Thursday, February 09, 2006

The Payment Paradigm


"Get a LOW mortgage payment!"
"Payments YOU can afford!"
"OWN a condo! Payments under $1995!"

I'm sure that many of you have seen similar signs or advertisements out there. It's all about the payment baby!! It seems the housing industry has taken a page from the car finance industry. "Sell the payment, not the price!".

I know I have touched on this issue before, but this article by Rich Toscano of Professor Piggington fame, got me thinking again.

In the last asset bubble that burst a mere 5 years ago, the new paradigm was the 'new economy' and that P/E ratios could defy logic for long periods of time. This time we are looking at the "Payment Paradigm" (PP)!

That is all that anybody cares about anymore. When I'm getting the information needed to price a loan for a broker, I ask "what kind of loan is the borrower looking for?" The answer I get more than any other: "Lowest mortgage payment possible...".

Ever wonder why the auto finance guys always want to talk payment, and "what are you willing to spend per month?". The finance guys will find a way to make the payment fit. Even wonder why car payments terms have gone from 48 months to 60, 72, 84, and even 96 months? If the auto industry ever takes a page from the mortgage industry, then they could start doing option-ARMs to get more people into ultra-luxury cars, and exotic sports cars. You thought Bentley' and Ferrari's were expensive now...just wait until the option ARM gets the payments down on those bad boys!!

The same thing is going on in the mortgage industry. First it was the ARM loan. Rates were declining, and there was still a decent spread between short and long term rates. COOL...payment goes down a bit, I can 'afford' a more expensive home.

Next you have the Interest Only (I/O) loan. This is usually tied to an ARM, with an interest only period of 2-3 years for most subprime loans, and up to 5, 7, or 10 years for your alt-a or a a-paper borrowers.

But as property kept appreciating...the payments were essentially 'staying the same'....for the short term anyway. Who cares if the house is 200k, or 600k, the payment is the same! That's all that matters right?

After all, most people are moving every 3-5 years now. Since not many people are staying for 30 years, why get a 30yr mortgage?!?!? Get an I/O ARM, that will keep your payments low until you move.

The prices kept going up, but the mortgage industry found a way to keep "payments" low. Enter the option-ARM, or neg-am loan. This beauty of a loan has a 1% payment option...in addition to an interest only payment, a 15yr amortized payment, and a 30yr amortized payment. Notice I didn't say fixed...because the rates are not. Even the 15 and 30 year payments are tied to an index that fluctuates. Your payment will be amortized over 30 years whether the rate is 5% or 9%. So even your 30 year "fixed" payment will adjust with these loans. But let's get back to the 1% payment.

Let's take a $1,000,000 loan. The 1% payment is only $3,216.40 a month!! Hey, not bad for a million dollar loan!! Even with property taxes of $900-1000 a month, I know here are lots of families that could 'afford' a $4200 monthly payment. Just to give you something to relate to, the interest only payment would be about $5000 a month (yes, that is about $1800 a month of negative amortization). The problem is that, even at a 6.25% rate, which is pretty low for a fixed payment in a million dollar loan, the payment would be $6,157 a month...before taxes. Not many people can afford a $7200 monthly mortgage payment...no matter what the price of the home. But who cares, I'll take the $4200 payment!! After all, property only goes up, and I will 'automatically' make money when I sell!! ...right?!?!?!?

Welcome to the 'new' "Payment Paradigm". Never mind the price, just worry about the monthly. Get in trouble? ...get a HELOC, take out a second, refi INTO an option-ARM if you aren't there already!

Like most other "new paradigms" that stray too far from the fundamentals, I think this one will pass. I think the next 24 months are going to be very telling for the entire industry. Most of the "PP" depends on these artificially low payments for shorter, fixed periods of time. The clock is ticking now, but in 2007 1.4-1.5 trillion dollars worth of loans are going to put this new paradigm to the test.

How do YOU think it will turn out?!?!?

I'm going to go price out a new Lamborghini while you think about it....

Have a great weekend! If you need more content than just this blog, there are about 400 posts (and growing!) to read in the forums. As usual, I look forward to the comments and feedback!

-----
I am going to keep making my posts over here, but most of the comments are happening at the new site. Go to...
www.housingbubblecasualty.com
or
www.anotherf@ckedborrower.com

...if you would like to see more comments and activity. Don't forgot to check out the activity in the FORUMS!

SoCalMtgGuy

8 Comments:

Blogger octal77 said...


This topic is fascinating on two
distinct levels:

1) It illustrates how historically
low interest rates and loose lending
standards can morph into byzantine
financial products that encourage
borrowers to delay the day of
reckoning into the future.
2) But what I find even more
interesting is why we as a culture,
accept such nonsense as the way
to live a happy, productive life?

My quesiton to the group is: Why?
Why does our culture encourage
the I-deserve-it, gotta-have-it-now
mentality? I am 56 years old and
I don't recall such cultural
attitudes when I was a kid. Whats
changed? Will it ever end?

2/10/2006 8:19 AM  
Blogger SoCalMtgGuy said...

octal77

See the post under "POPULAR POSTS" (on the right side) titled "MTV Cribs..." OR click the link below.

That might help some.

SoCalMtgGuy

MTV Cribs, Bling, and the housing bubble??

2/10/2006 8:30 AM  
Anonymous NickV said...

We went car shopping recently for essentially the first time. I was astounded that the sales-droid wanted to discuss payments, not price. It really blew my mind. I'm still having problems getting over the concept that people shop this way.

Now you tell me that people shop for houses this way??? Not sure my brain can Paradigm Shift that much.

2/10/2006 12:24 PM  
Blogger octal77 said...

Socal

...See the post under "POPULAR POSTS" (on the right side) titled "MTV Cribs..."

Thanks for the link. It's a great
read and I highly recommend to
everyone.

Slightly OT, but I hope that a
Micheal Moore type is making
a documentary film about all
this hysteria. Future generations
could view it and shake their
heads in disbelief.

Thanks for your great blog.

2/10/2006 1:25 PM  
Anonymous Anonymous said...

Well as a 56 year don't you need fools like this "gotta have it now" group to sell your overpriced pos house. If you didn't have them then youur house would probably be worth about 40% less.

2/10/2006 2:29 PM  
Anonymous Anonymous said...

octal77: I personally think it has to do with greed than anything else. The appreciation has been happening for a few years now and this assures people real-estate just keeps going up. People are either afraid of being priced out or want to join the crowd to make money. Trust me, I talked to 10 people -- even educated ones -- 9 our 10 thought it would go up and up. As an independent thinker, I didn't buy in this crap. I knew it drops at one point but really hard to know exactly when.

2/10/2006 3:34 PM  
Blogger grim said...

I just completed a compilation of articles from the NY Times that covered the 1980s real estate bubble and it's crash.

Please, take the time to read it, it's an eye opener..

Home Prices Do Fall

Caveat Emptor!
Grim

2/10/2006 4:20 PM  
Blogger Richie said...

I'm sure many people are thinking this is all a "new econonmy" for real estate. You no longer need to live in a house 10-15 years before you can sell it at a profit. Now, you just need to live in it 2 years (mainly so you can get your profit back tax-free) and then sell it for double what you bought it for. That might work once, but I doubt it will work twice.

-Richie

2/10/2006 7:57 PM  

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