Lay awake at night, Oh so low, just so troubled. Can't get a job, Laid off and I'm having double trouble.
Financial markets have no mercy. They take no prisoners, except maybe those that are now imprisoned in their homes. The financial markets do not care what the prices mean to you or to anyone else for that matter. If falling house prices costs people money, ruins their credit, and forces them into bankruptcy, well, that is what can happen when people speculate in financial markets. There are likely many people losing sleep over their losses in real estate and the stock market while simultaneously worrying about their job. These are not carefree times.
This too shall pass. Despite all the turmoil, the sun will rise tomorrow, and it will be another beautiful day in Southern California. People will meet, fall in love, get married, start families, and look to buy a house. Hopefully, they will chose to rent for a while instead.
Enjoy the new Suzanne Researched This video, now with subtitles.
I dont care what you say We never played by the same rules anyway.
There are some listings where you can tell the owner just doesn't care anymore. Put yourself in his shoes: the house you own is worth far less than you paid and far less than you owe. There is no way you can sell it for enough to get any of your money back, and your credit is shot. Why would you care?
There was a time when people purchased houses because they wanted to provide a home for their family. They took on debt they could reasonably afford, and they made payments until they sold. If they made a little money in the transaction, that was a bonus. Once prices started going up, and people saw that could make a great deal of money by owning, the profit motive started to creep into their thought process. Once prices really went up a lot, and did so very quickly, profit became the primary motivation for buying real estate. The fact that they could live in the place while they were making a fortune was a bonus. That is still the psychology dominating our real estate market, and it is the primary motivation behind the continued activity of knife catchers buying at what are still grossly inflated prices locally.
In time this psychology will change. Lenders are no longer going to enable speculation with 100% financing and liar loans, and worse yet, they are actually going to require people to pay off mortgages. Serial refinancing is over. Oh the horror of it. Can you imagine what will happen to prices when people start believing they will actually have to pay off the debt from their wage income? The Ponzi scheme of ever-increasing debt where each buyer was more leveraged than the last has come crashing down. It is only the few knife catchers who believe they will get to pass this debt on to someone else who are willing to buy in this market. We should probably thank them. Someone has to absorb the losses between today and the eventual bottom.
I would like to welcome readers of the OC Register to the Irvine Housing Blog. We provide analysis of market trends and profiles of properties in Irvine, California. Today we have an analysis post, like many that can be found in our analysis section, and we also have a property profile showing the distress in one of Irvine's newer neighborhoods. Thank you for stopping by.
but you tell me over and over and over again my friend, ah, you don't believe we're on the eve of destruction.
There has been plenty of conjecture about the impact of adjustable-rate mortgages (ARMs) on the future of our housing market. Some people believe that if interest rates remain low that the upcoming ARM resets will not cause many foreclosures. This is wrong. Today's post examines what will happen when these resets occur, and it will demonstrate why this problem is so big.
By now, most of you have seen the ARM reset schedule shown above. But what does it really mean, and why is this a problem? ARMs became very popular in the bubble rally because they allowed people to finance huge sums of money with smaller payments. In time, it became the only viable alternative for financing. There are two types of ARMs: interest-only and negative amortization (Option ARMs). A typical ARM has a fixed interest rate for a brief period, then the interest rate adjusts and the payment is recast. Option ARMs tend to me more complicated. They have more frequent adjustments -- which are almost always to higher rates and higher payments -- and they have the option to pay less than the interest-only amount which results in negative amortization (a fancy way of saying your mortgage balance goes up). There are two terms that are important to understand with respect to ARMs: reset and recast. A reset is a change in interest rate being charged on the loan. These loans are all scheduled to reset at different times, and depending upon changes in the underlying index rate, the interest rate may go up or down. When the interest rate changes, or when the amortization method changes, the payment is recast which means it changes. Any change in payment is technically a recast, but the dreaded recast, the recast that causes all the problems, occurs when the amortization changes and the loan must be repaid.
It is not the interest rate reset that is the main problem, it is the recast to a fully amortized repayment schedule that causes dramatic payment shock.
Don't you understand, what I'm trying to say? Can't you see the fear that I'm feeling today?
At some point, a loan must be paid off. All loans eventually revert to fully-amortized loans requiring the borrower to pay back both the interest and the principal. During the bubble, people believed they could refinance continually from one ARM to another in a process known as serial refinancing. Most borrowers have come to believe mortgage debt is something you perpetually service and never retire. The collapse of mortgage lending that caused the bankruptcy of the subprime industry and the government to take over the GSEs has put an end to serial refinancing. Now people are going to have to pay off their debts. Most can't afford to.
Let's look at a typical example. During the bubble, there was a significant increase in allowed debt-to-income ratios. People who were eager to get rich on real estate stretched themselves to buy houses. This was not a passive result of high prices, this was the driving force of the price rally. As a result, many people are putting 40% or more of their gross income toward housing. Assume a borrower who was making $120,000 a year decided to take out a 5-year fixed, interest-only adjustable rate mortgage with a 40% DTI. They would be putting $4000 a month toward their housing payment, and with a 5% interest rate, they could finance $960,000. Does borrowing 8 times income seem impossible? It was not uncommon.
Let's assume this borrower has been making this $4,000 a month payment, since 2005, and their 5-year fixed period is coming to and end in 2010. What is going to happen? Let's look at the scenario people envision where this will not be a problem. Let's say interest rates are still extremely low in 2010 (something that is not very likely) and that the interest rate reset does not change the borrower's interest rate. At the end of the 5-year period, the mortgage recasts to a fully amortized payment schedule over the remaining 25 years of the loan. The payment which was $4,000 a month goes up to $5,612.06. The borrower was already putting a crushing 40% of their income toward their housing payment. How are they going to afford a 40% higher payment? Is it likely that their income rose 40% in 5 years? Can they afford a 56% DTI? You see, the problem with the interest rate reset is not the change in the interest rate, it is the recast to a fully-amortized schedule. Keep in mind; this is the best-case scenario where mortgage interest rates are still at historic lows seen during the bubble. If mortgage interest rates go up, which seems likely if risk is properly priced into them, then the payment shock at reset/recast is even worse.
So why can't the borrower just refinance into either another ARM or a 30-year loan? Remember the credit crunch? Loan terms have gotten much tighter. Lenders are requiring 20% equity, and the allowable DTIs are falling. Did the property go up 20% in value? No, values have declined. Did the borrower save up enough money to pay down the mortgage? No, they were putting all their money toward their interest-only payment? Did the borrower's income rise 40% or more over the last 5 years? Possible, but given the current state of our economy, it is not very likely. In short, the borrower is screwed. They will not be able to refinance, and they will not be able to support the new mortgage payment. They will end up in foreclosure.
If the button is pushed, there's no running away, There'll be noone to save with the world in a grave,
This is an enormous problem. Eighty percent of loan originations in 2005 and 2006 in Orange County were interest-only or negative amortization. This isn't just a few loans that will result in a few foreclosures. This is the bulk of our financing. You can see what these resets do to home prices by looking at the areas dominated by subprime. Santa Ana, Riverside County, Stockton, and many other markets that were dominated by subprime have been blasted back to 2001 pricing more than 50% off the peak. This did not occur because these neighborhoods were less desirable, it occurred because their loans reset in 2007 and 2008. The loans in Irvine and the more desirable areas in Orange County are set to reset from 2009-2011. The problems for the high end are in front of us, not behind us.
People who were buying or doing cash-out refinancing during the bubble were betting on 4 things: 1. Interest rates would stay low. 2. Loose loan terms would be available. 3. House prices would keep rising. 4. Incomes would keep rising. If any one of these four things did not happen, they were going to lose their house. It would only take one of these four conditions to change for disaster to occur. In the real world, all four of these things did not happen, and now we are facing a foreclosure crisis rivaling the Great Depression. Most people were not aware of the risks they were taking on, and many who were aware of them really believed everything would work out in their favor. They were tragically mistaken.
Time to kiss the world goodbye Falling down on all that I've ever known
Malcom Gladwell wrote a book called The Tipping Point. In it he traces how social phenomenon including financial manias can spread like a disease epidemic. In many real estate markets, we are witnessing a new epidemic: walkaways. Statistics have shown that the rate of foreclosure rises dramatically when homeowners fall underwater. Some estimates are that as many as 12,000,000 homeowners are currently underwater, and as many as 20,000,000 will be before prices stabilize. These are alarming statistics for a banking industry already rendered insolvent by losses on their mortgage portfolios.
The tipping point with respect to walkaways is not difficult to understand. Many people bought at inflated prices because they thought prices would continue to rise. When prices went down, they examined their alternatives (something they should have done in advance) and realized it was much cheaper to rent than to continue making payments on the depreciating asset. Anecdotally, there also seems to be a correlation between how much money people put into the transaction and how far underwater they must fall before they give up. Several months ago, most of the properties I profiled were 100% financing deals gone bad. Some of these owners were not far underwater, but they were giving up anyway because there was no point in continuing to make payments and actually losing some of their money. However, lately I have been seeing more and more properties where the owners had put 10% down. Many of these properties, like today's featured property, were 10% or more below their loan amount before they gave up.
There has been much conjecture on the fate of Option ARM holders and whether or not these borrowers have given up already and sold into the declining market. Certainly many of the properties I have profiled have been Option ARMs. However, it doesn't seem likely that these people have given up and already sold. Why would they? For them, their current house payment on the teaser rate is actually less than renting. Plus, they can stay in the house for 7-12 months free-of-charge after stopping payments. Their incentive is to stay in the property until their recast, then quit making payments and ride it out. Most of these people have already given up, and their plan is to do just what I describe. They make up an enormous shadow inventory of unlisted properties that will be hitting the market as foreclosures. Some of these people might list at a breakeven price and hope, but with market prices putting them far underwater in many circumstances, most of these people do not bother.
The subprime implosion set the stage for the collapse of the more desirable markets like Irvine. The implosion of subprime lowered prices in all markets and made financing much more difficult to obtain. The lower prices has put all the Option ARM, Alt-A and Prime ARM holders in a precarious financing situation. Many will be unable to refinance because they are either underwater or they do not meet the more stringent standards. If they cannot afford the payment when their ARMs reset -- something that will be a particular problem for Option ARM holders -- they will go into foreclosure. It is only a matter of time.
I am still anticipating price declines this fall and winter. The economy is heading into a tailspin, unemployment is increasing, and credit is still tightening. These are not rally conditions. However, we will not see the full brunt of the foreclosure problem in Irvine until 2009 through 2011, and it will be a year or two beyond that before all these reseting ARMs become foreclosures and work their way through the system.
In Santa Ana, parts of Riverside County, and other subprime dominated markets, the worst is over. Prices there are down 50% or more in many of these areas. They may not see appreciation any time soon, but they are already seeing a recovery in sales volumes, and many properties are at or near the bottom in pricing. The same is not true for Irvine. The brunt of our problems are ahead of us, not behind us...
I was cryin' when I met you Now I'm tryin' to forget you Your love is sweet misery
For all our wisdom and collective experience, none of us knows what the markets will do next. Like an ocean current or a raging river, a financial market charts its own course. It is fickle and feckless and flows without regard to our hopes and dreams. The ebbs and flows of financial markets are meaningful to us, but in reality they are just movements in price; nothing more. Price rallies make homeowners blissful and renters bitter, while price declines make homeowners gloomy and renters gleeful. These feelings and emotions are independent of movements in price. The market just moves, that is all it does. It is benign, yet dangerous; it is indifferent, yet demonstrative; the market is a paradox which we must simply accept.
I was cryin' just to get you Now I'm dyin' 'cause I let you
When today's featured property was purchased in 2005, the owner undoubtedly thought they made the purchase of a lifetime. This property was certain to appreciate at 15% a year. It would be worth $2,000,000 soon enough. Now the owner is trying to forget this place. They listed the property at a short-sale price, they have proceeded to knock almost 20% off the asking price and still no takers.
Listing Price History
Date
Price
Aug 26, 2008
$535,000
Sep 05, 2008
$525,000
Sep 17, 2008
$515,000
Sep 25, 2008
$505,000
Sep 29, 2008
$495,000
Oct 07, 2008
$485,000
Oct 15, 2008
$465,000
Oct 20, 2008
$445,000
Oct 21, 2008
$435,000
Oct 27, 2008
$425,000
Of course, they are not alone. We have profiled another property nearby lately: 65 Weepingwood #97, Irvine, CA 92614. This nearly identical property was an REO, and the lender let it go for $385,000. Do you think today's seller will get 10% more? I doubt it.
