Borrowers Balk At Lifetime Of Debt
The 35 year loan program from the California Housing Finance Agency has been out for a while and the ModBee checks to see how it's going. "'For anyone who can fit into this program, this is the way to go. You can't beat it,' Neal said of the loan to finance up to 100 percent of a home's price. It can be combined with other options for a loan value of 103 percent."
"Yet, the loan is little used. Neal has issued five of the loans since the program started in March. Statewide, 127 of the loans have been approved."
With so much use of interest-only and adjustable rate loans, policy makers must be scratching their heads as to why this program isn't being adopted.
"Neal used the state program to help Davis and her family buy a $211,000 house. 'They put more money down on their car.'"
Mercury News informs us that the state will help out "low" income households. "CalHFA-backed loans in Santa Clara County are available to one or two person households with incomes up to $122,168 a year."
In California, they even have a different measure for debt. "Lenders traditionally limited borrowers' housing costs to 28 percent of their incomes, and total debt payments to 36 percent. In California's high-cost housing markets, however, lenders have stretched their limits for a borrower's total debt load. For a well-qualified borrower, '45 percent is very doable.'"
18 Comments:
Ben,
Tons of bubble-related Q&A in the "Ask Realty Times" column today:
http://realtytimes.com/rtcpages/20050506_askrt.htm
Sample questions: "Why won't my beautiful house sell even when priced less than I paid?"; "My house doesn't appraise for the sale price. What do I do?"; "My husband thinks the market is going to tank and wants to sell and rent. I don't want to. Is this a good idea?"
Good stuff.
So this couple needed an IO loan to lower their payment from $1500 to $1100 a month.
The clearly have no business buying that home. If they can't afford an extra $400 dollars a month, how will they handle their payment when their IO term is up, and rates are up, meaning a monthly payment of much more than $1500.
What, are they gambling that inflation with bail them out. Assuming they still have a job.
I also blame the peddlers pushing these loans so they can may cash of the orgination fees. They should all be sued...
It's all about finance.
Interest-only loans are a new development. In the last boom/bust here in Calif, we didn't have I/Os. So there was a natural brake on asset appreciation. Today with the majority of new Calif homebuyers choosing I/Os to stretch to afford homes, there is no such brake.
There's a law of diminishing returns on term mortgages. For example, a conventional 30yr 500K mortgage at 6% costs $2,997 a month. If you extend that term to 60 years (twice as long), the monthly payment is $2,570 or 15% less. So in a simplistic sense, you could "afford" to pay 15% more for a home with a 60yr. But if you extend the term to 100 years, the monthly is $2,506, only 2% lower than the 60yr. So there is a point where extending the duration doesn't help.
But with I/Os, there is no term so everything depends on the rate itself. The only way to keep bringing the monthly lower with I/Os is to lower the rate.
So we've seen rates come down and that got real estate moving. Then we've seen ARMs and I/Os come along and that has lowered the monthly. But there's not much left to do. Extending the duration is an option but a minor one.
I worry that if too many are carrying I/Os, the market will box itself into a corner. If rates rise and/or prices fall, millions of so-called "homeowners" (i call them "homeowers") would take a savage beating...as would the mortgage holders.
So not only are I/Os risky for buyers, they are risky for our whole financial system. And now that you have government entities (state of Calif) fueling this by offering cheap govt financing for supposed "low income" households (i.e., as if $122K a year is low), this is getting extremely dangerous.
This needs to end now.
An interest-only mortage is not an "infinite" term loan. Interest-only mortgages consist of an "interest" period (typically 10 years), followed by an amortized period (typically 20 years) where the principle is paid off.
This is one reason why interest-only loans are riskier. After the IO period the monthly payment jumps substantially, as the amortization period begins, and the payment is higher because it's only amortized over 20 years rather than 30.
Combine an IO loan and an ARM and the buyer could get double whammy if interest rates rise.
***
---An interest-only mortage is not an "infinite" term loan. Interest-only mortgages consist of an "interest" period (typically 10 years), followed by an amortized period (typically 20 years) where the principle is paid off.---
Given the magnitude of the house price rise over the past 5 years and given the high pct of people using I/O now, I can see a housing slump lasting 10-20 years unless the decline dead ahead shakes out all the weak hands in one fell swoop (or is it one swell foop?).
If we see a slump, most if not all of the I/O brigade will be underwater on their mortgages. Then to make matters worse, once the I/O portion of the program expires, their monthly payments shoot up. A 30yr conventional $500K mortgage at 6% costs $3,000. Amortizing over 20 years, the same mortgage costs $3,582---20% more. If rates rise to let's say 7.5% instead of 6%, the payment is $4,027---34% more.
That's a big difference. If this isn't risky, I don't know what is.
prof,
i've been lending for 20 years and have never seen the kind of wreckless behavior before. if makes sense if you consider how many people are involved in the feeding chain. volumes peaked in 2003 and the only way to feed the "volume monster" was to step over the line of sound credit underwriting standards. i will tell you that the majority of loans written are 80/20 (read no equity), done on a stated income basis (because they don't have the income to qualify otherwise), fixed for no more than 3 years and usually carrying a "soft" prepayment penalty. not only will they get whacked by rising rates when the loan adjusts, but they won't be able to get out of the loan. risky, you bet.
deb,
prepayment penalties are generally 6 months interest. penalty is in place anywhere from 1 to 5 years, usually 3 years.
"When the bubble deflates and pops, economic deflation will control our daily lives....Get yourself some gold and silver... it will buy your bread to survive in the coming future... while paper Federal Reserve Notes will burn in your furnace to heat your homes."
I don't understand why you would argue for a deflationary scenario and then advise us to prepare for hyperinflation. While I agree that we might be in for a severe 1930's style depression, gold is not the way to prepare for it because the price of gold will go down in deflation like everything else. In fact paper money becomes more valuable during a depression since there is little demand, sellers cut prices. During the Great Depression, CPI inflation was something like MINUS 10% per year as prices fell. Now, notice I said "paper money" and not bank deposits since banks will fail in a depression due to bad loans, and then you cannot get your money out of the bank unless you believe the FDIC can absorb all of the bad loans. That's why grandpa keeps his money in his mattress.
Melody,
I hadn't heard that particular number but Greenspan said this week that total derivatives sit at $220 trillion so that kind of an increase wouldn't be out of the question. I did know about the JPMorgan position.
That's a lot of paper. I hope it is stronger than it looks.
I disagree we will have "deflation" as we did in the 30s. I rather think we will see a period where the gov prints money to dig us out of the credit bubble they've created. How else will the gov pay off it's debts?
But that will not save the housing bubble, since housing will scale with salaries, and imports from China/India will keep our wages low.
But the money the gov prints will lead to future increases in the prices of commodities: gold, silver, oil, etc, and their respective companies that mine them.
Just my opinion.
Anon 12:24
I am not agreeing or disagreeing, because I don't know, but it seems to me that if they are going to just print money, they better make sure it doesn't get into the hands of real estate speculators, or it won't get us out of the debt bubble. They better just print it and load it onto a cargo ship and send it to Japan and China to buy back the Treasury notes.
John,
The bank positions are nuts.
John,
"look at those derivative positions...still think your money is 100% safe in a bank?"
I agree. Cash in this case is not king. If banks are not safe, should be hold physical cash.
Some have suggested gold and silver, but won't those decrease in value in a depression. Gold is not money anymore, and cannot be used to pay debts. The gov only takes federal reserve notes, so I don't understand why some people think gold will appreciate in the coming depression. This time, gold may actually decrease in value?
Very confused. I'm sure that's what the gov wants...
Still feel deep down inside that gold is safer that federal reserve notes.
(we will see a period where the gov prints money to dig us out of the credit bubble)
It surprises me how many people think that the government can simply print money. I think Germany tried that once, leading to hyperinflation and world war, with the famous pictures of German women burning worthless paper money in their stoves to cook dinner. As a result, the US money supply is not directly controlled by the government, nor does it "create" money. In a fiat money system, banks are the entities that create money out of nothing when they make loans. The govermnent sets reserve requirements for the banks and fed funds rates. Practically, the closest the government can come to "printing" money is to lower interest rates to zero. It came pretty damn close with extended period of 1% fed funds. The key point of this is that you can bring interest rates as low as you want but in order to increase the money supply, there has to be a willing borrower and a bank with sufficient capital reserves to make the loan. That is why Japan has no inflation with 0% interest since its banks have inadequate reserves due to bad loans.
Back in the gold standard days, the bank reserves actually had to be in gold, but now reserves are in fed funds instead of gold. That is why if the derivatives explode, banks may fail, reserves will decrease, economy will slow, inflation may give way to deflation. That is not the time to own gold. The time to own gold is in hyperinflation like the seventies, we had stagflation due to rising oil prices making goods more expensive which led to workers demanding raises which squeezed corporate profits leading to a vicious inflationary cycle. And guess what we did? We blew a GOLD bubble bringing the metal up several hundred percent before it crashed and has not regained that level to this day even without adjusting for inflation!
Anon 4:12
Iv'e seen um printin it. I even have sum.
4:12 anon,
I agree, someone must borrow a dollar into existence. If people become afraid to take out a loan, the central bank will be pushing on a string. They already are, actually, because businesses are refusing to borrow. Some say that's why the Fed created the housing bubble, because that was the only willing money creation tool at their disposal. Thanks, good comment!
---BoulderBo wrote: i will tell you that the majority of loans written are 80/20 (read no equity), done on a stated income basis (because they don't have the income to qualify otherwise)---
If I were king, I'd outlaw stated income loans. What kind of loan is this? Who loans money to someone without any idea of their financial situation? I have an acquaintance who just bought a $300K home on a "stated income" basis. She has no assets. She works part-time (if at all). She makes less than $30K a year.
To top it off, the home she bought is an "investment" property. It is out of state and she has no plans to live in it. The rent it generates is less than the mortgage---so she's in a negative income position. Not a good thing when you have no assets and no full-time job.
I asked her how she qualified for a loan. "Stated income," she said. What's that? "My broker said I needed to show $65K household income to qualify. So I wrote down $65K on the form. My broker says they never check," she said. Nice.
Lendee: I'd like to borrow $300,000.
Lender: OK. What's your collateral?
Lendee: This killer home I'd like to buy. It's an investment, you see. Though the rent doesn't cover expenses and I'll be losing money every month, the real estate market is so hot that it doesn't matter. We'll all be rich very soon!
Lender: Fair enough. How do I know you can pay the loan off? How much income do you make? How long have been at your job? What other assets do you have?
Lendee: None of your business.
Lender: Fair enough. I think we have a deal.
The federal government CAN print money, as long as it runs a budget deficit. The Treasury sells bonds to pay for the deficit. If there is insufficient demand for the bonds, then the price of the bonds will fall and yields will rise. The Federal Reserve can fight this rise in bond yields by buying the bonds itself, using money created out of thin air. What happens is that the Federal Reserve just creates a checking account at a Federal Reserve bank containing as much money as it wants and then uses this money to buy the bonds, thereby pusing the bond prices back up and the bond yields back down. The Federal Reserve creates and destroys money like this all the time to control the overnight rate, but there is no legal or practical reason why it can't also try to control the longer rates.
The "pushing on a string" phenomenon only occurs when the government is reluctant to use the full powers of money creation and deficit financing. My feelings is that this phrase was invented as a way of intentionally deceiving the public, since there are always many constituencies that WANT more inflation. For example, everyone involved in this housing bubble would love to see hyperinflation. Normally, the rich and the bankers and the other powers that be want to avoid hyperinflation. By talking about "pushing on a string" these powers that be can make it sound like the government is incapable of creating the desired inflation, and thereby keep the masses from demanding it.
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