The New York Times reports details of the Obama administration foreclosure prevention initiative today, and it looks like it is only delaying the inevitable. The plan pays lenders a flat fee to reduce loan interest rates to no more than 38 percent of a family’s gross monthly income. Then the government pays the actual cost of reducing the interest rate further to 31 percent of the gross monthly income. This rate would remain for five years, then will rise one percent a year until it is back to its original amount. Let's crunch some numbers, shall we?
According to the National Associate of Realtors (NAR), the average home price in the US as of February 4th is $213,100. According to the census bureau, the average family income in 2007 was $50,233. While figures are not yet available for the current average, we would have to assume it is lower, given layoffs and wage reductions that are so common right now. Let's be conservative and call the average $45,000. Let us further assume that the family has one of those "bad" mortgages that started with low payments but quickly increased them to, 8%. That would be a monthly mortgage payment of $1,562.92 or $18,755.04 per year. This mortgage payment represents 41% of the family's gross income.
Under the Obama plan, the family's mortgage payment would be reduced to $1,162.5, roughly 5.15% interest. That rate will remain in effect for five years, then rise 1% until it is back to 8%, just under eight years total. By then the family will be back in the same boat.
Obviously, the plan hopes that inflation will cause salaries to rise so that the restored mortgage payment will by then be only 31% of gross family income. In order for that to happen, the family income has to be $60,500 by 2017. That is a 34.4% increase in family income over eight years. But according to inflationdata.com, the inflation rate in January was 0.03%. For the family to reach the magic 31% mark, inflation would have to increase substantially. If it does, inflation will not only raise wages, but also the cost of gas, food, clothing, etc. So the family's extra income will be at least partially eaten up by those increases, leaving less for the mortgage.
My question is...are we really solving the problem or just delaying it? Many of the families this plan is designed to help bought at the top of the real estate market. Now that home prices have fallen so drastically (17% in the last year alone, according to NAR), most homeowners who bought in the last several years owe much more than the home is worth. Home prices have fallen so drastically, and the economy is so sluggish, it appears likely that in eight years these rescued homeowners will still owe more than the home is worth. And unless they increase their income past inflation levels, they will again be paying too high a percentage of gross income for their mortgage.
One advantage of this plan is that it stops the bleeding now. Given our current situation, that is not a bad thing. But the plan will not "fix" the problem, as we will see after five years when those mortgage interest rates start to rise again. And those properties will continue to be a sword of Damocles hanging over the real estate market.
Showing posts with label real estate. Show all posts
Showing posts with label real estate. Show all posts
Wednesday, March 4, 2009
Thursday, February 19, 2009
Toxic Real Estate
Back in 2003-4, I was shopping for a house and frustrated by the rapidly rising home prices. My ex and I had purchased a house in Los Angeles in 2000 for $265K. That seemed like a crazy-high mortgage to me at the time. Now it makes me nostalgic. By the time we split in 2003, the house was worth over $400K. She sold it in late 2006 for $780K (smart woman). Now, Zillow lists the house at $561K. Good luck getting that price in today's market.
The house was on a hill side with a commanding view and the neighborhood did "pop" after we bought, so it retained more value than many homes in LA. Still, the buyer lost 28% of the home value on paper, and probably over 35% if he were to sell. Houses built in far outlaying communities at the height of the boom have lost over 50% of their value. That's if you can get anybody to buy them, which you probably can't.
The big crisis in the housing bubble burst came because too many people got mortgages who should not have. During the go-go years of the housing boom, some people were absolutely frantic to buy a home. Everybody else had one, the prices kept going up and up and up, and if you didn't own a house you could not get any of that free money falling from the sky. So crazed buyers would have bidding wars, and houses would sometimes go for 10-15% over the listing price. I suspect the winners of those bidding wars are feeling like losers now.
According to RealtyTrac, there were over 3 million foreclosure filings in 2008 (up 81% from 2007 and 225% from 2006). Banks repossessed over 850,000 properties in 2008, more than double the previous year. And 2009 is looking much worse. By the end of this year, we could have over two million repossessed homes sitting empty, waiting for meth heads to remove their fixtures and render them even less valuable. My question is...what do we do with those properties, and how can we stabilize real estate prices with that much inventory and no buyers?
One big problem is that nobody knows where the bottom is. It is entirely possible that the home that seems like a bargain today because it fell from $400K to $280K, could lose another 10 to 20% of it's value, maybe more. Who knows? That uncertainty is effecting the housing market big time. To me, the biggest challenge is those millions of empty homes. It's like gangreen has infected your foot and spread up to the ankle and knee, heading for your hip. The only solution is to cut it out. So one might conjecture that bulldozing those empty houses would decrease supply to meet demand, and stabilize prices as a result. But the banks own those houses. Even though they are upside down on each one, they cannot walk away from whatever value is in them.
According to the National Association of Realtors, the average home price in December was $213K. Let's assume that the average value of reposessed homes is much lower, say $120K. That would mean there is $240Billion of inventory on the market that, for the most part, nobody wants to buy. While we address the financial crisis, much attention has been paid to "toxic mortgages". These are typically bad loans where the home owner didn't read the fine print and the monthly mortgage payment keeps rising until they can't afford to pay it. All of that is part of the banking crisis. But nobody is talking about toxic real estate. And as long is the situation isn't addressed, I fear the gangreen will continue to spread.
The house was on a hill side with a commanding view and the neighborhood did "pop" after we bought, so it retained more value than many homes in LA. Still, the buyer lost 28% of the home value on paper, and probably over 35% if he were to sell. Houses built in far outlaying communities at the height of the boom have lost over 50% of their value. That's if you can get anybody to buy them, which you probably can't.
The big crisis in the housing bubble burst came because too many people got mortgages who should not have. During the go-go years of the housing boom, some people were absolutely frantic to buy a home. Everybody else had one, the prices kept going up and up and up, and if you didn't own a house you could not get any of that free money falling from the sky. So crazed buyers would have bidding wars, and houses would sometimes go for 10-15% over the listing price. I suspect the winners of those bidding wars are feeling like losers now.
According to RealtyTrac, there were over 3 million foreclosure filings in 2008 (up 81% from 2007 and 225% from 2006). Banks repossessed over 850,000 properties in 2008, more than double the previous year. And 2009 is looking much worse. By the end of this year, we could have over two million repossessed homes sitting empty, waiting for meth heads to remove their fixtures and render them even less valuable. My question is...what do we do with those properties, and how can we stabilize real estate prices with that much inventory and no buyers?
One big problem is that nobody knows where the bottom is. It is entirely possible that the home that seems like a bargain today because it fell from $400K to $280K, could lose another 10 to 20% of it's value, maybe more. Who knows? That uncertainty is effecting the housing market big time. To me, the biggest challenge is those millions of empty homes. It's like gangreen has infected your foot and spread up to the ankle and knee, heading for your hip. The only solution is to cut it out. So one might conjecture that bulldozing those empty houses would decrease supply to meet demand, and stabilize prices as a result. But the banks own those houses. Even though they are upside down on each one, they cannot walk away from whatever value is in them.
According to the National Association of Realtors, the average home price in December was $213K. Let's assume that the average value of reposessed homes is much lower, say $120K. That would mean there is $240Billion of inventory on the market that, for the most part, nobody wants to buy. While we address the financial crisis, much attention has been paid to "toxic mortgages". These are typically bad loans where the home owner didn't read the fine print and the monthly mortgage payment keeps rising until they can't afford to pay it. All of that is part of the banking crisis. But nobody is talking about toxic real estate. And as long is the situation isn't addressed, I fear the gangreen will continue to spread.
Subscribe to:
Posts (Atom)
