Asking Price: $565,000
Address: 143 Islington, Irvine, CA 92620
{book5}
In 2004, Alan Greenspan, then the head of the Federal Reserve, had this to say, “Indeed, recent research within the Federal Reserve suggests that many
homeowners might have saved tens of thousands of dollars had they held
adjustable-rate mortgages rather than fixed-rate mortgages during the
past decade.” Many people took this as a tacit endorsement of these loans by the head of the Federal Reserve.
The ignorance of Greenspan’s statement reveals a pathological mindset among policy makers in Washington; the people in charge genuinely believed the general population capable of managing their own financial risks — risks they often are not aware of and obviously do not understand. For evidence of this ignorance one has to look no further than the nationwide epidemic of foreclosures. Regulators took this same attitude toward major financial institutions. The resulting flaunting of risk is the direct cause of the severe economic recession we are now enduring.
When an entire population is encouraged to take tremendous risk, the resulting losses can be so large that neither the individuals nor the institutions that encouraged them can absorb the losses. The Government must step in as the counter-party who absorbs the losses others cannot; hence, you and I and everyone else is paying for the excesses of The Great Housing Bubble.
{book3}
The government is going to tackle the issue of how much risk can financial institutions take on in upcoming policy and regulation debates. Today, I want to focus on whether or not people should be allowed to risk foreclosure with an adjustable-rate mortgage.
I have already made my position known in Bring Back Paternalism in the Mortgage Market. I am no longer the Reagan Era free-market capitalist I used to be. I am not alone in making this philosophical change. Privatizing profits is great, but the need to nationalize the losses reveals that free-market capitalism never really existed, and perhaps needs to be further regulated in order to protect the public interest.
Much of the risk sold into the mortgage market during the bubble has already blown up in the form of subprime loans. The worst loan program was commonly known as the two-twenty-eight (2/28), and it was given to subprime borrowers. It has a low fixed payment for the first two years, then the interest rate and payment would reset to a much higher value and recast to a fully amortized schedule for the remaining 28 years. Anecdotal evidence is that most of these borrowers were only qualified
based on their ability to make the initial minimum payment (Credit
Suisse, 2007). The demise of this loan has flattened the low end of the housing market.
All adjustable rate mortgages (ARMs) are risky because the payments can go higher thus increasing the likelihood of borrowers losing their homes. Interest-only ARMs are bad because they
generally have a fixed payment for a short period followed by a rate
and payment adjustment. This adjustment is almost always higher;
sometimes, it is much higher. At the time of reset (or recast), if the borrower is
unable to make the new payment (salary does not increase), or if the
borrower is unable refinance the loan (home declines in value below the
loan amount), the borrower will lose the home. It is that simple.
These risks are real, as many homeowners have already discovered.
Given the problems with ARMs, why do people use them? What is their incentive? When compared to fixed rate mortgages, people who use ARMs can finance greater sums and thereby outbid more conservative borrowers. This enables the reckless to outbid the responsible to obtain real estate. This is a powerful inducement to take on the risk of ARM loans; however, since borrowers have proven unwilling to accept the consequences of their risky behavior (foreclosure), it is legitimate to ask if this behavior should be permitted at all (Obviously, I don’t think it should be).
The problems with ARMs are many and obvious, but the overriding problems was the failure to qualify people based on the largest payment possible under the loan program. Let me explain.
Buried in the terms of your loan contact is the maximum interest rate you could be charged on the loan. Many people who signed up for 4% ARMs this year have a clause buried in their contract whereby the interest rate could increase by several percentage points during the life of the loan. Most people are qualified based on their ability to make the payment based on the initial rate period; if interest rates go up, or if there is an amortization recast, the loan blows up and the borrower loses the home.
Lenders are willing to loan people money on these terms because they believe (1) interest rates will not go up that much, or (2) people will either refinance into another ARM or (3) sell the home. As the Great Housing Bubble proved, those assumptions are erroneous.
All ARMs rely on the fact that lenders believe they have transferred the risk to some other party — either a borrower or an insurer. However, when too much risk has been concentrated on borrowers or insurers, they become unable to absorb the losses and the whole system becomes unstable.
The only way ARMs can be a stable lending vehicle is if the borrower is qualified based on the payment required with the largest combination of loan balance and interest rates allowable under the terms of the note. Anything less than that leaves a dead zone where borrwers can fall into the foreclosure abyss.
Dead Zone of ARM Interest Rates
If people were qualified based on the payment required at the contractual limit, ARMs would no longer be dangerous — and they would no longer be useful as an “affordablity” product. Lenders might be able to construct ARMs with low contractual limits to permit ARMs under certain circumstances, but they would no longer function as an affordability product, and borrwers would not have to choose between risking foreclosure or missing out on buying a property to the competition.
The beauty of fixed-rate mortgages is that borrowers can truly manage their payment risk. Since the payment is fixed, they know they can make the payment barring a job loss (which we have seen plenty of). An ARM provides no mechanism for the borrower to control their payment risk. If the terms of the note allow the interest rate charged to skyrocket, the borrower will surely default.
The scary part of this story is that we are still writing ARMs with unstable terms. I have written about the Temporary Affordability and the Third Foreclosure Wave. We are still building this foreclosure tsunami of the future, and nobody seems to care because we are solving our immediate problems with excess foreclosures. Putting people into unstable loans just pushes the problem out a few years, but it does not solve it.
If we are lucky, this third wave of foreclosures will coincide with the upcoming wave caused by Option ARMs and interest-only ARMs given to Alt-A and Prime borrowers. If interest rates go up dramatically while that wave is cresting, we may flush all these bad loans out of the system once and for all… Perhaps I am too much of an optimist. Until we stop writing ARMs with unstable terms, the housing market will continue to be volatile and prone to bouts of numerous foreclosures.
Asking Price: $565,000
Income Requirement: $141,250
Downpayment Needed: $113,000
Purchase Price: $520,000
Purchase Date: 12/12/2003
Address: 143 Islington, Irvine, CA 92620
| Beds: | 3 |
| Baths: | 3 |
| Sq. Ft.: | 1,610 |
| $/Sq. Ft.: | $351 |
| Lot Size: | – |
| Property Type: | Condominium |
| Style: | Mediterranean |
| Stories: | 2 |
| Floor: | 1 |
| View: | Pool |
| Year Built: | 1998 |
| Community: | Northwood |
| County: | Orange |
| MLS#: | S577718 |
| Source: | SoCalMLS |
| Status: | Active |
| On Redfin: | 1 day |
ceilings, corian counter tops, laminated wood floors, ceiling fans,
Euro-white cabinetry in kitchen, mounted custom mirror in dining room,
end unit with slate stone hardscape in spacious side and back yard.
Priced right for a quick sale.
POOL VIEW? You mean, I am expected to pay over half a million dollars, and the pool isn’t even mine? WTF?
I don’t know why, but this listing really bothers me. Is this what life in Irvine has come to? We are expected to pay $565,000 for a 3 bedroom condo with a view of a pool. Shouldn’t half a million dollars get you a single-family detached home with a yard and a pool of your own?
Priced right for a quick sale? If you say so….
This property was purchased on 12/12/2003 for $520,000. The owners used a $408,000 first mortgage and a $112,000 downpayment. Since then they have opened HELOCs for $206,000 and $261,300 respectively. Based on the increasing demand for HELOC limits, it appears they have taken out this money. If so, they are not losing their downpayment, only their good credit.
If this property sells for its current asking price, and if a 6% commission is paid, the total gain on the sale will be $11,100. The total loss will depend on how much of the HELOC money was taken out.
It’s the exclamation point that puts that listing over the edge of insanity.
And isn’t it great, it comes with “Floor: 1”. WTF? Are they saying it has a floor? Or it has two stories but only one floor between them? If so, then this truly is a remarkable house.
Look at the living room photo: two storeys, one floor. Saves time when vacuuming.
“The beauty of fixed-rate mortgages is that borrowers can truly manage their payment risk. Since the payment is fixed, they know they can make the payment barring a job loss”
This is the case in times of modest inflation. However, if you get deflation, the payments become harder to make. That was a problem before the Federal Reserve existed, and also during the Depression. The Federal govt is trying very hard to avoid it this time around.
True. I would seem to me the fairest way to spread risk between borrower and lender is to index the payment to an income index. Not sure how this would work, but with ARMs and fixed rate loans, there is still risk on both sides.
The majority of home loans in Western countries are adjustable. Because most currencies were not (until recently) as stable as the US dollar, most long-term loans are indeed adjustable. So if Western Europe can manage them, then we should be able to as well.
Of course, with the fed throwing gasoline on the inflation fire, we might soon see loans (like Eastern Europe currently have) denominated in euro, yen or Swiss francs. And THOSE are adjustable, too. Yikes!
Because ARMs have a variety of underlying interest rates (e.g., 90 day treasury, LIBOR 30 day, LIBOR 1 yr, etc.), and different maximums and maximum interest changes, the foreclosures brought about by rising interest rates would not be synchronized. They would extend over a period of years, because some of the loans would take much longer to rise materially.
This does not bode well for a housing recovery anywhere ARMs were very common. Not only will there be underwater borrowers wanting to get out of their house in 2012-2020, listing their homes right as prices get to loan value, there may also be distressed sellers whose ARM payment is now impossible to sustain over the long term.
Yes, unless these loans are flushed from the system with capitulatory selling, the people with these loans will serve as a market overhang for many, many years.
“All ARMs rely on the fact that lenders believe they have transferred the risk to some other party—either a borrower or an insurer.”
…or the investors of the Securitized Trust, which still account for a large portion of the ARMs and are a huge portion of the foreclosures. MBS should be outlawed right along side of the ARMs…IMHO the MBS should be outlawed and dissolved immediately.
How about we start with outlawing the CDS (credit default swaps) first. Without the CDS, many of the toxic MBS programs would have never came to be.
I think MBS can serve a useful purpose if they are properly regulated.
“When compared to fixed rate mortgages, people who use ARMs can finance greater sums and thereby outbid more conservative borrowers. This enables the reckless to outbid the responsible to obtain real estate.”
Exactly. You have characterized the situation perfectly. We moved from out of state and tried to buy in the OC (Irvine, Dana Point, San Clemente, NB, etc.) two years ago and got entirely too frustrated – to get a then-reasonable price for a house. The lenders were pushing 10 year interest only loans to us. Sounded decent considering we could “buy more” with the ten years of lower payments. What fools we were to even consider it – thankfully we rented instead and are still renting!
I don’t think no/low down ARMs are good for the market in any situation. Even for highly qualified buyers, it skews the prices and creates an incentive for the buyer to walk away if prices drop. That can happen for no/low down loans for conventional financing too. But ARMs give such low payments (allowing for crazy bid-ups with so much cushion in the monthly payment) that the “skin in the game” is not only low or non-existent at the front, the monthly is so low too so that the “buyer” (debtor) can be done with the whole thing pretty easily (psychologically — i.e., it’s easier to walk away) if the value tanks.
I think any loan product that makes the playing field less level for people who use conventional financing is b-a-d. Let’s hope these types of loans go the way of the dinosaur and are extinct in the near future!
How did the lenders (or the borrowers) ever expect to be able to refinance into a “non” ARM mortgage? The lender qualified them for the lowest possible payment but didn’t bother to confirm that they would be able to pay the full payments in two years? Were they anticipating a series of ARM refinances? If not the model makes no sense at all. At their salary they could NEVER afford anything other than an ARM – they knew this and the lender knew this.
“How did the lenders (or the borrowers) ever expect to be able to refinance into a “non” ARM mortgage? … Were they anticipating a series of ARM refinances?”
Most lenders did not care because they were securitizing the loans, and most borrowers just assumed they could serial refinance. That is the very essence of a Ponzi Scheme, and it is why the whole system collapsed.
By what legal premise could ARMs be outlawed? We can see that the mortgage market can create massive nationwide problems, but through what framework does creating mortgage lending standards exist? I don’t think you could outlaw me offering IR some sort of adjustable rate loan.
Aren’t MBS’s registered with the SEC? Not that they’ve replaced their dentures, but couldn’t the SEC set up some standard?
The gov’t could start by only allowing Fannie & Freddie to buy and securitize a very specific type of mortgage, with strict standards.
I have thought about ARMs being ‘screw-you’ loans. The homeowner will want to refinance into a fixed after the temporary fixed period and the lender wants the balloon rate after adjustment. You’ve got both sides trying to screw the other, leaving everyone…screwed.
Doesn’t Europe use ARMs almost exclusively? Their foreclosure rate is lower, but I think they also mandate higher dp’s.
ARMs could never be “banned,” but their terms could be regulated to the point that they failed to serve as an affordability product. If the GSEs set their guidelines for insurance is such a way as to make sure a borrower could afford the highest possible payment (something they should be doing anyway), then much of the problem would go away.
I am not sure about Europe, but I know Canada relies almost exclusively on ARMs. The US used to rely on ARMs with high downpayments prior to the Great Depression, but that system proved to be unstable as well, particularly during a period of major deflation. The hope is that the risk is mitigated by the high downpayment requirements. It doesn’t always work.
Regulating through the GSE’s would be very effective today, but unfortunately isn’t discussed much. One side wants to kill them, and the other wants them to be looser, thus they’re missing out on an opportunity to do some good through them.
The GSEs’ power to “regulate” stems from their ability to insure against losses. Since they are the main mortgage insurer, they can name their own terms.
Toxic mortgages should be “regulated” out of the system. Unfortunately, the government is using the GSEs to backstop more of these loans, using our money to do it.
For arguments sake:
Let’s assume that there are no 30 year mortgages, it’s like Canada and you can only take out a 5 year ARM mortgage that the originating bank holds on its books. Further, you cannot refi – if you want out early, you must pay the bank the interest for the remainder of the term plus the principal owed in order to terminate the mortgage early. This means that all the risks are borne by the homeowner and by the bank. And if things go south, the homeowner loses the house, and the bank may or may not make money selling the house. Which makes the bank paraoid at origination time (ie. paternalistic, making sure borrower can pay them back and so on).
Now let’s assume there are no ARMs, there are only 15 and 30 year fixed mortgages that Fannie Mae and Freddie Mac buy from originators. That means that the homeowner has less risk. The originator also has less risk as after the collect fees originating, it’s not their problem how the loan performs. This means that the US taxpayers (as they backup Fannie and Freddie) now have borne all the risk. Further, that risk is larger than the prior Canadian case as the originators are less paranoid (ie. who cares if this loan goes bad – not my problem), and there is additional risk as it’s far more difficult to forecast employment, house price, and interest trends for 15 or 30 years instead of 5.
Which system is fairer? The one that puts all the risks and costs onto the parties that stand to benefit from the transaction (homeowner, bank)? Or the one that puts alll the risks and costs onto all the US taxpayers who stand to gain no benefit from the transaction?
Thanks Anonymous – I was going to make this point but you beat me to it.
Your contention that all the risks are concentrated with the GSEs is not accurate. The homeowner still has risk because they can still lose their homes. The banks may not have risk, but they are not permitted to act irrationally because they still must conform to the standards set by the GSEs. The GSEs themselves would only be taking on the risks they allowed themselves through their underwriting. The real risk in the system would be governmental pressures on the GSEs to relax their lending standards.
Also, you stated it is easier to forecast 5 years ahead instead of 15 or 30. So what? If the loan is amortizing, the LTV is becoming more favorable to lenders and borrowers because the equity is increasing. If the home is paid off and there is no loan, foreclosure risk drops to zero. In the case of subsequent 5 year balloons, the risk is perpetuated forever.
Maybe forecasting 5 years is “easier” but apparetly forecasting even six months or a year isn’t very easy for the banks, the Fed, etc. is it?
A local bank manager, who knows his customers, and has his own bank’s money at risk, is likely to be able to make a smarter loan than a government agency far away, desperately trying to tighten rules to prevent exploiters from looting public money. (ie. the IRS has lots of rules – but that doesn’t put the loophole finding accountants out of business, or prevent Buffet from paying a lower percentage of income in tax that his secretary does, does it?).
For every well intentioned govt program, there are a bunch of jerks who run in and exploit it to loot public money. That’s just how it is.
A local bank manager who knows his or her clients is not curtailed in lending to anyone he sees fit assuming the bank capital is there to hold the portfolio loan. The GSEs standardize lending. This has both good and bad aspects; the good is the distribution of capital to where it is needed through the secondary market, and the bad is the denial of loans to creditworthy borrowers because they may not conform to national standards.
For a resonsible banker, the GSE rules can be bad. However, for your subprime just got myself a licence to do this sales type guy – the GSE rules are a good thing.
Anonymous
1. Check the Bank of Montreal website link elsewhere in today’s blog. A very sane lending program. Wish it was available here.
a. No prepayment penalty
b. loans up to 18 yrs.
2. Canada has no Fannie or Freddie
MBS’s must be registered with the SEC, yes. They are a security. They used to be illegal in this country. The reinstitution of the MBS coincides nicely with the beginning of housing bubbles.
What are you talking about?
To classify all ARMs as evil because of the mess we are in, is similar to how after Enron’s collapse we decided all stock options are evil.
I’ve had an ARM before. I got it when interest rates were a few points above historical norms. So I was able to drop my rate a bit with the hope I can refinance (or move) when rates stabilized. Looking back, it worked great for me and I’d do it again if a similar situation arose.
The problem is, when we had interest rates BELOW historical norms and people are getting ARMs so that they can afford a house.
My wife and I have a joke about buying soda, which is you never buy anything with 2 adjectives… “diet lime coke”, “diet caffeine free”, “cherry vanilla”… one adjective is fine, two is a warning sign.
Same can be said for loans. A standard ARM used properly is fine. You toss other crap on top of it, then you get into trouble.
The other issue, we need to just simply go back to more traditional housing lending practices. What ever happened to 20% down and 1/3 of your post tax income going to your house payments… and that you keep 6 months incoming tucked away as a buffer.
“To classify all ARMs as evil because of the mess we are in, is similar to how after Enron’s collapse we decided all stock options are evil.”
Actually, it is not the same at all. In our current mess, ARMs really are a big part of the problem. With Enron, stock options had very little to do with the collapse; Enron’s problems were related to accounting.
Anyone who takes out an ARM and benefits got lucky; it’s that simple. In your circumstance, you could have taken out a fixed-rate mortgage to avoid the risk of rising interest rates, and if rates moved lower, you could have refinanced. The ARM did nothing for you that a fixed-rate mortgage could not have done — except exposing you to additional risk.
By that logic, no down-payment mortgage products are OK because mine has worked out well for me. There are always examples of something working out OK for someone, hell 5/6 players of Russian roulette come out OK. The no-DP risk was somewhat offset by our 14% DTI, and my wife’s profession.
An ARM on a loan with 50% down, and only taking 10% of gross income to service is OK. Where does the line get drawn, and how do you mix it with other loan risk factors? The problem was having bad neg-am ARMs, low DP’s, and high DTI. You could tolerate one for a given loan, but when you hit all three it’s a strikeout every time.
I like “diet lime Coke,” but would never buy “caffeine-free Classic lime Coke Zero Plus.”
That would be ridiculous.
From Calculated Risk:
(Irvine) Office Building Sells at 40% Below Construction Costs
This is the property next to the North Korea towers. Between the properties on the south side of Jamboree and the Central Park West project to the north, this intersection is the black hole of Irvine real estate.
In order for us to find a sustainable bottom in our local economy, haircuts like this must happen … over and over. We’re about to have another (larger) one at the beautiful St. Regis Resort in Monarch Beach.
Idiots with no regard for reason & logic must be held to the fire.
St. Regis may or may not be a victim of coincidence. After the presidents denouncement of the AIG party held there, what corporation of any sort would hold any kind of function there? And how is a resort like that supposed to survive with zero business traffic?
IR,
(Irvine) Office Building Sells at 40% Below Construction Costs
Is the 40% of total cost (land plus construction cost) or just cost of building the structure plus permits/studies? The land’s change in value is a kicker.
On the loans, this country was found in part on freedom which included responsibility. If all the parties, i.e., agents, bankers, brokers and borrowers, were held personally responsible over the life of the loan, the USA and world would not be in this mess. The phantom “profits” were skimmed off the top on fees and bonus and pensions/taxpayers left holding the bad. The CDO/CDS, packaged as fax-insurance, allowed unregulated trading of insurance like product that were just gambling on debt without a enforcer to collect the gambling debts. In many US regulated industries, the guilty would be doing serious time for what happened. In this case, too many in govt and GS were involved to touch them.
It’s not the ARM’s or even the subprime mortgages that caused the collapse of the financial system. Like a lot of products, these are tools that are very useful for a small percentage of people in specific situations. Think of someone who is waiting for an estate to emerge from probate, or a spouse to graduate from medical school. If there’s a local bank or S&L that wants to risk their assets with a loan that is safe and profitable, who cares?
It was the process where these loans were fraudulently written, then packaged, securitized, insured, reinsured, and used to create massive phony profits with incredible leverage. This was aided and abetted by the ongoing merger of financial institutions, and the hollowing out of these to benefit the kleptocrats at the top.
That process, with no risks for the lenders who originated the mortgages, spawned an industry of juking the stats.
Fixing the mortgage system needs to start with re-regulating the entities that create the instruments which can engender massive systemic risk. Separate mortgage lending from banking, banking from investment, investment from insurance, and regulate hedge funds.
The toxic loans only exist because there is a market to securitize and “insure” the toxic loans with phony insurance.
Pool view: instead of California Girls sang by David Lee Roth, you get BBWs with noisy kids.
Common sense, responsibility and integrity can’t be legislated. The mortgage crisis wasn’t created by the availability of products; it was the result of their misuse by every entity involved, starting with the borrower.
Regarding Canadian mortgages, if memory serves virtually all mortgages there are no more than 5 years. You must re-apply for a new mortgage every 5 years. That probably accounts for the virtually complete use of adjustable rate mortgages. And I believe qualifying is substantially more stringent for the arms: traditional down payment minimums, debt to income ratios, etc. In other words, common sense and responsibility are built into the transaction. Neither the borrower nor the lender are taking longer term (beyond 5 years) risks than they can live with or need to.
That Canadian example seems odd. So after 5 years, if the market were to drop (i.e., house value drops), and you as an “owner” don’t want to “re-up” and get another loan…who takes the hit? I guess the “owner” if they can find a willing buyer. I don’t see how this system benefits the “buyer” –I see it as very risky for the so-called buyer. If they can’t/don’t want another loan after 5 years, or if the bank doesn’t want to give them another loan…the result is that they have to sell? I just don’t see how that system would work.
I haven’t looked into Canadian mortgages in years so my facts may not be correct. However, the scenarios you describe are the same in our current system.
If the market drops, house values drop for everybody.
If you don’t want another loan, you don’t have to apply.
If the bank doesn’t want to give you a new loan, go to another bank.
My perception is that the Canadian mortgages don’t disadvantage the borrower or lender at the expense of the other.
The problem with any system that utilizes ARMs is instability. Fixed-rate mortgages make for stable real estate markets because people can afford their payment regardless of what is occurring in the mortgage or resale real estate markets. Once you introduce large amounts of ARM financing, shocks to the mortgage market or real estate pricing causes a negative feedback with the ARM borrowers making problems even worse than they should be.
In short, ARMs equal volatility.
Negative feedback = self correcting. It means the feedback is in the opposite direction as the trend. If things are getting worse, negative feedback would make things better. Positive feedback sounds like the wrong term for what you describe, but it is indeed correct. Positive feedback = unstable.
There is some disadvantage to the borrower as s/he has to re-finance every x years (x = 3, 5 etc… Depending on the loan term). This does not allow for truly fixed costs (such as the 30yr fixed product) and if you want to switch banks (or sometimes even if you don’t), each bank will screw you with new and exciting fees.
Canada has a fairly stable RE market. Therefore it does work, regardless of who gets “hurt”.
I grew up in Canada and longer term (20 or 30 year) mortgages are common. No one wants constant bubble payments coming due, the costs of refinancing every 5 years would really increase the cost of housing.
There are a few differences between Canada and the US. Most importantly, there is no significant market for Canadian dollar denominated MBSs. As a result, banks have to hold a significant fraction of the mortgages they originate. The banks won’t issue fixed rate mortgages because they can’t hedge their term and inflation risks by selling on the mortgages. Also, the issuer can’t pass on the default risk on a questionable mortgage – this really limits the sub-prime market.
The US deductions for mortgage interest and capital gains on primary residences also don’t exist in Canada. So, housing is more obviously an expense than a source of wealth north of the border. Although, the mortgage bubble and speculation did bleed into larger Canadian cities (especially Vancouver and Toronto)
Mortgage rates are a bit higher because there is no secondary market but the lack of a secondary market helps limit bubbles – Canadian banks just don’t have enough capital to inflate a big bubble by themselves. Its also a real pain to try and buy a house without good credit. These issues were viewed as problems a few years ago but now as advantages.
Thanks for the clarification. You’ve pointed out differences that the U.S. mortgage market can learn from.
I thought it was that a Canadian could, say, get a 20 year mortgage, but what that really means is that the interest rate is only fixed for a 5 year period. When the 5 years is up, a new market based interest rate kicks in and can be locked for another 5 years. And so on.
Hmm, guess I’m wrong. Here is an link to the Canadian Bank of Montreal mortgage page
http://www4.bmo.com/personal/0,4344,35649_36724,00.html
This product is “new” (<10yrs old).
You might not be able not to legislate responsibility and integrity, but you can sure lessen the number of the transgressors by legislation. That’s why we have laws against driving 150mph on the freeway, DUI, murder, etc. If the law allowed those behaviors, the number of people injured would be skyrocket. The legislation doesn’t work in the long run when the law or enforcers are flagrently unjust or immoral.
newbie 2008: Good points. I agree that needed and cogent legislation is critical. I also feel that you can’t micromanage legislatively. Responsible legislation will allow and depend on the exercise of good judgment and responsibility. That’s what was missing in the current crisis.
See my post above on this
So I put together another ‘RE calculator’ this weekend. I’d like feedback (yes I realize its super plain and ugly).
The main intent is to look up places that have pre-bubble sales and see how it compares to current prices. I like looking up recently sold (in the last month) and see how things stack up.
What it does:
* Look up the mortgage rate for the month prior to the sale
* Calculate a 20% down payment
* Find the monthly mortgage for the loan (80% LTV)
* Adjust the monthly mortgage for inflation
* Spit out what purchase price (assuming 20% down) you’d have for todays (monthly) dollars – both at the original interest rate and todays (rough) interest rates
http://nothinbutnetworks.com/calc.html
A good example is my dads house in HB. He bought in 6/1991 for 250k – early on the back side of the last downturn. It seems rents are roughly even (his house would rent for ~2400-2800) if you account for inflation.
dafox. Thanks for the calculator. Among other things, it shows what a huge difference interest rates makes in the price of a home.
Yes, it is also why prices have been somewhat stable in Irvine over the last year. The drop in interest rates to 4.5% added about 15% to the affordability of a home here.
“Indeed, recent research within the Federal Reserve suggests that many homeowners might have saved tens of thousands of dollars had they held adjustable-rate mortgages rather than fixed-rate mortgages during the past decade.”
Why Alan said this?
I recalled after a rapid run up, at end of 2003, the house prices start to fall. And Alan said this at the beginning of 2004. And this really causes a big run up on prices and hence a fake prosperity in economics.
We know there is a president election coming (Nov 2004), and then 2005 Alan re-nominated by GWB again as Fed chairmen.
Do you think if there any consequence between this?
But Obama will never investigate this, why? If Kerry was elected as president 2004, Obama will have no chances for 2008 at all. Also, what Obama do now is exactly GWB have done:
GWB uses real estate bubble to bail out stock bubble while Obama uses US dollar to bail out real estate bubble. A quick short cut but will hurt us more. And this time US will lose even more.
We need another change so fast! God bless america.
I remember that prices began to back off a little and properties started to languish on the market for longer periods around 2003. Friend of mine who owned a mortgage brokerage remarked that he felt the bubble was about to pop.
But the fake “growth” machine had to be kept running at the top of the throttle at all costs. Bushco knew damn well that the wonderful economy and growth in “wealth” depended entirely on debt creation, asset inflation, and monetary manipulation, and that any pull-back would result in the whole shake structure toppling. They only hoped to keep it going until 2008.
Paul Volker issued a dire warning concerning the large systemic risk in 2004. He was not heeded, and neither were the handful of other financial experts who pointed out that never had any country ever survived this level of debt, that the overhang of public and private debt as a percentage of GDP exceeded anything the world had ever seen in the history of civilization.
This debacle was created and driven by our policy makers. Well I remember being exhorted to “put your wealth to work” and Bush crowing about the “wealth” people were supposedly accumulating in their houses, as I watched every place in my price range ratchet to unaffordability- unless, of course, I wanted to take out a pay option ARM for 6X my yearly income. I was offered many such, often with cash back at the closing, for I have a dozen friends and acquaintances who were in the mortgage biz and who made $200K or more a year doing such mortgages, and cash out refinances, which were where the real money was, I was told.
Don’t know if anybody noticed this, but the Tsunami is now HERE!
http://www.fieldcheckgroup.com/2009/06/14/6-14-the-next-foreclosure-wave/
http://members.cox.net/studio-od/big_wave_surfing.jpg
http://www.fieldcheckgroup.com/wp-content/uploads/2009/06/new-bar-all-3-stages-1.png
That’s a very good graph. We are in the lull from the lull starting last September, but it looks like we are about to come out of that and the second tidal wave is about to hit.
Of course, everybody has been saying this for months, so I’ll still only really believe it when I see it.
One thing about these aggregate graphs; the first wave was large in Riverside County and small in Orange County whereas this coming wave will be small in Riverside County and large in OC. The aggregate data only shows that there is a wave, but it does not tell us where it is or what market strata is going to be effected. This coming wave is aimed at the mid- to high-end properties where the first wave did little damage.
That makes sense that the higher end properties would mostly default later.
Irvine Renter, I’ll respectfully differ with you on the issue of playing nursemaid to borrowers.
We don’t need any more nanny-statism in this country, because that’s what’s caused our problems to begin with.
The financial industry is STILL pushing ARM mortgages and writing people for too-large mortgages because they now know that every time they make a mess, they will be bailed out. Borrowers are still stepping in over their heads under the auspices of the FHA- something like 95% of all home loans being written right now are FHA loans with 3.5%% down, along with the $8000 tax credit for first-time buyers. For the past 80 years, Big Daddy Government has created a vast array of programs to underwrite lending to marginal borrowers and buy the crap mortgage paper, so that borrowers can buy over their heads and their lenders are insulated from their risk.
We need to go the opposite direction. Shut down FNMA, GNMA, Freddie Mac, the FHA and HUD, and make it very clear that there will be no further assistance for lenders buried by bad loans.
We made a massive mistake with the bailouts, for not only have we now saddled our country with the biggest overhang of public debt ever to exist in the world, but we’ve sent a very important message to the financial world, which is that they can take all the risk they want with no consideration of the probable consequences, and we’ve not only let careless and dishonest borrowers off the hook but are enabling them in becoming repeat offenders
The “nanny statism” is an attempt to clean up the mess, not the cause. Many people would argue the cause was not enough government (during the Bush years) that caused the current problems, not too much.
Laura,
You are confusing the presence of bad regulation with the need for good regulation. This is the same specious argument anti-regulation proponents have been making for years, and it is just as wrong today as it was then.
Bad regulation needs to be changed. Good regulation needs to be put in its place. The all-regulation-is-bad argument is the mindset that allowed this disaster to occur. Two years ago, your arguments might have gotten some traction; now that we are all paying for this mess, not so much.
IR, the trouble is that, while you and I might be able to discern the difference between good and bad regulation, our policy makers can’t. The only thing they are capable of seeing is what serves their political purposes, and their notions of what constitutes “good” or “bad” regulation will always be informed by their idea of what will serve them politically. Some people are amazed at how they can abandon their professed principles in favor of the expediency of the moment, but they almost always are corrupted by the power they have.
Witness the complete capitulation of Alan Greenspan, who abandoned every principle he said he believed in during his early association with Ayn Rand. Witness how quickly he not only embraced Keynesian beliefs in manipulation of the money supply in order to run the economy, which is the tail wagging the dog, but abandoned all decency and honesty in his promotion of easy money during the 90s and early 2000s.
It’s now become trendy to blame the free market, but when have we ever had one? There was no free market at all here, for, while our financial firms had total license, the risks they were taking were shifted to the public. The bailout of Long Term Capital Management back in the 90s, which should NEVER have been done, was the watershed: it made it clear that they would be permitted to shift their risks to the public.
Freedom implies responsibility. There can be no freedom when one person is enslaved by being required to clean up someone else’s messes with no discernible benefit to himself, while another person is given total license with the understanding that the risk he is running will be shifted to someone else, in this case the public, who will be required to mop up his messes. That is now the case and has been ever since the first bailout, that of the S&Ls; back in the 80s.
What we have had for the past twenty-five years is NOT a “free market”, but a very rigged playing field extremely tilted to shovel the wealth of the nation to a few corporations while freeing them from the consequences of bad business decisions and allowing them to take obscene risk because the government agencies like FNMA, FHA, GNMA and the rest are there to help them offload their unacceptable risks onto us. This did not happen by accident, but was a deliberate creation of our leaders, who mouthed “free market” ideas while putting into place a very intricate Corporate Welfare State, which is the opposite of a free market.
How could we ever for one minute have pretended we had such a thing while promulgating government agencies whose only purpose is to buy the crap mortgage paper away from the lenders who create it? Believe me, bankers do not take risks they think they will have to eat. But they could do anything that turned a buck, safe in the knowledge that they could offload it to the Treasury via the FHA and the GSEs.
And it’s not just housing, but all of commerce that has been distorted by government subsidies and “private/public parterships”. Look at all the retail chains and shopping malls that are now failing and leaving the suburban landscape blighted with shuttered malls and power centers. Did you ever wonder who supported all this redundant retail to begin with? The taxpayers, that’s who, mostly at the local level via TIF districts and 10-year tax abatements. Did it ever make sense to shutter a 3-year old big box power center just to open a bigger one 2 miles down the road? No, unless you could construct it with a $40 million gift from the municipality in question, which was so desperate for future tax money that its leaders let themselves be gulled into forming a $100MM TIF district just for your store- then write in down over 3 years, then repeat the process a couple of miles away. I promise you that almost every Border’s Books, Linen’s and Things, Circuit City, Target, and Walmart, or other major chain store or mall built in the past 15 years got one or the other of these types of subsidies, with results that we can see, as these chains are beginning to fail. Circuit City and Linens gone, Border’s trading under $1 a share and closing stores. So we the taxpayers get a multiple beat-down: first, we pay to build the damn store, then we pay when our neighborhoods and towns are blighted by shuttered shopping centers, and we will pay very big for the wave of commercial defaults that is coming our way.
One writer stated, long ago, the capitalism requires virtue. Well, as long as our Corporate Welfare State enables and subsidizes malfeasance and completely insane risk, we can forget about the virtue, and as long as the body of taxpayers is legally enslaved to the financial houses and is required to clean up their messes, freedom is a joke.
I agree with Laura.
Big Daddy Government is not the answer. I look at today’s ‘white paper’ on financial regulation reform and just can’t fathom how our political leadership can be so completely unaware of the real disease rotting out the core of our mega financial institutions.
The white paper expands the power of the fed, keeps multiple overlapping agencies and promises another non-elected czar. Worse, it does nothing to address the megabanks themselves. There is no limit on how they operate, how large they can get etc.
The real problem is obvious to many people, including Sheila Blair at the FDIC. Our megabanks cannot be allowed to run gambling houses under the same roof as commercial banking. Obama understands that Clinton’s repeal of Glass Steagal opened up the Pandora’s box that led to the financial orgy during W’s administration, but he is apparently too politically constrained to directly address this issue. The only right path is to force gambling houses – loosely defined as businesses whose profits come soley from trading – to stand on their own and be transparent to the investors who fund them. It is not right to allow gambling houses within commercial banks to utilize consumer deposits and federally backstopped leverage to make outsized risky bets in the market. Because they hide in the shadow of the commercial bank they are enboldened to believe that government will never let the whole bank fail and thus the gambling traders will always be bailed out in the end. This creates an absurdly asymmetric risk-reward model which leaves the tax paying society holding the bag for the extravagant lifestyle of the few. How would you behave in Vegas if you had unlimited leverage to gamble and no responsibility for your losses?
The day when we return to commercial banks being commercial banks, focussed on taking deposits and making loans we will be on the road to recovery. Please support Sheila Blair in her efforts to take on the mega-Boards at Citi and BoA. She is already being hammered down by the political class. If she and the small group of likeminded people give up this effor then we are doomed to endlessly repeating financially-engineered crashes.
I’ll just step back down off my soapbox now. Sorry for the rant.
If you are going to throw out all the blame to one person you better have all your facts on who really caused dereg to occur and who proffited from it big time.
http://en.wikipedia.org/wiki/Glass-Steagall_Act
http://www.time.com/time/specials/packages/article/0,28804,1877351_1877350,00.html
http://www.time.com/time/specials/packages/completelist/0,29569,1877351,00.html
notice who wrote dereg:
As chairman of the Senate Banking Committee from 1995 through 2000, Gramm was Washington’s most prominent and outspoken champion of financial deregulation. He played a leading role in writing and pushing through Congress the 1999 repeal of the Depression-era Glass-Steagall Act, which separated commercial banks from Wall Street. He also inserted a key provision into the 2000 Commodity Futures Modernization Act that exempted over-the-counter derivatives like credit-default swaps from regulation by the Commodity Futures Trading Commission. Credit-default swaps took down AIG, which has cost the U.S. $150 billion thus far.
But the real blame is those that all found a way to profit off of the homeowner–and those folks know who they are–
Gramm could write it all he wanted to please his big money sponsors. However without Clinton’s signature it was DOA. Not enough votes to override a veto. I recommend reading the section of “Tearing Down the Walls” that covered how Sandy Weil leveraged his connection to Jesse Jackson to appeal to Clinton’s desire to be viewed as viewed as ‘champion of the black community’. Interesting politics including a promise by Weil to fund Clinton’s inner city education initiative.
We have had a federally controlled banking cartel for a long time now – complete with private profit and public risk carried through federal deposit insurance, Federal Reserve lender of last resort, and Federal Reserve too-big-to-fail policies. Letting the banks and politicians determine the bank underwriting standards at taxpayer risk generated the S & L bailout as well as the current problems. Yes, we should prohibit insured institutions, GSEs, and U.S. securities sellers from issuing variable rate home loans or securities; or should require underwriting at the maximum contract rate.
Meanwhile, the much bigger problem is the long-term debt bubble and the boom/bust cycle, which are caused by banks creating artificial credit expansion through “fractional reserve” banking. This is a gargantuan example of private gain and public risk, as the banks profit by expanding their loan book far beyond the actual additional savings provided by their depositors.
Prohibit fractional reserve banking – by requiring banks to match maturities of assets and liabilities – with no borrowing short and lending long. This will create a much more stable system, with new loans and investments tied to new savings, rather than a boom/bust/bubble cycle generated by bank profit-seeking behavior.
“Prohibit fractional reserve banking – by requiring banks to match maturities of assets and liabilities – with no borrowing short and lending long. ”
This will also send us back into the 1900’s.
IrvineRenter,
Awesome article – consider submitting it to SeekingAlpha, especially with the Greenspan quote and your deep policy analysis. Not sure if you read that site, but it’s a great center for investing and trading. I read your blog and SeekingAlpha considerably, and this would be a great article for the site. I have no vested interest in either site, just an enthusiastic reader wanting to learn:
http://seekingalpha.com/page/submit-an-article
No. ARM loans have served a great purpose in giving borrowers choices. ARM loans have worked very well for homeowners and the banks that would not have financed many of these borrowers without “exotic” financing.
ARM loans are like hand guns. You need to know what you are doing around them. You need to obtain them from licensed professionals only. You need to know their risks and their limitations. If you decide to ignore these issues, it then is a question of Darwinian evolution.
The collapse in mortgage financing was not due to ARM loans. It wasn’t due to Sub-Prime loans. It’s not due to Option ARM’s either. It’s principally due to underregulation of LO’s (where else can someone with a 5th grade education put you $1m in debt without recourse?), underregulation of Realtors (where else can you make $100kpy with a 4th grade knowledge of sales and economics – apologies to most 4th graders….) and the proliferation of FDIC insured companies offering reduced documentation loans to borrowers who had no business buying properties and no intent or ability of paying these loans back.
I’m a conservative by nature, but financial services re-regulation is well overdue.
I say we just get rid of Interest.
Lets face it, it’s usury.
It is not the banks’ fault that people took out loans they cannot afford to pay.
First of all i think that the ARM is a very reasonable product for a decently large portion of the population. Especially first time home buyers. There are a few reasons:
1) if you’re buying a starter home, why would you want to pay for 30 years of interest rate protection? Don’t forget banks don’t write 30 year fixeds for free, they’re taking interest rate risk too, so they charge you more than for an ARM. For that reason a 5/25 would be very reasonable for a young family with rising income and is planning on moving to a larger place within 5 years.
The problem is people who do 1 year ARMs on a teaser rate with 0 down. not 5 or 7 year fixed with 20+% down.
So lets do an experiment. What happens to somebody who buys a 500k house today with a 5 year ARM at 4.89% that resets to 6.5% in 5 years and 8.5% in 6 years? And lets also assume that they would have gotten a FRM at 5.67% (bankrate.com as of today)
So the FRM stays at $2878.90 per month for 30 years
The ARM starts at $2639, goes to 3,078 in year 6 and then $3649 (!) in year 7.
However, lets make one more assumption, during the 5 year fixed period, the borrower uses the extra $239 a month to pay down the mortgage debt each month.
So now at the end of 5 years, they have $19k more equity in their home than the FRM borrower, and their payment reset is down to $2,982 or 3.5% more than they were paying. I think that’s manageable after 5 years. The second reset is to $3534 which is a bit of a jump (+19% over last year, but they still have $17K more equity than the FRM borrower)
Basically, you’re better off under most 5/1 ARMs for a 7-8 year period. PROVIDED that you save the extra cash you’re saving and put it to work in your mortgage. So the ARM really helps the most prudent and conservative borrowers.
Even if rates cap out at 6 points over the starting rate, you’re paying about $4k /mo for the house after 8 years, a significant 43% over the FRM mortgage, but if mortgage rates are 10%, nominal incomes are probably kicking up relatively quickly as well, and you only need 4% raises for 8 years to keep the same real housing payment in terms of % of income, and then you’re still not going to get foreclosed.
You do realize your assumptions are crazy, right?
Take a look at year 7 in your scenario. The fixed-rate borrower is still paying $2,878 per month while you ARM borrower is paying $3,649. This is a good reason to use ARMs? Are you kidding?
Assume a borrower is disciplined enough to put extra toward principal…. Maybe 2% of borrowers ever do that. Most don’t have the extra to put toward principal, or they would not have used an ARM to begin with.
In fact, it you think about what you just described, it sounds very much like an Option ARM. I think we all know how that worked out.
Re-read what you wrote and tell me you honestly think an ARM is a good lending program.
No, i’m saying that for financially responsible borrowers who are choosing between a FRM and a ARM, the ARM may be the better answer.
Don’t forget, i took the MOST bearish assumptions in saying that mortgage rates will jump by 400bps.
Like i said, ARMs are not an affordability product, they are a specific product for people who do not see the value in buying 30 years of rate protection for something that that they want to live in for 5-7 years. Over 7 years, the 5/1 ARM is a superior product.
Over 30 years in a raising rate environment its better to get a 30 year FRM. You need to take your own circumstances into account.
If you’re a 28yo couple buying a 2/2 condo, an ARM is a vastly superior product. Do you really expect to keep your 2/2 in 7 years? If not, you’ve paid much less in interest and paid down your principal faster.
There’s no need to pay 30 years of interest rate protection in that case.
Two more points while i have my model open:
1) you pay less for the first 7 years under the ARM even using the maximum interest rate hikes. actually the length of time for jumbo ARMs is even greater
2)Would you pay extra for a 7 year car warranty if its not transferable to the new owner and you plan on buying a new car in 4 years?
Like i said, you need to make the numbers work using a FRM and then you can consider managing your cash flow and interest rate risk.
Also, ask people who had a 5/1 ARM that was underwritten in 2004 and ask them how its going? I bet they see a rate reduction this year.
Lot of assumptions in there.
I think ma ma always said…when you ASSUME you make an ASS out of U and ME.
It’s assumptions that got us in this mess.
We assumed:
-People will always be making more money
-Values of home always go up
-Borrowers can always re-fi before the ARMS reset.
OOOOOOOOOOOOOOPS!
Back in 2006, when I was looking at housing, to see what was available, the realtor used those EXACT 3 selling points to try and persuade me to buy.
You should also add the standard, “tax breaks will make up for the increased monthly payment.”
He also said, “make sure to bring your checkbook in case you want to buy that day.” I was like WTF, I don’t just make the most important financial decision in my entire life like that on the spot like I’m picking out new pants or something LOL.
Glad I walked away…
Oh yeah, don’t forget how Obama and the FEd ASSUMED that by lowering interest rates, this would have increased new buyers.
WRONG!
Re-fi’s came out of the wood work, and new buyers missed the window.
OOOOOOOOOOOOPS!
I love assumptions. Got any more?
Perhaps IR needs to refresh himself on the *primary* (and it’s not fraud) reasons why the S&L blew up. Then he’ll undertstand why you have fixed programs where the banks bear all the interest rate risks and arm programs where the risks are shared with the borrower.
I probably should do more research. I really don’t know anything about this subject; I just make it up as I go along.
The trolling isn’t very lulzy today. Nice retroll tho.
The point is the borrowers can’t handle that risk.
“Then he’ll undertstand why you have fixed programs where the banks bear all the interest rate risks and arm programs where the risks are shared with the borrower. ”
I love to SHARE RISK! Sign me up!
IR and Others..
we can talk all about wether this is good time to buy, or what’s coming etc, but the reality is that buying a home right now has become really difficult due to severe “competition” . i am not talking about getting loan etc. every damn decent home that comes on mkt gets like 10-15 offers. there is so much fraud going on where listing agent sells the REO property to someone he knows by blocking all other offers and then offering to sell the same property couple of months later at higher price, that it is unbelievable. ask anyone who is looking for home today (incl me) about how audacious the agents are about such frauds and how bad the competition is. i lost offer on 3 homes where it got sold for 30-40K less than my offer.
bottom line is, thats thats the reality. if there is such a huge demand, banks will have buyers to help them reduce inventory.
While anecdotes aren’t data, I’ve heard a couple of stories about low-priced REO’s going to someone other than the highest qualified bidder,and these were two potential buyers coming in with substantially more than 30% down, and impeccable documentation.
Inefficient markets.
I don’t see non-exotic ARMs as inherently toxic. I think that they are a better choice that fixed rate mortgages if one is not convinced that interest rates are headed higher for the next 20-30 years.
Suppose a buyer purchases a home with a large downpayment and a 15-year straight ARM – no negative amortization period, and at most a 1-year teaser rate, with payments that are well within her means.
She will then have periods of paying higher than the current interest rate, and periods of paying less, but the lender will be taking less risk than would be involved in a fixed-rate mortgage, and so would – in a rational market, which did exist before 2002 – give her a lower overall interest rate and lower points, if any.
I have known people who carried variable-rate mortgages for years, and did just fine. If you’re betting on relative stability of interest rates, either to the upside or the downside, then a variable-rate mortgage is a better deal for both the borrower and the lender.
I like all these ARM’ers who just refuse to pay their mortgade once the rates go up. That is really ethical and a great way to serve your kids. Here kids, I want you to pay for Daddy’s debt.
“don’t see non-exotic ARMs as inherently toxic. I think that they are a better choice that fixed rate mortgages if one is not CONVINCED that interest rates are headed higher for the next 20-30 years.”
Wow.
“Convinced”?? LOL!
I love people who invest based on speculation and opinions. Genius!
ARMs are a risk management tool for the bank.
They are used by a bank/lender to offload some of their interest rate risk to the borrower. It literally protects the bank from losing “opportunity” money if the rates fluctuate upward significantly. Then they can feel more at ease charging a lower starting rate because the borrower is agreeing to take on this risk.
Problem is, most borrowers aren’t in a position to be taking risks away from the banks, anymore than they are in a position to self-insure their home for fire. One of the whole points of a large institution like a bank (or an insurance company for instance) is they can handle the risk much better than the individual hoi polloi borrowers, by pooling it and charging a fee for it, like an insurance premium, which is why typically the 30 year fixed rates are higher than the adjustable rates.
Result: boneheads choose the high-risk product, analogous to buying stocks on margin, because they think it will save them money in the long run. Which, like other things, works until it doesn’t. ARMs are for people of means, if anyone.
A real dumbhead would be like someone who takes out an ARM (saves money by taking on big risk) and then turns around and buys comprehensive insurance for their automobile (pays an insurance company to take on the risk of collision/fire/theft).
Adjustable rate mortgages have always carried substantial risk to the borrower. The increased risk is correlated to the lower rate. We’ve always advised our clients to consider the long term when buying a home. But I think that it’s more likely that biggest factor in determining the risk of default is the amount of the down payment requirement. The zero-down and super-low-down payments combined with ARM’s was an invitation to default. That practice has been largely curtailed, although the 3.5% down payment for FHA loans is still very suspect.