Tuesday, September 12, 2006

Do you own your house? ...or does your house OWN you??

NOTE: This book title deals with allergies in the home. I think another book could be written with the same name...but along the lines of my post below.

I was restocking one of my accounts in the Palm Springs/Palm Desert area when one of the techs needed me to move out of the way so they could reach some instrument. I said "how are you doing?" They replied "I'm alive." I said "That is a good thing!" They said "I guess..." in a less than chipper mood as they left the room.

I assumed somebody was just having a busy day. It wasn't until I heard the next conversation that I found out why.

I guess it was this persons turn to drive to go pick up lunch, or run other errands for the office. I heard the person quip "I only have 4 dollars in my wallet until I get paid again. I just paid my mortgage and that is all the money I have until payday on Friday."

I don't know this person and it wasn't my business to say anything. I just listened as this all happend about 8-10 feet away from me. Now I know nothing of this persons finances, what their mortgage is, or what they 'own'...but I do know that the mortgage payment, however big or small it is, is putting some serious stress on this person.

I would assume the property is at least 300k, as that is pretty much a 'starter' home in the Palm Springs/Palm Desert area. I'm not here to debate this person or their situation...but to ask the question: Does this person own their house, or does their house own them?

I remember just a few years ago that it was OK to move somewhere and rent for a little while before making any decisions. I remember those 'rent vs. buy' calculators which have become so 'outdated' the past few years as the ONLY option was to buy, buy, buy!

I remember when it didn't make sense to buy unless you were going to be in the same place for at least 3-5 years. Oh wait, that was before the days when 5-10k per month of appreciation was 'in the bag'! You see, real estate is generally a long-term investment. It takes time for the real estate to appreciate and for the principal to be paid down. Not to mention the fact that you have 5-7% transaction costs that need to be figured in when buying/selling a piece of property. It wasn't that uncommon for people to actually RENT for a year or two because there was uncertainty with their job or they were actually going to save money for a downpayment. They didn't know if they would be moving, getting promoted, or changing jobs. It was the smart financial decision to make because MOST of the time it didn't make sense to buy a home for a short or uncertain time frame. Not to mention that it is OK to get on your feet, get some money saved, and make an informed decision when the correct time comes.

The problem came the past 5 years when if you waited a year or heaven forbid TWO years, you either lost 100k+ in 'appreciation' or became priced out 'forever'. What most people didn't realize is that they were competing with the rest of the masses who were also rushing to buy, buy buy...at whatever costs. The lenders were all too willing to 'help' people 'afford' the 'American dream'. Don't make enough...state your income. Don't have a downpayment, no problem...you don't need it. Heck, we will even give you 3-25% at closing to help you pay closing costs and even furnish the place. Have a BK, don't worry...we won't hold that aginst you. Want lower payments until you get promoted, make more money, or win the lottery...we have I/O and neg-am. You need to buy TODAY because prices are going up...look how rich everybody else is getting.

It is at this point that I loved to ask people: "what happens if property doesn't continue to keep going up?" You would have thought I just gave the Pope 'the finger' the way people would look at me. Heaven forbid this guy actually question the appreciation of housing, but he muttered the 'R' word at the same time. What do you mean it can make more sense to RENT than to buy?

For the past few years people quit 'doing the math' when making decisions about real estate. Sure, many people made a lot of money, and many more had a lot of 'equity' in their property. BUT, we are going to see the other side of a real estate boom starting in 2007. Just like people stood back and wondered why they bought 'whatever.com' when it was trading at 180 times future earnings, they will again stand back and wonder whey they paid 2-3 times the cost of 'renting' to 'own' the same property with creative financing. Just like the stock market, you don't have the gains until you SELL! Ever wonder why inventories are skyrocketing in many areas across the country??

That gets me back to my original question: Do you own your house, or does your house own you? If you have a fixed rate mortgage that you can afford...and by afford I don't mean having '4 bucks' in your wallet until payday, then you will probably be OK provided you are not forced to sell due to relocation or other unforseen circumstances. That said, you truly don't own your house until it is paid off. That is something that I think will become fashionable again some time here in the next decade. I remember when several friends and neighbors made that last payment. They were so excited to be completely DEBT FREE! No mortgage, no car payments, no credit cards...just property taxes and insurance.

If you have an I/O mortgage, you are just renting from the bank and your state. You do NOT own your house at this time. Sure, on paper, it is yours...but if you doubt me, stop making your mortgage payment for a few months and then let me know who REALLY owns that house. With an interest only mortgage, your principal balance isn't changing and you get the added joy of paying property taxes. Sure there is a tax write-off, but in most of the bubble areas that doesn't make up the difference between 'owning' and 'renting'. That wasn't a problem when property was increasing in value every month, but treading water financially when prices are flat or falling is NOT a good place to be, especially when facing an ARM that is about to reset to a much higher payment. Making higher payments on a decreasing asset sounds about as much fun...as renting! Ha ha...just kidding. You get the point.

Like I have said countless times before, 2007 is going to be the year of reckoning. We are going to find out who owns their house, and whose house OWNS them. I bet there will be thousands of home 'owners' who will wish they could give a landlord 30 days notice and get on with their lives. But instead, they will be trying to sell an 'asset' they over-paid for, in a market where every other person getting OWNED by their house is trying to sell as well. The same people competed with each other to buy these properties with creative financing...and when the tide really turns, they will all be scrambling for the door. If you think I'm crazy, then please tell my why less than 1-2% of all loans in 2000-2001 in California were I/O. Then in 2004-2005 you had over 80% using this kind of financing?

Who is getting OWNED.....YOU, or your HOUSE?

I look forward to the comments and feedback...



Anonymous Anonymous said...

How does the mls manipulate home price declines?

It seems the price drops are not be reflected in mls statistics.

Also if one is a business owner and wants a stated income loan with large down payment, how does one get the best rates?

9/13/2006 5:18 AM  
Blogger SoCalMtgGuy said...

All of the 'extra incentives' that were used to sell the property are not reflected in the MLS statistics. It doesn't say, the house sold for 450k, with 50k of 'free' upgrades.

If you are a business owner with a large downpayment, it should be fairly easy to get a loan with a decent rate. The higher your credit and the more you put down will help get you a lower rate.

If you plan on staying a 4+ years, I would suggest buying the rate down on a 30-year fixed mortgage. Your breakeven is about 3 years for your rate buydown points.



9/13/2006 8:40 AM  
Blogger powayseller said...

Check out Nouriel Roubini's post about national housing prices dropping 25-30%.

Read my comments at the bottom, where I explain the impact of 100,000 borrowers in San Diego, who took out I/O or option ARMs in the last 2 years.

Here's my comment, copied for convenience:

According to Loan Performance, 68% of purchases and refinancings in San Diego in each of the last 2 years were interest only and option ARMs (Great research, Kelly Bennett at VoiceofSanDiego.org!). Bob Visini of Loan Performance told the reporter that this was nothing to worry about, since 69% of homeowners in San Diego have fixed rate loans, so only 31% have adjustable rate loans.

What he doesn't understand is that homes are sold at the margin. In San Diego, considered the canary in the coal mine for the housing boom, we sold 40,000 homes per year at the height of the boom (this year it's going to be about 30,0000). If 68% of buyers in 2004 and 2005 got I/O and option ARMs, that is 54,400 buyers. Now add to that 68% of refinancings in 2004 and 2005 were of these loans; let's assume that the number of refis equals the number of purchases in the refi-crazy years of 04 and 05. That gives us over 100,000 people who have an interest only or option ARM "neutron" mortgage. Let's further assume they will try to sell in 2007 and 2008 as their loans reset.

Now we need to downward revise the current 30,000/year sales pace to 20,000 sales for 2007 and 2008, due to the continuing housing slowdown. It will probably be much less, but I'm being generous here.

If only 20,000 people sell their homes each year, and in the next 2 years we get 100,000 people listing their homes because their loans reset, the excess inventory alone is going ot put severe downward pressure on home prices. Now add to this that these sellers are very motivated, as they are probably in foreclosure, or it is an REO property already, and the downward pricing pressure is intense.

What everyone needs to understand, including Bob Visini of Loan Performance, is that housing prices are set at the margin. The homes sold set the price for the entire city. Let me repeat that: the 30,000 homes sold this year in San Diego set the price for the other 1.1 million homes which are not sold!

So once these ARM holders sell in the next few years, the prices of the rest of the homes will come crashing down. Now I just convinced myself that my 35% - 50% nominal drop in San Diego's median house price is being conservative. We will probably end up below replacement construction value, due to the sheer number of resetting loans. We will have about 5x regular inventory in distress sales, and they will set the price for the rest of the market.

Schahrzad Berkland

9/13/2006 1:10 PM  
Anonymous Anonymous said...

2007 is the reckoning, all right, but this will go on an on. The defaults are starting now, but they'll be growing well into 2008, because of the time delay in foreclosure and because none of the data out there today can capture all of the refi's done. A quick calc is that about 16m houses changed hands in 2004 and 2005 and if 50% of these were done on I/O loans, then that is about 8m houses, median proce was say US$300,000, then at 80% leverage that is 2.0 trillion of I/O mortgages outstanding with a nosebleed hike coming next year. Put that in context, that's 22% of US GDP and if 20% of these loans go under, then somebody has to absorb losses of 4.5% of GDP (0.22*0.2 or almost all of the book value of US banking system. I would put a 20% write off of these loans as extremely conservative. This is before you look at refi'd debt and before any significant reduction is appraisals flows through the system.

This thing has the potential to bring down the whole US financial system, never mind the few miserables that got sucked into this thing.

9/14/2006 2:56 PM  
Blogger Out at the peak said...

Powayseller: While I agree that we are in a world of hurt, I do not think 100% of the people who got ARM loans will be forced to sell. There will be a percentage that will pursue other options.

If prices drop more than 40%, there will likely be rampant crime and chaos as part of the fallout. Scary.

9/18/2006 11:36 AM  
Anonymous Anonymous said...

hey socalmtgguy,

im planning on buying a house in 2 yrs when the majority of ARM resets and ill have a decent down payment, what is exactly is "buying the rate down on a 30yr fixed mortgage" and "breakeven is about 3 yrs for your rate buydown pts"? thanks.

9/19/2006 9:19 AM  
Blogger SoCalMtgGuy said...

you can pay points up front (1 point = 1% of the loan value) to buy the rate down. It usually buys the rate down .5 to 1.0...depends on the lender and the loan.

Depending on the amount of the buydown, it will take about 3 years to 'breakeven' on what you paid up front.

Example. You pay $1000 to buy your rate down. This saves you $40 a month, so it will take 25 months to 'breakeven' so to speak for the buydown point.

If you plan on staying someplace for a while, it is worth doing a buydown as it will save quite a bit of money over the long haul.

I hope this helps answer your question.


9/19/2006 1:06 PM  
Anonymous Anonymous said...

thanks for the info socalmtgguy

9/19/2006 4:20 PM  

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