurance that most companies would take into account for housing debt ratios. If I did, the required annual income would be $80k a year, not $64k. Yes, I know that many single people and couples can ‘afford’ this type of payment…but if you look at the median income in California, it falls at about 53k. The government stats have the nationwide median income at about $45k. My point is that many people qualifying for these 300k loans are spending more than 30% of their income. An 18% jump in payment IS going to hurt. Keep this in mind: I can do fulldoc (W2’s and paystubs) to a 55% debt to income ratio. The author is talking about 30% just on mortgage, I’m talking about total debt payments. That probably puts the DTI the author is targeting in the 30-35% range, not the 55% range that many subprime loans are being done at. Keep in mind, this doesn’t include the ’stated income’ deals that couldn’t even fall into the 55% DTI category. I think it is completely comical to take increases in fuel costs, and compare it to mortgages adjusting. For the most part, individuals have more control over fuel usage than mortgage costs. Individuals can change they car they drive, drive less, take public transportation, carpool, etc. I know some people are driving a lot, but it takes a lot of driving for the extra 70-80 cents a gallon of gas to break people financially (as compared to a mortgage adjusting).

“Perhaps surprisingly, reset adjustments to sub-prime loans may not be as serious as
one might think. An adjustment on a $300,000 loan from 8.0 percent to 9.0 percent
(linked to a national prime rate or other index rate) leads to an increase in payments
from $2,201 to $2,414, about 9.6 percent higher than before. If a family had been
paying 30 percent of their income in mortgage payments, this increase would be 30
percent times 9.6 percent = 2.88 percent of their monthly income. Even a family
with stretched finances paying 40 percent of their monthly income on their mortgage
would experience an increase of 40 percent times 9.6 percent = 3.84 percent of
their monthly income. Such an increase is less in percentage terms than the earlier
example of the reset of a near-market-level adjustable loan. While painful, this
increase would probably not lead to an immediate default. Furthermore, if the
situation worsened and a default did occur, many lenders would be protected from
loss exposure by having used more conservative loan-to-value-ratio guidelines.”

I really don’t think this guy has a handle on the subprime mortgage market. One of the BIG misconceptions is that subprime is all high rates. Sorry to inform you, but for a long time there, I had ’subprime’ rates in the 5’s with a few blocks in the 4’s. Not too long ago, I could to a stated 100% loan for a borrower with a 620 FICO, and the rates would have been in the 6’s on the 1st and 10’s on the 2nd. Yes, there were some areas where borrowers could get into the 8’s and 9’s, but you would REALLY have to try to get rates that high! With all of the competition, there were times when subprime rates were better than A-paper rates on certain programs! I won’t go into it again, but for subprime loans, the author is using debt ratios that are too low. I used to do lots of loans for “a-paper” borrowers on the subprime side BECAUSE subprime would take the higher debt to income ratios (DTI), and the rates were about the same. I don’t know where he got the idea that lenders were using ‘more conservative’ guidelines with subprime borrowers as far at DTI is concerned.

“With this in mind, consider what happens when a 1 percent payment schedule is
reset to a market level of 6 percent. It matters little whether payments are calculated
on an interest-only basis or not; and it matters little whether the reset happens all at
once or in a series of increments. It is the broad magnitude of the reset increase,
brought about by interest rate differentials, that is important. From Table 10, the
monthly payments reset from $965 to $1,799, or 86 percent higher than before. A
family paying 30 percent of their income on mortgage payments would experience
this as 30 percent times 86 percent = 25.8 percent of their total income, which is
likely to be an unendurable strain. They would have to devote 30 percent + 25.8
percent = 55.8 percent of their income to mortgage payments alone. If, in addition,
the household has no equity in their home and therefore cannot sell or refinance, a
default may loom in the future.”

No argument from me there. I don’t think most borrowers have a handle on the type of loan that they have. This article from Yahoo supports that fact. 52 percent of the homeowners said they didn’t know much about the mortgage options that were available when they bought their homes. Gotta love it when half the people are pretty clueless to what will probably amount to the 2nd largest expenditure of their life (house), with taxes being the first. That should really tell you something right there. Half the people don’t know much about their mortgage options when buying a home. Even the article admits this is a vague question, but it doesn’t really surprise me with what I have seen the past 2 years in the market. Lots of borrowers know the ‘payment’ and that is about it. That means that 1 of your next door neighbors is probably clueless to the surprise coming in the mail when their mortgage adjusts. (this paragraph had corrections made after an inaccuracy on my part was pointed out in the comments)

“The difficulty of payment reset can be worse than what I have described. If the
original loan was 30 years with an introductory period of 2 years, the mortgage
would reset into a 28-year schedule rather than one of 30 years, resulting in higher
payments. Moreover, this does not consider the impact of negative amortization. A
loan with a true rate of 5 percent and minimum or introductory payments at 1
percent will add the remaining 4 percent to the balance of the loan, increasing the
amount owed by 4 percent per year, or 8 percent in two years. Thus, the newly reset
payments will be 8 percent higher because of this increase in principal – and it will
be less likely, after this increase, that the property will still have equity to make a sale
or refinance possible.”

I’m glad that he covered the fact that when a 2 year interest only ARM adjusts, the loan is amortized over the next 28 years, not 30 like most people ‘think’. I did the math for this exact scenario in this post. Check it out and see some realistic examples of what happens when 2, 3, 5, 7, and 10 year ARMs adjust.

Well, I hope I was able to shed some light on ‘another’ viewpoint here. I think the author did a good job overall. I believe he is looking at things on a ‘national’ scale instead of a ‘bubble area’ scale. I don’t think there is much of a ‘nationwide’ housing bubble…but I definitely think there are several areas that have become so disconnected from the fundamentals, that a correction is inevitable. I also agree that the crazy lending practices are probably more commonplace in the skyrocketing areas than the ‘normal’ areas where real estate isn’t booming.

Have a great weekend everybody…and I look forward to the comments and feedback!!

SoCalMtgGuy

I had the following report sent to me by a reader, and it has also been posted in the forums. It is a report from First American Corporation and it is titled “Mortgage Payment Reset - The Rumor and the Reality“, by Christopher L. Cagan PhD. and Director of Research and Analytics

There is a ton of good information and graphs in the report. It is 33 pages long, so please understand that it is going to take me a few days to get posts up on many of the points that I want to make.

I have read the whole thing quickly, and gone back over several items. Not only is there a lot of information in there, it is going to take time to digest it all, formulate informative content, and get that information to you. I’m going to talk about 2 things briefly right now, just to get the ‘equity rolling’.

That said, I think page 10 and 24 are excellent places to start.

Page 10 has a chart that shows the equity percentage at the time a home was purchased or refinanced. It has data from 1985, 90, 95, and 2000-2005. If somebody bought a house in 1994, but refinanced in 2003, they will fall into the 2003 data. I wish I could copy and paste the table into this page, but it is a PDF, so you will have to open it, or print it off yourself to follow along. *update: Thanks to Duke for the files below.

If you go back to 2000 - 2003, you will see that about 8% of the people in each year are still even or underwater. That number jumps to 10.6% in 2004, and 29% in 2005! I think you can pretty much include the people that have 0-5% equity (the author does this in a smaller table on page 11). It is going to cost 5% to sell your house with realtor/title/escrow fees. If you use the 10% decline the author speaks of, AND assume people need to sell and include the 5% transaction costs…lets look how many people are now even or underwater. By doing that you ‘wipe out’ the people in the 10-15% brackets (10% depreciation plus 5% transaction costs). That puts:
21.2% of the loans in 2000
23.7% in 2001
25.5% in 2002
28.8% in 2003
38.5% in 2004 and
57.1% in 2005 of the loans in a zero equity position.

Even if you assume that people are going to sit tight…look what 10, 15, and 20% declines do to people’s equity position.

Now take a look at page 24. This is the data that many of you have been dying to see. It is pretty representative of what I have seen the past 2 years. Look at the amount of loans below 2%. Those my friends, are called option ARM’s and those are our favorite negative amortization mortgages. If you add up the other low rate loans, you are probably looking at about 20% of the loans on that chart being option-ARMs. As a quick reminder, these are the loans with a minimum payment option, an interest only option, a 30yr amortization option, and a 15 yr amortization option. These loans are usually tied to the MTA, COSI, COFI, and on some cases a LIBOR index. Not all option-ARMs had the 1% start rate. Many could have rates in the 2-4% range depending on the credit, borrower, loan terms, and pre-pay penalties.

I know, I know, I wish we had this data from 2000-2003, but at the moment, I don’t have it. But look at the data from page 10. See how many people are not in a good equity position in 2004 and 2005. Now look at page 24, and look at the make-up of the loans that the people in 2004 and 2005 were using to ‘afford’ their properties! 7.7 million loans that total almost 1.9 TRILLION dollars of adjustable rate mortgages (ARMs) in the past 2 years! Lots of these loans were subprime 2/28’s and 3/27’s as well as A-paper 3/1, and 5/1 ARMs. These ARM borrowers in 2004/2005 are the people who have very little equity to begin with…and you can see how many of them are playing with loans that WILL adjust. They are not just going to adjust a little bit…for many of them, they are going to adjust a lot! Lots of the loans were interest only loans (I/O), that not only adjust in rate, but you have to start paying principal as well. When the 1% option-ARM recasts and you are looking at rates in the 5’s and 6’s…that is a large jump in payment as well. That doesn’t even take in to account the people that are making the minimum payment on the loan, which just tacks the ‘deferred interest’ on the back of the loan in the form of negative amortization!

Please feel free to post your questions and comments. I will do my best to answer them. As I was quickly reading through the document, no less than 25 things popped in my head that I could expound upon, or refute. There was definitely some misconceptions about the sub-prime market in there. Again, it is going to take some time to digest all of that information and then create informative posts that are easy to read and understand.

Thanks for stopping by, and I look forward to working through this data with you. Keep the comments and feedback coming…both here and in the forums!

SoCalMtgGuy

I have had the following article e-mailed to me no less than 10 times already today. The article in question made the front page of Yahoo Finance. Here is the article, written by David Bach, titled “Why Homeowners Get Rich and Renters Stay Poor”.

Now that you have read the article and seen one side of the story, it is time for me to get to work and pick off the main points in this article one by one. This is probably going to be a long one…so grab a drink, get comfortable, and get ready to look at things mathematically and logically using REALISTIC numbers from areas that have had lots of appreciation the past few years.

Now let’s get started…

First off, I am not against home ownership one bit! I am all for home ownership if it makes mathematical and financial sense. The problem is that in many areas of this country, it doesn’t make financial sense. I have demonstrated this in several previous posts (post one, post two, post three). I have no problem with trying to get 10 million people to own a home…as long as it is a good financial move based on TODAY’s numbers, not the numbers of 5, 10, or 50 years ago.

The article says it is going to “provide you with a common-sense way of looking at a real estate market that often seems crazy…“. Well, let’s just see about that!

“From 2001 to 2005, the average homeowner saw the value of his or her house jump by more than 50%. Many homeowners doubled, tripled, and in some cases even quadrupled their wealth in just five years because of exploding real estate values.

I think both these positions are wrong. My view is that the American dream of building a nest egg by owning a home is no fantasy. Homeowners have been getting rich off their real estate for years, and they will continue to do so in the future.”

So this guy doesn’t think that we are in a boom, or that it’s over?!?!? Good, at least we know where he ’stands’ on things. Let’s see if he has the DATA to back up his position.

He gives this first piece of data and then 5 more reasons. “How can I be so confident about the real estate road to riches? Well, U.S. real estate values have been going up steadily for nearly four decades — an average of 6.3% a year since 1968, which is when the National Association of Realtors first started keeping track. According to Freddie Mac (a.k.a., the Federal Home Loan Mortgage Corporation), since 1950 U.S. house prices have never experienced a year-to-year decline nationally.”

I seem to remember another country that said the exact same thing…Japan. Again, past performance is no guarantee of future results. They didn’t have widespread use of interest only loans, neg-am’s, option ARM’s, stated income, or 100% financing back in the the 1950’s. These loans started becoming popular in the 2002 time frame. We don’t have enough data to accurately analyze the impact of there exotic loans. We do have data that shows that interest only loans were last popular in the 1920’s. I wonder why it took about 70 years for them to become ‘popular’ again?

Let’s look at the 5 points the author has outlined. Hang on, it’s about to get fun!! Here is the first one:

1. Owning Is Cheaper Than Renting oh really?!?!?

People who say it’s cheaper to rent than to own are simply wrong. It gets better…trust me! Under certain circumstances in certain markets (where real estate values are overheated and rents are low), there may be some short-term advantages to renting. But over the long haul, renting simply isn’t a good deal. If you don’t own your own home, you can easily wind up spending more than half a million dollars on rent during the course of a lifetime — and probably a lot more.

Assume you’re renting a house for $1,500 a month. Now let’s say you stay put for 30 years, during which the landlord increases the rent by 5% a year. Over those 30 years, you will hand over a total of nearly $1.2 million in rent payments — and at the end, you’ll have nothing to show for it except a bunch of cancelled checks. To add insult to injury, you’ll now be paying $6,174 a month in rent!

What will balloon over the years is the value of your house. Say it goes up by 6% a year, which is actually slightly lower than the national average. After 30 years, you will own a home that’s worth just under $1.1 million.

Oh jeez…where to start?!?!? First off, you can’t make the statement that renting is cheaper than owning…and then use a pretty unrealistic example to prove your point. I don’t know of very many places where the rent is $1500 month, and you could buy the property TODAY for $200k. I’m not talking about paying $1500 for rent on a place the landlord bought for 200k years ago, you have to talk about today’s numbers. I pay about $1500 a month, and the property is about 500k.

Where does he get the 5% a year increase in rents? I have rented the same place for over 3 years now. I have had 1 rent increase of about $50 which equates to about 3%…over a 3 year period of time. I’m not saying that applies to every situation, but I can say that I have not seen 5% increases in rents each and every year. To say that rents will go up 5% a year forever is not a realistic statement.

I agree that $1500 a month is about right to ‘own’ a 200k home. If you put down 20%, had good credit, and got a fixed rate at 6.25%, your payment would be $985 a month. Add in $200-300 bucks in taxes, some insurance and maintenance, and you are close to that $1500 mark (assuming you put 40k down). What I don’t get is how you can make the statement that property will go up 6% every year from now on. I know that nationally, prices have ‘never gone down’, but Japan said the same thing. If that is the case, that means that the median price of a home in this country, about $238,000 today, will be over 1.1 million dollars in 30 years. I know a million dollars isn’t what it used to be, but I have a hard time believing that the median priced home in this country will be over 1.1 million dollars in 30 years. Sounds good on paper, when you assume his scenario, but we all know what happens when you ASS-U-ME!

Let’s get to his next point.

2. Homeowners Get Leverage

As much as I like stocks, bonds, and mutual funds, there’s little chance any of them will produce anything close to that return in such a short amount of time.

I don’t disagree with his math, and that it ‘looks good on paper’. Again, the PROBLEM with ALL of these arguments is that they ASSUME APPRECIATION!!!!!!!!! We have just experienced the largest expansion in Real Estate the world has ever seen. According to estimates by The Economist, “…the total value of residential property in developed economies rose by more than $30 trillion over the past five years, to over $70 trillion, an increase equivalent to 100% of those countries’ combined GDPs. Not only does this dwarf any previous house-price boom, it is larger than the global stockmarket bubble in the late 1990s (an increase over five years of 80% of GDP) or America’s stockmarket bubble in the late 1920s (55% of GDP). In other words, it looks like the biggest bubble in history.” I know this is worldwide, but you get the point. Just because something hasn’t happened in the past, doesn’t mean it won’t happen. But while we are on the topic of leverage, don’t forget to look at the post on leverage I did a while ago. It talks about the ‘other side’ leverage. Leverage is great when things go up, but it will crush you even faster on the way down.

I’ll lump number 3 and 4 together. Three talks about a tax break, and four talks about capital gains tax. I’m not disagreeing with these points too much. I’m not a tax expert, but I know there is a tax benefit, especially if you are talking about a 200k home. I have also read information that many ‘high income’ earners are hit with a little thing called the alternative minimum tax (AMT), which limits the amount of deductions they can make…mortgage interest deduction is included in this. I’m also aware that after 2 years of primary residence, you don’t have to pay capital gains taxes up to the first $250k in profits.

The final reason why buying is better than renting is:

5. Homeowners Become Savers

Each time you make a mortgage payment, you’re saving money. That’s because with each payment you’re reducing your loan balance a little — and that, in turn, is building your equity. (This assumes you don’t have an interest-only loan.) The longer you’re in your home, the more equity you build, the more you save — and the richer you get.

Again, on face value that is a true statement, but it is not realistic of what we are seeing in this market place. Take a look at this article from Forbes that tracks the amount of equity extracted from homes. In 2004 alone, they peg the number at about 569 BILLION dollars. Looks like a lot of homeowners are spending, not saving. Add up the past few years of ‘equity extraction’ and you are into the TRILLIONS of dollars. Again, interesting how he ‘assumes’ people don’t have interest only mortgages. The reality of the situation is that many people ARE having to use interest only mortgages to afford their homes in many of the high cost areas of this country.

Let’s look at his conclusion before I make my own. If You Want to Be Rich, Don’t Rent

Remember — as long as you’re alive, you have to live somewhere. So does everyone else you know. And because of that, homeownership will continue to be a great investment.

I don’t doubt that as a whole, homeowners are ‘richer’ than renters. Again, that statistic is probably before this massive run-up in prices. What bothers me is that “it’s never too late to catch the real estate wave.” What exactly does that mean? I have never seen a wave that eventually didn’t ‘crash’. Who are these ‘experts’ that say real estate is going to go up for the next 10 years? Who else is tired of the ‘you have to live somewhere’ line? I do live somewhere…at 1/2 to 1/3 of the cost of owning.

I think this guys statements are pretty far off base for a large part of the population. The median priced home in this country is about 238k, and he is using 200k homes with unrealistic rental prices and appreciations to make his point. He is writing this article to push his books and the “Homeowner Challenge”. Take a look at the cities they are doing these seminars. Here is a quick list…

NYC, New York
Seattle, Washington
San Francisco, California
Los Angeles, California
Phoenix, Arizona
Houston, Texas
Dallas, Texas
Boston, Massachusetts
Baltimore, Maryland
Philadelphia, Pennsylvania
Chicago, Illinois
Denver, Colorado
Atlanta, Georgia
Orlando, Florida

Now tell me, in how many of these areas you can buy a decent home for 200k?!?!? I’d love to see the San Francisco and Los Angeles seminars where this guy tells people it is better to buy TODAY, than rent. Tell the San Fran crowd how they will be better off buying 700k starter homes, instead of renting. Tell them how their 700k starter home will be worth millions in a few years. I look at that list of cities where they are doing seminars, and I think it is safe to say that most of those cities have had pretty big appreciation the past few years, and that the median income in most of those cities will not be able to afford the median priced home without resorting to creative financing and mortgages.

I have said it before and I will say it again. If you find a home you like, can put money down, get a fixed rate mortgage that you can afford, plan to stay a while, realize that property values might go down, and you are comfortable with all of those things, then go ahead and buy. The problem is that in most of the metropolitan areas and along both coasts, it is hard for most people to afford the price of homes without using interest only, 100% financing, stated income, option-ARMs, or other creative mortgage products.

It is also pretty amazing to me how these people seem to ignore the data out there, and keep saying that real estate only goes up! Every one of their calculations and arguments is based on things continuing to appreciate. I think the info is good, general, basic information if you were introducing 4th graders to real estate. I think it is incomplete and terrible advice for people that are looking to buy homes at TODAY’s prices in many areas that have seen massive appreciation. I think the article needs a lot more clarification before it is put on the front page of Yahoo Finance.

Don’t forget, I’m talking about buying TODAY!!! Hindsight is 20/20. Nobody can go back to 1997 and buy a bunch of property. You have to make decisions based on TODAY’s prices with your personal economic situation in mind. I think buying real estate in many areas today will make you “automatically upside down”, not a millionaire. Again, I’m not talking to people who already own, and I’m not telling people to sell. I’m trying to educate the person who wants to buy a home by any means necessary in any of the areas that have seen abnormal appreciation the past few years.

So, who do you think is right?!?!?

I look forward to the comments and feedback!

SoCalMtgGuy