How Are People Really Buying

post from Irvine Housing Blog on 06 January 2009 03:30:00 PM. © Irvine Housing Blog

Give It Away Now—Red Hot Chili Peppers

Give it away give it away give it away now
I cant tell iff Im a king pin or a pauper

In yesterday’s rather lengthy post, I discussed Debt-To-Income Ratios: The Forgotten Variable. Today, I want to bring together parts of that post with other issues in the marketplace to paint an accurate picture of where we are. In the discussion on DTIs, I had the following table that shows how the median income household is financing median income properties.

$ 91,101Irvine Median Income $ 7,592Monthly Median Income5.0%Interest Rate

Payments, Taxes, InsuranceDTI RatioMax Loan * $ 2,12628.0% $ 336,580 $ 2,35331.0% $ 372,643 $ 2,88538.0% $ 456,788 $ 3,64448.0% $ 576,995 $ 4,02453.0% $ 637,099* Max Loan based on 85% of payment going to debt service

The chart would suggest that people who are still borrowing 6 times their income are doing so by utilizing DTIs near 50% (which represents almost 80% of take home pay). The reality is slightly different. Lenders are telling me that most people buying today are using 5-year and 10-year interest-only mortgages to get the DTIs down to somewhat manageable levels. So how does that math work out?

A median income household earning $91,101 can put $2,885 toward housing payments and expenses if they utilize a 38% DTI. (I think this is insanely high, but the government seems to think this is manageable.) If 20% of the $2,885 needs to be set aside for taxes and insurance ($577 per month), then $2,308 can be put toward an interest-only mortgage payment at 5%. This will finance $553,920 which is a little over 6 times income. Add a downpayment to this, and median income households can “afford” a house price between $550,000 and $650,000. The numbers are a bit smaller with the higher jumbo interest rates, but the downpayment requirements are higher too. Plus, some lenders will still allow DTIs higher than 38%.

People using 38% DTIs, 10-year interest only mortgages and downpayments of 5% to 20% are sustaining the housing market.

Are you willing to do this? I’m not.

For this method of finance to sustain home ownership, mortgage interest rates will need to be at 5% in 10 years time and prices will have to be equal to or greater than they are today. If those two things do not happen, today’s buyers will not be able to refinance, and they will be in the same circumstances as those facing foreclosure today. The only other thing they can hope for is that they will have a much higher income to afford the payments.

In the 10 years while these homedebtors are waiting to see if they can refinance, they will endure crushing housing costs that crowd out all other forms of consumption or savings. People buying today do not believe the harsh economic realities of making crushing mortgage payments is going to go on very long. Most believe that appreciation is right around the corner and with it, they will be able to get a HELOC and begin supplementing their missing income through mortgage equity withdrawal.

Do you think that is going to happen. I don’t.

So there you have it: people buying today are doing the following:

Using 38% DTIs and interest only financing,
Betting the interest rates will still be at 5% when they need to refinance in 5 or 10 years,
Betting their house will appreciate between now and when they need to refinance,
Counting on rapid appreciation soon to provide free money they can tap with a HELOC,
Counting on banks giving them a HELOC after the banks just lost a trillion dollars doing the same.
Putting their faith in the Real Estate Gods to make it all happen.

It this does not work out as planned for today’s buyers, they will be renting from their lender for 5 or 10 years, then they may be evicted when they fail to make the increased rental payments on the banks money that will come due after their loan resets. During their rental period, they will be paying 30% to 40% more than traditional renters will be paying for the same property.

Greedy little people in a sea of distress
Keep your more to receive your less

So why are people doing this? Fear and greed. They are afraid that if they do not buy now, they will never get the chance again, and more importantly they want that free HELOC money they think is coming back soon. Fear might compel someone to buy, but only greed will compel them to pay that much.

In my opinion, if you took away the enticement of free money, prices would collapse almost immediately. We have documented on this blog the hundreds of thousands of dollars of free money borrowers got from their lenders. For those who sold at the peak, the money was totally free, and for those who didn’t, they have to pay with damaged credit. Big deal. They all got to spend or keep the free money.

Californian’s have learned this free money is there, and all they have to do is buy real estate to get it. The collective insanity of everyone believing and acting on this idea makes prices rise and makes the fantasy a reality. Right now, the only thing preventing this from happening is reluctance on the part of lenders to give away another trillion dollars in free money to people who will not pay them back. Personally, I don’t think this reluctance from the lenders is going to change. Funny how losing a trillion dollars will make you a bit more cautious…

It seems like there are some properties people just don’t want. I canunderstand all the crappy little condos in The Lakes (Lakepines,Pinewood, Streamview, etc.) but when you see newer, larger, moredesirable properties still in the system and still with decliningprices, you have to wonder what is going on. Today’s featured property was first on the IHB as a 2003 rollback in August of 2007, right as the credit crunch hit. It has been almost a year and a half since this property was first featured, and it is still making its way through the system.

Do you see why the hangover from the Great Housing Bubble is going to last longer than most people realize? We will be dealing with properties like this one for the better part of a decade. We still have a number of resets in 2011. It isn’t hard to imagine some of those still polluting the market in 2014. Plus we have all the knife catchers from 2007 and 2008 who used 5 year interest-only ARMs to clean up after.

Asking Price: $499,900

Income Requirement: $124,750

Downpayment Needed: $99,800

Monthly Equity Burn: $4,158

Purchase Price: $735,000

Purchase Date: 5/4/2006

Address: 144 Saint James #54, Irvine, CA 92606

Beds:4Baths:3Sq. Ft.:1,931$/Sq. Ft.:$259Lot Size:-Property Type:CondominiumStyle:ContemporaryYear Built:2002Stories:2Floor:1Area:WalnutCounty:OrangeMLS#:S538589Source:SoCalMLSStatus:ActiveOn Redfin:188 days

Unsold in 90+ days

Gated Community 3 Bedrooms, 2.5 Bathrooms with a Den or Office off the
Master Bedroom. Corian Counters and a center island. Custom tile
flooring and planation shutters.

planation?

If you look back at the original post, you see that the sellers were asking $651,900 in August of 2007. Now the asking price is $499,900.

This property was purchased on 5/4/2006 for $735,000 by a Married Woman as her sole and separate property. She used a $588,000 first mortgage, a $147,000 second mortgage, and a $0 downpayment.

The property was taken back by the lender on 3/13/2008 for $564,750. The second mortgage was wiped out.

If this property sells for its asking price, and if a 6% commission is paid, the total loss to whoever holds New Century’s toxic waste will be $265,094.

Yes, I can see where lenders and investors will be ready to start handing out HELOCs and second mortgages again soon…

Greedy little people in a sea of distress
Keep your more to receive your less
Unimpressed by material excess
Love is free love me say hell yes

Im a low brow but I rock a little know how
No time for the piggies or the hoosegow
Get smart get down with the pow wow
Never been a better time than right now

Bob marley poet and a prophet
Bob marley taught how to off it
Bob marley walkin like he talk it
Goodness me cant you see Im gonna cough it

Give it away give it away give it away now
Give it away give it away give it away now
Give it away give it away give it away now
I cant tell iff Im a king pin or a pauper

Give it away now
Give it away now

Give It Away Now—Red Hot Chili Pepper