I was listening to the radio I heard a song reminded me of long ago Back then I thought that things were never gonna change It used to be that I never had to feel the pain I know that things will never be the same now
I wanna go back And do it all over again But I can't go back I know
Right now, I don't want to see mortgage interest rates go higher. I plan to borrow heavily to buy as many cashflow-positive properties as I can get, and as long as interest rates are low, I hope to take advantage of them. However, the best thing for the housing market is not sustained low mortgage rates because those rates only benefit the few who qualify. We need lower prices, higher interest rates, and more people to qualify for mortgages.
often hear people wonder aloud why banks won't loosen underwriting standards on home mortgages. I'm beginning to wonder the same thing. That's because I think it is time for lenders to start issuing mortgages to non-prime borrowers again, though not on the same shaky terms that triggered the housing crisis of 2008, of course.
I wondered why we don't relax lending standards for investors in Should Government Mortgage Subsidies Be Offered to Cashflow Investors? There are many good borrowers being denied credit right now because lenders are so afraid of certain loan products that even the small number of borrowers who can properly utilize certain loan products are being denied. However, the main reason banks won't loosen underwriting standards is because they really don't know which ones they can loosen and still get their loans repaid.
First, the reason why lenders are hesitant to relax loan requirements: The heart of the matter is: Mortgage rates and their profitability margins are so low, it just isn't worth the risk to lend to anyone who is anything but a AAA+ credit-worthy consumer.
Furthermore, it takes an implicit guarantee from Fannie Mae or Freddie Mac, on top of that sterling rating, to make mortgage lending even semi-palatable for a bank or investor.
The real problem with mortgage lending is super low interest rates made possible by government loan guarantees. It started when the Federal Reserve began buying down interest rates through purchase of GSE insured loans. When the program terminated in early 2009, there was great concern that interest rates would rise. After the Fed quit purchasing GSE MBS, purchase applications and home sales plummeted. As purchase applications fell, so did interest rates as the supply of money available for home mortgages exceeded demand.
Mortgage interest rates are at historic lows for those with good credit who are borrowing less than the conforming limit; however, for those outside of these parameters, either the interest rate is significantly higher, or credit is simply not available. The market would ordinarily react by pushing interest rates higher. If the yield does not match the risk -- and the risk is much higher for non-insured loans -- the yield must go up to attract capital. Higher yields mean higher interest rates.
For better or worse, the housing market is fueled by Wall Street's appetite for mortgage-backed securities. As mortgage rates continue to set historical lows, so do their profitability margins -- as well as the profitability margins of the securities they reside in (that investors typically buy, sell and otherwise trade on).
Being that investors have no appetite for high-risk, low-yield investments, there's simply no money in mortgages right now. As a result there is very limited credit available in the marketplace, especially to non-prime borrowers.
This is not a problem limited to subprime borrowers. Anyone looking for a jumbo loan can expect to pay a much higher interest rate and be subject to very high qualification standards. Even then, these loans don't make much sense given the likelihood of declines at the high end.
This is in stark contrast to what was a high-risk, high-yield, credit free-for-all environment that was in place from 2002 until the housing market crash in late 2008.
So, it's been two years since the crash and the prevailing thought has become that: Interest rates must be kept low to keep consumers "incentivized" and "transacting." Unsustainable consumer incentives have run their course. A tax credit has been tried and proved expensively ineffective while interest rates have been kept artificially low for too long. These are strategies that treat the illness but do little toward finding a cure.
Current mortgage rates for the most qualified consumers and properties are hovering around 3.99 percent for a 30-year-fixed and as low as 2.875 percent for the 5-year-fixed variety. Yet while mortgage rates are jaw-droppingly low, the housing market is no closer to snapping out of the protracted downward spiral it's been in for a couple years now. You can drop rates to .399 percent, but if only a tiny consumer pool qualifies for such, there isn't enough benefit to impact the market in a meaningful way.
Money needs to be thoughtfully brought back to non-agency mortgage-backed securities, which would require higher interest rates and the yields they offer investors. Huh? Yes, increasing interest rates and the yields that accompany them are required if we want to see credit flow back into the non-agency -- that includes portfolio, jumbo, Alt-A and subprime loans -- mortgage-bond markets. We need more liquidity and credit in the non-prime, non-agency mortgage pools if we want to pull out of the housing quagmire, because there's a huge pool of non-prime borrowers who can afford mortgages.
If prices were allowed to fall, and if mortgage interest rates were allowed to find a natural equilibrium, credit would be made available to more people. The problem right now is not interest rates, it is the number of qualified borrowers who can take advantage of them. The market manipulation has made mortgage debt inexpensive and affordable, but only for a small number of people.
It isn't a matter of simply lowering qualification standards and allowing more people to borrow at low interest rates. We must find a natural market where risk is tied to yield, then we will have credit being made available to a larger number of people albeit at much higher rates.
Something that gets lost when discussing borrower defaults and foreclosures is that people who were prime borrowers are defaulting just as readily as non-prime borrowers. At the same time, there is an abundance of non-prime borrowers making their mortgage payments in a timely fashion.
I've had the opportunity to personally review residential mortgage-backed securities and can attest that FICO scores and loan-to-value ratios are not the leading factors behind mortgage defaults. That's why I think it's time to bring back the non-prime borrower into the mortgage market.
So, how high do rates need to be? Likely 300 to 400 basis points (3 percent to 4 percent) higher than they are today.
Therein lies the reason why this doesn't happen. If interest rates were 300 to 400 basis points higher, affordability would decline about 50%, and prices would crumble. A natural rate of interest after a catastrophe like the housing bubble would be much higher than it is today. The housing bubble was caused by a mispricing of risk, and we are still doing it. Before it was questionable credit default swaps that allowed the market to misprice risk, now it is the backing of the US government that is doing the same. AIG went under because of the credit default swaps they issued. The US taxpayer will likely absorb huge losses because we are currently underwriting the entire housing market.
Interest rates of 6 percent to 7 percent on a fixed-rate mortgage are still cheap money, and there is a very large pool of consumers who could afford mortgages with rates in this range but who qualify for nothing under today's agency-backed underwriting guidelines. Get back to mitigating risk with price, but in a more responsible way.
Non-prime borrowers will call for different underwriting standards. I'm not talking about going back to the days of no income, no asset, no job requirements; I suggest going back to more logical and flexible underwriting criteria. A heavy emphasis must still be kept on the substantive components of mortgage qualification: Credit, income and assets.
These suggestions will ultimately come to pass, but it will be years before we have anything resembling a natural market for interest rates or home prices. For now, propping up prices with artificial interest rates created by government backing is the official policy, and as long as our banks teeter on the edge of insolvency, this policy will continue.
Despite the robo-signing paperwork mess, there will continue to be abundance of foreclosed inventory flowing into the market -- that desperately needs buyers who desperately need credit -- or the property will continue to rot a hole into the housing market and U.S. economy for many years to come.
We learned a lot from the housing boom and subsequent bust. No one is suggesting that we go back to the period of 2003 to 2007. Increased awareness and transparency on many levels likely will prevent that.
Actually, many have suggested that we return to the bubble ways. Many of our efforts to prop up the market are similar to what we did in the bubble. For example, loan modification programs are essentially Option ARMs. No amount of awareness and transparency is going to prevent a housing bubble.
I recommend that lenders increase rates and yields to match the risk of the underlying borrower and security. A bold move like that will get investor liquidity and credit flowing back into a market that is choking itself out.
I agree that we need to match yield to risk to better serve the housing market, but it isn't going to happen any time soon because in order to do what he suggests, house prices would need to fall another 30% while interest rates doubled. The bank losses and chaos that would create make it unpalatable to policy makers and, of course, the banks -- if you can actually tell the difference between the two.
What passes for responsible mortgage management in Irvine
Most loan owners I profile in Irvine have more than doubled their mortgage. Almost all borrowers I see looking through the property records have added to their mortgage. It is a very rare case to find a homeowner who paid it down. What should be the norm -- paying down a mortgage on a 30-year amortization schedule -- is a rarity.
I hate to give borrowers in this category a "passing" grade, but this is the reality for most Americans. Growing credit card or mortgage debt slowly generally can be compensated for through home price appreciation, and although I consider this a bad idea, I can't really call it HELOC abuse, just foolish HELOC use. Is there a distinction there? I will let you decide.
Financial planners will tell you that most people fail to budget properly for unexpected expenses (they don't save), so when they fall behind a little each month, they put the balance on a credit card and hope they can pay it back with a tax return -- or during the bubble with a visit to the housing ATM.
People are still going to manage their bills this way going forward, and there will be pressures to "liberate" this equity to pay for these expenses. The money changers will continue to peddle this nonsense as sophisticated financial management. It is a stupid way to manage debt, and I give it a C.
The owners of today's featured property paid $192,000 on 6/17/1988. I don't have their original mortgage data, but they likely put 20% down.
On 4/6/1998 they refinanced with a $191,000 first mortgage. Ten years after buying this property, the mortgage nearly equaled their purchase price.
On 7/17/2000 they obtained a $37,000 HELOC.
On 12/10/2003 they got a $50,000 HELOC.
On 10/21/2004 they refinanced with a $215,000 first mortgage.
On 5/31/2007 they opened a $150,000 HELOC.
On 8/31/2009 they refinanced again with a $264,500 first mortgage.
After owning the house for 22 years, they should have it nearly paid off, but instead, they extracted $100,000 in equity and they have enlarged their mortgage considerably. They will still sell this home and make a significant profit -- thanks to the housing bubble.
So what do you think? Is this a reasonable way for people to manage their mortgage debt? Are these people acting wisely and responsibly?
Home Purchase Price … $192,000 Home Purchase Date .... 6/17/1988
Net Gain (Loss) .......... $548,720 Percent Change .......... 285.8% Annual Appreciation … 6.3%
Cost of Ownership ------------------------------------------------- $788,000 .......... Asking Price $157,600 .......... 20% Down Conventional 4.23% ............... Mortgage Interest Rate $630,400 .......... 30-Year Mortgage $149,166 .......... Income Requirement
$3,094 .......... Monthly Mortgage Payment
$683 .......... Property Tax $0 .......... Special Taxes and Levies (Mello Roos) $66 .......... Homeowners Insurance $0 .......... Homeowners Association Fees ============================================ $3,842 .......... Monthly Cash Outlays
-$726 .......... Tax Savings (% of Interest and Property Tax) -$872 .......... Equity Hidden in Payment $239 .......... Lost Income to Down Payment (net of taxes) $99 .......... Maintenance and Replacement Reserves ============================================ $2,582 .......... Monthly Cost of Ownership
Cash Acquisition Demands ------------------------------------------------------------------------------ $7,880 .......... Furnishing and Move In @1% $7,880 .......... Closing Costs @1% $6,304 ............ Interest Points @1% of Loan $157,600 .......... Down Payment ============================================ $179,664 .......... Total Cash Costs $39,500 ............ Emergency Cash Reserves ============================================ $219,164 .......... Total Savings Needed
Property Details for 4471 WYNGATE Cir Irvine, CA 92604 ------------------------------------------------------------------------------ Beds: 5 Baths: 3 baths Home size: 2,694 sq ft ($293 / sq ft) Lot Size: 5,000 sq ft Year Built: 1970 Days on Market: 5 Listing Updated: 40473 MLS Number: S636555 Property Type: Single Family, Residential Community: El Camino Real Tract: Wl ------------------------------------------------------------------------------ This is a custom home with light large open spaces. Custom wood work and hardwood flooring give the home a warm, friendly feeling. The windows are large and include operable skylights. This creates excellent cross ventilation. The home is located within walking distance to all schools. Irvine High School, Heritage Park, and Irvine public library are very close by. The home has three bedrooms downstairs and two upstairs, along with a large bonus room. The bonus room has a built-in Murphy bed. The three full bathrooms have been remodelled, and the master bathroom features a Jacuzzi tub. The upstairs bathroom is a Jack and Jill, opening to both bedrooms. There are two fireplaces. One is used brick in the living room. The other is in the master bedroom. Mature trees and landscaping make the exterior of the home lovely and relaxing. The home includes a gazebo in the backyard, which is included in the sale.
remodelled?
I hope you have enjoyed this week, and thank you for reading the Irvine Housing Blog: astutely observing the Irvine home market and combating California Kool-Aid since 2006.
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