Wednesday, August 02, 2006

The 'old way' vs. the 'new way'

I know, I know, it has been too long. But look at it this way, nothing 'major' has happened yet. Most of you that have read this blog for a while know what is coming. Sure, it is 'nice' or at least 'validating' for people on the 'bubble side' of things see inventories rising, appreciation slow or even go negative, and the "oh my gosh, the market turned so fast, I wasn't able to flip for huge money" stories that are showing up more and more.

The media is doing a great job in its role of 'lagging indicator', by warning people about the pitfalls of creative financing and adjustable rate mortgages. Too little, WAY too late. But then again, if they had tried to tell people to not use interest only ARMs to buy homes they couldn't afford a few years ago, people would have laughed in their face. Real estate only goes up....duh!

That said, let's look at the 'old way' that most people used to buy property. Lets use the 'new standard' for homes/condos/townhomes in most areas...the ever popular "Starting at only $400k!!" I am going to use 'rough' numbers here to illustrate a just bear with me. I am also going to assume these people have NO other debt that would figure in their debt car payments, no student loans, no credit card bills...pretty big assumption....but it will only help make the point when you see how much most people are spending on housing.

In the 'old days', you would need an 80k down-payment to buy a 400k home. If you were an individual or family making 80k a year, if you saved 10% of your gross income JUST for a down-payment, it would take 10 years to save your 80k. I know that most people would have invested the money along the way, so let's just say they put in in fixed income because they didn't want to lose any money. So figuring in the investing, lets say it would take about 7 years for them to save the money needed for the down-payment. A $320,000 mortgage at 7.5% would yield a principal and and interest payment of $2237.48 per month. Throw in another $400 a month for California taxes, and that brings the total to a rounded off $2640 per month...and that is NOT including any HOA or association fees that most condos and housing developments have today. That 80k a year translates to $6666.67 per month (GROSS). That housing payment is 39.6% of gross income...and remember, we are NOT including any HOA or other maintenance. Throw in a $250 or $300 HOA, and we are pushing a 45% debt debt ratio, JUST on housing. That doesn't leave a lot of money to save for retirement, disability insurance, other investments. Not to mention the new Escalade payment, the Best Buy card, Visa, Mastercard, the SDG&E bill, and the gas card. That is why the 'old way' was to keep housing costs at 30-35% of gross income. To really 'afford' this house, you would need to be making at least 100k a year. If you are making 100k a year, a $3000 a month housing expense puts your housing debt ratio at 36%. That is not too bad assuming you don't have a lot of other debt.

The problem is that the median income in California is about 50k a year...well short of the 100k+ needed to really afford these 400k "starter homes". Again, crazy me was actually assuming people had some 'skin' in the game by putting down 20%. So remember that the mortgage numbers above are for a 320k loan.

With my new job, my territory consists of San Diego, Orange County, Riverside, San Bernadino, Palm Springs/Palm Desert, Temecula, and everything in between. So needless to day, I have seen most aspects of Southern California housing. From Crystal Cove and Newport Beach all the way to the 909 and Indio. Today I was driving the 'back way' from Temecula to Palm Springs. I was driving through Hemet and I was completely amazed at ALL of the housing developments that all had starting prices of "400k". I didn't spend much time there, as I was just passing through, but all I saw were gas stations, fast food, and your basic shopping center type stores. I by no means saw the potential for thousands of the 6-figure jobs that would be needed to purchase the hundreds and hundreds of homes that were for sale "starting at 400k".

These same homes are all over the desert communities. I know that there are quite a few people making 100k+, but there is no logical reason why every new home or condo should 'start' at 400k!

I know we have done it before, but let's look how MOST people are/were 'affording' these 400k starter homes. First off, most are not putting any money down. The lenders I used to work for had 80/20 combo loan programs, but they also had 100% 1-loan programs, that could be interest only as well. Take a 400k loan at 5% Interest Only (a typical rate of 2 years ago), and you get a payment of only $1666,67 per month!! Saweeeeet!!! Throw in some takes and you are about $2000-2100 per month. With the 'relaxed' lending standards, the lenders I worked for would take a 'full doc' debt ratio of 55%...and a stated income debt ratio of 45-50% depending on the loan. Take the $2100 payment at a 55% debt ratio you only need to gross about $3850 per month ($42,600 per year) to 'afford' a 400k loan. The income needed would be higher on the 80/20 loans because the 20% seconds were NOT interest only, and were at higher interest rates. I won't even get into the neg-am and other creative financing at this time. Check out the archives and popular posts for more info on those loans.

The scary part comes with the 'stated income' loans. Go to this website and click the 'facts' on the left hand side. When a recent sample of stated income loans were compared to IRS records, it was found that 60% of the loans had income exaggerated by 50% or more! Now I know that the study was only a pool of 100 stated loans, and many of you won't believe it, but from what I saw on a daily basis I don't doubt this stat one bit. There were broker offices that only did stated loans. Some brokers would laugh when I asked if the borrower was going full doc or not.

HOW else could things get sooooo out of whack from actual incomes???? Come on, I'm waiting.

During the past 5 years, down-payments have slowly faded away...but lending standards have faded into oblivion.

It will only be a matter of time until the fundamentals return. Making a low teaser payment for 2, 3 or 5 years only works when prices go up. Many people are going to have that sick feeling in the pit of their stomachs when their teaser ARM adjusts and their property is worth 100k less than they 'paid' for it....and there is nothing that the great econoMISSED Leslie Appleton-Young can say to take that feeling away.

Why save for 6, 7, or 8 years and get a fixed rate loan when you can just 'state' your income, not put any money down, and make 6-figures in appreciation a year??? Eventually you come to a point where the dollar can't be stretched anymore. You come to a point where the massive 'guaranteed' appreciation isn't there. You come to a point where the mentality shifts. Actually...we are just getting there now.

I look forward to the comments and feedback...



Anonymous Anonymous said...

Have missed your insights, but hope the job is going well.

Have seen a clear change in attitudes - and that turn in many joe sickpack market perspective was quicker to happen than most of us thought. Still, instead of fighting the education battle (ie, facts to demonstrate the problem) I now find myself just not agreeing (I think we've all stopped preaching at this point) on the magintude of potential drop. Because 95% of people really, really don't want to know the details. Politics, 401K plans, the VCR, house financing economics...

People are talking about all these re-adjustments they're hearing about and when I ask 'would you even believe me that you've probaly seen 5-10% of the total loans you'll eventually hear about readjusted - 90% of those will reset into 2008 so it's the tip of the iceberg'...if they believe me the predictable reaction is similar to when one realizes you just left your wallet in a public place.



8/03/2006 12:28 AM  
Anonymous Anonymous said...

Welcome back.

the link is broken.

8/03/2006 7:04 AM  
Anonymous Anonymous said...

Great usual. The link is

8/03/2006 12:32 PM  
Anonymous Anonymous said...

Well stated article and quite correct. I remember when I bought my house in Las Vegas in November of 2000. The house was a five bedroom, three bath, three car garage on a 1/5th acre two story with views of the entire Las Vegas valley and Strip, as well as a 15X30 ft. inground pool in its own fenced off palm studded enclave. The cost was $205,000. I put 20% down and wrote the check at closing and I remember even then the mortgage folks saying hardly anyone put money down anymore. I did it to avoid PMI and because I felt it was the right way to buy. I sold the house in June 05 for an enormous profit. It turns out the prices peeked in June 05 in Las Vegas. The house next to mine, 1670 sq.ft, much smaller, no view, small yard sold for $355,000 in Nov. 04. The latest appraisal has it at $343,000. I bought my current luxury home in the Midwest for $227,000, larger home, custom built, on 4.3 acres of half forest and half lawns for cash from the LV sale. Now I have no mortgage, no debts, and my only concern is that a severe recession doesn't evolve into a great depression. I may be debt-free, which is great! But I still need to work.

8/04/2006 11:21 AM  
Blogger Out at the peak said...

Thanks for the new post.

You are spot on about a true affordability crisis. When I bought in Jan 2001, my income was stuck at $75K for four years, and my mortgage was $280K fixed at 5.5%. I just made ends meet every month. Nothing too fancy on the side. Things just got tighter over the years.

So I am unsure how people are truly surviving today's real cost. Of course, many are faking it, and that can't last forever.t

8/07/2006 5:27 PM  
Anonymous Anonymous said...



8/08/2006 10:52 AM  
Blogger jerseycityjoan said...

Great post and great attitude, too.

Keep up the good work.

8/28/2006 3:11 PM  

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