August 25, 2005

WE'LL BE FEEDING HOUSES TO CATTLE LIKE TULIP BULBS IN MERE MONTHS:

Fed Up With Housing Misinformation (James J. Cramer, 8/25/2005, RealMoney.com)

We are at a really and truly bizarre moment where the papers and the television shows are all filled with how buying a condo's now worse than buying eToys common on that secondary in 2000.

We are convincing ourselves -- typically through journalists who couldn't afford or didn't buy homes -- that owning an apartment's dumber than paying $30 for Webvan and owning a beach house is like buying the Viant $100 secondary.

May I suggest that most of this stuff is plain stupid?


You can suggest, but folks are too smart to listen.

Posted by Orrin Judd at August 25, 2005 2:06 PM
Comments

Isn't the return on investment of a home lower than it was, say, ten years ago?

Posted by: Bartman at August 25, 2005 3:13 PM

Bartman:

Don't know, but I do know this--it's no less a home than it was ten years ago.

Posted by: oj at August 25, 2005 3:19 PM

Good point.

Posted by: Bartman at August 25, 2005 3:24 PM

I like Jim Cramer, and I've learned a lot from him over the years, but citing him as an authority on housing values is, shall we say, risible.

Mr. Cramer is a TRADER, an anti-Buffet or Graham, a guy who makes his money betting on momentum, holding positions for days, weeks, or at most months. Jim Cramer and 30 year mortgages go together like oil & water.

Also, the article itself is about correctly valuing the stock prices of homebuilders, not the U.S. housing market, and is thus neutral about real estate pricing.

One can make money on the stocks of homebuilders if business is booming, and one can make money on the stocks of homebuilders if the real estate market craters.
It's "merely" a matter of guessing correctly which way it's going to go.

Having said that...
Mr. Cramer is, of course, correct.

Buying a home in most of America makes perfectly good sense.

There are only 53 metro areas in the U.S. where a perspective homebuyer ought to think it over, and maybe a dozen where a perspective homebuyer needs to know that they're probably going to have to stay in their home for a decade or more to break even.

As Jim says (Emph. add.):

The truth is that new-home sales remain robust but the rest of the economy is much weaker than we think...
There are pockets of undervaluation in housing and pockets of overvaluation. There are places where there are gluts...
[I]f the Fed decides that it is worried about borrowing on homes, as it was worried about borrowing for stocks, [...] the Fed simply has to say: "We don't want interest-only mortgages sold."
In fact, the Fed is like a very active Teddy Roosevelt: It speaks softly but it carries, and swings, a big stick, at the whole economy, even when it is one section -- interest rate-only mortgages on second, third and fourth homes -- that it really wants to cool.

In that last bit, Mr. Cramer is talking about the undercapitalized speculators that are driving prices and perceived demand in the hottest localized hyperprice discontinuity zones.

Posted by: Michael Herdegen at August 25, 2005 5:00 PM

So you wouldn't live in those areas?

Posted by: oj at August 25, 2005 5:11 PM

I wouldn't buy in those areas - as I've written in the past couple of days, I've recently lived in Boston and LA.

Posted by: Michael Herdegen at August 25, 2005 5:31 PM

And how much money did you lose by not buying?

Posted by: David Cohen at August 25, 2005 5:53 PM

So if you moved to Boston today you'd just rent until the bubble burst and then buy in?

Posted by: oj at August 25, 2005 5:56 PM

I would buy a home, but I would not invest in condos. A home is a place for me and my family to live. As such most of its value is consumed by us as shelter. This requires no further justification.

Buying residential real estate as an investment is another story. The trading cost is brutal, 6% in and out. So you need a major move to realize a profit. Further the carry is non trivial, maintinance and utilities alone will eat into profits. Keeping the place rented out is another problem.

Posted by: Robert Schwartz at August 25, 2005 7:00 PM

David Cohen:

I've MADE, or saved, money by not buying, as you read in THE BUBBLE BURST AND ALL I MADE WAS A 66% RETURN.

However, that is in part due to personal circumstances; your milage may vary.

oj:

Yes, although I question the use of the word "bubble" to describe the Greater Boston area real estate market.

After all, it's not like those homes will be as worthless as a Pets.com stock certificate once the market there cools.

If I could find some reasonable way to short the downtown Boston condo market, I'd do that as well.

From the linked thread:

Orrin assumes that 99% of homeowners will choose not to sell during the downturn, or will not have to. - Michael Herdegen

More than 1% will sell--all will buy other homes. - oj

Yes, and the point is that when they sell, they will in many cases LOSE MONEY on the deal, i.e., have to come up with out-of-pocket money to pay off their mortgage.

You appear to assume that such will have no effect on the national economy.

I disagree.

Michael: Do you have a cite for those mortgage numbers. They are much more extreme than any others I've seen. - David Cohen


Interest-only loans offer payment shock down the road

Sunday, July 24, 2005
By KATHLEEN LYNN
(Emph. add.)

[H]omeowners who use interest-only loans and stay put long enough could face a jump of $500, $1,000 or more in their monthly payments. Typically, the increase begins after five years.
"If you're stretched to the max to be able to make the interest-only payments, the question is: What are you going to do when the principal comes due?" said Doug Duncan, chief economist of the Mortgage Bankers Association in Washington.
Among these loans are [...] no-down-payment loans and "option ARMs," which allow buyers to vary their monthly payment. With all these loans, costs are lower in the beginning, but risks are higher later on. [...]

As recently as 2001, interest-only loans made up less than 3 percent of mortgages in New Jersey, but now account for about 20 percent of mortgages originated in the state. [...]
Nationally, interest-only and adjustable products made up 63 percent of mortgages written in the second half of 2004, according to the Mortgage Bankers Association.

Many buyers can't afford North Jersey's housing prices unless they use such mortgages. [House prices in North Jersey have more than doubled since 1999.] [...]
If property values deflate, homeowners who turned to creative financing could find themselves owing more on their mortgages than the house is worth [...]

Another concern is that mortgage rates - now near historic lows - may have only one way to go, and that's up. So homeowners could face a big hit when their adjustable loans start adjusting to market rates. Worse yet, the higher rates might hit at the same time homeowners have to start repaying the principal. [...]
Others say that if they can't face the higher payments, they'll just sell. But if a lot of borrowers are in the same circumstance, [it] would depress prices.

Many of these buyers would be better off renting, Gumbinger said. But if they do take creative loans, he advises that they set aside some of their extra cash flow every month in preparation for the day when payments will rise.
"At some point, the higher payment will come due," he said.
But he suspects many home buyers are not doing this; instead, the money freed up by lower mortgage payments is going toward cars and vacations. [...]

The percentage of homebuyers using interest-only loans has skyrocketed.

National 2005* 22.9%
National 2004 30.9%
National 2001 1.6%

New Jersey 2005* 20.0%
New Jersey 2004 19.4%
New Jersey 2001 2.4%

* Through May

Source: LoanPerformance, a subsidiary of First American Real Estate Solutions

How it works

An example of how an interest-only mortgage works, compared with a conventional mortgage:

Loan amount: $400,000

Five-year adjustable, interest-only loan:

At a recent average rate of 5.46 percent, monthly payments would start out at $1,820.

After five years:

If interest rate stays the same, monthly payment rises to $2,425.

If interest rate rises to 7.46 percent, monthly payment rises to $2,945.

Thirty-year, conventional fixed-rate loan:

At recent rate of 5.84 percent, monthly payment is $2,357, and never changes.

At the end of five years, homeowner would have built up this much equity through mortgage payments:

Interest-only loan: $0

Conventional loan: $28,526

Source: HSH Associates

How do you buy a home in a boom? The answer may be a new loan that's part blessing, part time bomb.

May 16, 2005
By Cybele Weisser, MONEY Magazine
(Emph. add.)

According to mortgage data firm LoanPerformance, nearly a third of home loans made last year nationwide included an interest-only option, up from almost none four years ago.
In the hottest real estate markets in the country (particularly on the coasts) lenders say that as many as 70 percent of new loans are interest-only.

The problem: Those low payments don't last. Eventually, every interest-only mortgage converts to a regular one, and [...] you'll see a steep rise in your monthly payments. And because most IO mortgages are also adjustable, that increase could be doubly harsh if rates go up.
"I think there is a day of reckoning coming for these loans in the hands of the wrong people," says Patricia Houlihan, a financial planner in Reston, Va. [...]

What people commonly call an interest-only mortgage isn't one particular type of loan. Rather, interest-only is an option that can be attached to any mortgage.
And in every case, after a certain time (usually five, seven or 10 years) the mortgage becomes fully amortizing, and you must pay both interest and principal. Because you're repaying the principal in 20 or 25 years, not 30, those principal payments are higher than they would have been.

Posted by: Michael Herdegen at August 25, 2005 8:00 PM

But in the end there's no bubble and the demand for homes stays pretty much the same, although prices may adjust temporarily, no?

Posted by: oj at August 25, 2005 8:29 PM

Michael: The two stats I was interested in seeing backup for were:

[1] [I]n America's top 50 local hyperpriced unsupported discontinuity zones; [putting] 3%, or LESS, [down] is the norm ....

[2] Further, 40% of mortgages written in '04, in those 50 markets, were INTEREST ONLY.

Maybe I'm being stupid, but I don't see either stat in the material you cited. The only way I'm aware that you can legally get a mortgage with a down-payment of 3% or less is if you have an FHA or VA (no down-payment) loan, or some similar government-insured mortgage. As far as I know, those aren't nearly as common as you're suggesting. I wonder if you confused ARMS with interest-only mortgages. IOs are considered a type of ARM and ARMs were about 40% of mortgages issued last year. IOs, from all the data I can see, were not a major percentage of ARMs, although they certainly are growing.

Posted by: David Cohen at August 25, 2005 9:11 PM

Michael: I wondered the same thing (are the stats you are seeing aggregating ARMs and IOs.) Your point about interest rates seems solid, they're certainly going to go up. By the way, you can say the bubble word -- "hyperpriced local discontinuity zone" gave me a cramp just typing it once. OJ will fling his own feces at you for it but he does that for fun anyway.

Posted by: joe shropshire at August 25, 2005 9:37 PM

These:

The percentage of homebuyers using interest-only loans has skyrocketed.

National 2005* 22.9%
National 2004 30.9%
National 2001 1.6%

According to mortgage data firm LoanPerformance, nearly a third of home loans made last year nationwide included an interest-only option, up from almost none four years ago.
In the hottest real estate markets in the country (particularly on the coasts) ==>> lenders say that as many as 70 percent of new loans are interest-only.

Are not the same as this ?:

Further, 40% of mortgages written in '04, in those 50 markets, were INTEREST ONLY.

IOs, in the above passages, are pretty clearly delineated from regular ARMs:

What people commonly call an interest-only mortgage isn't one particular type of loan. Rather, interest-only is an option that can be attached to any mortgage.

As recently as 2001, interest-only loans made up less than 3 percent of mortgages in New Jersey, but now account for about 20 percent of mortgages originated in the state. [...]

Nationally, interest-only and adjustable products made up 63 percent of mortgages written in the second half of 2004, according to the Mortgage Bankers Association.

An example of how an interest-only mortgage works, compared with a conventional mortgage:

Five-year adjustable, interest-only loan:

Eventually, every interest-only mortgage converts to a regular one

because most IO mortgages are also adjustable

In 2001, ARMs made up far more than 2.5% of NJ loans, so that stat clearly refers to IOs only; IOs and ARMs together made up 63% of mortgages written in the second half of 2004, but IOs alone made up only 31% of mortgages in all of 2004.

Part of the confusion may be that there are actually FOUR possibilites:

* A fixed-rate conventional loan
* An adjustable-rate conventional loan
* A fixed-rate loan with an IO option
* An adjustable-rate loan with an IO option

Obviously, there has been explosive growth in the last catagory, but an IO loan isn't necessarily also an ARM.

David Cohen:

Also:

Among these loans are [...] no-down-payment loans

I'll come up with some more citations, but you might try the links, the articles go into a bit more depth and might answer a few questions.

oj:

Yes, but.

Defining a decade spent in the same home as "temporary" puts you well outside the viewpoint and experience of the average American.

(As if there were anything about you that wasn't already at the fringe of American viewpoints).

Posted by: Michael Herdegen at August 25, 2005 10:54 PM

The adjustment will be temporary...again.

Posted by: oj at August 25, 2005 11:01 PM

Michael: As a matter of definition, IOs are considered a type of ARM when mortgage statistics are compiled. There is no IO mortgage that is not lumped under ARMs, including the Fannie Mae InterestFirst mortgages, which allow 10 or 15 interest only years out of a 30 year term.

Here is a pretty good discussion that puts IOs at about one-fifth by dollar volume of mortgages issued in the first quarter of this year, which is still a lot, and at about 15% by originations for the hot markets for 2004. The numbers you quote, showing 31% of 2004 mortgages are interest-only, seem to trace back to a single Fortune article in May 2005 that I can't get access to on the web. I don't know where Fortune got its numbers, or even if they're being reported accurately, but they don't tally with anything else I've seen reported by the industry, Fannie Mae or the government.

Posted by: David Cohen at August 25, 2005 11:35 PM

After a little more research, the 31% stat traces back to a San Francisco research firm called "LoanPerformance" and pertains only to loans packaged for resale and, maybe, only to loans on new purchases of single family houses, which would exclude more than half the market. The LoanPerformance data is not transparent or public, so there's no way to figure out where they got their numbers or if they are being reported accurately. Oddly, LoanPerformance says that Georgia has the highest percentage of interest-only loans for new single family houses in 2004.

Posted by: David Cohen at August 25, 2005 11:52 PM

David Cohen:

If all IOs are counted as ARMs, then why would there be an "IO and ARM" number reported ?

Great link.

From nationalmortgagenews.com (Emph. add.):

A study by the National Association of Realtors says the second home market — vacation and "investment" properties — is on fire with such sales accounting for 36% of all homes sold in 2004. The trade group, which for the first time did extensive research on the subject, found that 23% of all homes purchased were for investment while another 13% functioned as vacation homes. In 2004 a record 2.82 million in second homes were acquired, a 16% increase from the previous year. [...] A NAR spokesman said he was surprised by what the trade group found and noted that many investors appear to be buying more than one second home. [...]
NMN, the publisher of this book, has been tracking the IO phenomenon [...] Two years ago very few residential lenders were funding IOs [...] In the first quarter the nation's lenders funded $141 billion in IO loans out of a total production pie of $663 billion. According to NMN, [...] a stunning 312% increase from the same quarter last year. [...] One mortgage insurance executive told the newspaper that the IO is a fine product "for certain customers" but lenders are pushing it too aggressively to first-time home buyers. "It shouldn't be a first-time homebuyer product," he said. "There is going to be trouble one day." Then there's the rating agencies which are beginning to voice doubts about the loans. [...] Still, it's a product to keep an eye on, along with the payment option loan where the consumer is given one of four payment choices each month, one of which allows them to chose the lowest possible payment. One top ranked lender told us that 50% of its payment option customers chose the lowest payment each month. That's not a promising sign.

In other words, speculators are driving up prices, and families are shoehorning themselves into loans that they can barely meet the interest payments on, counting on equity appreciation to bail them out.

A classic house of cards.

Posted by: Michael Herdegen at August 26, 2005 2:01 AM

Here's a good one - instead of putting 3% down, you put -3% down !

Zero Down Payment Assistance mortgage products:

Zero Down Payment 103% Plan up to $375,000, a loan that allows borrower's to finance up to 100% LTV. They can even include up to 3% closing costs and prepaid fees in the home loan amount, for a total loan LTV of 103%!

Zero Down Payment, 80/20 with a combined mortgage loan amount up to $500,000.

No Down payment loans are my specialty.

Below are no down payment loans allowing you to buy a home with no down payment. Many programs allow more debt than "conventional" loans making your dream of homeownership possible.

80/20 loans, also described as combination financing or piggyback loans, offer a convenient way to provide creative financing in a purchase...
In a purchase transaction, a second trust is frequently used in combination with a first trust to avoid paying Private Mortgage Insurance or PMI. The first trust is always set at 80% of your purchase price which eliminates the need for PMI. We add a second trust of 20% of the purchase price or value. There are actually two versions of this program offered by several lenders. The first will require you to have 3% cash in the transaction (covering your closing costs) and the second requires no cash at all.

100% Financing No Down-payment Mortgage

100% Financing Mortgages have become a popular choice for financing a home.

Zero down payment or 100% financing - either a 1st mortgage exclusively or a combination of a 1st and 2nd mortgage (sometimes referred to as a piggyback mortgage).

Understanding No Down Payment Mortgages

Who Is a No Down Payment Mortgage For?

For some people, putting no money down on a house may be the only way to buy one. First-time home buyers may not have enough saved up for a 20% down payment or might want to use the money they’ve saved for other uses, like buying furniture...

Posted by: Michael Herdegen at August 26, 2005 4:33 AM

Home buyers are using lower down payments and more borrowing to pay for their houses.

August 16, 2005
By Les Christie, CNN/Money staff writer

[According to] SMR Research, which studies market trends in the mortgage industry:

In the first six months of 2005, 38.1 percent of home buyers who financed their homes did so with a down payment of five percent or less of the purchase price, up from 30.6 percent in 2000.

And the percentage of buyers paying the traditional 20-percent downpayment fell to 33.7 percent of borrowers, down from 39.1 percent in 2000.

Posted by: Michael Herdegen at August 26, 2005 6:36 AM

Wow. Well, at least when it comes to no or low down payment loans, it's not the mortgage company taking advantage of the buyer.

Posted by: David Cohen at August 26, 2005 8:48 AM
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