Thursday, May 25, 2006

Caveat Emptor: "The Days of Something for Nothing are Over."

The Sacramento Bee's editorial page warns against loose lending standards.

Risky new mortgages -- interest-only with no down payment, or adjustable-rate mortgages with low initial teaser rates -- have allowed people to buy houses at prices way beyond what they can really afford. When the interest-only period or the teaser rate ends after the first few years, borrowers face much higher monthly payments. Borrowers can face, for example, a jump in monthly payments from $800 to $3,000...

The grim conclusion is that we can expect to see foreclosures and bankruptcies. It's already happening, as a story in Wednesday's Bee made clear.

Congress and federal banking regulators -- from the Federal Deposit Insurance Corporation to the Federal Reserve to the Office of the Comptroller of the Currency -- need to step in to tighten up interest-only and adjustable-rate mortgages before the housing market drags the whole economy down.

Until then, it's "caveat emptor" -- let the buyer beware. This may seem like heresy in a land where Gold Rush fever lingers, but people may be forced to go back to building wealth the old-fashioned way: saving money and taking out a traditional 30-year mortgage with 20 percent down and a fixed interest rate.

The days of something for nothing are over. Again.


Wannabuy said...

While I regularly read this blog, I'll be an infrequent poster.

What I do want to say is that loan standards must be tightened up.

Obviously PMI insurers are going to lose their shirt, so their reserve requirements must be increased dramatically. This will double or triple the cost of PMI.

10% down payments must become the minimum once again. (Ok, Vetrans get VA loans... but that's differnt and a small subset of the population.)

PMI will drive people back to 20% down payments.

But do recall that once upon a time a 30% down payment was required for the good 30 year mortgage rate. Time to impliment a 0.125% penalty for loans originated with less than a 30% down payment and put caviats that any HELOC put on the house within 180 days of purchase automatically triggers this.

Also, if HELOCs drop equity below 20%... force PMI.

Its the only way, in my opinion, to keep the market sane.


BitterRenter said...

The days of 20%dp's against 30yr FRM's as the standard are over, never to return. Wishing it were not so is as understandable as it is pointless.

Happy Renter said...

I drove by the Sac Towers sight last night. They have a new sign up saying "now selling phase 3".
They don't seem to have done anything in a year. The only equipment on the sight is an old decrepid John-Deere backhoe. It is severely rusted and does not look opperational. You can buy such tractors for about $2000. I think it was placed there just for show.
A legitimate construction company wouldn't waist their time with such a piece of equipment.
I thought those tower were to be completed in 2007 but they've barely started.
I think that project will end up scraped.

Rob Dawg said...

Interestingly we already have the rule necessary to prevent most of this; owner occupancy.

When I bought my first rental the bank in addition to blood samples and hostages insisted on a cash flow analysis that discounted rental income by 20% in addition to expenses and before tax breaks. They didn't insist on cash positive but they expected any difference to be considered a monthly personal expense against regular income.

You'd be hard pressed to find any property in LV, PHX, Palm Springs of anywhere in SoCal that sold in the last 5 years that meets those 1987 criteria.

Wannabuy said...


While I agree 20% dp's are gone for now...

The Fed has been talking about "recommending" a tightening in mortgage qualifications.

If foreclosures start to occur, what has *always* happened in the past? Banks tighten up lending requirements and force larger down payments.

This isn't a wish, just a note of the normal real-estate cycle.


Happy Renter said...

Here's an old arcticle from the peek. It was a fun little flashback for me, knowing where we are right now.

tom stone said...

robert,always nice to see your posts,the wave of foreclosures coming ashore will cause the usual too late tightening,and an overreaction,your 1987 scenario is familiar to me and i'd sure like to see it again.i expect to see huge changes in underwriting and dp requirements in a year because you will not be able to sell the current style of loans on the secondary market...i think of them as diseased turkey loans...and i am bemused that they can still sell anything that smells this bad.

Happy Renter said...

I think the new phase of the
Sac(k) towers has a reduced price tag.

Happy Renter said...
This comment has been removed by a blog administrator.
Happy Renter said...

Here is thread full of trend junkys raving about the towers.

My guess is most of the deposits come from helocs from current residences. Those that plan on living in the towers are depending on the sale of the current residence and or loose lending.
That money is evaporating as we speak.

Wannabuy said...

happy renter

Thanks for the link on the tower. Very interesting. I see that mania where I work... there is nothing to do but get out of the way.

Man, when this is done, how will we get anyone to buy real estate backed bonds? The risk/return will need to be corrected. Either rates will go up, or the risk goes down (PMI, larger down payments, or bond insurance which is really higher rates).

Or... said nicely by Tom Stone:
"i expect to see huge changes in underwriting and dp requirements in a year because you will not be able to sell the current style of loans on the secondary market...i think of them as diseased turkey loans...and i am bemused that they can still sell anything that smells this bad."


tom stone said...

btw neil,i'm a loan broker in santa rosa,and you are dam right i talk this way to potential clients,i have been around and in the real estate biz all my life,and 14 years in risk management gave me a fine understanding of bad paper.the lending practices of the last few years have been both shameful and stupid.i expect bankers to be shameless,but the degree of stupidity surprises me,even though einstein described it as the second infinity.