Pay Me My Money Down — Bruce Springsteen

In a healthy real estate market, people only take on as much debt as they can afford, and they work to pay it off as quickly as possible. Debt is something to be retired not endlessly serviced.

If you look at the equity curve of real estate, you see that equity is built in 3 major ways:

1. Speculation.
2. Inflation.
3. Debt Retirement.

A truth that everyone is becoming painfully aware of is that speculative equity is not stable. Prices once detached from fundamentals will return to them at some point. The return to fundamentals is either accomplished through actual price declines or a period where prices increase at a rate less than inflation. It is usually the former. Speculative equity cannot be counted on, and it is only captured through careful analysis or blind luck. It is usually the latter.

Inflation equity is really not equity at all. If your house doubles in value in 20 years, but the value of the currency has cut in half, you really haven’t gained anything. On paper you have a gain, but the money you get out has no more buying power than the money you put in, so you really haven’t benefitted as much as you think you have. Inflation equity will preserve your wealth, but it will not add to it.

The real way to make money through long-term ownership of real estate is through obtaining financing equity. You get this by paying off your loan. This method of building wealth, the only one that really works, has been much maligned over the last decade as fantasies of easy money through boundless appreciation gripped the market.

Pay me or go to jail
Pay me my money down

The last time we had a healthy, fairly valued market was from 1995-1999. During this period, people did not believe in endless appreciation because prices had been declining since 1991. Buyers realized the only way to make money in real estate was to borrow a small amount and pay it off or pay such a small amount that you could rent the place for positive cashflow. Once prices start going up, people see that they can profit from appreciation, and the slow, steady method of building wealth through retiring debt seems rather quaint and old fashioned.

Once prices start really going up, paying down mortgage debt is an unnecessary financial burden. Why bother paying an extra $500 a month toward your housing debt when the house is going up in value about $5,000 a month? Why not just use interest-only financing and spend that $500? Well, that is such a good idea, the next step is obvious: why not utilize a loan where you don’t even pay the interest and free up that payment money for consumer spending. The Option ARM is born.

But why be satisfied with only falling behind $500 a month on your mortgage when house values are going up $5,000 a month? Why not borrow more? Why not go withdraw the equity in huge lump sums? After all, it is accumulating far faster than it can be spent. If you refinance or open HELOCs periodically, you can extract this free money as soon as it becomes available. Why not?

Do you see how speculative equity is a slow seducer? The foolish and irrational seems completely logical when you look at the changing circumstances.

When a Ponzi Scheme is built on debt, like it was during the Great Housing Bubble, each person in the chain must assume a larger debt than the person who came before them. Since nobody is paying down debt, and since most people are furiously adding to it, the amount of debt buyers needed to take on in order to pay off the debts of the seller becomes very large. There is a point where the debt becomes too large for people to service, and they default on their payments. Once banks stop getting paid back, they stop making loans: a credit crunch.

The challenge for lenders in the wake of a crashing Ponzi Scheme is to rediscover the debt-to-income levels people can support for residential real estate. Historically this number has been around 28%. The challenge for the market is to endure the crash back to pricing levels consistent with stable borrowing levels. We are in that process right now.

During the price decline, market psychology will also change. People will slowly recognize that the personal financing methods they believed were stable during the bubble (interest-only and negative amortization loans at high DTIs) are not stable and should not be used. As long as market participants believe in the fantasy of speculative equity, they will utilize whatever means of financing is available to them to acquire as much real estate as possible. It is the knife-catcher mentality. The slow grind of declining prices will pulverize this faulty thinking over time, but in the interim, people will continue to overpay for real estate to the degree that they can.

Eventually, it will become widely recognized that borrowing a small amount and paying down a mortgage is the only real method of accumulating wealth in real estate. Of course, when this happens, the market is at the bottom, and the whole cycle begins all over again…

{book}

Today’s featured property is an example of how people get seduced by the free money of speculative appreciation. They were not bad HELOC abusers: a refinance here, a HELOC there, but over time this habit has more than doubled their mortgage obligations, and now they must sell their home before they fall underwater. Are you ready to assume their debts? Whoever buys this house is going to. They took out the free money and spent it, and now they need to find someone willing to pay off this debt before it becomes a short sale.

All their equity — initial, speculative, and inflation — was wiped out by their method of financing and mortgage management. Seventeen years of ownership, and they have nothing to show for it.

Asking Price: $699,900

Income Requirement: $175,000

Downpayment Needed: $140,000

Monthly Equity Burn: $5,833

Purchase Price: $355,000

Purchase Date: 9/18/1992

Address: 14 Deerwood East, Irvine, CA 92604

Beds:	4
Baths:	3
Sq. Ft.:	2,563
$/Sq. Ft.:	$273
Lot Size:	5,400 Sq. Ft.
Property Type:	Single Family Residence
Style:	Contemporary
Year Built:	1975
Stories:	2
Area:	El Camino Real
County:	Orange
MLS#:	S558822
Source:	SoCalMLS
Status:	Active
On Redfin:	1 day
New Listing (24 hours)

That description was not painful to read. Well done.

This property was purchased on 9/18/1992 for $355,000. The mortgage record database I use does not show their initial financing, but we can assume it was a $284,000 first mortgage, and a $71,000 downpayment.

• On 5/27/1999, they refinanced with a $335,000 first mortgage.
• On 6/5/2002, they refinanced with a $379,000 first mortgage.
• On 4/2/2003, they opened a stand-alone second for $40,000.
• On 11/10/2003, they refinanced with a $438,000 first mortgage.
• On 5/3/2004, they refinanced with a $490,000 first mortgage.
• On 5/22/2006, they opened a HELOC for $100,000.
• On 5/1/2007, the opened a HELOC for $160,000.
• Total mortgage debt is $650,000.
• Total mortgage equity withdrawal is approximately $315,000 plus their downpayment.

This is the kind of property I see every day. The owners doubled their debt through mortgage equity withdrawal. They do not meet the definition of a distressed seller, but they need to sell soon before they fall underwater, so they are likely motivated. Plus, their mortgage debt has probably grown faster than their incomes, so they are probably having difficulties sustaining the payments. As I have said before, They Are All Distressed.

If this house sells for its asking price, and if a 6% commission is paid, the owners stand to make $302,096. Out of this profit, they have already spent $315,000, so either this will be a short sale, or they will write a check for $12,904. With their 17 years of ownership, they didn’t make anything. At least the banks won’t lose much money on this one…

{book}

I thought I heard the captain say
Pay me my money down
Tomorrow is our sailing day
Pay me my money down

Well, If I’d been a rich man’s son
Pay me my money down
I’d sit on the river and watch it run
Pay me my money down

Pay Me My Money Down — Bruce Springsteen

P.S. I thought you might like this video:

Hey, Bernanke, Paulson, and, Bush: Pay off OUR Loans!

Save a Prayer — Duran Duran

Don’t say a prayer for me now,
Save it ’til the morning after

There will be some borrowers who will benefit from the ultra-low interest rates being engineered from the FED. Anyone who has not already refinanced into a 30-year fixed mortgage may have an opportunity to get out of their toxic mortgage. Of course, there are two problems: 1. Some people do not want the fixed rate mortgage, and 2. Very few people that do want it qualify for refinancing.

I remember having conversations with lenders in 2008 about the tightening loan terms. I was surprised by what they were telling me. Apparently, most people that were going in for refinancing were looking to refinance into another toxic mortgage with a low teaser rate. First, people with Option ARMs would ask for another one so they could stretch out their teaser rate period. Then, people who were getting out of Option ARMs (because they were no longer offered) were going with 1 year adjustables or whatever loan product gave them the smallest payment. People were not looking for stability, they were looking for the next bridge loan with the lowest possible payment. There is still a widespread perception among the borrowing public that serial refinancing from one teaser rate into another is a viable way to manage one’s mortgage obligations.

{book}

This dependency upon serial refinancing from one toxic loan to another is part of the reason people perceive today’s lending standards as being so restrictive even though by historic standards they are still quite loose (allowable DTIs are still at high-default levels, and they will tighten further). Everyone seems to be waiting for the return of toxic financing to re-inflate the housing bubble and allow them to continue serial refinancing their extreme indebtedness. I know I have said it a million times, but I will say it again: the loose financing of the bubble is not going to return.

Think about what the lenders just went through. Here at the IHB we have been documenting hundreds of thousands of dollars in lender losses on a daily basis. This is adding up to hundreds of billions if not trillions of dollars nationwide. This happened because the lenders were giving out too much money to people who could not pay them back. Does it seem likely they will do this again any time soon? Those people waiting for a HELOC dependant lifestyle to return might as well be awaiting the Rapture.

(Like all dreamers can’t find another way)
You don’t have to dream it all, just live a day

The people who do not want fixed-rate financing must be flushed out of the system. As long as these short-term adjustable rate loan programs are being offered, the foreclosure crisis is just being extended. Nobody using this form of financing is in a stable loan program, and they will experience one of two possible outcomes: 1. They will eventually get a fixed-rate loan, or 2. They will end up in foreclosure. The longer they wait until they go fixed, the more likely they are to end up in foreclosure. The only thing preventing their foreclosure is an interest rate reset while rates are higher.

The second group of people, those who do not qualify for refinancing, is actually must larger and much more of a problem, despite the spin to the contrary. To illustrate why this is a problem, let’s examine a typical Irvine homedebtor to see the circumstances he is facing.

Asking Price: $675,000

Income Requirement: $168,750

Downpayment Needed: $135,000

Monthly Equity Burn: $5,625

Purchase Price: $822,500

Purchase Date: 10/26/2006

Address: 26 Carver, Irvine, CA 92620

Beds:	4
Baths:	3
Sq. Ft.:	2,077
$/Sq. Ft.:	$325
Lot Size:	5,200 Sq. Ft.
Property Type:	Single Family Residence
Style:	Contemporary
Year Built:	1980
Stories:	2
Area:	Northwood
County:	Orange
MLS#:	P645526
Source:	SoCalMLS
Status:	Active
On Redfin:	179 days
Unsold in 90+ days

This property was purchased on 10/26/2006 for $822,500. The owner used a $650,000 first mortgage, a $172,500 HELOC, and a $0 downpayment. Since he bought at the peak, he has not had a chance to refinance and start living off the HELOC.

How would this owner refinance? Let’s say he went in to try. First, he would get an appraisal that would show the current market value to be around $625,000-$650,000. The best he could hope for would be a refinance at 80% appraised value, so the bank would offer him a loan of $520,000, assuming he met the other loan underwriting standards. Do you see the problem? Does it seem likely he has $300,000 of cash handy to pay off the other two mortgages in order to refinance?

• So here is a homeowner at least 20% underwater,
• he has current mortgage payments that are likely crushing him,
• there is an interest rate reset looming,
• there is an amortization recast looming
• there is little or no chance of appreciation bailing him out, and
• he is unable to refiance into a supportable mortgage payment.

What do you think is going to happen?

In all likelihood, this owner, and all the homeowners in a similar circumstance are going to default and go into foreclosure. The low interest rates are not going to solve his problems. The best they could do is make his payment burden somewhat less arduous for a brief period of time. Unless he receives significant debt relief or a huge increase in wage income, he cannot be saved.

What kind of government program or bailout will save this guy? Mr. Mortgage has recommended large-scale mortgage principal reductions. That would mean all the responsible would be required to subsidize the foolish and irresponsible who crowded the responsible out of the housing market. That would probably make my head explode. Realistically, what Mr. Mortgage proposes is the only thing that would be effective. Fortunately, it is so expensive and politically untenable that it will not come to pass.

Ultra-low interest rates if combined with some kind of refinance loan guarantee program would be another workable solution. If the GSEs started to guarantee loans for refinance on borrowers who are underwater, it might save some of those owners who genuinely want to stay in their family homes. Of course, this would be very expensive for the US taxpayer because speculators and flippers would sign up for the program if they thought it might buy them a couple of years of waiting. When prices do not come back, they will give up, and we will end up paying for their losses through the loan guarantee program.

If someone out there can enlighten me as to how the government can possibly solve this problem, I would like to read your ideas. Denying there is a problem is not a solution…

I hope you have enjoyed this week at the Irvine Housing Blog. Come back next week as we
continue chronicling ‘the seventh circle of real estate hell.’ Have a great weekend.

🙂

{book}

You saw me standing by the wall,
Corner of a main street
And the lights are flashing on your window sill
All alone ain’t much fun,
So you’re looking for the thrill
And you know just what it takes and where to go

Don’t say a prayer for me now,
Save it ’til the morning after
No, don’t say a prayer for me now,
Save it ’til the morning after
Save it ’til the morning after,
Save it till the morning after

Save a Prayer — Duran Duran

I Made a Mistake 2008

I recommend the video above. It is a classic 2008 recap.

This year, 2008, was the year the world came to recognize that we have a huge economic problem caused by housing. As with all crises there was denial by everyone at every turn, and this denial is still going on. The latest nonsense meme is that low interest rates are going to solve the ARM problem: bull$hit it may even make it worse.

I received a sign that the general public is moving from denial to fear in Irvine. Some people I know that bought in late 2007 are selling their starter home because they see prices going down. Just a couple of months ago, they were determined to hang on to both properties as “investments.” When even the most kool aid intoxicated start to see the fall in prices as an ongoing trend, and when these same people start to sell out of fear, the market is entering a new psychological stage.

Psychological Stages of Bubble Market

Today’s featured property is a 1/1 in Turtle Ridge that is showing significant distress. Apparently Turtle Ridge is not immune after all.

Asking Price: $300,000

Income Requirement: $75,000

Downpayment Needed: $60,000

Monthly Equity Burn: $2,500

Purchase Price: $445,000

Purchase Date: 3/25/2005

Address: 133 Danbrook, Irvine, CA 92603

Beds:	1
Baths:	1
Sq. Ft.:	822
$/Sq. Ft.:	$365
Lot Size:	–
Property Type:	Condominium
Style:	Other
Year Built:	2004
Stories:	1
Floor:	1
View:	Park or Green Belt, Has View
Area:	Turtle Ridge
County:	Orange
MLS#:	S521349
Source:	SoCalMLS
Status:	Active
On Redfin:	322 days
Unsold in 90+ days

every built?

Here is your chance to pay $300,000 for a glorified apartment.

This property was purchased on 3/25/2005 for $445,000. The owner used a $400,500 Option ARM first mortgage and a $44,500 downpayment. Not to worry, on 4/5/2006 he opened a HELOC for $60,000 and likely withdrew his downpayment plus $14,500.

If this property sells for its asking price, if a 6% commission is paid, and if the owner maxed out the HELOC, the total loss to the lender will be $178,500.

This property is being offered for 32.5% off its 2005 purchase price. This is not a ultra-low teaser price. Check out the listing history:

This property has been chasing the market down for almost a year.

{book}

Real Homes of Genius — Dr. Housing Bubble

Dr. Housing Bubble has done a great series on ridiculously overpriced properties that are so awful that one has to wonder WTF the buyers were thinking. He titled these posts Real Homes of Genius. It is a great series because the images and the prices hit you on a guttural level. Intuitively, you just know something is wrong. It doesn’t require any intellectual analysis of comparative rents or anything else to immediately realize these properties are ridiculously overpriced. If there was ever an undeniable proof of the housing bubble, it was properties like these.

{book}

We don’t have many Real Homes of Genius in Irvine, although today’s featured property is about as close as we get. Someone has managed to fit 4 bedrooms into 1,230 SF adjacent to I-5. There is nothing desirable about this property, and the huge price reductions are showing this truth.

Asking Price: $300,200

Income Requirement: $75,050

Downpayment Needed: $60,040

Monthly Equity Burn: $2,501

Purchase Price: $385,000

Purchase Date: 9/17/2004

Address: 1 Raleigh, Irvine, CA 92604

This one really is approaching investor levels. For an owner-occupant, this property is below rental parity. A rent of $1900-$2100 would give this property positive cashflow. Surely a 4 bedroom can rent for that much…

This property was purchased for $385,000 on 9/17/2004. The owner used a $308,000 first mortgage, a $57,750 second mortgage, and a $19,250 downpayment. On 11/8/2004, he opened a HELOC for $94,000, and likely extracted his downpayment plus some spending money. In all likelihood, the second mortgage is paid off with the HELOC. The total debt on the property is $402,000, and the total mortgage equity withdrawal is $36,250. I bet he wishes he had taken out more…

If this property sells for its asking price, the total loss to the lender will be $119,812 after a 6% commission.

{book}

Double Vision — Foreigner

Fill my eyes with that double vision
No disguise for that double vision

What is the premium for a detached product? There certainly is one. I would pay more for a similar product that does not have a shared wall, and so would most buyers. You have a greater sense of privacy with a detached unit, there is less noise, and there is something about being able to clearly identify a specific object as
“mine,” that you cannot obtain from an attached condo. Intellectually,
you might know there are property lines at the walls, but when you look
at an attached condo, you see one massive building you only own a part
of. It is not as emotionally satisfying. The question is how much is this premium?

Someone could probably do a study of the property records and come up with some aggregate estimate. I imagine it would be something like 10%-20%, but I have no data. An internet search brings up a number of studies in the UK housing market, but I found nothing referencing the United States. Whatever the actual number is, I suspect it is far less than 100%. Today we have two featured properties in Westpark. One is a 2/2 attached short sale being offered for $299,900, and the other is a 2/2 detached being offered for $599,999. Do you think the seller of this second property has any chance of selling it? I don’t.

Asking Price: $299,900

Income Requirement: $74,975

Downpayment Needed: $59,980

Monthly Equity Burn: $2,500

Purchase Price: $500,000

Purchase Date: 8/25/2006

Address: 61 Costero Aisle #242, Irvine, CA 92614

Beds:	2
Baths:	2
Sq. Ft.:	1,100
$/Sq. Ft.:	$273
Lot Size:	–
Property Type:	Condominium
Style:	Contemporary
Year Built:	1987
Stories:	2
Floor:	1
Area:	Westpark
County:	Orange
MLS#:	S557637
Source:	SoCalMLS
Status:	Active
On Redfin:	1 day
New Listing (24 hours)

A quiet and private apartment? This is an apartment despite the fact you can own it.

Why Title Case?

Stainles? ishwasher?

There is nothing desirable about this unit, which is why the $500,000 purchase price in 2006 is so amazing. I would ask WTF the owner was thinking, but I think we all know. The owners used 100% financing, so they really didn’t care. This property was rather unique in that the first mortgage was an Option ARM for 100% of the purchase price. There is no second mortgage, and there is, of course, no downpayment.

If this property sells for its asking price, First Guaranty Financial Corporation stands to lose $218.094 after a 6% commission.

This property is being offered for 40% off its peak purchase price.

I have to imagine the owner of today’s second featured property is hoping this isn’t considered a comparable sale.

{book}

Asking Price: $599,999

Income Requirement: $150,000

Downpayment Needed: $120,000

Monthly Equity Burn: $5,000

Purchase Price: $279,000

Purchase Date: 3/19/1999

Address: 8 Andisssa, Irvine, CA 92614

This property was purchased on $279,000 on 3/19/1999. The owner used a $251,000 first mortgage and a $28,000 downpayment. On 6/7/2002 she refinanced for $256,500, and on 1/5/2004 she opened a HELOC for $75,000. A relatively conservative borrower by Irvine standards.

If this property sells for its asking price, and if a 6% commission is paid, this owner stands to make $378,999. Good luck with that.

Is this second property worth double the first one?

{book}

Feeling down ‘n’ dirty, feeling kinda mean
I’ve been from one to another extreme
This time I had a good time, ain’t got time to wait
I wanna stick around till I can’t see straight
Fill my eyes with that double vision
No disguise for that double vision
Ooh, when it gets through to me, it’s always new to me
My double vision gets the best of me
Never do more than I, I really need
My mind is racing, but my body’s in the lead
Tonight’s the night, I’m gonna push it to the limit
I live all of my years in a single minute
Fill my eyes with that double vision
No disguise for that double vision
Ooh, when it gets through to me, it’s always new to me
My double vision always seems to get the best of me, the best of me, yeah-ah
Ooh, double vision, I need my double vision
Ooh, It takes me out of my head, takin’ me out of my head
Ooh, I get my double vision
Ooh, seeing double double, double vision
Ooh, oh my double vision
Ooh, double vision
Yeah-ah, I get double vision, ooh . . .

Double Vision — Foreigner