Interest Only Loans, 1.00% Mortgages

Saturday, May 21, 2005 | 10:45 AM

One of my favorite econopundits, the Penobscot Princess (still running in stealth mode), penned an intriguing dissertation on the "Housing Situation."


First things first: A faithful reader forwarded me this quote from an article in yesterday's Washington Post which discussed the HELOC/HEL bulletin that had been put forth by the OCC et al. You may wanna' siddown before you take it all in, it's that far beyond the pale:

"As long as the housing bubble doesn't burst, home equity lines should remain strong and remain safe," said Scott Stern, chief executive of Lenders One, a St. Louis-based cooperative of 60 mortgage companies that originate home-equity lines, including some that feature 100 percent loan-to-equity ratios. "As long as the bubble doesn't burst, there should be no serious problem."

Well, whadda' ya' think of that gem, eh? The CEO of a mortgage cooperative acknowledging a housing bubble!

And in the same breath quasi-dissing it as long as it remains intact.
Two things come to mind:

1. I surely hope that Mr. Stern has been quoted out of context. Way, way out.
2. I wonder if Mr. Stern understands that they call 'em bubbles because inevitably, they burst. Or has the real estate industry discovered some magical way to let all that air out, a teeny bit at a time?

And just to get you further riled up, check out these couple of on-line ads:

Jumbo Interest Only Loans 1.00% "Pick Your Payment" Mortgages Jumbos, Bi-Weekly & more! 5 1 Arm Libor Bad Credit OK. Interest Only Option Fast & Easy Online Application.

Okay, the first one has a "30-second" on-line application. The second one incites the borrower to "ask about our 1% Pay Option ARM and interest-only loans." You gotta' love it.

A 1% mortgage. As a noted Street pundit commented, this type of home purchase is more akin to renting from the bank with an option to buy later. And since, for all intents and purposes, loans of this crazy nature transfer 100% of the risk to the lender, I'd go a step further and classify the buyers as squatters, not home-owners. And that fact makes a great case for leaving the keys on the kitchen table and walking away very easily when "lights-out" is sounded. Very easily. But alas, I digress.

Now that we've got your attention, how about some hard facts? (Ahem):

According to the Mortgage Bankers Association, ARMs accounted for almost 46 percent of new mortgages in 2004 in $ terms and 32 percent by number. Compare to '03 which marked 29% and 19%, respectively. How telling is it when ARM use is up so significantly when fixed mortgage rates are pretty much flat from '03?

Stretch. Stretch.

The Federal Housing Finance Board also chimed in on the ARM topic by noting that ARM share is particularly significant and on the rise in the "boom" markets. So there's your proof as to what this ARM surge really means. And while there are surely some financially savvy players who are benefiting from the ARMs and other exotics, we are very confident in dissing the junk alibi that gets passed around every time the topic of ARM use comes up: simply looking to pay off the house in 3 years and move elsewhere. A cold-water flat sounds about right. Next.

Interest-only mortgages accounted for 23% of the $ value of non-agency mortgage securitizations in '04. These are high-risk ARMs and it is generally thought that they are being sought increasingly by those with bad credit and/or those who want those no-doc or low-doc loans. (Crack dealers come to mind). Sub-prime mortgage lending jumped to almost 20% of all loans (by number) from 9% in '03.

This marks a reversal in a 3-yr. decline in same. Now check this out: "The majority of subprime loans have been characterized by short-term adjustable-rate structures, many with prepayment penalties." (Ref.: FDIC citing "Mortgage Originations by Product", Inside Mortgage Finance, 2/25/05.) In for a nickel? In forever.

9% of '04 mortgages were taken out by investors vs. 6% in '03. (Newbies: "investors" is French for "speculators".) BUT: In at least some of the red-hot markets, this number is estimated to be as high as 19%.

"Academic studies show that residential property investors are less loss-averse than owner-occupants and thus more likely to sell precipitously in a declining market, thereby aggravating any existing downtrend in home prices.
" ... (Ref.: FDIC citing Loan Performance.)

Cover your short in air-sick bags.

Average US home prices rose by ~ 11% in '04, the largest nominal gain since 1979. That 11% is up from 7% apiece in '02 and '03. Want to adjust for inflation? Okay, then call the price appreciation 8% which is still a 30-year speed record.

As for a couple of items that help to shape the direction of home prices, how about we look at:

Rent: +2.7% in '04 and +2.3% apiece in '02 and '03. Oops, these comparatively lame increases surely do not validate soaring housing prices, eh?

Additionally, the rents figure surely make a further mockery of the OER line item in the CPI, but that's another day another story!

Income: +5.8% in '04 and +4.2% in '03. While these figures beat the rent increases, there is still no justification in saying that personal income levels are driving prices. Au contraire, this is further evidence of the big stretch

John Q. is making in order to buy a home. Or three.

The NAR (National Association of Realtors) compiles a "housing affordability index for first-time homebuyers" which utilizes home prices, in comes and interest rates. Last year, that index slipped 3.8 pts. to a read of 77.7.

Now bearing in mind those underlined-above factors considered by this index, it is thought-provoking to cogitate these comparisons: The index also dipped during the recession of '91. Think income. And the all-time low, 75.9, was marked in 2000 when mortgages were 8%. Think interest rates.

Thus, considering our current mélange of 1) soaring home prices, 2) stagnant wage growth and 3) a rising-rate environment, '05 is shaping up as a Trifecta in making a case for a further decline in the NAR's affordability index for '05, right?

Now go a step further and consider what could happen when first-time buyers are heading towards being shut out of the market. Besides boarding your daughter and son-in-law in the basement for another couple of years, we could make a case for overall slowing sales and of course, lower prices.

Back in February, the FDIC issued a report which called into question whether a housing price boom was always followed by a bust. For some reason which the astute will be quick to surmise, they felt the need to re-issue an updated report on the same topic. A couple of weeks ago. In the May 2 version, they used updated info including the HPI (Housing Price Index) which is put together by OFHEO. (That's where the above data on rents/income comes from.) Anyhow, the FDIC currently finds that the number of *boom markets increased by 72% last year and "now includes some 55 metropolitan areas".

*Boom according to the FDIC: inflation-adjusted prices up by at least 30% in a 3-year period; the define a bust as a home price decline of at least 15% (nominally) over 5-years.

(And before we go on, please note that the FDIC uses the term "housing boom" which is far less toxic than the term "housing bubble" in that a "boom" has a shot at a soft landing. Dig?)

Here's what they had to say:

"The broadening of the U.S. housing boom during 2004 may imply a growing role for national factors-including the availability, price, and terms of mortgage credit-in explaining home price trends. To the extent that credit conditions are in fact driving home price trends, the implication would be that a reversal in mortgage market conditions could contribute to an end of the housing boom. While history clearly shows that housing booms don't last forever, the manner in which they end matters for mortgage lenders and borrowers alike."

A reversal in mortgage market conditions. Ooh, they're getting warmer, eh? But not quite. Because they concluded in the report that a housing boom does not necessarily lead to a housing bust.

According to the FDIC, bust followed boom in only 17% of the incidences prior to 1998. Cool. Now what? Well, they went on to point out that busts are generally precipitated by some kind of shock to the local economy. I'm thinkin', for example, certain parts of Jersey when Lucent went haywire. The FDIC also explained that these busts resolved themselves eventually, but only after a period of stagnant prices (the extrapolation of the possibility of a period of stagnant prices in the current speculator-driven frenzy is far too painful to ponder) which played out over time as the economy/household income was scurrying to catch back up with the home prices.

They also opined that owing to the economic-distress factor which almost always precedes a bust, that they feel the metro areas (which are the hottest markets) are for the most part, buffered.

But then they finally turned the screw as they signed off as follows:

"But to the extent that credit conditions are driving home price trends, the implication would be that a reversal in mortgage market conditions-where interest rates rise and lenders tighten their standards-could contribute to an end of the housing boom. While our analysis shows that boom does not necessarily lead to bust, it remains to be seen to what degree the current situation might differ from our previous experience in U.S. housing markets . . . " 

Oh, there it is again. "a reversal in mortgage market conditions". That was on May 2. And that report is lengthy and also talks about current, funky lending practices, yada, yada, yada. And then the FDIC joined with the OCC, the FED and other regulatory agencies in issuing that warning/bulletin Monday on the OCC website. Which spoke about higher rates and tighter standards, i.e., a reversal in mortgage market conditions.

Uh-oh. They know. They all know. Every agency that signed off on that bulletin knows. But just how far the FED takes the rate-hike game, remains to be seen. Ask Orange County. Ask Mexico. Ask LTCM. Ask your neighbor with the HELOC.


Saturday, May 21, 2005 | 10:45 AM | Permalink | Comments (9) | TrackBack (0) add to | digg digg this! | technorati add to technorati | email email this post



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2/3 of SF Bay Area mortgages are interest only:
(check the graphs too by clicking on the pic on the right). The percentage of interest-only loans is highest in Vallejo, which basically means people who are most stretched in the area...

Posted by: idook | May 21, 2005 1:04:26 PM

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