Wednesday, December 20, 2006

Just a random thought on Interest rates, economy, international concerns, etc...

You know, I am beginning to wonder if the Utah real estate market might be gearing up for being the eye of the perfect storm. In a good way. Let me explain:

In the rest of the country, the economy is not as strong as it is in Utah. The real estate boom that the rest of the country enjoyed in the last two years pretty much sidestepped Utah altogether. In other areas, it was fueled by a large school of nationally motivated real estate investors, primarily from California, who were only looking at one factor in making purchase decisions: real property value appreciation. These were "paper-rich" people whose only increase in net-worth was through a massive increase in the value of their own real estate. Nobody was getting paid more at their jobs, nobody was winning the lottery, etc. When this happens, there is no local support for that increase in value - the local wages haven't changed to support the new values, so the locals aren't the ones buying homes, they're essentially locked out.

This, among a couple of other factors, produces a classic real estate bubble. By definition, the bubble is not self-sustainable, and is therefore susceptible to bursting - where the bottom drops out just as fast as it grew in the first place - which means the investors move to other places, like flies.

When investors become successful in areas, lender follow suit, and the whole industry balloons up, supporting this increased activity. If interest rates are a problem, in relation to the Federal Reserve rates, they will simply come up with programs that will allow these investors to be successful regardless. Note here as examples, Option Arm Loans, 100% financing, 2- and 3- year Arms, "Alt-A" lending, etc. Lenders will always to find ways to produce programs that make it possible to acquire the business of these investors. Lenders are in the business of selling money, that's what they do.

So, with all that being said, our little local state-wide economy, with the possible exception of Washington county (the fourth-fastest growing county in the nation, at last count), we have just chugged along. Sure, there are investors here from out-of-state buying homes they never intend to live in, or even hold for more than a year, but on the whole, these people are balanced out with the other members of our community.

Our unemployment rate is among the lowest in the nation, and employers report having difficulty attracting and keeping talented workers. It's so low, it basically is at the point where those who want to work, are doing exactly that. This does things to the housing market as well. When everybody who can, or wants to, is working, they are confident en masse. They are willing to buy homes, move up, or make improvements. This balances the investor pool as well, and makes the entire picture more stable.

So on to the "perfect storm" theory. When an economy is burgeoning, as ours is, and rates are fairly low and stable (5.625% 30 year fixed in Utah right now), and there is relatively low investor activity (because they have been taken out of the game from losses in other unstable markets - like Vegas, Phoenix, etc,), balance comes to the whole, and stability ensues.

Couple that concept with the following thoughts:

1. The economic bounty will likely last well into and through the next 24 months, or longer.
2. While we are on an interest rate upswing, that will only last for about that much longer as well, maybe 36 months or so.
3. Utah is not, and will not be, bothered by the mass of national real estate investors, because they are pretty much out of the game at this point.

This gives me the thought that we may well be insulating ourselves from that rate upswing with a strong local economy, allowing Utah to move through the next 24-36 months without much of a real estate downturn, either in valuation or in market inventory.

I think this is good for us, into the foreseeable future. Our job growth economy will carry Utah through to the next interest-rate downturn, and then we'll have another refi boom, people will be happier with borrowing money, lenders will be happier to sell it, and rates will be driven even further down, default rates will lower, international monetary investors will like the dollar better, because the nation's GDP will be better, and all will be well in happyville.

So, contrast this happy story to this one, in California, where values went through the roof, unsupported by the local economy: here

Monday, December 11, 2006

At some point, the borrower HAS to be accountable

A news story out of California. Under the heading of "A Loan That'll Get Ugly Fast."

Every day, Will Hertzberg owns a little less of his three-bedroom house in Corona. Like hundreds of thousands of other homeowners around the state, Hertzberg has a mortgage that lets him choose how much he pays each month. Like many of them, he always chooses to pay as little as possible.

His debt is swelling, and his mortgage company controls his fate. 'I am rather screwed,' he said.

Hertzberg could sell now, but his lender would charge him an $11,034 prepayment penalty, money he doesn't have. Yet if he stays, the housing market may tank, vaporizing what little equity he has left. 'I made choices, and they happened to be the wrong choices,' said Hertzberg.

One of his options is to pay $2,513 a month. That would cover the principal and interest as if it were a traditional 30-year loan. A second possibility is to pay $2,279, which would cover only the interest. But each month he always takes the cheapest option: paying $1,106 and promising to make up the shortfall later.

In 2003, only about 8 of every 1,000 people buying a home or refinancing a mortgage in California got a pay option loan, according to First American LoanPerformance. Last year, 1 in 5 loan applicants got one.

In the first eight months of 2006, even as the real estate market began to weaken amid fears of a downturn, the appeal increased again. Nearly 1 in 3 California loan applicants are now choosing them. The state boasts about 580,000 active pay option mortgages, about half the U.S. total.

Hertzberg bought his house 11 years ago for $129,995. With fresh paint and a few repairs, Hertzberg could probably sell his place for $275,000 more than he paid. He would see little of that, however, because he's already seen so much. Over the years he has taken out $190,000 in cash through refinancings.

Hertzberg's home equity paid off his credit cards, financed trips around the world, bought a $32,000 Toyota Avalon and enabled some lousy investments. He bought dot-com stocks and lost money. To recoup those losses, he bought commodities, and lost money faster.

'Free money always has the unfortunate effect of making people go overboard,' said Hertzberg, whose living room is strewn with financial publications including American Cash Flow Journal and Donald Trump's 'How to Get Rich.' 'You'd be surprised how fast $190,000 can go.'

Last fall, he went to a mortgage broker and refinanced again to make his payments easier to bear. He thought he would have a five-year window before the principal started coming due.

But the day of reckoning is arriving early. By paying the minimum, Hertzberg has increased the size of his loan in a little over a year from $320,000 to $332,616. His lender, Countrywide Financial Corp., recently sent him a letter warning that when his loan hits 115% of its original size he'll run out of credit with the company.

That will happen in about two years if he continues to take the smallest payment option. Then his minimum payment will automatically go up 150%, to $2,848 a month. 'If I could afford that,' he said, 'I wouldn't have needed this loan in the first place.'

It's a sorry situation, and Hertzberg is generous in assigning responsibility for it. To start with, he blames his mortgage broker, who didn't advise him how risky these loans were.

Few brokers do, U.S. Comptroller of the Currency John Dugan says. In an October speech, Dugan said the marketing materials for payment option loans often 'emphasized the low initial payments but glossed over the likelihood of much higher payments later.'

Although Dugan and other regulators are taking steps to address both problems, Hertzberg said they never should have allowed these loans to become so prevalent in the first place. 'The government wanted to keep the housing party going,' he said.

Yet who didn't want that? Hertzberg admits he was a willing co-conspirator. 'I got spoiled and complacent and was not prepared when the bottom fell out,' he said.

Several times a week, he gets a refinancing offer in the mail. Hertzberg always looks at these fliers, hopeful in spite of himself. 'I'm waiting for a 100-year loan,' he said. 'My heirs can worry about paying it off.'

This unfortunate borrower is right to blame his mortgage broker, but I would wager that, if pressed about it, the great preponderance of borrowers who find themselves in this situation knew what the pitfalls were with this particular loan type. (If you want more detailed info, look for it here.)

MANY homeowners over the last 3 or so years have ended up purchasing a home that they had no business even looking at. Whether it was simply that the price tag was too high, their credit too bad, their income situations too unstable... whatever. Having been in this business for a while, there are always people who are buying too much house. I can tell who they are every time they walk into the office. They have no money to put down, and most of the time (95%) have no money to even pay for closing costs, and have negotiated these with the seller.

Who is to blame for this? Some will say that the lender is to blame - while others will say that it is the buyer who shoulders the blame. In reality, and in a perfect world, the buyer is the one who is to blame here. Remember that in that "perfect world" the mortgage broker has educated the borrower on all aspects of every type of loan program under consideration, and the buyer has enough information upon which to base an educated decision. You would think that this fact alone would alleviate this entire problem, but you are wrong. By and large, with visions of sugar-plums dancing in their heads, a buyer reaches a point where it makes no matter whatsoever what the risks are, "all we want is to get into this house and have a $1200 payment, because that is what we can afford. You have a way to get me into this $500,000 house for that payment, and that's what I want."

A mortgage broker who does not educate his clients about every type of loan under consideration does a disservice to his client.

There has been lots of talk over the last year about how the government regulatory agencies need to crack down on this type of loan, and how those loans need to have more guidance, perhaps more disclosures to be signed by the borrower, etc. But at some point, the accountability needs to rest solely and squarely on the shoulders of the person who signed the note.

People's eyes get big, and we get this glazed thing that comes over us when we see a dream right before us, sitting there, calling our name, the song of a sexy siren right there in front of us. It happens all the time, with cars, vacations, jewelry, etc. It's bad when it happens when we're talking about a home, because it is a huge-ticket item, and it carries with it the possibility of catastrophic financial ruin. The glutinous consumption that is carried by a society's economic wealth is a problem.

So, dear borrower, if you're looking at a house for which you can only afford to make a "minimum payment", not even covering the total of the interest that is due each month, you deserve what you get. And what you will get is foreclosed upon.