Tuesday, March 13, 2007

It's a terrible time to buy a house 
Patrick.net explains why.

# Mass foreclosures due to the poor lending standards of the last few years. Banks happily loaned whatever amount borrowers wanted as long as the banks could then sell the loan, pushing the risk onto Fannie Mae (ultimately taxpayers) or onto buyers of mortgage backed securities (MBS's). Now that it has become clear that at least a trillion dollars in mortgage loans will not be repaid, Fannie Mae is under pressure not to buy risky loans and investors do not want MBS's. This means that the money available for mortgages is falling, and house prices will keep falling, probably for 5 years or more.

# Prices disconnected from fundamentals. House prices are far beyond any historically known relationship to rents or salaries. Rents are less than half of mortgage payments. Salaries cannot cover mortgages except in the very short term, by using adjustable interest-only loans.

# Interest rates increases. When rates go from 5% to 7%, that's a 40% increase in the amount of interest a buyer has to pay. House prices must drop proportionately to compensate.

For example, if interest rates are 5%, then $1000 per month ($12,000 per year) pays an interest-only loan of $240,000. If interest rates rise to 7%, then that same $1000 per month pays for a loan of only $171,428.

Even if the Fed does not raise rates any more, all those adjustable mortgages will go up anyway, because they will adjust upward from the low initial rate to the current rate.

# A flood of risky adjustable rate "home equity loans" draining equity from existing mortgages. Just like the bad primary ARM loans, these loans do not have fixed interest rates. When the interest rate adjusts upward, it can double monthly payments, forcing owners to sell.

# Extreme use of leverage. Leverage means using debt to amplify gain. Most people forget that losses get amplified as well. If a buyer puts 10% down and the house goes down 10%, he has lost 100% of his money on paper. If he has to sell due to job loss or an interest rate hike, he's bankrupt in the real world.

It's worse than that. House prices do not even have to fall to cause big losses. The cost of selling a house is at least 5%. On a $600,000 house, that's $30,000 lost even if prices just stay flat. So a 5% decline in housing prices bankrupts all those with 10% equity or less.

# Shortage of first-time buyers. According to the California Association of realtors, the percentage of Bay Area buyers who could afford a median-price house in the region plunged from 20 percent in July 2003 to 14 percent in July 2004. Strangely, the CAR then reported that affordability fell another 4 percent in 2005, yet claims affordability is still at 14%.

Again, lots more at the link.

Hat tip: Lee Distad.

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There's another factor here in hurricane country - insurance. Escrow payments (property insurance and tax) can now exceed mortgage P & I, as recent losses have led to most companies refusing to write new coverage for wind and hail damage.
While a lot of these are valid points, I'm not sure I'd use the San Francisco Bay Area as a benchmark for your average housing situation. It's kind of like using Beverly Hills as your baseline.
If you read through the entire link, the author does concede that real estate still makes sense in certain less inflated markets.

Real Estate is millions of micromarkets. There are always exceptions, even as there are generally stocks that do well even in bear markets. Vice stocks are a good example. Tobacco and gambling stocks are notoriously resistant to bear markets - and some investors do use funds like the Vice Fund and Morgan's FunShares (FUN) as diversifiers against the broad equity market.
Wouldn't all of those factors (foreclosures, forced sales, etc.) bloat the inventory and flood the market with affordable housing?

It looks to me like later this year might be a great time to buy a house.
Sorry, off topic. But it looks like the demand to “don’t just stand there, do something” about Walter Reed resulted in another ‘shot at and missed, shit at and hit’ scenario that will be counterproductive.

As usual, we see the iron triangle in operation – quality, speed, and cost effectiveness, you can pick any two.

I'd have to agree with the 'SF Bay Area isn't a good benchmark' idea.

Yes, it appears that the subprime lending is catching up with the lenders, but anybody could see that was coming.

There may be something to the 'as goes CA goes the country', but the housing market in CA was insane to start with.
Housing costs are factoring into where I would like to find a permanent teaching position. I won't be able to buy another house on a single-income teaching salary in the city where I currently live. I used to own a small "starter home" when I lived in AR, which I sold before moving back to TX. I'm not foolish enough to think I'll be able to buy a home immediately after finding a job, but I want to live somewhere that finding an affordable home in an area I would actually be willing to live in is feasible. I could "afford" a home in this town, but it wouldn't be in a neighborhood I'm willing to live in...
Since most banks turn up their noses at VA loans, and only select mortgage companies will handle them.

I wonder if this is going to make VA loans more attractive to banks and mortgage companies over the next couple of years?

We have a lot of guys getting out of the military and most will want to take advantage of a VA loan.

Is this going to make it harder for them to get that "starter house" or not?

Papa Ray
West Texas
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