71 Responses to “Fundamentals??? …an “old” perspective”

1. tj & the bear
   August 9th, 2006 21:35
   1

   Combine any of those factors with the ‘lawless lending’ of the past 5-8 years, and what do you think will happen?

   “The Great Depression II”.

2. Roro-says
   August 9th, 2006 21:53
   2

   Excellent post as always my friend! Sooo many people should read this.

3. wakawaka
   August 9th, 2006 22:03
   3

   i am not in the banking/lending business as you have been, but do you really think this last decade of loose lending is worse than the S&L crisis? i am old enough to remember the result of all that loose lending — hundreds of unfinished office buildings and condominiums, many just steel skeletons that sat for years like that. yes, i see that coming again in places like vegas, but is this time really worse? if so, then the real estate drop of the ’80s is just a starting point for what we are about to see.

   “It will only be a matter of time to see who is right on this one…”

   How much time are you thinking? i know you have said before that a lot of ARM resets will happen this year and many more next year. But how far off is the bottom?

4. Peter
   August 9th, 2006 22:19
   4

   SoCalMtgGuy,

   I see a problem with using the old guidelines today:
   > When considering a loan, a banker attaches great importance to three things: the borrowers ability to repay the loan, the borrowers credit history, and the borrowers character. The first two considerations can be calculated mathematically; the third requires judgment and experience.

   The problem is possible discrimination. The third criteria is very difficult to document, and it opens the door to denying credit because of color, creed etc. I don’t think there is a way anymore for a public institution but to build their decision on objective criteria alone. Maybe the credit score needs a revamp, maybe income and its steadiness needs to play a bigger role, maybe shortcuts, like getting positive appraisals, need to be discouraged stronger.

   Regards,

   Peter

5. SoCalMtgGuy
   August 9th, 2006 22:23
   5

   wakawaka

   I don’t know when the bottom will be. People should buy when the numbers make sense for them economically (money down, pay principal, still have money left for savings/retirement/etc.), and they find a place they like.

   People are talking about houses like it is a stock market of sorts.

   If you read the articles about ‘fuzzy’ accounting at Fannie/Freddie, and combine that will all the creative financing of the past 5-6 years, it impacts a lot of people.

   The similarities to the S&L are there. As the S&Ls got booming, the standards decreased because the times were good. Same thing in the mortgage industry. How else do you think homeownership reached record levels? It wasn’t because more people had saved 10-20% to put down, or because incomes doubled and tripled the past 5 years….it was a lowering of standards and increase use of creative lending at the same time.

   SoCalMtgGuy

6. Home_a_Loan
   August 9th, 2006 22:24
   6

   I’m curious: what incentivizes a borrower to tell the truth on a stated income loan? Is there something that says “under penalty of purjery” or something like that? Or is there some kind of fraud clause that can get you prison time?

   I have never had a mortgage myself (I may never need one at this point), but I can imagine someone “stretching” to qualify for a home would find it mighty tempting to just lie. Why wouldn’t they, especially if they were an “investor”. (Investor is in quotes because it hardly describes someone borrowing to the earballs to speculate on home prices.)

7. SoCalMtgGuy
   August 9th, 2006 22:32
   7

   Peter,

   I see your point about the borrowers character…but that is not really the issue I was focusing on.

   “The first two considerations can be calculated mathematically…”

   THAT is what I am talking about. Lending got away from ‘ability to repay’ and ‘credit history’. Lenders glossed over job history, income, and credit history. For a while there, a bwr could have gotten a 100% loan interest-only with a 560 credit score!

   I watched the guidelines for BKs (bankruptcy) deteriorate from 3 year seasoning, to 2, to 1, to 6 months, to 1 day out of BK, to no seasoning at all. A BK was no longer an obstacle to getting a mortgage…even to 95 and 100% financing.

   SoCalMtgGuy

8. wiseguy
   August 10th, 2006 06:03
   8

   Not to mention the no-doc loans. No income verified, No employment verified, no assets verified, nada except a credit score and a pulse. I am doing to no-doc refi’s right now. These loans are available and the consumers use them.

9. jmf
   August 10th, 2006 06:27
   9

   hello from germany,

   great post as always.

   i´ve hear the calls from new and lend.

   the forced buybacks o their latest mbs are coming home.
   their are a lot of early default payment. means as i understand it that the first rate is not payed!

   cfc has massiv problems to sell their “creative” loans to the mbs market. tehy have a lot now on tehir own balance sheet.

   the worst call was from ntbk. a very small player. big forced mbs buybacks there.

   i hope that leed to strikter criteria.
   http://www.immobilienblasen.blogspot.com/

10. Larry Littlefield
    August 10th, 2006 06:29
    10

    The next question is how the foreclosures and workouts will happen, with many of these loans being sold to third parties?

    I asked someone who knows about banks holiding foreclosed properties. Here is what I was told — they may do so for five years, and apply for an extension for an additional three years. But, they have to write off the entire loan as a loss, and do not get credit for the value of the property until it is sold.

    On a cash basis, however, taking the property stretches out the loss. In effect, while renting the place out the bank is like an FB with an negative carry, but with their own cost of capital rather than what they lend at.

    I read recently that originators are getting stuck with lots of option-ARMs, with the secondary market closing down. But what happens to those loans already sold in the secondary market?

    In an 80/20 situation, the senior lender will want to foreclose and try to sell at a 20% discount to the mortgage value. If houses fall more than 20%, expect a crisis at Fan and Fred. In the meantime, the older of the “20″ might bid the value of the “80″ and take the house, because the alternative is the loss of their entire investment. Of course, doing so puts at risk more than their original investment.

    A lot will depend on whether there is more than a 20 percent nominal decline. If there is in a large share of the country, the consequences could be severe. It wouldn’t surprise me if we end up with inflation covering any decline in value in excess of 20 percent.

11. Steve
    August 10th, 2006 06:36
    11

    Nice post, one nit:

    Dale Carnegie = author (How to win friends)
    Andrew Carnegie = wealthy businessman.

    They were very distant cousins, but different people.

12. SoCalMtgGuy
    August 10th, 2006 06:57
    12

    Steve,

    I just scanned the post, did I talk about Dale? Napoleon Hill met Andrew Carnegie when he was a boy. After spending years together, Andrew saw that Napoleon grasped ‘the idea’ and asked him if he would be willing to spend ‘20 years or more preparing to take it to the world’.

    Napoleon Hill wrote ‘Think and Grow Rich’ which is the motivational literature inspired by Andrew Carnegie.

    I hope this clears things up some.

    SoCalMtgGuy

13. haggis
    August 10th, 2006 07:39
    13

    I think you’ve written a very pertinent article.

    Fundamentals are too often scoffed at by scalliwags & rogues who are willing to sell anybody down the pike if they can make a dollar. Yet when these booms reach a crescendo they tend to suck in a lot of honest, naive sorts who reason ‘everyone else is doing it, it’s just a wee fib’.

    The truth is that traditional lending practices developed over centuries and were designed to prevent the kind of destructive excess we’re currently witnessing. Sadly, it will hurt a lot of individuals who only wanted to own a home.

    And it’s also going to be no picnic for the rest of society either.

    Cheers.

14. ethan
    August 10th, 2006 07:40
    14

    I was wondering what your estimate is of how long it might take lenders to tighten up their standards. Months? Days? Post-congressional hearings late next year (or whenever politicians start getting involved)?

    Also, my understanding is that car dealerships make a lot more money on people with bad credit who come in and finance a vehicle at an exorbitant rate + down payment than people who just come in and with great credit or just buy with cash. Is the same true for houses?

15. SoCalMtgGuy
    August 10th, 2006 07:55
    15

    Ethan,

    I would guess at least 2-3 years down the road. The markets will adjust before congressional hearings.

    Car dealers do make more money off people with worse credit. They extend the term and ’sell the payment’. Somebody says I am comfortable paying $400 a month…they crunch the numbers, and get the paymnet to $390…but over a longer period of time (5-6 years…or more!).

    With houses, the rate will be higher for somebody with worse credit because there is more risk. But there are many differeces between auto finance and mortgages.

    SoCalMtgGuy

16. Steve
    August 10th, 2006 08:02
    16

    re carnegie:
    whoops, I read too quickly:
    He was inspired by Andrew Carnegie, and became one of the greatest motivational authors in the world. He = nahill, not carnegie. My bad.

17. AZgolfer
    August 10th, 2006 08:39
    17

    Just talked to a guy here at work that is trying to sell his house. He said that the house behind him went into forclosure and was sold for 100K less than his asking price. He did not think it will effect the comps in the area becuase it was a forclosure. Is that true?

18. OCBear
    August 10th, 2006 08:48
    18

    Larry,

    I believe we only need a 20% decline in the “Bubble Markets”, for the possible extreme negative outcome. These Market’s are a disproportionate amount of total valuation in the country. Where we may only see a 5% decline in national housing values on a number basis, these areas may see a 20% decline or more.

    I too see the rampant inflation, but the devaluation to cover up the Housing Pop would have to be more like Hyperinflation and although possible, I do not see this as the most likely outcome.

    OCBear

19. Quincy k
    August 10th, 2006 09:19
    19

    AZgolfer,
    yes, a foreclosure will hurt the comps but it is up to the lender and the appraiser as to what effect. It doesn’t matter anyway if your friend lives in a high-supply area of Arizona. Trying to find a buyer, ANY buyer, will be his hardest obstacle at this point. 100k. Ouch. And it’s only the beginning.

20. foreclose_me
    August 10th, 2006 09:49
    20

    The problem is possible discrimination. The third criteria is very difficult to document, and it opens the door to denying credit because of color, creed etc.

    You’ve got it backwards: The problem is that banks aren’t allowed to discriminate. Do you really think that race is irrelevant to the ability to pay back a loan? Do you really think a foreigner who just crossed the river can be considered to have a measurable good character?

    It is illogical to think that the banker who manages our savings should be forced to lend those savings to a foreigner who just arrived in country. If I go to China, I don’t expect that I am going to be able to get a big loan from People’s Bank, and I have fantastic credit, character, and intelligence…in the United States. Instead, I would obtain credit from a lending institute which is familiar with the process of assessing character of White Christians from the USA.

    The other option for foreigners is that you must obtain a native business partner who shares in the risk. This is the rule in China.

21. bubba
    August 10th, 2006 10:19
    21

    >You’ve got it backwards: The problem is that banks aren’t >allowed to discriminate. Do you really think that race is >irrelevant to the ability to pay back a loan? Do you really >think a foreigner who just crossed the river can be considered >to have a measurable good character?

    Right - it’s all because of stupid laws. If only discrimination was allowed. It would all be milk and honey.
    /Sarcasm

    A foriegner who crossed over the river DOES NOT have a credit history. Nobody is forced to lend to them.

    For every toxic loan that was written, there would be plenty of legal reasons that it could be denied. Discrimination would never have been required to deny those. Just credit standards would have been enough.

    Prudence is required when you are dealing with someone who does not have a history of borrowing and repaying.

    Cite a case where a banker is forced to lend to someone without a credit history.

    People like you are real evil - spreading racial hatred very subtly - much more than these corrupt mortgage brokers.

22. subsonic22
    August 10th, 2006 11:36
    22

    You really hit this one out of the park SoCal, I wish I could write 1/2 as well as you do. This article should be required reading for any loan officer or LO wannabe. You would see very different attitudes in the mortgage lending industry if it was their own money being lent than someone elses.

    When I graduated from college and went to work full time, the company I joined was hired by the US government to service bad loans created by the S&L crisis of the 1980’s. The government had no choice but to bail out the S&L’s because the money lent was the depositors guaranteed funds. That won’t be the case with MBS’s since they are uninsured. I don’t think the hit on Fannie and Freddie (conforming paper) will be catastrophic sine there are some protections built in (MI, combo loans since the 2nd’s aren’t purchased by MBS’s, real underwriting standards). It will be for the investors who buy the toxic paper. They will not see the profits they envisioned. When you don’t have investors buying the toxic paper, then the low doc/no doc loans go away, then we’ll see how “valuable” these properties are worth.

23. lowballtimore
    August 10th, 2006 12:32
    23

    bubba, thanks for saying what needed to be said in response to foreclose_me, the supposed Christian. mortgage lending is done on a person-by-person basis, which by definition means that no assumptions can be made based on race, gender, religion, age, etc. even if a certain group has a higher poverty rate, that doesn’t matter because a lender is not lending to the whole group. they’re lending to one unique person sitting in front of them. if they’re going to use character assessment as part of their loan application materials, so to speak, they need to do the best they can to assess the *individual’s* character and not allow stereotypes or group-based trends to influence them.

    in fact, this is the mistake all of us make: thinking we know something about an individual because we *think* we know something about the group that we *think* that individual comes from.

    i still believe in innocent until proven guilty.

    -lowballtimore, a real Christian

24. seattle price drop
    August 10th, 2006 14:34
    24

    To me, the most important part of this low lending standards puzzle is the buying of the MBS’s.

    Once nobody wants to be left holding this bag, lending’s got to tighten. Right?

    So I’m keenly interested in any and all information about forced buybacks or refusal to buy them in the first place .

    Thanks to the German poster above for the links he’s been leaving on a few blogs regarding the buybacks of MBS’s.

    And to anybody else who has more info/insight to provide.

25. PapiDondeCasa
    August 10th, 2006 14:34
    25

    This past weekend I was reading an old book by Robert Allen called Nothing Down. It was written about 20 years ago and had a lot of relevance to today’s market. I know many will point out that Robert Allen’s character leaves a bit to be desired but after reading the book one thing became apparently clear; prior to the last five years nothing down was extremely rare and difficult to do! As a matter of fact, in the book he discusses wrap around mortgages with finding group investors and having the seller assume the note. Essentially, his tactics where designed at the height of a buyers market where rates were 15%+ and nothing down only occurred by strategic selling, negotiating, and finding willing sellers.

    Yet now, how has the tide turned? Nothing down loans are rather standard. You have your typical 80% LTV mortgages with a 20% second at a higher rate. Or you have a 90% LTV with a 10% HELOC. Standard things in this industry. Yet as in any investment risk is involved and instead of having a seller, bank, or individual take this added risk it has been auctioned off in the MBS market. Reminds me of how it is much easier to drop a bomb on an enemy than go head to head with a bayonet. The mortgage industry has depersonalized the entire lending process to make nothing down a rather common procedure. Even LTV of 125% exists to give you cash back at closing! These deals where fantasy only a few years ago but with such loose lending standards, this is the current marketplace (at least it was a few months ago).

    But now, just like an old western showdown, the silence is deafening in the real estate market; sellers on one side and buyers on the other. Who will blink first? Unfortunately sellers don’t realize their revolver is empty with blanks so when this stalemate ends, we know what will happen because when something as ridiculous as nothing down becomes common, we know we are in for a big showdown.

26. ElSolAqui
    August 10th, 2006 14:57
    26

    Just look at the case below:

    Let us run a hypothetical for San Francisco:

    Purchase home: Take out a $500,000 mortgage at 6.5%.

    PI = $3,160.34
    TI = $600

    Total monthly payment = $3,760
    Net house payment after tax savings = $3,260

    *****
    Renting equivalent place = $2,000
    Invest difference of $1,260 in a 8% investment fund

    *****

    So let us run a 30 year scenario from both.

    If you are renting this is your result:

    Starting with $1,260 and depositing $1,260 monthly over 30 years (at a rate of return 8% compounded monthly), you will save $1,787,453.

    ****

    Let us now that the house appreciated at an average of 3% (which is the historical average). After 30 years the value of the home is:

    $1,228,421

    ****

    In this case renting actually makes more sense in the long run.

27. Gloria White
    August 10th, 2006 18:57
    27

    ElSolAqui

    Where can we get 8% return for 30 years straight? I’d love to invest there!

28. theotherside
    August 10th, 2006 19:10
    28

    to ElSolAqui:

    ANALYSIS NOT REALISTIC…as usual, the devil is in the details.
    1- INFLATION is one key missing component in your analysis. Payments on a 30yr fixed mtg is FIXED, but your rent will likely increase with inflation, and over 30yr it can be painful…check the going rental rate of a house in 1976 to convince yourself.
    2- PAST PERFORMANCE IS NOT A GUARANTY OF FUTURE PERFORMANCE and yada yada. 8% at what level of risk?….you may want to use the 30yr rate on a AAA bond or government bond (5.07%).
    3- After 30yr, the buyer holds a house free and clear (apart from tax, which even go down depending on the level of retirement income) while the renter still owes the landlord a monthly rent.
    4- Most people can not resist the temptation of raiding their savings (or 401K) so I will conclude by saying that hopefully you will still have the $$ at the bank after 30yr…. Although, this point is a weak one, because you could argue that with all the crazy HELOCs, the buyer may also be tempted to raid his home equity.

    And as an aside: Remember, the best investment strategy in the stock market is to track a given index with a PASSIVE fund with low cost (SPY for example). So talk yourself out of trying to take on more risk or follow the latest guru of the day…IT DOES NOT WORK!

29. theotherside
    August 10th, 2006 19:51
    29

    to ElSolAqui:

    I redid your calculations with 8% return (assuming annual compounding which seems more appropriate here) and a mere 3% annual inflation (rent increase) and your $1,787,453 becomes $827,982.

    Now, even if your $500,000 house loose 30% in the first year (bubble crash) and then grow by 3% annually, you end up with $849,542 , i.e. more!!!

30. FirstTimeBuyer
    August 10th, 2006 20:09
    30

    Your rent vs buy scenario omits some expenses when buying a house. Here are the expenses I came up with, over 30 years:

    Interest paid on that $500K loan @ 6.5%: $637,722

    Maintenance (1% annually): $180,000

    Transaction costs:
    * Purchase closing: $12,000
    * Sale closing: $30,000

    Property taxes ($10K a year):
    * $300,000

    Realtor fees (5%):
    * $50,000

    Total fees associated with “owning” that house for 30 years: $1,209,722

    And you suggested a sale price of $1,228,421, which leaves $18,699.

31. wakawaka
    August 10th, 2006 22:17
    31

    SoCal,

    Pardon my ignorance, but what kind of a rise in rates — one point, two points, etc — would it take to double, or even triple, someone’s payment when their ARM adjusts? Also, someone told me that the last time the SoCal market turned, around ‘89 or so, it wasn’t as if sellers suddenly had buyers offering them less for their properties, but rather that almost overnight all the buyers vanished, like a ghost town. Is that what we are looking at now? There is a real estate agent who listed his own house near me for 1.37 on june 15th. when i called him a couple of weeks later he was very cocky and told me it would definintely sell for that or higher. Well, I saw it was still for sale so i called again, and a significantly more scared-sounding voice told me it’s now 1.29. Sure 80,000 is real money, but the big change was his tone. I get the feeling that, at least in L.A., things have changed quickly.

32. SoCalMtgGuy
    August 10th, 2006 23:08
    32

    wakawaka

    I have crunched many of those numbers in past posts. Scan the popular posts and the archives for lots more math.

    That said, many of the ARMs are interest only…so when the ARM adjusts, the borrower not only gets an increase in rate, but they start paying principal as well…on whatever term is left.

    Example: Bwr does a 5 year I/O ARM that then starts to adjust. Not only does the rate go up, but the principal payments are amortized over the next 25 years…not 30.

    Many people will say “Hey SoCalMtgGuy…you are an idiot, they will just refi before that happens…”

    That is the plan, but if values slip when they do their appraisal to refi, they won’t be able to refi, and thus they are F’d.

    Stay tuned…

    SoCalMtgGuy

33. TStockmann
    August 11th, 2006 00:27
    33

    I’m curious about the secondary market for those 20% purchase seconds and/or related derivatives. What kind of return are buyers of those securities demanding? Is there a significant difference in rates of return for buyer recourse and nonrecourse seconds, or is it pretty much assumed that if someone loses his/her house to foreclosure, the odds of being able to find anything else to attach are all that good? Is there a practical way to find out who’s buying them? A lot of economists seem to think risk premiums are at an all time low, but those would seem to be pretty toxic paper.

34. theotherside
    August 11th, 2006 05:01
    34

    To FirstTimeBuyer

    What about the tax write-off?

    Assuming a 25% tax rate (plausible for such a house) your expenses are $1209722 * 0.75 = $907,291.5

    So that $18,699 becomes $321,129.5 !!!

    Now if instead of 8% return we use a 6%, the renters end up with only $466,160

    (instead of $1,787,453 with 8% return and 3% rent increase or $827,982 with 8% increase and 3% rent increase)…

35. steve
    August 11th, 2006 08:02
    35

    Re: the posts on rent vs buy.

    The one thing that is hard to quantify in the rent-vs-buy calculation is the opportunity cost of locking up your money. What opportunities for job advancement are left on the table because of being tied down? What investment opportunities are left on the table because the money is tied up?

    If the arithmetical result of rent-vs-buy is even close to break-even, then the intangible of opportunity cost makes the outcome quite clear.

36. bw
    August 11th, 2006 08:34
    36

    What opportunities for job advancement are left on the table because of being tied down?

    This is a very good point. I once pointed out earlier that buying a house does not automatically guarantee that you can sell it later on. This is especially true in a declining market (i.e. one that is experiencing rising inventories and falling sales). In which case, the housing market can become ‘illiquid’ in a hurry..

    Also, if the house can’t be sold, then how does one take advantage of the new job opportunity without getting into some kind of financial bind?

    I suspect that right now there are a lot of people paying double mortgages or a mortgage and rent at the same time. This can not be good.

37. bw
    August 11th, 2006 08:53
    37

    theotherside said:

    “To FirstTimeBuyer

    What about the tax write-off?

    Assuming a 25% tax rate (plausible for such a house) your expenses are $1209722 * 0.75 = $907,291.5

    So that $18,699 becomes $321,129.5 !!!”

    This won’t happen if you get hit with the AMT (Alternative Minimum Tax) instead.

    [Link]

38. Yeesh
    August 11th, 2006 09:34
    38

    Uh, the home-interest deduction isn’t affected by the AMT.

    The following is FROM THE LINK THAT YOU POSTED! :

    “Even though some deductions still stand, including those for mortgage-interest and charitable donation…”

    Next time read something before asking the rest of us to.

39. bw
    August 11th, 2006 09:42
    39

    theotherside also said:

    “Now, even if your $500,000 house loose 30% in the first year (bubble crash) and then grow by 3% annually, you end up with $849,542 , i.e. more!!! ”

    and said:

    “Personal story:
    Bought a house in late 2003 for about 500,000. Put 170,000+20,000 (closing cost) down. Mortgage of 330,000. Chose a very traditional conventional 30 year fixed @ 5.75%.
    Taxes-HOA-Insurance about 7000/year.Recently put the house on the market in thelow 730,000 got a low ball offer at 670,000. ” - in a previous post.

    For the total cost (PITI), I come up with $903360 over a 30 year time period.

    The interest cost is $363360 for the life of the loan. Assuming that you do not get hit with the AMT at some point in the future (not likely), the tax deduction at 25% is $90840. Let’s also say that you get another $52500 from taxes-hoa-insurance deduction. Total deduction is now at $143430.

    Total cost minus deductions is now at $760020.

    Original closing cost was $20K, now add in another closing cost of 5% of $849,542 = $42477.

    New total cost is now at $822497. Selling at $849542 leaves you with $27K over 30 years. The down payment (money tied up) was $170K. This represents a compounded rate of return of 0.466% per year for 30 years.

    As I mentioned before, the current rate of return on a 4-week T-bill is now at 5.22% per year.

40. bw
    August 11th, 2006 09:48
    40

    Thank’s for the counterpoint. I didn’t notice that before.

    [Link]

41. Bombo_buster
    August 11th, 2006 11:17
    41

    Principle or Principal?

    principle: n 1: a basic generalization that is accepted as true and that can be used as a basis for reasoning or conduct; 2: a rule or standard especially of good behaviour

    principal: adj: most important element; n 1: the original amount of a debt on which interest is calculated; 2: the educator who has executive authority for a school

42. Soubashi
    August 11th, 2006 11:59
    42

    The Charles Schwab in your article is not Charles R. Schwab of the brokerage fame. Charles R. Schwab was born on 1937, long after Carnegie died.

    That Charles M. Schwab in your article was a sidekick of Andrew Carnegie.

43. JJ in SoCal
    August 11th, 2006 12:06
    43

    Talk about being at the right place at the right time. I bought a home in SoCal. 2003 with a fixed 30yr using ’stated income’ and ‘100% financing’. I make the cash but my credit blows. No problem said the lender, so they used my wife’s A credit with stated income. 100% financed. Soon after I bought I thought ‘great, these fools financed me, I got my home, but I will prob take a hit and be in the negative soon when the market crashses with 100 financing’. Thank God I was wrong as prices wents nuts soon after. I know have over 200k equity (soon to be left on the table). I was lucky. Again, right place at the right time.

44. the otherside
    August 11th, 2006 12:22
    44

    To bw:

    Thanks for your good point on the down payment of $170,000.

    I did not use my case as an example but was using instead the example of post #26 of ElSolAqui.

    I REDID the calculations with a 3% annual rent increase (to compare apples to apples, we need to account for your housing expenses as a renter), 5.22% return on investment and a $170,000 down payment.

    A similar house will be listing for rent at $2,800, but given the market condition, we will assume a reasonable starting rent of $2,000.

    On one hand, we will also assume that the total cost of owning the house is $822,497 per post #39. This translates approx. into $27,417 of yearly cost.

    On the other hand the rent will cost about $24,000 in year 1, $24,720 in year 2, $25,462 in year 3 and so on….to $56,558 in year 30 (3% rent increase per year!).

    So in year 1 the renter ends up with $170,000 * 1.0522 = $178,874, in year 2 the renter ends up with ($178,874 + $27,417 - $24,720) * 1.0522 = $191,806 … and so on to ($242,428 + $27,417 - $27,823) * 1.0522 = $254,656 in year 7…. to… ($352,252
    + $27,417 - $56558) * 1.0522 = $323,111 in year 31.

    TAKE HOME MESSAGE: At the beginning of year 31, you end up with:

    $323,111
    if you decide to rent (3% rent inflation over 30yr) and invest your down payment ($170,000) plus cash flow (@ 5,22% with annual compounding).

    versus

    $27,045
    if you decide to buy a house, @ $500,000 in 2003 (5.75% rate, $7000 TI, $330,000 mtg), see the value rise to $670,000 in 2006, then see value drop 43% to $382,000 in 2007 (housing bubble), and then 3% annual rate of return for 27 yr (in line with inflation).
    This number includes ALL closing, plus realtor fees (to buy and to sell in 30 year) costs AND tax write-off.

    We could not quantify the opportunity cost of having so much money tied up for 30yr in a house on one hand vs. the pain of being a renter for 30yr (utility function!!!). And we did not perform a discounted cash flow analysis and use the present value of the $$ amounts listed above.

45. bw
    August 11th, 2006 19:25
    45

    theotherside,

    You did what you thought was the best thing to do in 2003 and that’s good enough. Other than that, if you really do plan to ride out the current correction in the real estate market, then I think you will do just fine.

    Anyway,

    $170K*(1.039)^30-$170K = $365K net.

    0.39 is 3.9% which is the effective T-bill yield after taxes (25%).

46. the otherside
    August 11th, 2006 21:36
    46

    I still maintain that you have to take into account your rental costs, so the correct analysis using the correct rate on the T-bill is…

    TAKE HOME MESSAGE:

    At the beginning of year 31, you end up with:

    $117,598
    if you decide to rent (3% rent inflation over 30yr) and invest your down payment ($170,000) plus cash flow (@ 3.9% with annual compounding and instead of 5.22%).

    versus

    $27,045
    if you decide to buy a house, @ $500,000 in 2003 (5.75% rate, $7000 TI, $330,000 mtg), see the value rise to $670,000 in 2006, then see value drop 43% to $382,000 in 2007 (housing bubble), and then 3% annual rate of return for 27 yr (in line with inflation).
    This number includes ALL closing, plus realtor fees (to buy and to sell in 30 year) costs AND tax write-off.

    SoCalMtgGuy,
    a good idea for your NEXT POST could be about the BOTTOM LINE concerning the strategy that most people at shooting for

    Trying to sell now at the high, rent for a while in the hope of buying back at a discount in 3 yr…

    More specifically:
    House bought at $500,000 with 20 down at 5.75% (30yr fixed) in 2003, sold at $670,000 in 2006, rent for 3 yr @ $2,000 and buy a similar house in 2009.

    Assuming a rate of 7% in 2009 on a 24yr fixed mortgage and 4.5% ( realtor fees ) + $10,000 ( transfer tax at selling ) + $20,000 ( closing cost at buying ), what’s is the break-even point ( maximum price at which house should be bought at in 2009 to end-up with the same payment?)

    HOW MUCH of a crash (in %) people trying to TIME this market needs to make money!!!

47. theotherside
    August 12th, 2006 12:37
    47

    QUESTION:

    HOW MUCH of a crash (in %) people trying to TIME this market needs to make money?

    EXAMPLE:

    Buy in 2004 a house for $500,000, with $100,000 down and 5.75%. Tax-hoa-insurance $7,000/yr. $1,000/yr maintenance. Total payment = $3,000/month

    Personal tax rate 25%, inflation rate 3%, T-bill rate 3.9% for cash flow investment (5.22% gross and 25% tax).

    Sell in 2006 for $670,000 with 4.5% realtor fees, $10,000 closing costs. rent at $2000/month in 2007, $2060/month in 2008 and $2,122/month in 2009 (3% inflation).

    Buy in 2009 with $20,000 closing costs. Mortgage rate at 7% for a 25yr mortgage.

    BOTTOM LINE:

    A- in 2009, you BUY BACK at $590,000 (14% drop) ===> you break even, ie $3,000/month for the remaining 25yr.

    B- in 2009, you BUY BACK at $545000 (23% drop) ===> your new total payment is $2,666/month (you save $334 or 11%) for the remaining 25yr.

    C- in 2009, you BUY BACK at $500,000 (34% drop back to late 2003 prices) ===> your new total payment is $2,348/month (you save $652 or 22%) for the remaining 25yr.

    CALCULATIONS:

    1- in 2006, mtg balance is $389,405
    2- total buying and selling costs are $60,150 (back-and forth fees+ realtor fees)
    3- net proceed is $220,445 in 2006 and $247,256 after 3yr at 3.9%
    4- save 28,443-$24,000=$4,443 in housing costs in 2007, invest at 3.9% for 2 yr and get $4796 in 2009
    5- save $28,528-$24,720=$3,808 in housing costs in 2008, invest at 3.9% for 1 yr and get $3957 in 2009
    6- save $28,618.25-$25,462=$3,157 in housing costs in 2009
    7- TOTAL CASH available for down payment on a 25yr mtg at 7% in 2009 is $259,165

48. bw
    August 12th, 2006 18:13
    48

    This is a description of the Price to Rent Ratio for San Diego:

    http://photos1.blogger.com/img/243/2888/640/sandiego.jpg

    The historical norm is, as one would expect, around 1.0.

    Fast forward to 2006, and it looks like the Price to Rent ratio is still hovering around 1.7 (i.e. 70% overvalued) with fair value at $289.7K.

    http://money.cnn.com/2006/07/25/real_estate/housing_market_values/index.htm

    The median quoted in the above article is $491.6K. However, one of the more popular “asking price” trackers is showing an even higher value than this at $537.5K.

    http://www.housingtracker.net/askingprices/metro/California/SanDiego-Carlsbad-SanMarcos/

    7- TOTAL CASH available for down payment on a 25yr mtg at 7% in 2009 is $259,165

    Sounds like this amount of money is pretty close to fair value.

49. Sensible Lender
    August 14th, 2006 10:47
    49

    Enjoy the blog. Its a shame people like SoCal leave the home loan business, we need more people like him (I have been in the business for 30 years.)

    Regarding people refinancing when their ARM adjusts and goes off Interest-only: This is going to be a big problem. However, just as there are differences in rates and fees amoung lenders, there are differences in programs that are not easily noticed. At my bank, if you have a 3/1, 5/1, 7/1, 10/1 loan, you can refinance (extend your fixed period with no cash-out) any time to any other program without an appraisal. Value can drop big and we do not care. Only two conditions: your current credit report is decent (not great, just no major problems), and you have not had any late mortgage payments of 30 days+ in the last year. It helps when a bank keeps all of its loans. There are several banks that do this….and have low rates and fees.

50. wiseguy
    August 14th, 2006 14:15
    50

    Sensible Lender

    Those are the “big banks” that service their own loans. The problem is that most of those loans were originated by lenders who are going to sell the loans soon afterward and I think that most of them will not streamline refi’s. This is going to be a problem. I am a LO for a broker and the overwhelming majority of our loans are interest only arms and now pay option arms. We are even doing some 100% option arms. In fact, I am surprised when someone does a 30 year fixed. They usually only qualify for those when they’ve sold and have a huge down payment. I am sure you’ve seen alot during your career, but I’d bet nothing like what we are about to see…..

51. subsonic22
    August 15th, 2006 06:00
    51

    Some ARM’s have a conversion feature that allow the borrower to switch over to a fixed rate mortgage. The rate is determined by current market conditions on the 30 year rate. For example, the typical conversion rate is similar to when an ARM resets, you have an index and margin. If a borrower would choose to convert an ARM to a fixed today, the index would be the 60 day required net yield (as of today 6.53%), the margin would be .50 (represents the servicing fee, almost double what a lender usually gets), add the two together, round up to the nearest 1/8th and the borrower has a fixed 7.00% loan for the remainder of the term. There is usually a fee to do this, maybe $300 - $400, but it is a whole lot less expensive to refi.

    Not all ARM’s have this conversion option because it costs a little more and would result in the borrower of having to pay a slightly higher rate.

52. wiseguy
    August 15th, 2006 08:35
    52

    Not to mention no longer interest only which most of them are. The result is whether or not they convert to a fixed, most of them will be FBs.

53. doubtful
    August 15th, 2006 09:08
    53

    Saw this today: NAR President Thomas M. Stevens said,“Speculators have left the market, meaning most buyers in the market today – both single-family and condo – are serious buyers who plan to stay in their homes as a long-term investment.”

    Ha! I know probably a dozen people who have bought houses and condos in the last few years as investments, and ALL of them are still in, figuring they’ll rent for a few years and see equity gains. I bet most speculators are still in — I don’t believe their mindset changed so quickly.

    Am I wrong?

54. maddawg
    August 15th, 2006 10:23
    54

    Larry - I know they are easy targets, but, among entities that are exposed to mortgage credit risk Fannie and Freddie are probably in the “least bad” position because they have both lost market share of the credit guarantee market during a time in which most of this silliness has occurred. Further, sub prime represents a tiny fraction of their credit guarantee business. Most of their exposure to sub prime is through purchases of AAA-rated tranches of sub prime MBS. Oh and they tend to require mortgage insurance on anything with less than 20% down. I am not trying to suggest that a 20% drop in home prices would be good for either, but there are a lot of other players who would do worse in such a scenario. (e.g., sub prime hybrid mortgage bank/thrift/REITs, Mortgage insurers, etc.)

    SoCal Mortgage guy - Great website….really enjoy your stuff.

    I would add that the new way is a function of Wall St. and MBS. Originators are only going to lend to the standard by which the capital markets require - not the standards of John Pierrpont Morgan - or any other icon of banking. The reality is until the credit losses arrive in a manner that really causes the bid for residual paper to disappear or demand a higher risk premium, the mortgage market is likely to continue to be supported by the bid for paper from Wall St. Right now, we are just seeing the early bad seasoning of loans such that Freemont had to take a charge for repurchases from its whole loan buyers to account for early payment defaults. Without naming names, Accredited Home lenders implied that New Century was playing games with such on its 2Q06 conference call. That said, it all comes back to the bid from Wall St., as long as the Wall st firms can earn enough profit from paying 102 for sub prime mortgages, they will continue to do so. Of course the minute the bid for the residual tranches disappears…..things are likely to get really ugly really fast. I just don’t see that happening until you have a “major” credit blow-up….

55. theotherside
    August 15th, 2006 10:29
    55

    doubtful asks: Am I wrong?

    It depends! If instead of focusing on the first part:

    “Speculators have left the market,…”

    you focus on the second part:

    “…meaning most buyers in the market TODAY – both single-family and condo – are serious buyers…”

    the sentence does not look like the typical NAR spin….

56. doubtful
    August 15th, 2006 11:24
    56

    otherside:

    you’re right — i read it wrong. he’s saying those buying today. however, i think it’s wrong to say speculators have left the market, in that speculators are sitting on a ton of housing they will unload when the drop starts to scare them. whether that’s when it hits 10, 20, 30 percent, who knows, but i can’t see them carrying these properties in a market like that. so maybe they’ve left the buy side (though i still have my doubts) but they’re definitely still in on the supply side, in a big way.

57. Rob
    August 16th, 2006 12:07
    57

    doubtful:

    I have friends that are housing flippers also. They have not left the game either. If we can draw any comparisons from stock speculators we are not close yet. In stocks most speculators sell their winners too soon and hold on to their loosers too long. For some reason, taking a loss is much more painful and the pain is put off until it is unbearable. They will throw good money after the bad in an effort to delay the outcome. They will refi until they can refi no more. They will put renters in and loose money every month until they can no longer stand the drain. It will take time.

58. Anon in SoCal
    August 16th, 2006 12:21
    58

    True true. I have a friend who no matter what credible data and stats I throw his way pointing to a bust.. still says he remains ‘optimistic’ about the future. More like wishful thinking I told him. He is mortgaged to the hilt on several house with I/O and Option Arms. It’s almost like a cult thing. Hold on to real estate because it always goes up he says. The Donald says so. These guys are the same guys that were selling AL Williams and AMWAy several years ago. Always looking for shortcut in life to the money. Go back to school and get a degree I say and get a real job.

59. BobW
    August 18th, 2006 11:03
    59

    SoCalMtgGuy,

    I consistently like what you have to say, so please take this in the spirit in which it’s offered:

    A (former) mortgage broker should spell “principal” (the amount originally borrowed) correctly.

    The “principles” of good lending and borrowing, on the other hand, are what this post is about: the fundamentals, the basic ideas.

    Example: This post is about the principles that should prevail in lending, in order to ensure that the principal and interest are paid as agreed.

    You obviously make good use of the concepts. Hope you can make the spelling good too, so that your readers will learn it right as well.

    Please keep up the good work. You have already made a big difference.

    Bob

60. TresSher
    August 18th, 2006 15:30
    60

    As someone who got out of the stock market in 1998 and have my personal residence currently on the market, it seems like everywhere I turn, people are still buying property for investment. Yesterday, my hairdresser told me he was going to fly up to Idaho to look at property. I just grimaced when he indicated his determination.

    I remember cautioning my friends about the unjustified valuations in the stock market in 1999. At that point, I was just someone throwing a damper on the party. Later in 2000, gee… ummmm… actually felt badly that it tanked as much as it did.

    And, what about those Saturday/Sunday real estate and mortgage radio shows? “Yes, we can help you buy properties in other states. We’ll gladly make money while you take all the risks.” “We’ll gladly help you take even more cash out of your property and throw yourself further into debt.” It’s like listening to lambs being brought to slaughter. Except these lambs are trotting merrily along, eager to meet their fate.

    Thanks for letting me vent.

61. watchoutbelow
    August 18th, 2006 15:47
    61

    On the radio today they were talking about consumer confidence being the lowest since Hurricane Katrina, and they had a quote from Treasury Secretary Henry Paulson saying he can’t understand it, because current economic statistics are good. Gee, I wonder if it could have anything to do with people starting to realize that the value of their home is about to drop precipitously. You know, kind of like the way deer start to sense there’s an earthquake coming or something.

62. bw
    August 19th, 2006 07:11
    62

    The San Diego real estate market is starting to tank as people crowd around all the shops and malls and spend like there’s no tomorrow.

    It looks like a lot of people out there are going to be in for a rude awakening..

63. Anon in SoCal
    August 22nd, 2006 16:28
    63

    BobW:
    Like Tony Montan would say “Ju arr en esshollll’
    Like the ol cliche says…this is not a spelling bee blog. Get over it. You RE agent troll you. Busted.

64. SOCAL DUO
    August 24th, 2006 05:27
    64

    As a rental property owner of a condo I bought in the last downturn and a renter of my primary residence, I want to bring up one point that seems to have been missed in the rent vs. buy discussions.

    In the last SoCal downturn, rental prices went DOWN as more porperties hit the market. I fully exspect both the rent I recieve and the rent I pay to go down in the next few years - perhaps not significantly, but at least a few percent.

    As more properties to rent become available, renters approach their landlords with comparable rental listings and ask for a rent deduction.

    Just my two cents- great blog!

65. Rob
    August 24th, 2006 11:26
    65

    I overheard a segment on our local NPR radio station last night of a real estate agent in San Louis Obispo California. They had a client that listed their property for 1.2M and had no interested buyers after 8 months on the market. The people had to move so they gradually reduced the price and finally accepted an offer of 749K for the residence. The realtor was saying that prices would have to come down dramatically to bring back the buyers. She said that people that had bought over the last three years could be in trouble if they have to sell. I was surprised with her candor.

66. wiseguy
    August 27th, 2006 09:39
    66

    Bob is an a$$hole

67. Brownie
    August 27th, 2006 21:15
    67

    Man, I love this site. I always ask myself, who is buying all these homes over 500K. It is comforting to know that a lot of what we are seeing IS NOT reality and those people are gonna pay big time for stretching themselves so thin. This whole situation could get real ugly real quick, at least for those who are over extended. But for those who do value savings, investing and long term gain over short term pleasure, this could be the huge buying opportunity we have been waiting for for so long. I always hear people say “prices are sticky downward”. I think that theory is about to go out the window here in the next few years.

68. ZAHAGSOKN1
    December 31st, 2006 07:51
    68

    Array

69. mlmonly
    June 14th, 2007 18:02
    69

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    I’m afraid it’s time I was saying goodbye.

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