Herb Greenberg has a lengthy repost of an email from a mortgage industry veteran who says that the troubles in the mortgage industry are only beginning:
Sub-prime aren’t the only kind of loans imploding. Second mortgages, hybrid intermediate-term ARMS, and the soon-to-be infamous Pay Option ARM are also feeling substantial pressure. The latter three loan types mostly were considered ‘prime’ so they are being overlooked, but will haunt the financial markets for years to come. Versions of these loans were made available to sub-prime borrowers of course, but the vast majority were considered ‘prime’ or Alt-A. The caveat is that the differentiation between Prime and ALT-A got smaller and smaller over the years until finally in late 2005/2006 there was virtually no difference in program type or rate.
This is definitely one of those “read the whole post” items.
The vicious cycle that has driven the housing industry is reversing upon itself. It probably started with lower lending standards. More people could get approved for mortgages, so demand for housing rose. That caused house prices to go up, which created a market for more exotic mortgages that allowed people to buy houses without putting down money or eating the monthly payment on a standard fixed-rate mortgage. These exotic mortgages enabled people to buy more house than they could with a traditional fixed rate mortgage, and enabled people with less money to buy houses in expensive areas. That in turn drove demand and caused houses to rise even more. The catch was that as long as houses were appreciating, people could keep refinancing to keep the interest rates on their loans from resetting.
Now we’re seeing the inevitable reversal. When houses stopped appreciating so rapidly, people started seeing their loans reset to rates they couldn’t afford in the first place, and now they’re seeing foreclosures. That hurts the banks, who in turn tighten up their lending standards, and that results in less homes getting sold, and thus less appreciation and even drops in home prices in some areas. The cycle that caused home prices to spiral upward sure looks like it’s going to cause them to spiral downward. Here’s what Greenberg’s correspondent says:
One final thought. How can any of this get repaired unless home values stabilize? And how will that happen? In Northern California, a household income of $90,000 per year could legitimately pay the minimum monthly payment on an Option ARM on a million home for the past several years. Most Option ARMs allowed zero to 5% down. Therefore, given the average income of the Bay Area, most families could buy that million dollar home. A home seller had a vast pool of available buyers.
Now, with all the exotic programs gone, a household income of $175,000 is needed to buy that same home, which is about 10% of the Bay Area households. And, inventories are up 500%. So, in a nutshell we have 90% fewer qualified buyers for five-times the number of homes. To get housing moving again in Northern California, either all the exotic programs must come back, everyone must get a 100% raise or home prices have to fall 50%. None, except the last sound remotely possible.
I think we’re in for a lot more pain.
And I don’t understand how people with a household income of $175,000 can afford a million dollar home. If you buy a million dollar home and put only 5% down, your payments on a 30 year mortgage at 7% are about $6,300 a month. Mortgage lenders will tell you that your mortgage payment shouldn’t be more than 35% of your take home income, which means for a $6,300 payment you need to be taking home roughly $18,000 a month. That means you need to be taking home $216,000 annually, after taxes, health insurance, and all the other stuff that gets deducted from your paycheck.