HOUSING BUBBLE OR CREDIT BUBBLE?

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Millionaire Now! by Larry Nusbaum

This blog is based on the organizational principles found in my new book, "Millionaire Now! - A Financial Toolbox with Seven Steps to Wealth".

HOUSING BUBBLE OR CREDIT BUBBLE?

Posted on 09/08/2006 07:45:00 | Link | Post Comment

I will attempt to answer and discuss the various scenarios and lend advice if you are worried about your own situation.
http://www.millionairenowbook.blogspot.com/

First premise: There are no bad loans, just bad borrowers.
I just read the cover story of Business Week as well as the MSN story. Of course, there are some inaccuracies and individual horror stories that do not tell us anything. Why? Because, lose your job and you are in trouble.

Second premise: There is no reason to use a broker when you can use a direct lender, such as Washington Mutual or Bank of America. But, if you must use a sub-prime lender because of bad credit, look at my rule number one below: NO PRE-PAYMENT PENALTIES.

Third premise: dont confuse an interest-only ARM with an Option Arm. Only the Option ARM can put the borrower into a negative amortization position. Both products have economists worried as hell.
The theory behind each:
a) Interest only: You can secure a fixed rate (and payment) for 3, 5 or 10 years. The rates are under 6% currently. – This loan is good for almost everyone.
b) Option ARM : It holds down the minimum payment in the first 1, 3 or 5 years below the fully amortizing payment and even below the interest-only payment. If the borrower makes the minimum payment only, the deficit of interest is added to the “outstanding loan balance” on a monthly basis. Usually, the loan balance can not exceed the 125% of the original loan amount. This loan is good for someone who intends to hold a property short-term, especially investment property (and to help avoid negative cash-flow out of the box).

Fourth premise: These so called exotic loans are not new. They have been around forever! And, I have used them all personally.

Fifth premise: 100% financing has no bearing on this debate or concern. It doesnt tell us anything about how the loan was underwritten or what the payment reset structure is about.

Here are some of my rules that I post each week:

1. Always avoid first mortgages carrying pre-payment penalties.
There is no reason to accept that loan provision and it can come back to bite you. Keep this in mind as you read on!

2. NEVER pay down the rate on a loan in the form of points or origination.
These are rip-off fees that you will never recover. In fact, the A.P.R. is the most mis-leading rate that you will be quoted. Why? Because it spreads out the points over 30 years instead of the more likely 2-5 years in which you will likely keep the loan.

3. Do not get suckered into a 30-year fixed rate loan.
Especially now, after the move up in rates. Unless, of course, you find one with no points, no fees and no pre-payment penalty. Why? Because, you wont be in the loan more than 2-5 years and when adding in points and fees your actual rate may be wind up being closer to 8-9%.

4. Do not refinance your house and combine consumer debt for the purposes of Debt Consolidation.
Most lenders do not agree with me. However, why make unsecured debt secured by your home? Isnt that, in theory, putting your household at more risk than not in case something goes wrong? Also, you can not compare credit card rates (18%) to mortgage rates (6%) and conclude that its better to take the lower rate when you are comparing unsecured to secured debt. You will no doubt be fooled by the lenders worksheet showing a lower combined monthly payment. But, simply call your creditors and negotiate lower rates.

Read: HOW MUCH LOAN DO I QUALIFY FOR? &
My Questions on Home Loans and a Lenders Answers

Now, go back in time and we find there have always been poor underwriters and careful underwriters. (Poor, meaning that they qualify an applicant to the interest-only payment and not to the fully amortized payment). There have always been so called exotic loans: neg-am, 40-year am and interest only. There have always been market tops (June, 1990 was such a top). I do not know of any lenders having to refinance borrowers in anything but an orderly process. In fact, appraisals are actually coming in higher than sales prices (not unusual considering they go back 6 months for comps).
Resets can all be met with orderly refinancing into......another neg-am or interest only loan. And, the beauty is that the rates for 5 or 10 year interest only loans are under 6%! So, the idea that we are facing an onslaught of foreclosures because of resets that will double a borrowers payment never made sense and will not cause housing to crumble. Like the economic cycle of autos, supply and demand (as well as regional job formation) and interest rates play into the cycle. A condo buyer in Phoenix should not care a bit what SFR are selling for in upstate NY, for example.
And, there have been many more calling for a pop in the housing bubble long before Dr. Roubini. And, if we wait long enough it may still happen. No one knows as always. But, had anyone sold a couple years back....and missed the greatest two years ever (2004 & 2005), when would they ever get back in? One thing for sure, while out and not being able to go back in: THEY ARE MAKING SOMEONE ELSE FAT AND HAPPY AS THEY PAY RENT!

Two recent articles: The secrets out about exotic mortgages seem to be out: MSNBC notes Exotic mortgages seen losing their allure; BusinessWeek is even blunter: Nightmare Mortgages;

Starting with the first one from MSNBC, talk to anyone who knows and San Francisco is not a bubble city. However, that is not to say that California is not a concern with the massive amounts of ARMs facing a payment adjustment!

They use an example: One is a California homeowner making only minimum payments on a $402,000 loan. The current full interest rate on the loan is 7.6 percent, but the borrower has been paying just $1,348.47, far less than whats needed to fully amortize the mortgage over its 30-year term. If the loan reset at todays rates, the full payment required would be $2,887.50 : more than double what the homeowner is currently paying.

I am guessing that the interest only rate is about 4%. ($1348.47 x 12 over $402,000). It doesnt say when they bought the property, but you can bet it didnt go down in value over the past 12, 24, or 36 months. Remember my rule number 3 above? So, if this guy gets a new interest-only loan at 5.75%, his payment goes from $1348 to $1926. Or, if he gets another Option ARM his payment may remain about the same. Please keep in mind that any good underwriter would have qualified this person for the $1926, as a minimum, at the time of origination.

Now the BusinessWeek article: Nightmare Mortgages
Remember what I said above: There are no bad loans, just bad borrowers.

The bill is coming due. Many of the option ARMs taken out in 2004 and 2005 are resetting at much higher payment schedules -- often to the astonishment of people who thought the low installments were fixed for at least five years. DOES THIS MEAN PEOPLE DIDNT ASK OR COULD THEY BE WRONG?

It was an unbeatable opportunity, he thought. If he refinanced the mortgage on his $500,000 home into an option ARM, he could save $14,000 in interest payments over three years. : Thats wrong, because he deferred $14,000 but didnt save a thing. Do not accept pre-payment clauses, ever!

Most reputable lenders offer Interest-Only and Option ARM products that do not reset in the first 5 years and carry a first year pre-payment penalty of only 2%. However, most loans are sold and few are bought. ARMs arent for everyone anymore than the 30-year fixed rate loan is. Loans are financial tools to enhance your real estate ownership. Get advice, dont get sold.

From the WSJ : Refinancing From an ARM To a Fixed-Rate Home Loan

1 Comments:

: I agree with your objection to prepays. But sub prime lenders almost always charge prepays which are very expensive to buy out. How do you get around that?

Marc Levenson
Pleasanton, California; posted by PrePay Penalties @ 01/18/2007 18:11PM

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