Higher mortgage interest rates will cause loan balances to shrink and prices to decline; although, realtors would prefer to you believe it means you will be priced out forever.
Today's featured property is another equity surfer hoping to sell out with a few dollars before the auction.
Irvine Home Address … 7 West RAVENNA Irvine, CA 92614
Resale Home Price …… $939,000
I see the bad moon arising.
I see trouble on the way.
I see earthquakes and lightnin'.
I see bad times today.
Don't go around tonight,
Well, it's bound to take your life,
There's a bad moon on the rise.
Creedence Clearwater Revival — Bad Moon Rising
Rising interest rates are a bad omen for the housing market. When the market is composed only of first-time buyers and renting former owners, no move-up market exists. Very few offers on properties have been submitted over the last few years where the buyer is contingent on selling a home. Without home equity to create a move-up market, pricing is established at the limit of available savings and loan balances. In short, it is set almost entirely by first-time buyers.
When first-time buyers face rising interest rates, their ability to borrow is curtailed. If there were no distressed sales, such an occurrence would cause a drop in volume followed by a drop in prices. When distressed sales are abundant, prices quickly drop to a new clearing price established by current loan terms. In our current market environment, higher interest rates will result in lower prices.
In January of 2010, I wrote about realtor ways in the post Urgency Versus Reality: realtors Win, Buyers Lose. I had just attended a realtor sales meeting where the interest rate gambit first surfaced:
realtor Reason Du Jour
The marketing presentation I attended had many examples of how to manipulate the current situation to create urgency when none exists. One of these pertains to the inevitability of rising interest rates, and it goes something like this:
If a buyer is looking at a $400,000 home, very low interest rates make the payment affordable, but when interest rates go up, it will be harder and harder to finance that $400,000 home. In fact, if interest rates go up a full point, a buyer might lose as much as $100,000 in buying power; therefore, you should buy before interest rates go up.
Hmmm… I nearly raised my hand to ask a follow up question but then I contemplated who my audience was and what they understand about real estate markets and finance, I decided against it. I ask the question here:
OK, if I buy today, the buyer who wants to purchase the house from me in the future when I am ready to move may not be able to borrow as much money. Won't that make my house harder to sell, and might I have to lower the price — a great deal — like the $100,000 mentioned in the example? Isn't the fact that my take-out buyer is going to be much less leveraged working against me?
We all know the answer to those questions (Your Buyer’s Loan Terms), and that was when I had an epiphany: the realtor mind is unconcerned with reality, it is only concerned with urgency, and if urgency conflicts with reality, urgency wins, and buyers lose. Buyers are supposed to believe the realtor cares and that they are looking out for the buyer's best interest; beliefs wholly incompatible with a realtor Mind®™ that places urgency over honesty.
Now that the troops in the field are all trained in how to make the interest rate argument, the NAr is stepping up its faux news stories to scare the masses.
Higher payments could price many would-be buyers out of the market
By ADRIAN SAINZ and ALAN ZIBEL
WASHINGTON – The era of record-low mortgage rates is over.
The average rate on a 30-year loan has jumped from about 5 percent to more than 5.3 percent in just the past week. As mortgages get more expensive, more would-be homeowners are priced out of the market — a threat to the fragile recovery in the housing market.
Buy now or be priced out forever. They never get tired of that nonsense, do they?
In an environment where sellers do not have to sell, and there is very little inventory, sellers can hold their prices and affordability drops; however, when must-sell inventory hits the market, prices drop to the level of affordability necessary to clear the supply. Because we have more must-sell inventory on the way, higher intersest rates will translate to lower prices.
And if you wanted to refinance at a super-low rate, you may have missed your chance. Mortgages under 4 percent are still available, but only for loans that reset in five or seven years, probably to higher rates.
Rates are going up because of the improving economy and the end of a government push to make mortgages cheaper.
Yes, that is exactly why interest rates are going up.
Right now, investors have few good choices. The Federal Reserve has lowered interest rates to zero to push money out of savings accounts. The next best investment is longer term Government Treasuries, but the Federal Reserve has lowered the returns on those to historic lows to push money out of those as well. With few viable alternatives, money seeking a higher return will gravitate toward government-backed mortgage loans because they are basically as safe as Treasuries because they have explicit government backing.
Government insured mortgage finance is the next rung up the debt ladder from 10-year Treasuries. The only thing preventing an exodus of capital from the mortgage market is lack of a better place to go. The recent stock market reflation rally owns much of its strength to money finding a better return. As new opportunities arise — which is the sign of an economic recovery — money flows from safe assets to riskier assets yielding better returns.
When money leaves a market — as it will with mortgages — yields must rise in that market to attract capital. If yields must be raised to attract capital to residential mortgages, then mortgage interest rates must move higher.
For people putting their homes on the market this spring, rising rates may actually be a good thing. Buyers are racing to complete their purchases and lock in something decent before rates go even higher.
"We are seeing some panic among potential buyers who have not found houses yet," said Craig Strent, co-founder of Apex Home Loans in Bethesda, Md. "They're saying: Man, I should have found a house three weeks ago or last month when rates are lower."
And realtors and mortgage brokers everywhere will stoke that fear to set the market on fire. Scare the crap out of buyers, and they will bid whatever sellers want to obtain the property. When the properties decline in value, they will feel no guilt over their fear mongering.
Decline in purchasing power
It's all about affordability. For every 1 percentage point rise in rates, 300,000 to 400,000 would-be buyers are priced out of the market in a given year, according to the National Association of Realtors.
The rule of thumb is that every 1 percentage point increase in mortgage rates reduces a buyer's purchasing power by about 10 percent.
For example, taking out a 30-year mortgage for $300,000 at a rate of 5 percent will cost you about $1,600 a month, not including taxes and insurance. But the same monthly payment at a rate of 6 percent will only get you a loan of $270,000.
Eureka! Someone finally did the math properly. This "news" story is a NAr press release disguised as news. Do you think any would-be buyers who read it stopped and wondered, "Wouldn't that make a $300,000 home fall to $270,000?" I hope they are asking that question because the answer is yes.
Good economic news is the first reason rates are rising: U.S. government debt, a safe haven during the recession, is losing its appeal as investors turn to stocks and riskier corporate bonds.
Lower demand for debt means the government has to offer a better interest rate to sell its bonds. The yield on the 10-year Treasury note, which is closely tracked by mortgage rates, has hovered around 4 percent all week, the highest since June.
The second reason is the Federal Reserve. Last week, the Fed ended its program to push mortgage rates down by buying up mortgage-backed securities. When demand from the central bank was high, rates plummeted to about 4.7 percent for much of last year. And business boomed for mortgage lenders as homeowners raced to refinance out of adjustable-rate mortgages and into fixed loans.
As of Wednesday, the Mortgage Bankers Association put the national average for a 30-year fixed-rate mortgage at 5.31 percent. One week ago, it was 5.04 percent.
6 percent rates likely
Many analysts forecast rates will rise as high as 6 percent by early next year. If they go much higher, the already shaky housing recovery could stall. And that could slow the broader economic rebound.
Not really. The reason interest rates will go up is because the economy is doing better. All higher mortgage interest rates will do is make home prices go down. That will have little or no impact on what happens in the broader economy; although, it will keep residential investment in check.
In a normal market, with home prices steadily rising, a jump in rates doesn't cause a big dip in demand. That's because people know their homes will eventually rise in value, and are willing to accept a higher mortgage payment.
Yes, some buyers are stupid. With cajoling from the NAr and the belief prices will go to the moon, borrowers often over extend themselves to capture appreciation and live the HELOC good life.
But now home prices are flat nationally and still falling in some places. Potential buyers are nervous about jumping in.
"In this environment, any rise in mortgage rates does significant damage because people don't think they're going to get their money back" if prices fall, said Mark Zandi, chief economist at Moody's Analytics.
That is because they won't get their money back. People are wise to sit on the fence and see how this plays out.
For people who bought their first home in the 1980s, when rates stayed over 10 percent for several years, paying 6 percent for a home loan may seem like a steal. But it's coming as a shock to many first-time homebuyers this spring.
Rising interest rates is also going to put a cramp on HELOC borrowing. That is going to come as a shock to everyone buying their personal ATM machines.
In Overland Park, Kan., Sirena Barlow checks mortgage rates online once a day. She's been shopping for a something around $130,000 and wants to sign a contract this month, to take advantage of a tax credit for first-time homebuyers.
Barlow, a legal assistant, has already told her landlord she's moving, so her stress level is high. Her real estate agent, Michael Maher, has been doing his best to calm Barlow and other clients, but rising rates are making them anxious.
"It's like giving hyperactive kids ice cream," he said. "It has really taken the ones who are focused on buying and amped them up a little bit."
Perhaps that characterization is correct, and this realtor is a Realtor and really is calming his clients. I rather doubt it. realtors for the most part are using any tool they can to motivate buyers including trying to scare them with the spectre of higher interest rates and lower affordability.
Spending themselves out of house and home
Since there is no shortage of wretched HELOC abuse among Irvine's elite, I thought we might look at yet another. Owners like these are the rule rather than the exception. From what I have observed, many loan owners were taking out their equity and spending it in a measured way to consume some significant portion of their appreciation income. Many borrowers overspent their home-price appreciation even when it accrued at the dizzying rates of the housing bubble rally. Those that were more restrained — perhaps they only spent 50% to 70% of their imagined gains — those borrowers are the ones to surfed the equity wave and departed peacefully on shore no better or worse for the journey but with memories of the good times.
I still have difficulty getting my mind around the idea that home-price appreciation is income. California borrowers freely access and spend this money as a gift from the housing market gods. Many borrowers set up plans where they routinely go to the housing ATM as a yearly bonus or housing stipend. These same borrowers are eagerly awaiting the return of widespread appreciation so they can resume cashing out of the housing ATM. Are the banks really going to do that again so soon?
- This property was purchased on 11/18/2002 for $655,000. The owners used a $530,000 first mortgage, a $66,750 second mortgage, and a $58,250 down payment.
- On 2/2/2004 the first mortgage was refinanced for $605,000.
- On 5/12/2005 the first mortgage was refinanced for $620,000.
- On 6/20/2007 the first mortgage was refinanced for $745,000.
- Total mortgage equity withdrawal is $148,250, a fairly typical Irvine take on the last half of the bubble.
These people were very ordinary in their HELOC spending — conservative you could argue. This is what passes as sophisticated financial management in California.
Recording Date: 11/16/2009
Document Type: Notice of Sale
Recording Date: 08/07/2009
Document Type: Notice of Default
Irvine Home Address … 7 West RAVENNA Irvine, CA 92614
Resale Home Price … $939,000
Home Purchase Price … $655,000
Home Purchase Date …. 11/18/2002
Net Gain (Loss) ………. $227,660
Percent Change ………. 43.4%
Annual Appreciation … 4.6%
Cost of Ownership
$939,000 ………. Asking Price
$187,800 ………. 20% Down Conventional
5.24% …………… Mortgage Interest Rate
$751,200 ………. 30-Year Mortgage
$199,776 ………. Income Requirement
$4,144 ………. Monthly Mortgage Payment
$814 ………. Property Tax
$67 ………. Special Taxes and Levies (Mello Roos)
$78 ………. Homeowners Insurance
$36 ………. Homeowners Association Fees
$5,138 ………. Monthly Cash Outlays
-$1024 ………. Tax Savings (% of Interest and Property Tax)
-$863 ………. Equity Hidden in Payment
$390 ………. Lost Income to Down Payment (net of taxes)
$117 ………. Maintenance and Replacement Reserves
$3,759 ………. Monthly Cost of Ownership
Cash Acquisition Demands
$9,390 ………. Furnishing and Move In @1%
$9,390 ………. Closing Costs @1%
$7,512 ………… Interest Points @1% of Loan
$187,800 ………. Down Payment
$214,092 ………. Total Cash Costs
$57,600 ………… Emergency Cash Reserves
$271,692 ………. Total Savings Needed
Sq. Ft.:: 2528
Lot Size:: 6,500 Sq. Ft.
Property Type:: Residential, Single Family
Style:: Two Level, Contemporary
XLENT QUIET INSIDE TRACK LOCATION, WITH NEW HARDWOOD FLOORING, DESIGNER PAINTS, WITH PROFESSIONAL LANDSCAPING AND BEAUTIFUL POOL, SPA. LARGE CUL-DE-SAC LOT, VERY DESIRABLE FLOOR PLAN AND AWARDS WINNING SCHOOLS.
I hope you have enjoyed this week, and thank you for reading the Irvine Housing Blog: astutely observing the Irvine home market and combating California Kool-Aid since 2006.
Have a great weekend,