The interest rate cycle is very long, and we are bouncing off historic lows. It is reasonable to think interest rates may go up based on reversion to the mean. The average over the full cycle (down, up, down) is 9%, and interest rates generally hover between 7% and 11%.
Back in early December, I noted Mortgage interest rates hit five-month high. Since then, other pundits are starting to proclaim the end of the era of mortgage interest rates below 5%.
By Les Christie, staff writer — January 1, 2011: 3:47 PM ET
NEW YORK (CNNMoney.com) — The era of near 4% mortgage rates has ended after a quick rate rise since early November. But some industry experts think that may be a good thing for the flagging housing market.
The average 30-year fixed mortgage rate has risen to 4.86% from 4.17%, according to Freddie Mac's weekly mortgage market survey. In the Bankrate.com weekly survey, the rate has risen to 5.02% — crossing the 5% mark for the second time in three weeks — after being as low as 4.42% as recently as early November.
Rates haven't been this high since May and forecasters now predict them to remain between 5% and 6% for all of 2011.
“You can kiss those record lows goodbye,” said Greg McBride, chief economist for Bankrate.com.
Is this a good contrarian indicator? Since everyone is starting to say interest rates are going much higher, will the market reverse and send interest rates back down?
Keith Gumbinger of HSH Associates, a provider of mortgage information said that the market reached a new plateau.
“I don't think we're going back to a 50-year low anytime soon without an economic collapse,” he said. “Rates will probably never revisit those levels.”
That is the essence of the argument: rates will not go back to ultra-low levels as long as their are competing investments where returns are attractive, something which requires an expanding economy.
The increase will push mortgage payments higher for homebuyers. When rates rise from 4.25% to 5% it takes away about 9% of buying power, according to McBride.
“That's nothing to sneeze at,” he said. “But it's still small relative to the steep drop in home prices over the past few years.”
He is right. In Las Vegas where prices are very affordable, a small decrease in affordability will not make much difference; however, in inflated California markets where every penny of affordability is needed to support pricing, rising interest rates will be a serious problem.
Good for the market?
Higher interest rates may even prove stimulating to the still quiet housing market in which sales volume and prices are scraping near their bottoms.
“The initial phase of an interest rate increase generally does not hurt markets,” said Lawrence Yun, chief economist for the National Association of Realtors. “In fact, it can help.”
The rapid rise introduces an element of urgency for potential homebuyers. They may now rush to buy before rates spurt even more.
The strength of the economic recovery will have far more impact on the housing market that this relatively modest increase in mortgage rates, according to Yun. If hiring gains momentum, housing markets should revive.
“If we add 2 million jobs as expected in 2011, and mortgage rates rise only moderately, we should see existing-home sales rise to a higher, sustainable volume,” said Yun.
Gumbinger said that demand for homes may be tempered somewhat by the increased mortgage costs and so affect home prices a bit but the improving job picture and better consumer confidence matter much more.
“If the other factors are aligned,” he said, “interest rates are not a big thing.”
Economists are correct to point out that jobs are the creator of all real estate demand. The unemployed may desire houses, but they don't effectively add to demand.
What follows will be repeated by the NAR often over the next several years. They will complain that “stringent” lending standards are hindering the market and squelching demand. Of course, realtors embraced the Option ARM because it stimulated demand, so we can't count on the NAR to be objective about what lending standards should be.
The real mortgage challenge, according to Yun, is to increase the number of loan applicants winning approvals. Too many potential homebuyers are still finding it difficult to qualify for loans.
“The current mortgage market is a unique situation” he said. “It's less about rates than it is about underwriting standards, which are, in my opinion, still too stringent.”
“If lenders return to more normal, safe underwriting standards for creditworthy buyers, there would be a bigger boost to the housing market and spillover benefits for the broader economy.”
So do you think the era of sub-5% mortgage interest rates is gone for good?
Fannie Mae shadow inventory
In 2011 we will see many properties emerge from shadow inventory. Lenders are not going to let these sit vacant and rot on their books forever. Fannie Mae is moving to liquidate the one that started as a default in mid 2009.
Foreclosure Record
Recording Date: 12/31/2009
Document Type: Notice of Sale
Foreclosure Record
Recording Date: 09/17/2009
Document Type: Notice of Default
Fannie Mae bought the property in May of 2010, and it took them 6 months to get it to market. It must be interesting to be a project manager for the banks. Usually a slow and inefficient project manager wouldn't last long, but they probably rise to the top in the bank's property management department.
The property was originally purchased on 11/2/2000 for $170,000. The owner used a $165,150 first mortgage and a $4,850 down payment.
On 12/31/2001 they refinanced with a $166,500 first mortgage.
On 12/13/2002 they refinanced with a $193,000 first mortgage.
On 8/3/2005 they refinanced with a $233,558 first mortgage.
On 1/4/2006 they refinanced with a $258,748 Fannie Mae first mortgage. The GSEs entered the bubble late as a response to losing market share. This was one of the stupid loans they made that we are now paying for in the GSE bailout.
On 1/12/2007 they obtained a $15,778 HELOC.
On 5/25/2007 they got a $42,663 HELOC.
Total property debt is $301,411.
Total mortgage equity withdrawal is $136,261. Not a lot, but enough to cost them their home.
According to the listing agent, this listing is a bank owned (foreclosed) property.
Great opportunity at a great price! Come see this beautiful condo located in wonderful community! Rich dark wood cabinets bring the kitchen to life! New paint and carpet installed throughout makes the property feel like new! Beautiful views of the bay are within walking distance! Don't pass up on this great opportunity!
this is the one of the worst catastrophes in the world.
[indecipherable] its flames…
Crashing, oh!
Four- or five-hundred feet into the sky and it…
it's a terrific crash, ladies and gentlemen.
It's smoke, and it's in flames now;
and the frame is crashing to the ground,
not quite to the mooring mast.
Oh, the humanity!
Herbert Morrison — WLS radio
Housing bubbles are catastrophes. Like the Hindenburg or the Titanic, house prices had an aura of invincibility that came crashing down and sunk to an (under)watery grave.
If a mortgage product were to inflate a housing bubble, the pump and hose that primes the first stages are adjustable rate mortgages. These risky products give the market ability to weather interest rate shocks, but they also provide the air that inflates prices 10% to 15% above stable prices set by using fixed-rate mortgages.
Californians pay too much for their houses because many get trapped into adjustable-rate mortgages to borrow as much as possible. It becomes a rite-of-passage that your first purchase requires you to take on a risky loan and stretch to the max so your bank can extract as much money as possible from your working life.
Some wise up to the adjustable-rate mortgage trap, and they either refinance or move to a different home when their financial situation changes. They take with them the equity built up from the frightened masses that came after and inflated neighborhood values.
Adjustable rate mortgages are not a product I like because it forces borrowers to assume interest rate risk. Many people who use adjustable rate mortgages claim they understand interest rate risk, but in the last 30 years, interest rates have done nothing but go down. There has been no consumer risk in holding adjustable-rate paper.
That changes when interest rates hit the bottom of the cycle and begin to rise.
Each adjustment in rate going forward represents a larger cost to the borrower. Everyone stretching today to get into real estate using an adjustable rate mortgage will face an increasing payment without obtaining any appreciation to compensate. It's a lose – lose. Those using fixed rate mortgages with affordable payments can weather any storm.
Adjustable rate mortgages will burn most who use them over the next decade. Those with assumable fixed rate mortgages will fare the best.
Also, for those awaiting the return of HELOC riches, how much of that equity are you going to borrow at 7% when your primary mortgage is 4.5%?
The article that follows is a bit wonkish, but it provides a detailed explanation of how adjustable rate mortgages impact the California real estate market.
This article discusses how the ratio of adjustable rate mortgages (ARMs) to all loans originated in California can be used to determine the health and direction of California’s near-term real estate market.
Data Courtesy of MDA Dataquick, the US Federal Reserve, and Standard and Poor’s
The above charts present two real estate market perspectives on adjustable rate mortgage loan (ARM) volume in California. Both charts track ARM loans as a percentage of all mortgages recorded in California (the blue line), called the arms-to-loans (ATL) ratio. The first chart juxtaposes California’s ATL ratio with the fixed rate mortgage (FRM) rate for the Western Census Region (the green line), while the second chart joins the ATL ratio with the combined monthly tri-city average of low-tier home pricing in San Diego, Los Angeles and San Francisco (the red line).
The ATL ratio is a crucial measure of the relationship between ARMs and FRMs, and can be used to determine probable sales volume and price movements for 12 and 24 months forward (respectively). [For a more detailed look at home pricing in California, see the first tuesday Market Chart, California Tiered Home Pricing.]
In the top chart, notice the collapse of ARM lending after 2006. ARMs went from nearly 80% of the market down to 2%.
ARMs depend on FRM Rates
The availability of purchase-assist money is the single most powerful engine driving price movement in California real estate transactions, as shown by the boom in sales volume and pricing caused by excess funding in the mid-2000s; a phenomenon called the financial accelerator effect. Purchase-assist money is delivered almost exclusively by either ARMs or FRMs (except for the very few buyers who pay cash). [For more information about the financial accelerator, see the May 2010 first tuesday article, Cleaning up after the ruptured housing bubble.]
Because mortgage financing is so dominant in sales transactions, the friction in the movement between the 30-year FRM Rate and the ATL ratio is essential to the understanding of brokers who wish to hazard a prediction of what lies ahead for their real estate market.
Combined in analysis, these two factors – the FRM rate and the ATL ratio – have the power to predict California’s future home sales volume and price movement. Local market conditions, on the other hand, seem to have little influence on sales volume and pricing, since both are controlled by financing trends, which are moved only by the bond market and federal monetary policies. [For a more global review and critique of ARMs, see the March 2010 first tuesday article, The Danger of an ARMs Buildup.]
The FRM-ATL Connection
30-year FRMs are the most basic and essential form of financing for homebuyers in the real estate market. If FRMs are available at comparatively low rates, and the homebuyer is well-informed (and somewhat rational), the homebuyer will almost always choose the FRM over the much riskier ARM loan.
When ARMs became 80% of the market in 2006, nearly everyone forgot the common sense idea that fixed-rate debt is better. Now that ARMs are nearly extinct, some are lemanting their demise. Good bye and good riddance.
In a normally functioning purchase-assist and refinancing mortgage market, the percentage of ARMs – the ATL ratio – rises and falls only in direct response to changes in FRM rates, in sympathy until friction develops and leads to a deviation in movement between the ATL ratio and FRM rates. Such a deviation is a clear warning of an impending distortion in real estate sales volume and pricing.
As the top chart vividly indicates, observed rises in FRM rates tend to lead to increases in ARM volume, the normal situation. The reasons are intuitive, since ARMs allow borrowers to obtain more funding when the FRM rate increases (sellers refuse to lower their prices in response to FRM rates, so buyers are forced to either lower their standard of living or obtain a higher amount of funding).
Note that this normal dynamic is not present in a market laden with distressed properties. If affordability declines in a normal market, buyers often foolishly adjust by taking out ARM loans since sellers rarely come down on price. However, since so much of our current inventory is distressed, for this inventory to clear, prices must come down to whatever price level borrowers can obtain. In other words, it is different this time.
For instance, the number of ARMs jumped dramatically when FRM rates were raised in 1988, 1994 and 1999. Prices never moved down, as the ARM supported sellers’ demands by delivering more money than the buyers would otherwise be qualified to borrow.
It is useful to think of ARMs as bridge loans, spanning gaps in the availability of purchase money when FRM rates rise. Any rise in FRM rates immediately reduces the buyer’s purchasing power, since lenders do not permit buyers to make loan payments higher than 31% of their income. Higher interest rates always mean lower principal amounts are available to borrow. [For more on the influence of rates upon the buyer’s ability to get financing, see the first tuesday Market Chart, Buyer Purchasing Power.]
This is the point I have been making for months now. Lower borrowing amounts when coupled with excessive must-sell inventor leads to lower prices.
When FRM rates rise, ARMs tend to keep prices from falling. Unfortunately, ARMs originated in excess will quickly cause prices to rise during periods of flat or declining FRM rates. ARM financing permits sellers to raise prices beyond what buyers would otherwise be able to pay. Increased availability of funds from ARMs help stabilize the market in a time of temporarily high FRM rates, but they can just as quickly lead to a home pricing bubble and a potential market crash when the ATL ratio is running contrary to the FRM rate movement as occurred in 1993 and 2002.
ARMs are the cause of volatility in California's housing market. The Option ARM was the culprit that inflated the Great Housing Bubble because it allowed huge principal values with tiny payments. The same payment can finance two or more times the loan amount with an Option ARM as compared to a FRM.
In the past, ARMs in healthy markets have generally made up approximately 20% to 40% of the home loan market, while the remainder is made up of FRM loans. If the ATL ratio exceeds 40%, which normally happens when FRM rates rise too high, it is a sign of instability in the financing market, and forebodes potential problems for homeowners and homebuyers in the near future – weaker sales volume and home prices.
Forecasting the future
With FRM rate movements in mind, it is possible to forecast the future of sales volume and sales price trends by comparing FRM rates with movement in the ATL ratio. To do so, take a close look at the correlation from year to year between FRM rates and the ATL ratio on the first chart above.
Ordinarily, the ATL ratio rises and falls in tandem with FRM rates, roughly following it in a stable and nearly parallel relationship. However, this stable relationship can and does sometimes fail when external factors cause the ATL to move contrary the FRM rate. Such external factors may include:
increases in jumbo loan demand;
rapid shifts in demographic demands to buy or sell;
too much or too little construction activity; or
changes in government regulations on homeownership or mortgage financing.
You can develop an understanding of what will be the real estate sales volume for the next 12 months, and sales price movement for a full 24 months by following any failure in ATL/FRM relationship.
In the real estate market, home sales volume tends to rise and fall in a cyclical fashion corresponding to economic recessions (represented above by gray vertical bars on the charts) and booms. Home prices change primarily due to prior changes in sales volume, although the pricing inertia generated by rising sales volume tends to continue for 8 to 12 months after home sales volume reaches its apex (this delayed change in pricing, which is particular to SFR property, is referred to as the sticky pricing phenomenon). [For a more thorough analysis of sticky pricing, see the first tuesday December 2009 article, TheFlat Line Recovery: A Side-Effect of Sticky Housing Prices.]
To make an accurate and well-informed prediction of home sales volume and pricing in California, the only figures you need are the ATL ratio and the FRM rate for the past 12 months. When these two figures fail to move in tandem during the prior 12 months, the friction between them is predictive of the extent of the change in sales volume and pricing trends in future months. Which direction the trend will take depends upon whether the two rates become more closely aligned or more distant.
It is unnecessary to look to any information other than the correlation between the ATL ratio and the FRM rate for forecasting the next 12 months of sales volume and 24 months of pricing. All other factors either reflect the ATL and FRM rates, or are directly caused by the fluctuations in those rates. For instance, while the volume of notices of default (NODs) and trustee’s deeds (TDs) may appear to have an influence on price movement at the moment of analysis, in fact NOD/TD volume is merely a manifestation of prior price movements which are dictated by FRM and ATL frictions. [For more information on NODs in the current market, see the first tuesday Market Chart,NODs and Trustee’s Deeds.]
When the ATL ratio parallels the movement of FRM rates, both sales volume and prices will remain fairly constant in the future. This is the definition of a normal market: looking forward, readers can safely predict that neither a measurable boom in pricing nor a recession will take place in the two years following such conditions.
Instead, sales volume will continue much the same as at present for at least 12 months, and prices will remain reasonably steady, adjusting upward at approximately the rate of inflation in the consumer price index (CPI) for a longer period, another 6 to 12 months. [For the most current CPI figures, see the first tuesday Rates Page.]
However, any sustained period (12 months or more) in which the two factors are at odds with one another, as demonstrated by a widening or narrowing of the space between the two lines on the ATL/FRM chart, discloses a hazardous abnormality in the home financing market. Any such abnormality establishes a divergent trend going forward in real estate sales and pricing. Examples of such divergences are elucidated below.
I have used the loosly defined term “normal” market on many occassions. The definition above is a good one, if a bit technical.
Historical trends
To get a clear idea of the power of FRM rates and the ATL ratio to predict action in the real estate market, take a look at these illustrative instances:
1. Between 1996 and 2002, the ATL ratio moved in approximate synchronicity with FRM rates, in an example of the ideal lending conditions on the market. Thanks to stable and sane loan demands by homebuyers and homeowners, real estate prices rose at a slow and sustainable rate for the duration of this period.
2. Beginning in 2002, FRM rates dropped continuously for two years. In the meantime, the ATL ratio began to rise, thanks to deregulation of lenders and Wall Street Bankers which allowed them to push for increased use of ARM loans and the concurrent rise in asset prices. The unnatural rise in ARMs led to excessive home price increases, which continued to rise for one to two years even after a return to standard ATL/FRM synchronicity (the ATL ratio peaked in early 2005, but home pricing did not reach its apex until one year later).
3. Between 2005 and 2009, FRM rates remained flat, but the ATL ratio reversed course and dropped significantly. The declining ATL ratio, coupled with a flat FRM, presaged an inevitable decline in housing prices, and a similar drop in the amount of money available for homebuyers and homeowners to borrow. In short, the dropping ATL ratio (without a drop in FRM rates) was both a symptom and a cause of the catastrophic Great Recession. Lenders dropped FRM rates further, in early 2009, but the ATL ratio responded by dropping to almost zero, a condition that exists at the end of 2010.
The authors contention is backed up by the data. Although this indicator and explanation are hard to follow, it makes sense that sudden changes in financing behavior, particularly the use of risky ARM loans, will lead to market volatility and instability.
The current market
As of October 2010, adjustable rate mortgages (ARMs) made up only 5% of mortgage market originations statewide, compared to 77% at the height of the Millennium Boom (for comparison, the peak national rate was only 36% ARMs). This 5% ATL is very low, yet it is higher than the bottom of 2% in May 2009, and continues a downward trend from an ATL ratio of 6.5% in May 2010.
Both the ATL ratio and the FRM rates are bouncing around at about the same level, with the ATL ratio literally bumping along on the bottom (as it cannot go lower than zero). Yes, the FRM is artificially low and will move around depending on the effectiveness of Fed and congressional stimulus at end of 2010 which will take effect throughout 2011, but that is not the issue.
The ATL/FRM relationship has remained relatively normal for the past year, after a logical bounce at the end of 2009. Sales volume is thus likely to remain constant or drop over the next 12 months, and the same is true of prices for the next 18 to 24 months from now. Buyers need not expect any changes in market conditions until mid- to late 2012. Government programs to encourage ownership, or to create pre-foreclosure workout sessions, will not significantly alter this situation. It will change only if buyers return to the streets intent on scarfing up real estate.
History also helps us to predict how ARMs will behave at the end of a real estate recession. Historically, recessions have led to a restabilization of the ATL ratio between 20 to 40% levels, typically following the FRM rate closely for three to five years following the recession’s end. This rule is not absolute, however; most recently, the period of 2001 to 2004 violated this condition (due to government efforts to artificially bolster the homeownership rate in the US from 64% to 70%, at the expense of homebuyers who were financially unprepared for homeownership).
As the gatekeepers to real estate, brokers and their agents need to know the shift in mortgage preferences among homebuyers from fixed rate mortgage (FRM) to ARM financing in the absence of increased FRM rates means the real estate market is destabilizing.
ARMs are not a stable loan product, and although 20% to 40% may typically be present, that only means 20% to 40% of the buyers are taking foolish risks and remaining market participants must deal with it. The presence of ARMs is not helpful, but the product doesn't totally destabilize the market while ratios are in that range and prices are rising.
With insight to apply this information, they will be able to provide better advice to both sellers and homebuyers.
The author is assuming agents care enough to convey truthful information even when they have it. My observation is that agents don't care about the truth unless it is helpful in generating a commission.
ARMs and the dysfunctional real estate market
While an ATL of up to 40% indicates a healthy home sales market, we wish to clarify that ARMs are almost never beneficial to the individual homebuyer, and are in fact largely (if not totally) responsible for the Great Recession in the real estate market.
The weaknesses of the real estate market revealed by the recent Millennium Boom (and the associated GreatRecession)are tied inextricably to the prevalence of ARM originations during that period. Without ARMs, introduced in 1982 by authority of the US Treasury, the world of real estate would not be in its present dire condition. Financing the purchase of any type of real estate with ARMs points to several key instabilities in a momentum environment of increasing sales volume:
Homebuyers are over-anxious. Over-anxious homebuyers who cannot finance the purchase of homes with stable long-term FRM loans will make the myopic decision to resort to ARMs in order to get into the home immediately, even though this choice entails greatly over-extending their future finances. They are not being told, nor do they themselves properly consider, the true cost of ARM loans when short-term rates increase — as they invariably and often dramatically do in normal business cycles of recession and recovery. This overheating of the real estate market — its weakness — creates a breeding ground for speculators and ever more ARM borrowing.
Speculators have a large presence in the market. ARMs provide a free lunch for flippers: rates are cheap with minimum cash flow requirements in the short term, providing speculators with enough time to get in, wait for prices to go up — the rush delivered by a momentum-based market — and then sell, hoping all the time to take a profit. ARMs also lower origination costs: a great incentive for speculators.
Home prices are unnaturally inflated. As more speculators enter the market to suck out their share of rising equities, they bid up property without any need to consider the fundamentals of real estate valuation, and over-inflation of housing prices ensues.
All of these conditions point to a most financially pernicious condition: the asset bubble. Thus, whenever ARM loans — sometimes referred to as zero-ability-to-pay (ZAP) loans — inconsistently rise in popularity compared to movement in the FRM rate (as indicated by an aberrant increase in the ATL ratio and a flat or dropping FRM rate),
This is a brilliant insight. ARMs equal instability. The more ARMs dominate the market, the more unstable that market is and the deeper the potential correction.
it should raise a massive red flag in the face of industry professionals. Such a rise in ARMs means that the Federal Reserve (the Fed) will soon need to slam on the brakes of the speeding real estate market before the new bubble implodes.
If only real estate professionals cared enough to send a warning. Few in the industry would argue against a bubble when so many are making so much from its inflation. Besides, as I can attest, any such warnings will be largely ignored anyway. People are going to do what they are going to do, often irrespective of the information made available to them.
The Fed accomplishes this primarily by raising short-term rates, which determine ARM origination costs and rates, and by raising reserve requirements for private banks to discourage lending in the overheating real estate market. The Fed’s measures, in turn, result in upward payment adjustments on ARMs that discourage new purchases and put current homeowners at risk of loss by sale or by foreclosure.
The advice below is some of the best I have come across. Do you think anyone in the real estate industry is actually telling thier customers stuff like this:
Knowledge brokers can use
The old joke in lending is that when a borrower opts for an ARM loan, lenders not only get an ARM off the borrower, but eventually his leg, as well. The industry has long been aware of what borrowers cannot seem to take to heart: ARMs are great only for the lenders who gladly take the fees and for speculators who don’t care about long-term ownership or market stability.
Agents need to counsel their buyers not to succumb to the toxic ARM. Brokers and agents who keep a close eye on the ATL will have the knowledge(and as fiduciaries, the duty) to provide the warning bells to their clients by supplying up-to-date information and their opinions about the potential direction of ARM rates and the prices of real estate.
As ARMs become more popular during this recovery, as they will, potential buyers will become more confident. Faced with these conditions, prospective homebuyers will find it increasingly difficult to compete with their ARM-using peers, and will opt to use ARMs once more in spite of the untenable risk they present.
This is my greatest concern with the way properties are being released. Everyone will end up in an ARM. If every new buyer is forced to stretch to the max in order to make up for the bad debts at the banks, everyone still ends up paying a huge loan ownership tax to the banks. I don't feel like putting the maximum allowable DTI toward a house less comfortable than my rental for the privilege of paying huge interest payments in hopes of future appreciation. Forget it.
These buyers must be told that there is no wisdom in mortgaging their future financial solvency for what will amount to a short-term tenancy when they can no longer make mortgage payments on their ARM. The mistake of an ARM purchase will only be compounded by the fact the new owner has most likely paid too high a price, since ARMs are only useful when homes become unavailable at FRM rates.
The high purchase price, unfortunately, makes it impossible for the buyer to resell and recover any equity when things turn sour at the end of the virtuous cycle. Able, informed buyers drive speculators away, giving sellers a fair price for their properties and brokers and agents a stable income.
Routine house spender
Finding a loan owner with a quarter million dollars worth of HELOC abuse is routine. It has little impact any more. I am still astonished by how common these borrowers are. You wouldn't think all of them borrowed over $100K. They did.
This house was purchased on 9/22/2000 for $265,000. The owner used a $251,750 first mortgage and a $13,250 down payment.
On 4/12/2004 he refinanced with a $315,000 first mortgage.
On 9/16/2004 he refinanced again for $381,500.
On 3/30/2005 he opened a stand-alone second for $50,000.
On 1/5/2006 he refinanced the stand-alone second for $50,000 and obtained a $20,000 HELOC.
On 8/16/1006 he refinanced with a $119,100 stand-alone second mortgage.
Total property debt is $500,600.
Total mortgage equity withdrawal is $248,850.
Total squatting time two years and counting.
Foreclosure Record
Recording Date: 09/15/2010
Document Type: Notice of Sale
Foreclosure Record
Recording Date: 06/25/2009
Document Type: Notice of Sale
Foreclosure Record
Recording Date: 03/20/2009
Document Type: Notice of Default
This owner made it through all of 2009 and 2010 without making a payment. It appears he is still living there.
-$346 ………. Tax Savings (% of Interest and Property Tax)
-$458 ………. Equity Hidden in Payment
$28 ………. Lost Income to Down Payment (net of taxes)
$50 ………. Maintenance and Replacement Reserves
============================================
$1,776 ………. Monthly Cost of Ownership
Cash Acquisition Demands
——————————————————————————
$4,000 ………. Furnishing and Move In @1%
$4,000 ………. Closing Costs @1%
$3,860 ………… Interest Points @1% of Loan
$14,000 ………. Down Payment
============================================
$25,860 ………. Total Cash Costs
$27,200 ………… Emergency Cash Reserves
============================================
$53,060 ………. Total Savings Needed
Property Details for 14952 GAINFORD Cir Irvine, CA 92604
——————————————————————————
Beds: : 3
Baths: : 2
Sq. Ft.: : 1112
Lot Size: : 5,096 Sq. Ft.
Property Type:: Residential, Single Family
Style:: One Level, Other
View:: Faces Northwest
Year Built: : 1971
Community: : El Camino Real
County: : Orange
MLS#: : S632589
——————————————————————————
Come see this exquisite property in the El Camino Real area of Irvine! Property is a detached home close to 1200 sq feet and has a lot size of 5000 sq feet with a nice spacious backyard. Kitchen, Dining area, and Bathrooms were recently remodeled with new countertops and cabinetary in some areas. Some new additions to the house include a new fence in the back yard, new roof, crown molding in the master bedroom, vaulted ceilings in the living room, and laminate flooring in the family room and new tile in the kitchen. Best of all, no HOA or Mello Roos fees!
“Most of the macroeconomic conditions I made in 2008 are still operative, and several of the predictions I made which came true will likely repeat in 2009. These are:
2008 will see the worst single-year decline in the median house price ever recorded
One or more of our major financial institutions and one or more of our major homebuilders will fail
A severe local recession
I predict we will see many more angry homedebtor’s troll the blog
I do not believe 2009 will see median house prices decline as much as 2008, but I do believe they will drop significantly, particularly in high-end neighborhoods. The low-end neighborhoods are closer to the bottom than to the top, so 30%+ declines in these neighborhoods are not likely. The high end neighborhoods will experience big drops. Most did not drop 30% last year, so they have more room to drop. The unemployment rate is high, and the economy is in recession which will put pressures on home prices. The dreaded ARM problem is not going away, and these loans will start blowing up this year and on through 2011.”
Not much has changed from my review of the situation a year ago. Lenders did manage to avoid dealing with the problem for a full year, so prices did not budge, and we now have a massive shadow inventory.
“However, there is one bright spot for the housing market that will blunt the declines in 2009: ultra-low mortgage interest rates. We will see properties at rental parity in 2009. The low interest rates are going to reduce the cost of borrowing to the point that many properties will reach rental parity this year.”
I got that one right, and
“With the low interest rates, and with the foreclosures resulting from this year’s loan resets being a year away, we are in a good position to see our first bear market rally. This summer, we might see two or three months of sustained appreciation.”
That happened too, and it happened for the reasons described. As I have noted on other occasions, these conditions are not sustainable.
Predictions for 2010
In looking ahead to 2010, I see a number of important factors that will influence the housing market. Many of the issues discussed today will be the focus of future posts.
Mortgage interest rates will increase in 2010
I don't know how high they will go, but mortgage interest rates will begin their ascent to a (somewhat) natural market. Any stable homeowner who has not refinanced should do it now or forever miss their chance.
The interest rate on the mortgage averaged 4.86% in the week ended Thursday, up from 4.81% in the prior week, according to Freddie Mac, a buyer of residential mortgages. A year ago, this mortgage averaged 5.14%.
“For the year as a whole, 30-year fixed mortgage rates averaged just below 4.7%, which represented the lowest annual average since 1955, when the average price of a home was $22,000,” said Frank Nothaft, chief economist at Freddie Mac, in a statement.
With the rise in interest rates over the last 6-8 weeks, interest rates are now within 0.28% of where they started the year, and the strength of the trend reversal suggests we will likely see 5.14% interest rates and perhaps higher in 2011.
I have no idea what interest rates will do. I think they will move higher, but I haven't beaten a coin flip so far. Perhaps the explicit government gurantee on FHA and GSE debt will keep money in residential mortgages even as better rates of return in riskier assets entices some investors. If risk adverse money thinks mortgage loans are a bulletproof investment because the US government is specifically backing the repayment of the loan through the insurance sold by FHA and now the GSEs. This guarantee may cause money to pool in residential mortgages for safety and keep interest rates very low for a long time. It could go either way, and I have no foresight for either scenario. Flip a coin: heads rates go up, and tails rates go down. Ask the magic 8-ball, “Will interest rates go up?” It told me, “Maybe.”
The direction of mortgage interest rates is important for two reasons. One, it motivates people to lock in long term rates. The days of floating your rate lock are over. Playing for short term volatility by delaying your rate lock fights against the broader trend. Rising rates will also stop the refinance market. The days of Ponzi borrowing cheap money are over.
The second reason higher rates is important is because higher rates create costs that cannot be passed on to a borrower who is already borrowing at their limit (see everyone in California). As interest rates go up, the amounts people can finance with a 31% DTI go down. You can't escape the math.
Incomes must go up — which doesn't seem likely in the face of high unemployment — or
Debt-to-income ratios are relaxed so borrowers can borrow more. That is called a Ponzi scheme, so to avoid further losses, the DTI will stay capped at 31% for the foreseeable future.
Loan balances must decrease. This is the most likely scenario since incomes are not going up, and neither are DTI ratios.
Smaller loan balances makes for lower bids from potential buyers. The desire for real estate may be strong, the measurable demand will be shrinking along with loan balances. Prices would have to move lower with the inventory that needs to move through the system.
Inventory will increase in 2010
Eventually, lenders are going to have to foreclose on properties, kick out the squatters, and resell the houses in the resale market. Inventory is coming; how much of that we will see in 2010 is anyone's guess, but I believe we will see much more than we saw in 2009.
Affordability will improve as mid to high end properties are released to the market, and prices of the houses of greatest interest to buyers in Irvine should come down because, despite the buyer interest, there are more properties in distress than there are buyers interested in obtaining them.
One year ago there were 446 homes on the MLS. On the last business day of 2011, there were 725 homes for sale in Irvine. That's an increase of over 60%! I mark that down as a win.
Properties selling at or below rental parity becomes the norm in 2010.
As I have noted on other occasions, many properties, even in Irvine, are trading at or below rental parity. This will happen more often, and it will happen at higher and higher price points.
This is what we observed in late 2010 due to falling prices and super low interest rates.
Sales volumes will increase in 2010
Despite the rumors of a healthy real estate market, transaction volumes remain 15% below historic norms on a seasonally adjusted basis. Sales volumes will increase due to greater supply, and prices will go down.
Sales were up slightly, but not much. Unemployment continues to be a problem and the lack of a move-up market continues to plague sales.
Prices in Irvine will fall 2%-5% in 2010
Increasing interest rates will decrease affordability, and increasing supply will force saleguaranteehe market. The combination will cause prices to begin a multi-year slow decline similar to the 1994-1997 period. The price decline will not be orderly, and the relative stability in the median will mask seismic shifts within the market at sales composition changes (more mid to high end properties will sell) and prices of individual properties decline.
Even though the rally fizzled out, it may have carried prices up enough to stop them from going negative year-over-year. I concede defeat.
Basically, my outlook for 2011 is unchanged from 2010. (1) Inventory will go up. (2) Properties selling at or below rental parity will be the norm. (3) Sales volumes will increase. (4) Prices in Irvine will fall 2% to 5% in 2011.
Whatever the result, the leg down in pricing from the double-dip will be the last move down in this market cycle. The housing market will bottom at different times in different market tiers. I think the biggest discounts will be at the high end going forward. The lowest tier of the housing market may have already hit bottom. If not, it will bottom first. With low end support producing the first wave of move-up equity buyers, the slow grinding declines of higher price points can finally cease, perhaps in 2014. During the next three years, expect a range-bound housing market with a slightly lower bias.
If you want a series of projections on the housing market I like, check out Calculated Risk's post:
Two weeks ago I posted some questions for next year: Ten Economic Questions for 2011. I'm working through the questions and trying to add some predictions, or at least some thoughts for each question before the end of year.
1) House Prices: How much further will house prices fall on the national repeat sales indexes (Case-Shiller, CoreLogic)? Will house prices bottom in 2011?
There is no perfect gauge of “normal” house prices. Changes in house prices depend on local supply and demand. Heck, there is no perfect measure of house prices!
That said, probably the three most useful measures of house prices are 1) real house prices, 2) the house price-to-rent ratio, and 3) the house price-to-median household income ratio. These are just general guides.
Real House Prices
The following graph shows the Case-Shiller Composite 20 index, and the CoreLogic House Price Index in real terms (adjusted for inflation using CPI less shelter).
Click on graph for larger image in graph gallery.
In real terms, both indexes are back to early 2001 prices. Also both indexes are at post-bubble lows.
As I've noted before, I don't expect real prices to fall to '98 levels. In many areas – if the population is increasing – house prices increase slightly faster than inflation over time, so there is an upward slope in real prices.
If real prices fall to 100 on this index (seems possible) that implies about a 10% decline in real prices. However what everyone wants to know is the change in nominal prices (not inflation adjusted). If real prices eventually fall 10%, that doesn't mean nominal prices will fall that far. House prices tend to be sticky downwards, except in areas with a large number of foreclosures. That is key a reason why prices have been falling for years, instead of adjusting immediately.
Price-to-Rent
In October 2004, Fed economist John Krainer and researcher Chishen Wei wrote a Fed letter on price to rent ratios: House Prices and Fundamental Value. Kainer and Wei presented a price-to-rent ratio using the OFHEO house price index and the Owners' Equivalent Rent (OER) from the BLS.
Here is a similar graph through October 2010 using the Case-Shiller Composite 20 and CoreLogic House Price Index.
This graph shows the price to rent ratio (January 1998 = 1.0).
I'd expect this ratio to decline another 10% to 20%. That could happen with falling house prices or rents increasing (recent reports suggest rents are now increasing).
Price to Household Income
The third graph shows the Case Shiller National price index (quarterly) and the median household income (from the Census Bureau, 2010 estimated).
Once again this ratio is still a little high, and I'd expect this ratio might decline another 10%. That could be a combination of falling house prices and an increase in the median household income.
This isn't like in 2005 when prices were way out of the normal range by these measures, but it does appear prices are still a little too high.
House Prices and Supply
The final graph (repeat) shows existing home months-of-supply (left axis), and the annualized change in the Case-Shiller composite 20 house price index (right axis, inverted).
House prices are through October using the composite 20 index. Months-of-supply is through November.
We need to continue to watch inventory and months-of-supply closely for hints about house prices. Right now house prices are falling at about a 10% annual rate.
I think national house prices – as measured by these repeat sales indexes – will decline another 5% to 10% from the October levels. I think it is likely that nominal house prices will bottom in 2011, but that real house prices (and the price-to-income ratio) will decline for another two to three years.
Some of you take this far too seriously
I enjoy writing for the IHB, and I try to do it the best I can given the new demands on my time. I don't get to spend as much time in the comments as I would like, but i do read them every day and participate from time to time. Mostly I have said what I had to say in the post, and making a comment would have merely restated the post, so i don't bother. I prefer others to have the last word.
When I started out writing for the IHB back in early 2007, people needed to be warned about the impending house price crash, and I was unequivocal in my message not to buy a house. As the price crash ran its course, house prices in many markets became very affordable, but Irvine has only recently seen some deals trade at or below rental parity. In some markets the discount to own versus renting is close to 40%. Can you imagine that?
With the changing conditions, I began to change my message. I began telling people they can buy with the understanding that the house price may likely decline for a few years then recover slowly. If you need to sell in the next 3 to 5 years, don't buy now. Shevy has been saying the same thing since we began working together. It's still true, but the bottom window may be in 1 to 4 years rather than 3 to 5. Buying does not hurt on a nominal basis if you hold for at least 7 years. By then between the loan amortization and the stabilized market, there should be enough equity to pay a realtor and get out, perhaps with a few extra dollars if we inflate another bubble.
When I write for the IHB, i like to be creative, and sometimes that includes trying to capture an emotion or attitude in a cartoon or pull it out of a news story. Sometimes will will advocate positions or write in a certain style because it is fun, not because it is some deeply held belief. I enjoy the humor in the stories, and the culture of home price appreciation Ponzies is a funny item to document. They are part of the housing story. I didn't cast the part, I merely report the activity and note it for what it is. It's the entitlement that is shocking to me. And the huge dollar amounts borrowed and spent is shocking too. These borrowers ripping off the banks that gave them the free money… well, what does two wrongs make?
I don't stress much about the Ponzis. I write about them because they are the story. They are not the majority in Irvine. Most people here are good people who work hard and save money. Kudos to them. However, Ponzies have a significant presence as evidenced by the property records, and the toll the market must pay for their activities is yet to be paid.
The IHB is still just a hobby. I write some crazy stuff about housing, and people stop by to read it. It's a laugh. Don't take it too seriously. I don't.
Seriously, we will continue to improve
Writing for the IHB is a great personal discipline for me. It takes habits and deadlines that must not be missed. I have tried to make each post feel thought through and cared about. I want to continue to present information to a high standard. Unfortunately, I must accomplish this within the time available. I will improve in 2011.
We plan to provide more market data and other information. I don't know what form that will take, but I would like to present understandable housing market data. There are other bells and whistles we are considering, but for now, I will remain mum until we have something ready to debut.
Most people who look for a home in Irvine search on the internet and when they do, they nearly all find the IHB. Unfortunately, not all of these people find what they are looking for. We hope we can serve more of their needs with future site enhancements.
Beautifully customized home with spacious floor plan and architectural features such as rounded corners and door arches. Highly upgraded throughout including the gourment kitchen with granite countertops, custom cabinetry, high end stainless steel appliances and a wine frig/bar area. Travertine flooring downstairs, designer carpet upstairs, custom cabinetry in all baths, solid wood doors, custom shutters, surround sound system, epoxy finished garage floor and much more. The tropically landscaped backyard includes over $100k in upgrades with a travertine patio, pool, spa, BBQ, bar and firepit. Must see to appreciate!
Fresh Fall in Home Prices Is Headwind for Economy; Other Signs Still Strong
By S. MITRA KALITA And SUDEEP REDDY — DECEMBER 29, 2010
A new bout of declining home prices is threatening to hamper the U.S. recovery, just as consumers and the overall economy have been showing signs of healing.
Home prices across 20 major metropolitan areas fell 1.3% in October from September, the third straight month-over-month drop, according to the S&P/Case-Shiller home-price index released Tuesday. Many economists expect the declines to continue into at least next spring, erasing most of the gains made since prices bottomed out in early 2009.
The housing market, which appeared poised for a recovery earlier in the year, now could be heading for a second downward drift.
“This looks like a double-dip [in housing] is pretty much on the way, if not already here,” said David Blitzer, chairman of the Standard & Poor's index committee. “Somebody who thought last year that it's going to be straight up from here was wrong.“
That's right. The bears were right, and the bulls were wrong.
Enough gloating. Back to the serious business of documenting the ongoing collapse of real estate prices.
Other news in recent weeks, however, has offered hope the economy is on the cusp of strong, sustainable growth. Retail sales returned to levels seen just before the recession started in 2007. Manufacturing continues to expand. U.S. exports are back to where they were just before the financial crisis.
Optimism among heads of small businesses and large corporations is also near pre-recession levels. And tax legislation that includes a one-year payroll-tax cut for most workers has boosted prospects.
Yet the twin forces of jobs and housing remain trouble spots. The labor market has added a million jobs in the past year, but that pace is far too slow to offset an unemployment rate that climbed to 9.8% last month.
Job worries are hampering consumer confidence despite strength in holiday sales and a rising stock market. The Conference Board, a business research group, said Tuesday that its confidence index fell to 52.5 from 54.3 in November, as consumers' views about job availability worsened.
The index, after rising through May as the economy showed early signs of improvement, now has retreated to its level of a year ago. The percentage of people planning to buy a home is also back to where it was a year ago, erasing improvement seen in early 2010.
U.S. Consumer-Confidence Index Slips
In the Case-Shiller data, all 20 cities in the index posted month-over-month declines in October.
As for year-over-year data, only four areas—Los Angeles, San Diego, San Francisco and Washington, D.C.—showed prices higher than in October 2009. Six markets hit their lowest since prices started falling four years ago, dropping below their spring 2009 levels, when most regions saw prices bottom out. The six were Atlanta, Miami, Seattle, Tampa, Charlotte, N.C., and Portland, Ore.
Prices in several markets, including Las Vegas and Cleveland, are nearly down to 2000 levels.
The low end in Las Vegas is trading at the early 90s levels. The good stuff still hangs on at 2004 prices. The good stuff will continue to decline, but investors and new owner-occupants will keep low-end prices stable.
The housing index was driven down by factors including the expiration of a federal tax credit for buyers who signed contracts by April 30, which caused demand to fall off.
Prices also were weighed down by a huge inventory of foreclosed homes, which tend to sell at sharply discounted prices.
In recent months, according to the National Association of Realtors, foreclosure and other distressed sales have represented more than 30% of home sales—and more than half in some states, such as Nevada.
Wells Fargo & Co. projects prices will drop 8% more by mid-2011, given high supply. “Demand is still dead in the water,” said Wells economist Sam Bullard.
Prices also face other hurdles: slightly rising mortgage rates, and homeowners who owe more on their houses than they're worth, and thus may walk away as values dip further.
The owners under pressure include Tasha McLaughlin, a 33-year-old mother of two in Sacramento's South Natomas neighborhood. She and her husband, Steve, bought their two-bedroom house in 2004 for $256,000, intending to stay about five years. After 11 months of trying to sell it between 2006 and 2007, the family took it off the market.
“Everyone is saying we should foreclose or claim bankruptcy, but I have a moral issue with that,” said Mrs. McLaughlin. “The more we try to pay the mortgage and pinch pennies, the more we get punished.”
Now, with a similar home down the block listed for $80,000, the McLaughlins are accepting that they won't recoup their losses anytime soon. Their interest-only loan is set to increase their current $1,600 monthly payment to $2,200 in seven years. If they were to default on their mortgage and walk away, they calculate that in about the same time, seven years, their credit scores would be stable enough to allow them to buy again elsewhere.
“I am just going to swallow my pride and walk out. I have to,” said Mrs. McLaughlin. “The market for homes is not going up.“
Housing analysts agree that markets such as Sacramento, Las Vegas and parts of Arizona and Florida are at risk of more declines. “These places relied so heavily on mortgages and real estate for their economy that we're going to see a two-tiered recovery,” said Chris Mayer, a professor of real estate at Columbia Business School. “Luxury spending is not going on across the country—it's happening among highly skilled consumers who live in the places that have seen some recovery.”
Homes remain a key part of Americans' wealth. Households held $6.4 trillion of home equity at the end of the third quarter, alongside $12.2 trillion in stocks and mutual-fund shares, according to Federal Reserve data.
For every dollar decline in housing wealth, consumers reduce spending by about a nickel in the subsequent 18 months, Moody's Economy.com chief economist Mark Zandi estimates. He cautioned that other factors, such as the stock market's strength and tax credits, could offset this effect.
“People feel poorer when their houses are going down in value,” said Jack Fitzgerald, chief executive of Fitzgerald Auto Malls, which has a dozen locations along the East Coast. He is seeing many customers who could buy new cars choosing used cars instead, “spending as little as they can.” While sales are improving, he expects them to grow only slowly, given all the consumer uncertainty.
Still, the overall economy's dependence on housing diminished greatly since the financial crisis, said Ivy Zelman, chief executive of Zelman & Associates, a housing-research firm. “Consumers have shown us they can still spend even if home prices go down,” she said. But falling home values “put a lid on the recovery and the magnitude of it.”
I don't believe house prices will fall a large amount from here. They will go down, particularly at the high end, but with an improving economic picture, demand for housing will improve. Considering it has been hovering near historic lows for years, it is bound to pick up some in 2011. Much will depend on the course of interest rates and unemployment. If interest rates move higher and unemployment stays high, house prices may fall significantly, but if interest rates remain low, and if unemployment drops, we won't see a significant uptick in prices because hte overhead supply, but we could see a big increase in sales volumes. That would be great for clearing the market.
100% financing deal emerges from 2.5 years of shadow inventory
Today's featured property was purchased on 9/16/2005 for $509,000. The owners used a $356,300 first mortgage, a $152,700 stand-alone second, and a $0 down payment. The defaulted about three years ago.
Foreclosure Record
Recording Date: 05/12/2010
Document Type: Notice of Sale
Foreclosure Record
Recording Date: 02/09/2010
Document Type: Notice of Default
Foreclosure Record
Recording Date: 11/02/2009
Document Type: Notice of Rescission
Foreclosure Record
Recording Date: 06/04/2009
Document Type: Notice of Sale
Foreclosure Record
Recording Date: 04/21/2008
Document Type: Notice of Default
Since this was a purchase money, non-recourse mortgage, the bank was in no hurry to foreclose and take the loss. There is no prospect of recovery on this loan. The finally got around to foreclosing on 7/19/2010 for $431,484, then they spent several months preparing it for sale — which looks like they did nothing.
Are the shadow inventory deniers still making fools of themselves, or has everyone accepted that shadow inventory is real and not that hard to find?
-$311 ………. Tax Savings (% of Interest and Property Tax)
-$412 ………. Equity Hidden in Payment
$25 ………. Lost Income to Down Payment (net of taxes)
$45 ………. Maintenance and Replacement Reserves
============================================
$1,940 ………. Monthly Cost of Ownership
Cash Acquisition Demands
——————————————————————————
$3,599 ………. Furnishing and Move In @1%
$3,599 ………. Closing Costs @1%
$3,473 ………… Interest Points @1% of Loan
$12,597 ………. Down Payment
============================================
$23,268 ………. Total Cash Costs
$29,700 ………… Emergency Cash Reserves
============================================
$52,968 ………. Total Savings Needed
Property Details for 2100 TIMBERWOOD Irvine, CA 92620
——————————————————————————
Beds: 2
Baths: 1 bath
Home size: 1,270 sq ft
($283 / sq ft)
Lot Size: n/a
Year Built: 2005
Days on Market: 73
Listing Updated: 40526
MLS Number: P755549
Property Type: Condominium, Residential
Community: Northwood
Tract: Cust
———————————————————
According to the listing agent, this listing is a bank owned (foreclosed) property.
Like new! Immaculate one bedroom + loft (used at a bedroom) townhouse built in 2005 located in the desirable Collage complex. Unit features include brand new paint and carpet throughout, fireplace, one car garage, patio with pool views, walk-in closet and storage room. Complex is equipped with beautifully manicured landscaping, pool, spa and secure gate access. Property will be sold with washer, dryer, stove/range and dishwasher.
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.
Anyone who is underwater on their mortgage and struggling with payments is considering strategic default. Many of these people will succumb to mortgage distress whether or not they chose the timing of their default. They are debt zombies. Many others who are underwater and struggling could survive the real estate recession and divert significant family money toward excessive loan payments, but they see the advantages of a lower housing cost, so many of them are choosing to strategically default because it is in their best interest financially to do so.
Many of those who chose not to strategically default make this choice because they believe making the payment is a moral obligation — an obligation above and beyond what is written in the contract. Banks are relying on those borrowers motivated by their perceived morality to keep making payments. Unfortunately, there is no longer a moral stigma associated with strategic default (accelerated default is a more accurate term).
Banks need a moral stigma to be associated with loan repayment. If the transaction were viewed by borrowers as a simple business transaction — which it is — then issues of morality are not effective at cajoling debtors into repayment, particularly when default is in the best interest of the debtor. Banks have long relied on borrower morality to get repaid.
Due to the events of the Great Housing Bubble, borrowers no longer feel a moral obligation to repay their mortgage debts. Borrowers view the system as corrupt. Many borrowers believe greedy lenders inflated prices with oversized loans to pad their own profit margins. Those borrowers are correct in their views and beliefs, and based on that view, many borrowers no longer feel compelled by morality to repay their mortgage debt.
'Strategic default' losing stigma as homes go deeper underwater
By Jane Hodges
msnbc.com contributor msnbc.com contributor
updated 12/20/2010 12:11:34 PM ET
More Americans than ever are showing a willingness to walk away from their underwater homes, according to a recent survey. Chris Kelly is a perfect example of someone who never thought she would send the bank “jingle mail” — mailing the keys back. But she did.
Until last year Kelly, a 46-year-old administrative assistant, was living in a 3,000-square-foot home she owned with her ex-husband in the Seattle suburbs.
The duo had put the three-bedroom, three-and-a-half bath home on the market before finalizing their divorce in the spring of 2009 but had no luck luring move-up buyers to the $600,000 home even after price markdowns.
Kelly wound up living there solo, struggling to make the mortgage payments. But as she kept writing checks, and worrying, she became aware that she’d have to make a hard choice: Leave the house while she still had decent savings, or pay until she’d emptied out all her accounts and then enter foreclosure.
In the latter scenario, she’d have to look for a lease with no money left for a deposit. Either way, she’d lose the home, whose value had dropped underwater — below what the couple owed on it.
I know people who have wiped out their personal and retirement savings because they were unable to get themselves to default while they still had the ability to pay. It's like the slot machine gambler that refuses to get up until every last dollar has been lost. The decision to default gets forced upon them when they can no longer raid savings or Ponzi borrow to make payments. Decision by indecision is very painful in cases where accelerated default would have proven beneficial.
“It was a pretty clear decision,” says Kelly, who now lives in Austin, Texas. “I knew I had to walk away. The longer I stayed there, the worse my credit would be and the harder time I’d have finding a rental.”
So a year ago she walked way, joining the growing number of Americans willing to turn their backs on homes they can neither sell nor afford to keep. The real estate industry calls this “strategic default,” referring to people who choose to walk away even when they can technically afford to continue paying their mortgage.
Lenders would certainly prefer all borrowers to be dutiful on their way to the debtors gallows by draining every last drop of savings rather than considering options and making a “strategic” or considered decision.
Nearly half, 48 percent, of homeowners with a mortgage said they would consider walking away from their home if they owed more on it than it was worth, according to a Harris Interactive survey released this month. The survey was conducted in November for real estate listings site Trulia and foreclosure research firm RealtyTrac.
Just six months ago, a similar survey indicated that only 41 percent of consumers would consider walking if they were underwater on their mortgages.
Is a 7% movement in this statistic meaningful? I think it is. Who do you think this 7% who changed their minds are? Who else would be thinking about it? Those faced with the decision, of course. A certain amount of the stigma will fall away as people know “good people” including family, friends, and acquaintances that have elected to accelerate their defaults. The trend will be for this statistic to trend toward complete acceptance over the next several years.
“It’s a phenomenon we haven’t seen before in the housing market,” said Rick Sharga, senior vice president of RealtyTrac. “The mindset of why people purchase a home has changed over the past decade.”
In the early 2000s, as home prices rose sharply and steadily, many buyers saw their home as an investment. But in the wake of the housing bust, it's clear that a home has become far more of a “utility” — a form of shelter — than an investment.
Actually, only the public perception has changed. Houses have never been a good long-term speculative investment. The rate of appreciation only matches inflation, the carrying costs are high, the transaction costs are high, and the market is prone to bouts of illiquidity. Given these circumstances, only during brief periods of upward volatility (sucker rallies) is it possible to reap major appreciation benefits from owning residential real estate. It has always been about utility of ownership, but people are only now detoxifying from the kool aid enough to see it.
Over the next year, hundreds of thousands of homeowners will face the question of whether to walk away as their mortgage payments spike.
Sharga said that $300 billion worth of adjustable rate mortgages are expected to reset upward over the next 12 to 15 months, adding on average $1,000 to monthly mortgage payments on homes that already are worth 30 percent to 50 percent less than their original sale price.
Remember, it isn't the reset of the interest rate that is a problem because rates are still low, the real problem is the recasting of these loans from interest-only to fully amortizing. The recasts add significantly to the payment as Sharga suggested above.
Roughly 23.2 percent of all single-family homeowners who have a mortgage are underwater on their property, according to third-quarter data from Zillow. (Zillow estimates that 40 percent of single-family homes are owned, with the rest mortgaged.)
Major banks, including Bank of America and Wells Fargo, are preparing to work with these owners through modification programs that may include principal reduction or temporary interest-only loan payments until markets improve and refinancing is possible, Sharga says.
But clearly, many homeowners may have motivation to walk. They’ll see their mortgage payments spike at a time when their home value is underwater the deepest.
American homeowners lost $1.7 trillion in home value during 2010, a far higher loss of equity than the $1 trillion lost during 2009, according to Zillow data released earlier this month. Zillow also reported on a blog that less than one-fourth of the 129 metro areas it tracks showed home value gains in 2010.
In addition, the impacts to credit from a foreclosure are typically less damaging than those from a bankruptcy, which hits more lines of credit and loans than just the home loan. According to Barry Paperno, consumer operations manager at myFico.com, the consumer site for Minneapolis-based credit scoring company Fair Isaac Corp., a personal bankruptcy can shave 130 to 240 points off a person’s credit score, while a foreclosure typically reduces a score by 85 to 160 points. (FICO scores range from 350 to 850, with higher scores better.)
“It’s serious, and it certainly complicate future purchases,” Paperno says. “Compared to a bankruptcy, though, the score impact can be surprisingly different.”
The latest Harris survey also revealed some interesting gender differences in attitudes about strategic default: Men were nearly 50 percent more likely than women to consider walking away from an underwater loan, with 57 percent indicating willingness, vs. 40 percent of women.
That one surprises me. It may be interesting to see that broken down by who manages the money in the family. It's probably a higher percentage among those who face the realities of the bills than those that do not.
Pete Flint, CEO of Trulia, said that this may indicate men take a more investment-minded approach to homeownership and evaluate when to walk as a financial decision, while women may view their property as a home and have a harder time with the concept of leaving it even under fiscal duress.
Kelly embodies both approaches. She says she was torn about the decision, but couldn’t let sentiment overtake what, ultimately, was a move toward self-preservation.
“I never thought that this was something that would happen,” she says. “I loved that house.”
Is this about survival, or is this about entitlement? Ultimately, each borrower evaluates financial alternatives, determines the emotional toll to be paid, and finally makes a decision and acts on it. Some may consider that survival, but it is really the survival of entitlement. It is wise to squat in a nice home and avoid sending those resources to a lender, and it is wise to find a comparable rental for less than the former house payment. That's why borrowers quit paying and squat until finally moving into a rental. It's a trend we will see more of in 2011.
They didn't risk much of their money
Prior to the housing bubble, if you owned a $2,000,000 home, it meant you probably had more than a $1,000,000 in equity because very few borrowers tried to manage a note over $1,000,000. During the housing bubble, loans over $1,000,000 became common. Too common.
Todays featured property was purchased for $1,987,500 on 9/30/2006, right at the peak. The owners used a $1,490,300 first mortgage, a $298,050 second mortgage, and a $199,150 down payment.
Two months later on 12/6/2006 they opened a $250,000 HELOC and had immdieate access to their downpayment money plus another $50,850 in free money.
On 3/6/2007 they refinanced with a $1,770,000 Option ARM with a 2% teaer rate and obtained a $150,000 HELOC.
-$1683 ………. Tax Savings (% of Interest and Property Tax)
-$1954 ………. Equity Hidden in Payment
$817 ………. Lost Income to Down Payment (net of taxes)
$257 ………. Maintenance and Replacement Reserves
============================================
$9,332 ………. Monthly Cost of Ownership
Cash Acquisition Demands
——————————————————————————
$20,590 ………. Furnishing and Move In @1%
$20,590 ………. Closing Costs @1%
$16,472 ………… Interest Points @1% of Loan
$411,800 ………. Down Payment
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$469,452 ………. Total Cash Costs
$143,000 ………… Emergency Cash Reserves
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$612,452 ………. Total Savings Needed
Property Details for 20 WOODS Trl Irvine, CA 92603
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Beds: 5
Baths: 4 full 1 part baths
Home size: 3,800 sq ft
($542 / sq ft)
Lot Size: 10,236 sq ft
Year Built: 2006
Days on Market: 348
Listing Updated: 40519
MLS Number: S600723
Property Type: Single Family, Residential
Community: Turtle Ridge
Tract: Arez
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According to the listing agent, this listing may be a pre-foreclosure or short sale.
This Luxury Built Pardee Home is situated at the end of the cul-de-sac Nestled alongside Nature. Step thru the Gated entryway to two sitting areas, Built-in BBQ features Granite top seating gather around the firepit or just enjoy the nearly 10,000 sq. ft. lot and upgraded hardscaping. 5 bedrooms & Bonus Room allow room for any family needs. Designer Mahogany cabinetry, Viking Professional Stainless Steel appliances, Blt-in desk, Baltic Brown Granite Counters Center island w/bar seating. Living/Family Room Fireplaces. Spacious Family Room with cozy breakfast nook. Laura Ashley Plantation Shutters throughout. Recessed Lighting, Wired for surrond sound or security. 3 car garage features Remoteless entry & Epoxy flooring. Master suite features elegant Master Bath with jacuzzi tub and dual shower fixtures. Upstairs laundry room. Upgraded carpeting and neutral decor makes it easy for this to be your new home, VERY CLEAN and hardly lived it.
In Las Vegas where prices are very affordable, a small decrease in affordability will not make much difference; however, in inflated California markets where every penny of affordability is needed to support pricing, rising interest rates will be a serious problem.
Banks need a moral stigma to be associated with loan repayment. If the transaction were viewed by borrowers as a simple business transaction — which it is — then issues of morality are not effective at cajoling debtors into repayment, particularly when default is in the best interest of the debtor. Banks have long relied on borrower morality to get repaid.
Given these circumstances, only during brief periods of upward volatility (sucker rallies) is it possible to reap major appreciation benefits from owning residential real estate. It has always been about utility of ownership, but people are only now detoxifying from the kool aid enough to see it.
This Luxury Built Pardee Home is situated at the end of the cul-de-sac Nestled alongside Nature. Step thru the Gated entryway to two sitting areas, Built-in BBQ features Granite top seating gather around the firepit or just enjoy the nearly 10,000 sq. ft. lot and upgraded hardscaping. 5 bedrooms & Bonus Room allow room for any family needs. Designer Mahogany cabinetry, Viking Professional Stainless Steel appliances, Blt-in desk, Baltic Brown Granite Counters Center island w/bar seating. Living/Family Room Fireplaces. Spacious Family Room with cozy breakfast nook. Laura Ashley Plantation Shutters throughout. Recessed Lighting, Wired for surrond sound or security. 3 car garage features Remoteless entry & Epoxy flooring. Master suite features elegant Master Bath with jacuzzi tub and dual shower fixtures. Upstairs laundry room. Upgraded carpeting and neutral decor makes it easy for this to be your new home, VERY CLEAN and hardly lived it.