Advice for F'd Borrowers
(reposting this by request from a reader)
"The real estate bubble: It sounds like something out of a second-rate horror movie. And it's some homeowners' worst nightmare.
You buy the biggest home you can afford and use every dime to do it. Now, instead of increasing in value, the worth of your home, sweet home takes a nose dive. The bubble has burst, leaving you in a financial mess."
"If you find yourself in a similar situation, don't be afraid -- like most nightmares, this one's a lot less scary in the light of day, where following a number of dos and don'ts can lead you to the best possible outcome."
1. DON'T panic
"If you can afford your payments and you like your house, a bubble can't really hurt you.
One of the biggest fears with a bubble is that the homeowner will owe more than the house is actually worth. But that's usually only a factor if you're selling, need to tap your home equity, or have an adjustable-rate mortgage (or some funky option where you're skipping or delaying paying the equity) and interest rates start to rise."
2. DO stay put
"Make sure you can make your payments "not just currently, but what the payment will be in the next two, three, four, five years," says Ric Edelman, author of "The Truth About Money."
If you can, happily stay put and enjoy your house."
"An adjustable-rate mortgage can be a scary prospect, especially if your home's value actually starts to drop and your rate begins to rise. It gets even worse if your income isn't keeping pace. This could be a good time to trade your current adjustable-rate (or interest-only or a negative-amortization) loan for a fixed-rate version."
3. DO stay informed
"Keep up with what's going on with home values in your area and neighborhood."
This can be difficult if you are relying on listening to real estate agents and mortgage brokers and housing developers for your information. Remember, these people don't make money unless you buy or sell a house using their services. Their job is at risk if you don't give them your business. It is their business to overcome your objections. They are looking out for their best interest first, and that is to make the sale, and if they feel they have removed your obstacles to making a purchase then thay have done their job. That is not the same thing as acting on YOUR best interest. You are going to have to consider YOUR circumstances and your own best interest first. THEN when you know what you want to buy and how much you CAN afford, then seek out a professional who can present to you their products available to meet your need.
To Stay Informed Look Around:
- Are long-term interest rates going up?
- Are existing houses sitting on the market longer?
- And how does that trend compare to months and years past?
- Is it much cheaper to rent?
- Is the number of second homes increasing?
- Are people investing in the local home market to make money, rather than to live in a home?
"One of the frequent definitions people give for bubbles is if people are buying just in expectation that the prices will rise, than out of some underlying need," says Andrew Leventis, an economist with the Office of Federal Housing Enterprise Oversight.
- Has traffic in housing permits slowed?
"Developers are really sensitive to the market," says Mike Schenk, vice president of economics and statistics for the Credit Union National Association.
- Are local unemployment rates up?
- Or do you expect they will increase?
4. DO eliminate uncertainty
"If you suspect rates are going to rise and values are going down, and you have an adjustable-rate home equity line of credit or home equity loan, this might be a good time to step up the payments."
'"Minimize your exposure," says Nicolas Retsinas, director of the Joint Center for Housing Studies at Harvard University. "A home equity loan is one more front you have to be prepared to defend or cover."'
A bit more on the Intererst Only Mortgage Situation
"Interest-only loans, nearly unheard of three years ago, have jumped in popularity. “IO” mortgages, which come in many shapes and sizes, can shave 20 to 30 percent off monthly payments because they temporarily relieve borrowers of the need to pay any principal. But after that temporary reprieve, mortgage payments jump sharply. Fully one-third of mortgages opened last year were interest-only loans, causing a stir of concern among economists including Federal Reserve Chairman Alan Greenspan."
% of "IO" Mortgages in 2005
Bay Area: 82%
Sonoma: 80% (annecdotal according to a local broker)
Sonoma County: 69%
Why all the ARMs? Is it because they are great products? Hardly. While a viable product for some, they are primarily being used because of the unaffordability of homes. People simply CANNOT afford to buy using a traditional product. Therefore they use a risky loan and speculate on the future of housing prices hoping they won't lose. Not a good strategy. If you are considering a loan like this and you already know that 80% of buyers in the past year are doing the same- what does that tell you about who is left to buy your house from you when you can no longer afford your mortgage? What does that tell you about where housing prices are headed?
"But interest-only loans seem conservative compared to the latest lending rage, the negative-amortization loan. Consumers who sign up don’t even have to pay the full interest owed the bank each month. Instead, they borrow more money as time goes by, making minimum payments in a way that echoes the world of revolving credit card debt. In a housing market that goes suddenly flat, such a loan guarantees the buyer will be “upside down” after a few years — meaning their home will be worth less than the mortgage on it."
"Few financial experts or even mortgage brokers see these loans as a sound borrowing technique for most consumers. Yet according to UBS analyst David Liu, 40 percent of mortgages over $360,000 that have closed so far this year are “neg-am” loans. And the Internet is crawling with all manner of come-ons, offering products with names like “Name Your Payment” loans."
“I always remind people that those things are offered on the Internet alongside Viagra ads and deals with shady folks from Nigeria,” said UCLA economics professor Edward Leamer. He believes the rise in riskier mortgages is a sure signal that America is indeed in a housing bubble, and he worries consumers who are anxious to buy high-priced homes are getting in over their heads.
“I can't say everybody doesn’t know what they are doing, but this is a direction that is very worrisome.”
"Interest-only loans haven’t been this popular since the late 1920s; negative-amortization loans since the early 1980s California housing boom. Both those trends ended badly. But today, there are entire families of adjustable-rate, interest-only loans."
"Consumers who choose negative-amortization loans — also called option ARMs — are not locked into additional borrowing each month. Loan holders can choose one of four options — a minimum payment that results in “deferred interest,” increasing the mortgage balance; an interest-only payment; a payment that represents a traditional 30-year mortgage rate; and a larger payment that represents an accelerated 15-year mortgage payment. But a UBS study recently suggested that 70 percent of neg-am mortgage holders make just the minimum payment."
Such monthly borrowing from your house spells real trouble, financial experts say.
“The only way you can assume that kind of risk is you are saying the house is going to appreciate substantially, you are assuming your income will increase significantly, or you are assuming interest rates will fall or remain the same,” said Robert Manning, author of "Credit Card Nation" and a personal finance expert. “If interest rates rise, property values fall or your income stays the same, you are absolutely screwed.”