Sunday, May 22, 2005

"Free Money" Is Not A "Bad Day At The Races"

The NCTimes wants to help borrowers with the array of borrowing options. "There are other strategies for lowering monthly payments or increasing total borrowing ability, and those strategies rely on mortgage products that were not even available to most purchasers as recently as a decade ago, according to Doug Perry, of Countrywide Home Loans."

"'Home values and purchase prices have gone up so tremendously, it's led to a number of products to assist consumers to be able to buy and to provide flexible options so they can afford what they buy,' Perry said."

"When Paul Espinoza decided to refinance the home he owns he decided to go with an interest-only package in order to reduce his monthly payment. What he didn't know at the time he signed his refinancing documents was that his principal amount would continue to climb. 'The cost to you is really the amount that the principal goes up over the period of the loan,' said Espinoza who felt that he wasn't made fully aware of that possibility by his lender when he arranged for the new deal. 'I'm curious why this isn't mentioned by loan officers?'"

"Rob McNelis, president of the California Association of Mortgage Brokers' San Diego chapter said, 'We've all known this rapid price appreciation is unsustainable. Historically, the real rate of home price appreciation is around 3 to 3.5 percent; not a bad day at the races when you realize it's free money.'"

33 Comments:

At 3:19 PM, Blogger John Law said...

looks like loan officers be misbehavin...

 
At 3:27 PM, Anonymous Anonymous said...

Didn't know where to put this... In today's Orlando Sentinel:

http://www.orlandosentinel.com/media/photo/2005-05/17676873.gif

Can't believe people can see all this coverage on the bubble and still buy!

 
At 3:52 PM, Anonymous guynoir said...

("Historically, the real rate of home price appreciation is around 3 to 3.5 percent; not a bad day at the races when you realize it's free money.'")

Over the past 50-75 years, stocks have done much better than 3-3.5% and so have bonds. So if you were betting long-term on RE, you'd have to bet to show to collect (to extend the horse race theme.)

That's why the current mania is so dangerous. Owning your own home is a good thing for a number of reasons, not least of which is to be able to essentially "force save" by building equity. But that isn't possible if you go interest-only or buy at the wrong time.

RE, as the guy says, is not like winning the lottery. You can expect small gains over very long periods of time. But when appreciation outstrips historical averages three-to-five-fold for a stretch of years, you can expect a significant reversion to the mean.

Plenty of stock market analysts are quick to point out how risky it is to buy the market when it is historically overvalued. Your 10- and 20-year returns are dramatically lower if you buy in at the wrong time.

And how is housing appreciation "free money"? You are risking principal loss for a 3% annual gain. Even if you put nothing down, if the home depreciates, you are in the hole. And with prices at current levels, that hole can be very deep indeed.

 
At 4:00 PM, Anonymous Anonymous said...

"Can't believe people can see all this coverage on the bubble and still buy!"

Once media coverage of the bubble increases, fear will slowly replace greed. Suddenly, no one will be buying.

 
At 4:02 PM, Blogger JLP said...

I'm curious as to how the principal amount grows under an I/O loan. I didn't know that lenders could do that.

JLP

AllThingsFinancial

 
At 4:02 PM, Anonymous jimbo said...

('We've all known this rapid price appreciation is unsustainable.)

The boom in creative finance encourages homebuyers to pay less upfront or early in the loan term. This allows homebuyers to pay higher nominal real estate prices. Most buyers know that they will be paying significantly higher monthly payments down the road. The hope is that the home they are buying will have appreciated enough to make up the difference.

So it's clear that EZ finance has been perhaps the greatest single contributor to the home price boom, with groupthink and optimistic sentiment running in second.

I think what is happening is that we are essentially borrowing tomorrow's appreciation. The home appreciation we might have seen over the next 5-10 years has been compressed into the past five.

If the realtor in the article is correct and RE should only be appreciating 3% a year, we might even have borrowed the next 20-30 years worth of appreciation.

I can't imagine how this realtor can keep a straight face when he says that RE historically appreciates 3% a year when it has just appreciated 200-300% over the past 5-7 years in many markets.

 
At 4:14 PM, Anonymous Anonymous said...

4:02 jimbo -- I agree with you that we have borrowed tomorrow's appreciation. But a crash will pay it back a lot quicker than you might otherwise expect.

 
At 4:17 PM, Anonymous Anonymous said...

It really makes me wonder the motive behind reflation if it would ultimately fail.

 
At 4:20 PM, Anonymous Anonymous said...

Read the complete article that Ben linked. It is Alice in Wonderland. This just astounds me:

"Often, borrowers find that, if they keep the loan for its full term, the payments for the first half of the loan are low and manageable, and for the second half of the loan they could double, triple or rise even higher."

So will it be: "Shucks, Elmer, that tripling of our monthly mortgage payment shore is going to hurt some!" This fellow made his statement very matter-of-factly. I can't -- it just doesn't register that we are on the same planet.
Chip

 
At 4:32 PM, Anonymous Anonymous said...

Just the other day I was getting my hair cut & I started talking to my hairstylist about how crazy the housing market is.

After chatting for awhile I asked her if she rents. She said "no, I just bought a condo (in LA) a couple of months ago. I am really stressing about it though because if interest rates go up I am screwed. But my real estate agent told me I can just re-finance in 5 years so not to worry".

Here I thought we were on the same page about the housing market yet by the end of the covnersation I felt like I had just had a conversation with a crazy person. I think it finally dawned on her the risk she has put herself in.

I felt bad for her because it sounded like she was getting a lot of pressure from her friends who bought a few years ago & had been rubbing her face in it. She was under the impression that it is now or never.

Nothing is worth that kind of stress. There are always alternatives.

 
At 5:13 PM, Anonymous ruffian said...

(I felt bad for her because it sounded like she was getting a lot of pressure from her friends who bought a few years ago & had been rubbing her face in it.)

That sounds like someone I know. She is 40ish, unmarried, works part/time, has no savings or assets, makes well under $30K a year. Lives in a studio apt here in Calif.

Last summer, she went back to the Midwest (where she is from) to visit relatives. When she got back, I asked her how her trip went. "It was great. I bought a house," she said with the same tone of voice someone would use who just bought a pair of shoes.

"Oh, are you moving back there?" I asked. "No, it's an investment," she replied.

I was dumbstruck. Turns out one of her relatives is a realtorâ„¢ and she's doing well. She talked my acquaintance into the purchase by telling her, "The sooner you get in, the sooner you will start making money like me."

The "investment" is an older home in pretty good shape, though will obviously need TLC to keep it that way. She put nothing down, got a stated-income loan because she doesn't make anywhere near enough to qualify for a standard mortgage. Some friends of hers are renting it out (though for how long is anyone's guess) and the negative cash flow is about $250-$350 a month.

That's who is getting into the real estate "investment" market, folks. Low income, no assets, absentee landlord, neg cash flow, "fraud" loan.

But she's part of the Ownership Society and I guess that's what matters...

 
At 5:20 PM, Anonymous boulderbo said...

can't stress this enough, if you've investigated what type of financing has gone on of late, the interest only, neg-am, silent second, no money down, no income verification loans have exploded. these new products have not developed over the last "ten years" as the article describes, they have dominated the market over the last 24 months. i don't hear alot about investors jumping into the real estate market with cash purchases because the returns are so great (guess what, they're patiently waiting for the bust). the only thing that you read about or see in the stats are the misinformed newbies buying 2 or 4 or 8 homes with 100% financing waiting to become millionaires. if this is not a sure sign of the top of the bubble, nothing is. the sad part is that the middle class family purchasing a home for the first time are going to experience a very difficult time over the next two or three years. they didn't deserve this.

 
At 5:26 PM, Anonymous Anonymous said...

5:20

"...the sad part is that the middle class family purchasing a home for the first time are going to experience a very difficult time over the next two or three years. they didn't deserve this."

Well said.

 
At 5:32 PM, Anonymous Anonymous said...

It seems that we have quite a few "fraud" story. Isn't it a moral duty for us to report them to the authority?

 
At 5:44 PM, Anonymous Anonymous said...

"'Home values and purchase prices have gone up so tremendously, it's led to a number of products to assist consumers to be able to buy and to provide flexible options so they can afford what they buy,' Perry said."

I think this statement would be more accurate if it were rearranged like this...


"'A number of products to assist consumers to be able to buy and to provide flexible options so they can afford a home mortgage payment have caused values and purchase prices to go up so tremendously....

 
At 6:02 PM, Anonymous Anonymous said...

5:44 --- you got that right.

 
At 6:08 PM, Blogger deb said...

JPL,

"I'm curious as to how the principal amount grows under an I/O loan. I didn't know that lenders could do that."

Negative amortization. The borrower doesn't even pay the full interest due and the balance gets tacked on the loan amt. Nice, huh?

****
Anon 5:44,

"'A number of products to assist consumers to be able to buy and to provide flexible options so they can afford a home mortgage payment have caused values and purchase prices to go up so tremendously...."

SO TRUE!!!! Are we the only ones in the world who can see this obvious truth?

 
At 6:13 PM, Blogger Tulkinghorn said...

Three years ago I had $100,000 in cash and went looking for investment property in the Boston Area.

My standard is that I wanted something that would give me 8% return on my investment once all the financing, taxes, and appropriate insurance were paid for.

I could not find anything I was confident I could break even on. Since the the market has gone up another 40%.

This could get really ugly.

 
At 6:22 PM, Blogger Melody said...

Free money.... how about a free house. My mouth dropped on this one.

http://www.cbsnews.com/stories/2005/05/19/eveningnews/main696675.shtml

 
At 6:58 PM, Anonymous Anonymous said...

Another sign of the housing bubble:

In April 2005 there were 285 references to "housing bubble" using a Gooogle News search.

In May 2005 there were 795 references to the "housing bubble" on google news. Thats over 2.5 times as many articles just so far in the month of May. The increased awareness will bring pop the bubble soon.

 
At 7:04 PM, Anonymous Anonymous said...

I just ran it and go 1090.

 
At 7:37 PM, Anonymous Anonymous said...

"She got a stated-income loan because she doesn't make anywhere near enough."

I think she just committed a fraud.
She may want to know that. It may never bites her back, but if she stops making payments in first 12 months and will be foreclosed on, it will trigger automatic investigation procedure.
Mike C., Chicago.

 
At 7:48 PM, Anonymous Anonymous said...

7:37 -- I think that might happen to the 22-year-old smarty, in an article (I think Las Vegas) referred to in a previous post, who has bought an obscene number of properties. Fraud is pretty clearly defined in the statutes and is nothing more than what old-fashioned moms and dads taught to their children: don't lie -- if you do, you'll pay. I would be totally unsympathetic if some of these flippers got caught in fraud for what they put down in their mortgage applications. Who knows? Maybe a side benefit of the coming crash will be a heavy lesson to our young people about the virtue of truthfulness.
Chip

 
At 8:00 PM, Anonymous Anonymous said...

As a result of the rampant mortgage fraud which we are anecdotally hearing about, I think I may know what the next HOT niche real estate sector wil be: WHITE COLLAR PRISONS! Does Wackenhut build white collar prisons? Go long the white collar prison builders!

TheGuru

 
At 8:18 PM, Blogger Tulkinghorn said...

The mortgage application fraud is serious business. It is a federal crime; you can do some time.

I have a friend/client who got caught on this and spent 6 months in Federal prison in a commercial loan fraud case. His crime? On a subdivision loan app he claimed the property was zoned for 12 lots, instead of 8, the correct amount. There was a zoning appeal underway that would eventually change the number, but when he signed the application, he lied. The project collapsed when the market sank, And the bank lost its customers a lot of money -- so the bank found a scapegoat, and they made sure he paid.

The moral: if the bank is pissed off enough, they will go after you with criminal as well as civil complaints. Either the bank officers will take responsibility for their stupid policies, or they will lay the blame on the consumer they encouraged to commit fraud.

What do you think they will do?

 
At 9:16 PM, Anonymous historybugg said...

(Isn't it a moral duty for us to report them to the authority?)

Who would that be? The mortgage police? This is a wink-wink transaction b/w consenting adults. Pretty much an "I'm shocked, shocked to find gambling going on in here" kind of thing. We have a society filled with millions of Captain Renaults. It's not the ownership society, it's the "wink, wink" society.

 
At 9:26 PM, Anonymous hobbes said...

$$$

Here's a sample Sunday in the life of a 25-year-old American who is bullish on the Ownership Society:

10 am---hungover, checks email, finds three credit card come-ons at 0% for 6 months, each offering $5,000 cash advance features.

12 noon---flush with the realization that he now has $15K in "free money" to play with, our hero spends the afternoon looking at condo conversion open houses

3 pm---puts a "lowball" bid of 10% over asking on a condo

4 pm---bid is accepted and our "investor" spends an hour or two online looking for stated-income no-down mortgage loans...while quaffing a few Coronas

6 pm---kicks back, eats a pizza, and watches No-limit holdem poker on TV

7 pm---buddy calls and says, "We're going to Vegas, got three free room nights". "Awesome," says our hero, who then drives to airport for midnite flight to Vegas. On way to airport, stops off at convenience to pick up 5 SuperLotto tix 'cuz pot is up to $100M.

Not a bad day at the races, indeed....

 
At 9:51 PM, Anonymous Awaiting the Carsh said...

I've got another Antelope Valley (Palmdale, Lancaster, CA) update from this weekend. I went to the Beazer grand opening for a small subdivision with an initial release of 19 homes. There were many more buyers than homes (you'd think they were giving them away). They had a drawing at 10:00AM. They pulled a name and you were then handed a SOLD button to place on which lot you were buying. No models to look at just 2 dimensional floor plans. These lemmings were applauding each other as they proudly placed their SOLD button on their lot (made me want to barf). I go to these openings to gauge the level of speculation and mania. Unfortunetely, the boom is still alive and well in the A.V. I struck up a conversation with one of these financial wizards and he told me he just bought a home two years ago. I asked "you don't like it". He replied with glee, "NO, I'm going to rent it out and use the equity to buy this one". The endless supply of morons continues. He's risking his current primary residence to buy another in the Spring of 05'. I looked at him with incredulous amazment to which he returned that deer in the headlights look. He is completely clueless!

Here's the thing. I hope the government does not bail out idiots like this. When it all goes down, I just know the ones that caused this mess will get all kinds of help (read that as tax payers' money). They do not deserve nor should they be granted any leniency what so ever. I remember a scene from Saving Private Ryan when the U.S. Forces put a flame thrower to a machine gun bunker that for the past three hours has beeen mowing down U.S. Rangers. As the German soldiers come runing out, bodies on fire, one Ranger yells "DON'T SHOOT, LET'EM BURN". That's what I'll be saying. Am I bitter, you betcha! I make a good living and have saved for years and the greedy have hi-jacked this housing market. I'm 41 with a wife and kids, I can't afford to be on the wrong side when this goes down. The stakes are just too high. I have an ejection seat and I have one hand on the D-Ring. If this doesn't start to head back to sanity by September, I out of California for good.

 
At 10:14 PM, Anonymous Anonymous said...

"Am I bitter, you betcha!"

You should be bitter. Most people here are. A great country is being ruined by a bunch of idiots. Let them burn!

 
At 10:24 PM, Anonymous diogenes said...

(These lemmings were applauding each other as they proudly placed their SOLD button on their lot)

If a bunch of folks with hat-sized IQs want to piss away what little money they have on a spin of the wheel, what can you do?

Have you noticed how many casinos are springing up all over the country? They ain't building 'em for fun. When you combine speculative fever with a nearly limitless supply of suckers, you've got a bonanza for sharks and sharps.

The homebuilders are the corporate equivalent of those guys on the corner running the three-card monte games. They buy up swampland or landfill on the cheap, slap up some cardboard frames, and watch as the sheep line up to outbid one another for the right to buy into these future ghettos.

Hell's bells, they don't even hafta build 'em. Just show 'em a floor plan downloaded off the Internets. Tell 'em there's gonna be some trees over yonder, a cement lake just down the pike, and presto, fistfights break out over who'll get the once-in-a-lifetime chance to get a piece of this can't-miss action. Maybe Ponch from CHIPs will make an appearance to give it legitimacy.

They say that a fool and his money are soon parted. The real riddle is how the two got together in the first place. Oh yeah, I forgot, you don't need money anymore to get on the Ownership train. Just sign on the line and we'll take care of everything.

 
At 12:03 AM, Anonymous Anonymous said...

I understand that it is odd that people are paying so much for such little nowadays BUT what makes everyone think its going to crash? People have been saying it for years now and things have only gone way up. Rates are only slowly creeping up and what will be the straw that breaks? Maybe this IS market correction and house have been undervalued...? Who knows? I just have this weird feeling that this crap is going to go one for a few more years(or more). Sad but maybe true...
Later JS

 
At 3:38 AM, Blogger Tulkinghorn said...

I think it will crash because of the instabilityu of the secondary market for mortgages.

The easy credit for consumers is still there because the money supply is still there. When investors stop buying MBS then money supply for retail mortgages will tighten.

There is a tipping point somewhere. It is a fool's game to predict when it will come.

I decided that the peak of the stock market came in 1999. That is not what happened, but I was was right on the fundamentals. I did not pull out of stocks, just diversified appropriately. I stil felt like a chump as the market went up for another two years.

A small investor can't diversify real estate holdings short of investing in REITs, but from what I have seen poking around the Bankruptcy records of darling REITs from 15 years ago (lots of fraud, predatory practices, insider dealings), caveat emptor.

 
At 6:36 AM, Anonymous boulderbo said...

a couple of things that remember from the last downturn: loan and bank officers being led from offices in handcuffs, vulture funds buying portfolios of deficiency judgements for 3 or 4 cents on the dollar with plans to collect when the borrowers got back on their feet (that's right, you don't just walk away from the house), condos in denver and cape cod selling for $12,000, and most importantly lenders ceasing all loans as they had real estate headaches to deal with.

 

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