WP: Many Buyers Opt for Risky Mortgages(Interest Only Worry Economists)

[RamboLiberal]

http://www.washingtonpost.com/wp-dyn/content/article/2005/05/27/AR2005052701345_pf.html

More than a third of the mortgages written in the Washington area this year are a risky new kind of loan that lets borrowers pay back only the interest, delaying for years repayment of any loan principal. Economists warn that the new loans are essentially a gamble that home prices will continue to rise at a brisk pace, allowing the borrower to either sell the home at a profit or refinance before the principal payments come due.

The loans are attractive because their initial monthly payments are tantalizingly low -- about $1,367 a month for a $320,000 mortgage, compared with about $1,842 a month for a traditional 30-year, fixed-rate loan. If home prices fall, though, borrowers could lose big.

"It's a game of musical chairs," said Allen J. Fishbein, director of housing and credit policy at the Consumer Federation of America. "Somebody is going to have the chair pulled out from under them when they find prices have leveled out and they try to sell, only to find they can't sell for what they paid for it."

About 54 percent of home buyers in the District purchased their homes using interest-only loans so far this year, according to LoanPerformance, a San Francisco-based company that tracks loan originations nationwide. About one-third of buyers in Maryland and Virginia are buying with interest-only loans.

[Mountainman]

1. Before the depression people had interest only loans. They never paid any

principal. When the balloon payment came due they just rolled the loan over into another interest only loan. Banks needed to pay cash to those who wanted to withdraw their savings so they called the loans in and people could not pay so the banks sold the houses and the people were on the street.

[bluedeminredstate]

2. You can't believe the McMansion developments

going up all around the DC area. The cost to get in one of those is so exhorbitant that this kind of loan is like an inducement to get the buyer in the house. This is going on up to a hour's drive from DC, so there's little time to enjoy the albatross either...
My husband and I drive up there once a month from Richmond to the doctor and see this sprawl in what were once beautiful rural areas, and now they can't pack them into these ridiculous, over-priced "estates" fast enough.
We were just talking about the loans that people take to get into these houses and what would happen if the house lost value if the people had to relocate or move in a hurry or got into financial trouble. It would be awful to be stuck with a loan on a house that's worth less than what you owe. It would be something you'd never dig out of.
It seems like the huge number of new pseudo-mansions around DC would have to reach a peak at some point, but they just keep slapping them up. With all the different things life throws at you this scheme seems like a time bomb for a very large number of families.


:hide:

[ovidsen]

5. You speak the truth!

There are lots of places where "McMansion Mania" abounds, but from personal experience (we lived in Arlington for 15 years, moving out last year) I think the DC area is one of the worst.

We didn't even look at McMansions, realizing that an interest only loan for a piece of crap house on a postage size lot an hour from work was just asking for it.

These things are time bombs with short fuses. :nuke:

[MountainLaurel]

11. It's not just the McMansions

The cost of housing overall is such that if you have a smidgen of debt, are single, won't be selling a current place to get downpayment money, or aren't working for a defense contractor, you're going to have serious problems buying anything here. My 1BR condo, small and unremarkable in a tolerable neighborhood outside the Beltway on the busline but a few miles from Metro, went for more than $200K a few weeks ago. Only by selling that and my fiancee's place will we be able to buy something big enough for two adult humans, two large dogs, and a cat.

[MADem]

20. And aren't they HIDEOUS!!!

With their brick fronts, and their vinyl siding sides and rears, on a sliver of land, with massive garages, those standard ugly decks, so close to one another that you can sit on the crapper and have a conversation out the window with your neighbor on his crapper!

And of course, they all have these vaulted entryways, and great room cathedral ceilings, with lights so high you'd kill yourself falling off a ladder to change a bulb or dust them, and let's not even talk about the expense of heating those monstrosities. And the construction--a pissed-off five year old could put a foot through the drywall without too much trouble!

I find them offensive, but they appeal to people who like everything shiny and new. I like a house that is well lived in and well loved, myself, and doesn't take half a paycheck to heat!

[Writer]

3. We have a HELOC with an interest only option

The idea is to lower our rate so that we can pay MORE in principle than we would on a traditional loan. And we do pay more than we need to monthly into our principle.

But I consider us one of the lucky ones, as our goal is only to reduce our debt faster, not to afford the basics. Most individuals want their damn mini-mansions with the open floor plan. (I think these houses are exceptionally ugly.) To meet this demand, developers build huge two-story houses on tiny 4000 sq. foot lots, constucting them with matchsticks and bubblegum. They look nice for the first 5-7 years but start deteriorating quickly. Accordingly, banks make money selling risky interest only loans to customers. The longer the principle remains, the more banks make money off of them. As many Americans are not responsible with their debt, this is a formula for disaster. Not only is their house not the steal they assumed it to be, the loan builds no value at all.

Americans need to learn how to live with less. The market for brand new homes in this country is a sham. I blame those damn make-over shows on TLC and HGTV that leave us with the impression that we must have the lifestyles they show us on the screen.

Writer.

[reprobate]

4. Americans know nothing of economics. Years ago my dad taught 3 things....

.

1. If it sounds too good to be true, it probably is.

2. Never, ever spend principle

3. There ain't no free lunch.

Ok, not very sophisticated as far as economics go. But these three rules have let me accumulate at least a smidgeon of wealth, retire at 54, and never worry about money from now on.

And let's face it, if everyone followed these rules, there's be no repuglicans in office.

[Iowa]

14. Great post reprobate!

I followed a similar path. I saved like crazy and retired early with a fairly large chunk of money, but I live in an $80,000 house. My house doesn't impress anyone, but it's plenty good enough - and I'm free.

I followed these rules:

1) Live far below your means.
2) Assets, NOT income, will set you free.
3) Avoid debt like the plague.
4) Make only tiny improvements in your standard of living as you go.
5) Don't get hooked on "stuff". Find your happiness elsewhere.

[faithnotgreed]

15. love your points iowa - especially #1 and 5. glad youre here....

[Iowa]

16. Thanks faithnotgreed!

[cliss]

6. Aren't those unbelievable figures? 54%, and 33%

now THAT's what I call gambling. Roll the dice....sweat a lot....blow on the dice, pray for good luck.....toss......snake eyes.

My boss is feeling resentful these day. He's upset because several of his friends are buying 2nd & 3rd houses, as income property. They hold them for a while, and then "flip" them for big profit.

The boss feels left out of this lucrative scheme. As I'm listening to this sob story, I'm thinking...."yes, why don't you go out there and try your luck?"

There's always the Greater Fool Theory.

On another note, I read that there is now 3 TIMES as many paper mortgages floating around, as there are real properties. I think it was on the order of $1 trillion dollars that's nothing more than Styrofoam packing peanuts.

Unbelievable.

[salin]

8. Yikes... that figure I assume refers to the number

of mortgages people take out on their one property?

People are desperate or foolish. I own (no debt) but regularly get the "you have been approved for a line of equity up to 150% of the value of your home..." Ya right.

[demnan]

7. I just have a little condo

and I have a conventional loan with interest plus principal but I worry about the bursting housing bubble. I'm content with what I have, I'm just not sure how I will be when my condo is worth half what it is now and I'm still paying on this loan.

[pokercat999]

19. If you live in the DC market

you really shouldn't worry if you intend to stay where you are. The projections I've seen from real people with years of real estate experience show a mild downturn 2-3% after a few more years and then a leveling off and a return to a small increase every year. Unless of course something big happens like peak oil is for real! Then all bets are off, but then your biggest problem may be getting your next meal. The housing market may be the least of our worries! But should you over extend and speculate on real estate, I'm not. I'm sellling out for a good profit and moving south where I can buy a home almost all cash and play golf.

The smart money people on DU are correct about saving/spending as was your grandfather.

[EST]

9. It will take only a tiny glitch-

When the interest rates begin to rise in earnest and the contracts need to be re-negotiated, those plastic behemoths won't even make good mass housing shelters.
I am fortunate enough to be married to a banking person who managed to arrange it so that we can get the full payment amounts credited to principle for several months at a time without accruing interest on interest. By slamming every spare penny (we do not party - maybe we're dull) into it we are down to owing $16K after nine years and that'll be paid off in a year.
That's the only way we could live with ourselves. How in the world people can stand the strain of basically just paying rent and facing that huge debt in an uncertain future is simply not computable---wew!

On more thinking: our simple house on twenty acres isn't nearly as impressive as those mansions. (Oh, well...sigh)

[lavenderdiva]

18. I'm new to understanding the money world, mortgages, et al...

but am wondering if you would let me know the type of mortgage you have, that allows you to make headway on the principle? thanks in advance!

[EST]

23. Rather standard mortgage

The trick is that whatever you can skip -a beer, lunch, don't buy that neato thing you've "always wanted," that is finally on sale-skip it. Put off buying things for a day or a month (sorta' like A A) and every week take whatever money you have not spent plus a little more than you can afford (skimp a little on next week's budget) and physically take it to the bank (I refuse to do business with other than local banks) and have them put it against your mortgage.
Any extra at all that you get is not found money or fun money - it's mortgage money that you forgot to pay - take it to the bank and pay it on your project.
If a substantial windfall should come your way, don't give in to the temptation to became debt free: put that rascal away in a separate account, the more secure the better, and continue to slog along unless there is simply no other alternative.

If you can, figure out what you are going to spend on expenses and plan to do it in cash and put that cash in a jar on the refrigerator. Each day, take out what you budgeted and nothing more. If you get in a little bind, too bad, life can stand a little excitement, especially now that you've become a social bore. Be creative; you'll survive. If you tend to bless yourself with little favors - smoking, snacks, whatever - cut your consumption by half. The easiest way to do that is the same stuff. Procrastinate. You know you can put it off for an hour, so do it.
At the end of the day, put the cash back into the jar or into the stash that is, for sure, going to the bank at the end of the week.
I do most of my banking at one bank and I make it a point to have a short meeting with the bank president once in a while. Although I know they're gong to do it anyway, I make a big deal about having them run a credit on us and ask his advice on something, anything, even if we both know he's a ditz and his advice is worthless except, perhaps, as a weather vane.
I can (and have) gotten a letter of credit for $125,000.00 on a simple phone call for one of my hare-brained schemes or another and gotten it the same day, with the paperwork to be created later, if I decide to spend the money. The reason is, of course, that he knows it's solid and he'd better be nice if he wants to get any interest money from me at all.
We are not very special people (except in our own, tiny circle,) with modest tastes and in no way big operators, but we are respected and trusted. I would rather die than break a promise. Period.

On edit: The reason they will let us go for months without paying any interest or additional charges is that we are paid so far ahead and if they don't do it my way, p*** on em,' I'll pay the whole blame thing off and they will make even less.

[lavenderdiva]

25. thank you so much for sharing that!

those are really important points to remember, and certainly advice that I can follow! Obviously, it is working for you, and hopefully for me too... Thanks again!

[MADem]

21. Or a really bad terra thing....

And then the whole thing could just fall down upon itself. Of course, if that happens, the metro housing market will be the least of our worries....

[xray s]

10. It's even worse than you think

People are also grabbing up 'payment option mortgages'. They don't even require interest payments! You pay whatever you want to a month, and if your payment doesn't cover interest, they add the shortfall to the loan balance!!!

Sometimes it's so easy to see the lights of the freight train bearing down on you but you're still too stupid to get off the tracks...

The fallout from the BushCo economy is going to be a real bitch.

[hadrons]

12. easy credit ....

money is more available and its leading to some reckless decisions

[Zynx]

13. The housing bubble is just as real as the stock market bubble was in 2000.

Just like in 2000, it wasn't every part of the market that was out of control. In 1999, most stocks actually finished the year lower than when they started. We have people now with housing who are getting involved in all kinds of leveraged get rich quick schemes that will blow up in their faces in the end. The first sign out there that the end is near for this housing boom is that so many people are saying "This time it's different." or "Housing can't go down.". Both were said about stocks in 1999 and early 2000. Currently, it is a lot smarter to be in stocks and bonds than in real estate.

[LibDemAlways]

17. "They can't sell for what they paid for it"

Back in the early 90's prices spiked here in Southern Cal. so that new homes were costing upwards of $350,000. Then in the mid 90's the market cooled and those same homes were reselling in the $250,000 range. Those who had to sell for whatever reason took a beating, and those who stayed put are now smiling because around here right now the sky's the limit. However, these things are cyclical and when interest rates rise, prices will fall.

I live in a neighborhood of 30-35 year old tract houses from 1350 to 2400 sq. feet. Right now the least expensive home for sale in the neighborhood - a 3 bedroom on a busy street is listed at $729,000. That's nothing short of insane. Newer, bigger hillside homes built in the late 90's and originally sold for $400,000 are now being resold for $1,400,000. People paying these prices are getting those interest only loans at very low rates. They are putting practically nothing down.

I have a difficult time understanding how an appraiser can walk into an ordinary tract house that three or four years ago would have sold for $300,000 and decide it's worth close to a million. It just doesn't make sense.

I think all of this is pretty ominous, and when the bubble finally bursts, many, many people are going to lose their homes.

[sendero]

22. People just forget history..

.... and let their optimism overcome their good sense.

Some of you might remember the S&L crisis back in the early/mid 80s.

Here in Dallas, as in many other parts of the country, the crooked S&Ls were all to happy to fund speculators, who ran the prices of housing up drastically over a period of years.

When it came to a head, we had a nice little crash. It wasn't a devastating 30% crash, but it didn't matter. So many people were leveraged to the hilt in their homes, fully expecting continued appreciation, that there were a lot of upside-down loans and a lot of foreclosures.

The funny thing is, so many of these folks don't really seem to think this through. They say "I'm buying this to sell for a profit". Well, where are they going to live then? If there is house price appreciation that will facilitate that, it will affect every sector of housing from apartment rents to mansions.

The fact is that at that time, people still had the "inflationary" mentality of the 70s. In the 70s, it probably DID make good economic sense to buy all the house you could afford, because if you didn't you might never be able to because inflation was outstripping wage growth.

Oh well, I humbly add that I own my own home and haven't borrowed any money for over a decade. Debt is a tool, like guns, drugs, or chainsaws. It can be used for good, or it can be abused with disastrous consequences.

[Media_Lies_Daily]

24. The mortgage balloon is getting VERY close to the popping point.

[fortyfeetunder]

26. Same situation in Seattle

Seattle area had housing peaks starting from the early 90's and now, the average home price in King Co WA is about $320K. And the new stuff, McMansions are going in the range of 700K and up.

It's probably best to stay put, remodel if needed and wait for the bubble to burst. Then it will be a buyer's market for more realistic home prices.

[Ready2Snap]

27. When the bough breaks. . .

From "The Iceberg Cometh" in the June "Harper's"

Pete Peterson cites both Paul Volcker(former Fed Chairman) and Robert Rubin(former treasury sec.) as seeing "a hard landing"(Volcker) or "a day of reckoning"(Rubin) with regard to the fall of he dollar. This will cause foreign investors, The Bank of Japan and The Bank of China, which hold the lion's share of our foreign debt, to "lose confidence in America's financial stability. Then a steep fall of the dollar, a huge spike in in interest rates." . . . "Thirty-five percent of new mortgages in the U.S. today are on floating rates, so an interest-rate spike would cause mortgage rates to skyrocket."

The interest rate increase in the mid '80s, thanks to Reagan's gobbling up all the available capital to finance the arms build up, precipitated the housing crash in SoCal.

When the dollar breaks, as it most certainly must, even under the best of scenarios, your bower will fall(in value), but your payments will increase.

And should we somehow solve our near-term budget problems, our social entitlement programs, Social Security and especially Medicare, coupled with the incredible national debt run up by Bushco paint a bleak outlook for our future, both as a society and as a nation - think Argentina.

[Moxygirl]

28. This may be common sense to DUers

but I'm amazed at how many double income earners waste their free mortgage payments every year. Me and my wife are on a biweekly pay schedule like most people. We budget on two checks a month but of course get paid three times a month twice a year. If you sock away four full paychecks a year to the mortgage it makes a hell of a difference.

Also don't forget to put all those bonus checks into your mortgage and not a jetski, there will be time for all that AFTER the mortgage is paid in full.

Oh I almost forget another trick that's helped us pay off our 300000 mortgage in 6 years. When the car payment or the student loan are paid off for godsakes don't spend the money on stuff. Just keep paying those car payments and student loans just pay them into your mortgage. Your already used to not having the money so resist the temptation to buy junk with it.

I realize this all takes self control but its worth it when your FREE.