Tuesday, September 12, 2006
RE: The Rules Of The Slump
I'm a little fed up with the way the press is discussing this. It's not as if everyone's housing prices will go down at the same rate; some will even rise or stay steady as others fall. There are many factors to consider. The first is the baseline median for the area, which you determine by looking at median incomes for the county (I use HUD), and dividing the median family income by 12 (DC=$90,300, monthly is 7,525). For a given median sales price, figure the monthly principal & interest, add taxes and insurance, and figure the ratio of housing cost/other debt to monthly gross income. Here's a good loan calculator at Bankrate.com.
Let's try an example. NVAR is in many ways a bedroom community for the DC area. Let's use DC's monthly gross income.
Mo Gross Inc: 7,525
Median $ NVAR, August 2006: 459,000 (in August, 2005 it was $499,000)
Less 10% downpayment: 413,100
Monthly P&I from calculator (6.5%): 2,611.07.
Base Ratio P&I to Gross Income: 34.6% (should not exceed 25%)
To that P&I you would have to add taxes, PMI, and hazard insurance. It certainly won't be less than $500 a month, and might well be over $800 in some areas. Let's use bracket it between 500 and 800:
$3,111.07/$7,525 = .41 (41%); $3,411.07/$7,525 = .45(45%). (Should not exceed 28%)
Now, traditional lending guidelines say that your total monthly debt payments/gross income should not exceed 36%. Total monthly debt payments include student loans, credit cards and car payments. It is unlikely that most families buying in NVAR will have no other debt. Let's be quite conservative and say $300 in other debt a month. Our brackets now are:
$3,411.07/$7,525 = .45; $3,711.07/$7,525 = .49
Remember, gross income includes income/SS taxes! Figure 32%, and our hapless borrower is left with $5,117 monthly income, giving brackets of after debt/mortgage disposable income of $1,706 - $1,406 to cover utilities, transportation, car insurance, car repairs, home repairs, medical insurance/health, childcare, clothing and groceries. I don't think they're going to be saving much! A single person could do it, a childless couple can just about do it, and a couple with one child will not be able to do it. There's a reason why those traditional lending guidelines exist. For practical purposes, once you exceed 45% of your gross income in debt/property payments, you are sunk. One piece of bad luck or major unexpected expense, and you are not going to recover without a family bailout.
It's easy to see that the median-income borrower can't buy the median priced house in these areas using traditional mortgages, which is the sole reason that funny-money mortgages became so common. It's also easy to see that high tax locales will experience more price depreciation on average than low tax locales. Transportation costs, etc, will be a big issue as well. You have to adjust in each locality for those factors. I have also been quite conservative in the matter of other debt.
Figure your baseline drop to get your borrower below 40% on the lower bracket. In this case, that is equivalent to about $3,000 total monthly debt & housing cost, or a P&I of $2,200, which translates into a total loan of about $345,000 - $350,000. We'll be kind and assume that the borrower can make the same downpayment (originally $59,000), which means that median of $499,000 in August 2005 is going to have to end up no higher than $410,000. Note that I am using extremely conservative assumptions here about other debt and the downpayment, and the lower end of the bracket. The bracketed median price should be somewhere between $370,000 and $410,000 in today's dollars. This will occur over several years, and only takes into account the median for prime borrowers. Because of the conditions in many areas and low downpayments, most borrowers will not be prime. Add a half a percentage point to account for this, and we are looking at a total loan of about $330,000, and a list of $350,000 - $390,000.
From that baseline, you adjust up or down based on relative desirability, demographics, job picture, commute time/costs, prevailing interest rates and, most of all, property TAXES. Every time property taxes rise by $100 monthly, the baseline value of the property declines the P&I equivalent. At 6.5%, that is about $16,000.
The relatively flat median incomes have been discussed as they relate to this situation, but the untold story of this slump is what has happened to property taxes in some areas. The reason that many people financed out of good mortgages into funny-money loans was that they were pushed too far paying their bills at 5.5 or 6%, and they thought they could "catch up" by using those temporary 3.5% interest rates, usually not realizing that there were prepayment clauses and higher interest rates later on. No one's going to lend you money at 3.5%. No one. Rates were higher in the midst of the Great Depression.
I think NJ is in deep, deep trouble. Also, property insurance and taxes have ballooned in Florida, and I expect real values in many areas to decline by 40% to compensate. Some already have. It's fine for ecoidiots to throw out the statistic that 50% of the houses in the US are paid off. That's hardly significant if those houses are owned by older people with fixed incomes who are now being asked to pay property insurance and taxes that are equivalent to the mortgage they paid off.
I cannot stress enough that there is no more possible flexibility in lending terms, that the terrible unfunded pension/health costs of many states and localities are a millstone around the necks of the propertyholders there, and that demographics are bad (the retirement of boomers and the newfangled tradition of dumping workers before 60). All of this is contributing to a downward trend. Another way to put this is that overall government and consumer debt has reached the point at which it can increase no further.
The only way to offset this trend is for consumers to sharply retrench and for government to do likewise, while loosening government constrictions on productive industry within the US. You must have stimulation to offset this constriction. Otherwise, you are either looking at a recession that extends for more than four years, or, worst case, a genuine depression. We can probably avoid the depression by opening up immigration from India and China for wealthy people. That won't deal with public debt.
PS: For those who want to do these calculations for their own area, it's important to know that amortizations are scalable based on term and interest rate. So you can figure this rapidly by multiplying the payment for $10,000 at an interest rate by the median price/10,000. Or: The P&I payment for $10,000 over 30 years at 6.00% is $59.96, and the payment for a $100,000 loan over 30 years at 6.00% will be 10 * 59.96 (60) = @ 600, and the payment for a $400,000 loan over 30 years at 6.00 is 4 * 600 or 2,400. ($500,000 = 5 * 600 @$3,000)
$10,000, 30 years, 5.0% = 53.70
$10,000, 30 years, 5.5% = 56.78
$10,000, 30 years, 6.0% = 59.96
$10,000, 30 years, 6.5% = 63.21
$10,000, 30 years, 7.0% = 66.53
$10,000, 30 years, 7.5% = 69.92
"If this was any product regulated by the SEC, someone would be going to jail."
However, when you offer an ARM you are required to provide a disclosure before taking any fee (it's supposed to be given at application) showing how payments can adjust. My question is, didn't the people who got these read them? You are required to take it up to the maximum. Here's a link to an html version of one format: plain text.
As you can see, this shows the lifetime max and the fact that the monthly payment could come close to tripling, as well as how fast that could happen. I prefer another, clearer format, but the information is the same.
Maybe people simply cannot do the math! But read the examples given in these articles. They're not English-limited. They should be able to figure this out! Also, the dislcosure is required to contain a warning if negative amortization is possible.
They also have to get a handbook that lays it out, and explains the meaning of the terms. My guess is that a lot of cash-strapped people are willing partners in fooling themselves. I'm not saying that these salesmen don't deserve to lose their licenses. I'm just saying that something's wrong. Either we have reached the point at which engineers cannot divide by 10 and multiply by the figures given, or these disclosures aren't being given, or the people in question are signing them without reading them.
But I see ads all the time that say $X mortgage for $Y/month, where it's obvious that the numbers don't make sense unless $Y is going to go way up, and/or the mortgage balance is going to stay outstanding forever. I think putting stuff like that out is indeed deceptive, and Barry is probably right that no one would be likely to get away with this kind of thing for long in the public securities industry.
My instinct is that there must have been huge fraud for this to happen, combined with acute stupidity on the part of the "investors" and lenders. People were writing these loans when they knew the people couldn't pay them, but they figured they could refi or sell. Well, last year that was true, when the SF area was up over 17%.
I think there ought to be some sort of legal check on this behavior. I cannot figure out exactly how that could be done without causing more problems, but it's clear that we have a massive problem as is. I think the customer should be qualified on at least a five-year time frame, and if not, informed that they are unlikely to keep the house and referred for counseling, or something like that. Also, I think there should be special legal disadvantages to lenders in writing such loans if they do default. We need to put some accountability back into the system.
The net effect is that a large number of people who would have been good buyers have been turned into credit problems needlessly. A lot of the people who can pay will find themselves deeply underwater. I can't even begin to calculate the net drag on the economy for the next 5 years, but it's significant.
Feast your squinties on this over at Sonoma Housing Bubble blog...
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