Tick tock, tick tock, tick tock

Saturday, September 17, 2005

Our neighbors are moving. They found a place in Rescue on one acre. It's a 1979, 1793 sq ft box-house and it's costing them $560k. I don't just think it's crazy because their commute into Sac will be long and unnecessary, nor because it takes a good deal of planning and time management to make a trip to the grocery store. But because housing prices are so inflated and artificial and also because they're going with a high-risk, no-sense interest-only loan.

From the local NPR station: 88.9 KXJZ

Everyone knows the price of housing has skyrocketed in California, but commentator Ginger Rutland was surprised to learn how much our economy depends on those high priced homes.

By:
Ginger Rutland

Listen

Aired 9/16/2005 on Morning Edition
(Sacramento, CA)

My husband and I bought into the Sacramento housing market 20 years ago so I used to live secure in the knowledge that my house had appreciated hugely in value, a cushion against a lost job or unexpected expense. Then Dale Kasler, and Andrew LePage, reporters for the Sacramento Bee and friends of mine, wrote a series - Built on the Boom - that informed me my house may not be worth quite as much as all those folks pushing me to take out a home equity loan keep telling me.

Experts say Sacramento area homes are over valued by 54%. That's because home prices have far outstripped incomes and because many folks bought their high priced homes with ultra high-risk loans like 100% interest-only mortgages.

The experts predict housing prices will fall within the next two years. That upsets not just my peace of mind but all those people whose livelihoods depend on our inflated housing market - construction workers, real estate agents, and the financial industry. Real estate accounted for a whopping 40% of all new jobs created in California last year.

What's the message in all this? It isn't "don't buy a house." It is, "don't buy one you can't afford and don't finance it with funny money."

Ginger Rutland writes for the Sacramento Bee Opinion pages.

People think they're going to keep making more and more and more money on their house. It's this mentality that will be the reason the housing bubble bursts. When people start signing up for interest-only loans and the time comes that they start paying actual principle, they can't afford it. They even admit this. But they justify it and say, "My house will be worth more by then so I'll just sell it." This is ridiculous. Let's look at this more closely, shall we?

Said couple closes their interest-only loan for $560,000 and only pays interest on it for X amount of years - let's pretend it's 10 years (this is reasonable as they've already said that they will be living their a long time because they've always wanted "land" which is a whole different blog altogether because one measly acre is not "land", it's a "lot"). Now, let's say that five years have gone by. The housing prices have snapped back to normal levels and their house, using the numbers in the above report, is now worth only $363,600. But! They still have a loan for $560,000 and they haven't paid a drop of principle. Ouch! Can you imagine living in a house for years and paying money every month and not being even one penny closer to actually owning it???

Here's some more math:
If their loan amount is $560k, their interest only payments (at a rate of 6%) will be $2,800 for the first 10 years. This won't decrease like a normal mortgage payment does, because, remember, they're only paying the interest and the principle is not changing.

After 10 years, there are 20 years left on their loan, on which they now have to pay interest and principle (it's as if they've taken out a 20-year loan for $560k). Their payments will now be $4,100. And that's assuming that their interest rate will stay the same, which is likely not the case. In fact, their payments will probably be more like $4,600 since interest rates will be higher (potentially moreso than the generous 7.5% I just used for the last calculation).

One more thing... Since people often forget the past and it often comes back to haunt us when we think denial is enough protection, here's something else to consider (from TimeWeb):

In the mid to late 1980s, house prices began to accelerate rapidly, leading many owners to believe that what was happening to the value of their property would continue to persist. Many were persuaded to fuel their spending by borrowing money against the value of their house, as this value was, it seemed, ever-increasing. Many others sold their homes, moving to more expensive property; the increased mortgage borrowing would be more than offset, they thought, by the soaring housing market.

When retail price pressure reached its peak around 1989-1990, interest rates had to be used to cool the housing economy down. Mortgage lenders reacted by raising their rates, to 10-14%.

By this time, the brakes on the overall housing economy were floored and the housing market imploded spectacularly. The fall-out was as destructive as it was wide-spread. Thousands began to default on their mortgage payments, as the credit supply they had relied upon was turned off. Homeowners forced to sell their properties to repay their borrowing, found that their homes were now worth far less that they owed on their mortgages, thus causing "negative equity" problems.

It's silly for me to be surprised that people haven't learned their lesson, especially when so many of the homebuyers now were just babies when it happened the first time. But I am. I'm also sad, a little disgusted and a lot disappointed. Though not as much as those people who will lose hundreds of thousands of dollars.