Mortgage and real estate insanity
Last week I wrote about the potential for the subprime mortgage market meltdown. Let's correlate how the mortgage and real estate insanity over the past few years has impacted today's housing "bubble" (not) or correction (likely).
Benjamin Franklin was reputed to have said, “The definition of insanity is doing the same thing over and over and expecting different results.”
So what were and/or are the mortgage companies thinking? Take the subprime sector, mortgages were made available to borrowers with bad credit with little to no documentation requiring little to no downpayment and with little to no explanation to the borrower of the potential financial obligations during the term of the loan. Insanity?
Perhaps. Here's why. First of all, I don't want to pick on borrowers with less than perfect credit. Over the course of my life, I've had credit ups and downs but thankfully today, I have excellent credit. Those with high credit scores pay their bills on time every time, those with low scores do not pay their bills on time every time.
So the first bit of insanity has to be with the mortgage lenders who seemed to throw underwiting out the window when they loaned money to borrowers with a history of not making timely payments and expecting different results. Other borrowers may have felt they didn't have any other choice in order to afford the monthly payment and after all, what risk was there with rapidly appreciating real estate. They could refinance later or just flip the house and turn a profit.
Fast forward to today. Browse the headlines. Foreclosures are up and should anyone be surprised. Why? Borrowers couldn't or didn't make their payments. When the borrower noticed that the "teaser" rate or the 1 year ARM they signed up for with a low monthly payment changed to the regular rate in as little as one month with the "teaser" rate or a year later with the ARM reset, they discovered they could no longer make the monthly payment. With a history of not making timely payments and in many cases, having no vested interest in the house (with no downpayment, there was no equity (real money) at stake), in some cases, the payments stopped. The next thing many did was put their house on the market hoping to get out from under the higher payment with as much money as possible or simply to avoid foreclosure.
The impact on real estate. Simple. Unfortunately, when everyone runs to the exit at the same time, it's hard to get through and when available inventory started building up, supply and demand took over and the market shifted from a sellers market to a buyers market. Rather than prices rising at the same astounding rates, now prices have fallen somewhat. As the trend accelerated, those areas with the largest increases started to face the steepest declines. Can you say Florida, Arizona or Nevada?
The slump in home prices was both deeper and more widespread than ever before in the fourth quarter, a 2.7% decline in median prices during the 4th quarter compared to a year earlier according to the NAR. In addition, 73 markets of 149 tracked reported a decline in prices. That decline was far more widespread than in the third quarter, when only 45 markets reported drops.
A chart of the year over year increases and declines can be found courtesy of CNN Money. The good news for Charleston, 25th best in the survey with a 6.3% gain, however, inventory of Charleston real estate is still very plentiful potentially limiting expected appreciation.
And despite having so many loans go bad and with many mortgage companies in a little financial hot water, it continues. I don't want to pick on Lending Tree, it's just that because they are so big, their ads are just easier to find than other lenders. Here's an example of what they (and others) are offering:
$200,000 loan for $667/month!* Refinance Today!
4 Flexible Payment Options! Bad Credit Options!
*Start rate of 1.25% is fixed for the first 30 days with a fixed payment option for the first 12 months. Terms of payment are based on a margin of 3.250% plus the twelve-month average of monthly yields on actively traded United States Securities adjusted to a constant maturity of one year (4.563% as of January 9, 2007). APR of 7.991% and payment of $666.51 per month is based on a 30-year term, $200,000 loan amount at 1.25%, and may change if the index adjusts after the first 30 days. If minimum payment option is selected, deferred interest may accrue. Interest rate quoted assumes a credit score of 620+ with a loan-to-value (LTV) of 80% on a primary residence. The APR and payment will vary based on the specific terms of the loan selected and verification of information and credit. Rates are subject to change without notice. This product may not be appropriate for all borrowers. Please consult a financial advisor to weigh risks and benefits.
A $200,000 house costs more than $667 a month but you have to look at the fine print to figure that out and you really should read this fine print.
What are real mortgage rates today? Actually, they are still very good, and still very low by historical standards. One of my preferred lenders is quoting 5.875% for a 30 year fixed rate conventional loan. What does it take to qualify? Put 20% down, have a very good credit score (not excellent), something like at least 680 - 720 at minimum and provide the usual documentation. If you don't have all that, you'll pay a little more but you certainly don't have to get caught up in some of the insane and exotic mortgage loan products that have been offered recently.
The monthly payment for a $200,000 house with 20% down at 5.875% is $1096.46. Don't forget to add in insurance and property taxes to get your real payment, allow at least $250 per month in this instance so the total payment would be a very reasonable $1346 per month, good, realistic but certainly not the $667 offered in the above headline.
Find an excellent real estate agent who can refer you to an excellent mortgage lender and work together as a team when you want to buy a home.
Otherwise, the insanity continues. 