Archive for the 'Refinance' Category

Date: August 29th, 2007, Filed under Foreclosure, Mortgages, Refinance

Zion, IL
By A.B. Dada
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On my previous post titled Scary Housing Bubble Mortgage Calculator, Frishack posted the following comment that I wanted to reply to publicly.:

The fact that you may be upside down for a few years does not have any effect on what you are paying monthly, so just ignore the market ups and downs, and in the long run real estate always goes up.

This is a common line by Realtors and mortgage lenders. I disagree with it completely.

Real estate does NOT always go up. If you look at real estate prices in any 20-30 years time frame, while the dollar price of real estate may have gone up over that time frame, it definitely did NOT keep up with inflation’s destruction of the dollar.

On top of that, you’re paying interest, taxes, maintenance and possible association fees: a house is a bad, bad investment. What you want to do is stay ahead of the downswings. When you are upside down on a mortgage versus property value, you put yourself in a very scary position. What happens if you get sick, lose your job, or have to move? Let’s say that you bought a house last year for $200,000. In recent news all over the mainstream media, we’re seeing the first national housing market decline YOY in history. Some experts are already calling for 10-20% fall on average, with some communities seeing as much as a 50% decline before we hit bottom. I agree with those numbers, and I think it could be even worse depending on how bad the liquidity crisis becomes.

If you bought a $200,000 house with 0% down, and the market falls 10%, your house may have a value of $180,000, but in a year you’d have paid down almost NO principal, maybe $6,000. This means your mortgage would be $194,000 and you’d owe $180,000. Let’s assume you lost your job or you had a job transfer, and had to sell. That $180,000 house in a declining market likely won’t sell for your asking price — people don’t want to catch a falling knife. If someone offered $175,000, and you had to pay the Realtors 6%, you’re left with a check for $164,500, or almost $30,000 below your mortgage. Since America has a negative savings rate, we can make the assumption that most people have little to no liquid savings, or they’d have put it into a down payment. Banks aren’t going to take a 20% short sale most of the time, and if they did, they might issue you a 1099 for the short sale “gift.” Now you own the IRS a nice chunk of change at year’s end.

With 20% down, you are well protected to the rise and fall of the market. The housing market right now will be the worst financial investment market in US history. It will likely “lose” more asset value than the Great Depression, and it will also cause a huge segment of the industry to fall on hard times — leading to more bankruptcies, foreclosures, defaults, and job losses.

When people can’t HELOC more money out of their home ATM, they won’t shop at Home Depot for big appliances and granite counters. They won’t buy that new Hummer, or travel on that fun cruise. These industries will get slaughtered during a housing downturn. Businesses won’t have the capital to give raises or hire new staff, either. It’s a vicious cycle of downtrend we will likely face, with the Federal Reserve doing even more damage.

My personal rules are:

1. 20% down, minimum. Always.
2. Fixed rate mortgage for 30 years, never adjustable, ever.
3. 28% gross salary maximum mortgage payment, salary an average of last 3 years.
4. Calculate your mortgage payment at the same interest rate but over 15 years instead of 30. Pay that amount.
5. Put ALL bonuses, tax refunds and raises towards your mortgage, pay it off in 7-8 years.

The madness of easy credit in the last 10 years has caused a large percentage of home borrowers to finance houses at 5X, 6X, even 8X their annual income. This is crazy — how do you pay a mortgage that accounts for 60% of your gross income? How do you pay for insurance, maintenance and taxes, which are all going up, up, up? It’s a dangerous place to be, and I want nothing to do with it.

Comments: 5

Date: February 20th, 2007, Filed under Mortgages, Negative Amortization, Refinance

I read a hilarious article from RisMedia yesterday that still makes me chuckle, titled Adjustable Rate Loan Resets, Skyrocketing Mortgage Payments for Homeowners. It is a quick read.

The beginning of the article offers some good insight into the dangers ahead — dangers that many of my friends and family will be facing, even with my dire warnings for two years:

Many households that took advantage of “teaser rate” loans-types of adjustable rate mortgages that hold down payments for an initial period, are facing resets of their interest rates that can cause monthly payments to balloon upward of 10% to 50% as reported recently by realestatejournal.com. A $1 million mortgage taken out 30 months ago that started at $2,528 per month, could jump to just under $7,000 per month. According to the Mortgage Bankers Association, there are about $1.1 trillion to $1.5 trillion in ARMs that will face rate increases this year.

Yes, folks, that is trillion with a T. There is only one word that comes to my mind when I hear about these resets: oops. You reap what you sow, and if you’re sowing great overwhelming debt, you will reap years of servitude to the mortgage holder.

But that isn’t the funny part — that is the sad part. The funny part comes at the end:

One alternative many of SMR’s clients are seeking is negative amortization loans. Funded properly, this form of financing is a viable alternative for home buyers that need to minimize their monthly payments while shedding themselves of the thousands they will be paying through a mortgage reset.

What SMR is offering is to take the ARM loan — which originally cost just principal plus a teaser interest rate (1%), but then jumps to principal plus a high interest rate (8+%) — and turn it into a negative amortization loan. What this means is that instead of paying principal plus interest, you pay only interest, or only part of the interest, so the loan gets bigger over time. SMR sells this loan probably by telling their customers that their income will go up in the future, so they’ll be able to pay more when it is time to start paying off the principal. Why pay for the principal now with your mediocre income when you can just pay part of the interest, and then really start paying off the loan in the future when you’re wealthier and earn more? They might also sell it by explaining that the housing market is in a temporary decline, but eventually housing prices “always go up” so once the decline is over, your house will be worth more than the negative-amortization loan will cost to pay off.

Let’s look at a typical $250,000 home loan under an ARM with a teaser rate of 1%. In the first 2 years, your mortgage payment is $804.00 per month — nice! But the ARM will eventually reset to the current rate. After 2 years, if the current interest rate is 8%, your mortgage then jumps to $1758, assuming you only paid $804 per month for 2 years to bring your principal balance down to $235,500.00 at the time of reset. Basically, your mortgage payment will double after 2 years (approximately), and this does not consider property taxes, insurance or association dues. For many households, that doubling is not just unexpected, but painful if their housing market is in a decline and they can’t refinance to attempt to reduce payments again. Even worse, many teaser rate loans have prepayment penalties in the tens of thousands, making it impossible to refinance as their homes might be worth less than their current mortgage, not including refinancing with the penalties in place.

The negative amortization loan may seem to be the only option — why not refinance the new principal ($235,500) plus the prepayment penalities ($11,775) into a new negative amortization loan ($247,275)? Your payment would drop to “only” $632.

The problem with this situation is that you are now a speculator — just like someone buying stocks on margin (paying an interest rate for a loan to buy stocks in hopes that they will appreciate more than the interest rate you’re paying). If your speculations fail, you will be so far upside down on your mortgage that you may never get ahead. Even worse, many banks will put a cap on how far your can negatively amortize your loan — if you hit that cap, they will automatically force you to make positive-amortization payments that will be signfiicantly more than if you just paid your reset-rate originally. Remember, with a negative-amortization loan, your principal is never paid, but instead it is tacked on to your “payoff” mortgage amount. Your balance grows each month, and you’re speculating on a variety of hopeful outcomes:

1. Your income grows signficantly, enough to make a real mortgage payment,
2. Your house value grows significantly, enough to cover paying off your mortgage,
3. Your taxes and insurance don’t go up signficantly.

These are very unrealistic and, in fact, dangerous to speculate on.

My solution to the problem is the best there is — get out. Get out now! In many cases, you will have to bring cash to the closing to pay off the remainder of your loan plus penalties, but at least you’ll get out. If you have a good credit score, you can finance the shortfall with a signature loan or a loan against other assets. If you can’t do that, why would you even consider getting yourself into hotter water? Most real estate experts will tell you that there’s a frying pan, and there is a fire. I’m giving you another solution: get off the stove until you can really handle cooking your meal.

Discuss this article at the housing bubble forum.

Comments: 2