I mentioned in a post last week that I think this may be a bad time to buy a house. I thought I would elaborate on this just a little bit. No, this isn’t a financial blog and I’m not a financial expert. I have no financial training (other than what my dad has been teaching me over the years and the regular reading I do on the subject) and no one should make any decisions based on what I say here, blah, blah, blah.
However, knowing that a lot of people (read: women – sorry to generalize) don’t necessarily follow financial news, I thought it might be prudent of me to mention this and people can do whatever they want with it.
While this chart does not summarize the entire situation, I think it goes a long way to getting the conversation started. This little beauty was put together by Credit Suisse, probably a pretty recognizable name to most readers here.
Ok, so what does it mean? ARMs are Adjustable Rate Mortgages. Gazillions of homes have been purchased using ARMs over recent years. They start out with low teaser rates (1% interest for first year or two, etc. – I’m sure you’ve seen the ads all over tv in recent years). However, then they adjust – UP. Sometimes a lot. Sometimes a lot many times. So people who start out being able to make their payments find that in a few years they can’t. When that happens, they lose their house. Think foreclosures, bankruptcy, etc.
Now there isn’t necessarily anything wrong with ARMs when they are used in a proper situation (and there aren’t many of them that really are appropriate). What is wrong is that many of the ARMs that have been taken out are of the subprime variety. These are people who have bad credit histories and would never qualify for a traditional 30 year mortgage with 20% or even 5% or 10% down. There has also been a lot of mortgage fraud with no documentation loans in order to get people into these loans. So some guy who works as a janitor making $14,000 a year somehow qualifies to buy a $350,000 house in California. The rampant fraud is a whole nother story.
(I realize I’m glossing over big areas here, but I’m trying to just give an overview so people will investigate on their own.)
Ok, now look at the graphic. This graphic starts in January 2007. It shows the number of ARMs that will reset for the next 73 months. That is between now and 2013 if my math is correct. So far we are four months into this. Notice that although some ARMs have started resetting, the vast majority of them are yet to come. In fact, the first big uptick starts next month (June).
If you follow the news at all, I’m sure you have already heard about the slowdown in the area of real estate. Perhaps you’ve noticed that there are a lot of houses for sale right now where you live. You’ve heard about foreclosures. The National Association of Realtors (NAR) announced that sales of existing homes dropped 11.3% in March compared to the previous March. This is the biggest drop in 18 YEARS. March foreclosures increased 43% compared to last year to almost 150,000.
Now look at the graph again. We are FOUR MONTHS into this. The graph covers 73 MONTHS. And already there are a lot of people in a world of hurt.
Another aspect to consider is that a lot of people have been using their homes as ATMs over the past ten years. As home prices have continued to rise, people have taken their (perceived) equity out of their houses time and time again. Many people live in houses in which they have NO equity because they have taken it all out.
Yet another aspect to consider is the widespread speculation throughout the country. A lot of the run-up in housing prices is due to speculators. Speculators are trying to dump the homes they intended to flip for a quick buck.
But what does this have to do with me buying a house, Sallie? I’m glad you asked!
Let’s say John and Jane live on a street with twenty houses. There are a hundred houses in their development. They paid $200,000 for their house and they were able to get a conventional mortgage by putting down 20%. So in theory they had $40,000 in equity in their house when they moved in. For the sake of argument, let’s say that the houses on their street are all pretty similar. They might vary in price by no more than $10,000 – $15,000.
Unbeknownst to John and Jane, a few of their neighbors have been living off their equity in recent years. John and Jane could never figure out how their neighbors could afford the new SUVs and multiple trips each year, but that was how they did it. So their neighbors technically don’t have any equity in their houses. Another neighbor had terrible medical bills and made the same choice – to use the equity. A couple of their neighbors are new. They purchased their homes with subprime ARMs. They put 0% down so they don’t own anything in their house either.
Well, as life goes, things start to happen on their street.
- One couple retires and decides to sell. Since they are anxious to relocate closer to family and aren’t desperate for money, they sell their house as soon as they get a reasonable offer – one that is a little lower than what John and Jane would have expected.
- One of their neighbors with an ARM falls behind on the payments when the interest rates adjust, the bank forecloses, and then lists the house. Since the bank wants to unload it, they lower the price a bit and it sells.
- Another neighbor follows the financial world and is concerned about what he perceives is happening in the housing market. He decides now is the time to sell before prices really start dropping. Since he has a lot of equity in his house, he decides to unload it and is even willing to take a bit of a price cut in order to be sure he gets his money out.
- Another neighbor with an ARM doesn’t make it and loses the house. It gets auctioned off on the courthouse steps to the highest bidder – of course, at a bit of a lower price.
- Another house is purchased by a speculator from another state and he decides to cut his losses and unloads his house just to stop the financial bleeding.
Even though John and Jane haven’t done anything, based on the comps for their neighborhood, their house value is declining.
Now suppose John and Jane want to relocate for a new job. They need to sell their house and you look at it. They want $240,000 for it because of course real estate always goes up and they certainly should have some appreciation for all the months they’ve been making mortgage payments! Would you pay $240,000 for a house when the houses around them have been going in the $160,000 – $190,000 range? Of course not!
But suppose you really love the house and you are able to get John and Jane to come down to $200,000. Is it still a good buy? Maybe if you plan on living there for a long time and can afford to have property values continue to drop. But who knows where the bottom will be? How many more houses on that street and in that development are going to be sold at lower prices in the years ahead as the ARMs continue to reset? Do you want to pay $200,000 for a house and then find out in three years it is only worth $125,000?
If you put 20% down on that house, that means in just three years time you will be underwater. You will owe approximately $160,000 on a loan for a house that is only worth $125,000 on the current market. Do you look forward to making payments on $35,000 worth of house that really doesn’t exist? What happens if you need to relocate and need to sell? Will you be able to absorb a $35,000 loss as well as pay all the realtor fees out of your own pocket?
But you say, Sallie, prices can’t possibly drop that much! I say – look at that graph again. There are still 69 MONTHS ahead with a lot of people in houses they will never be able to hang onto. Who is going to buy them? Who is going to pay full price for them? Much of the recent economy has been based on this unrealistic run up in housing. The homebuilders are announcing all the time how their sales are off 30%, 40%, or 50% over the previous year. Think of all the people who aren’t going to be making much of a living as this thing unfolds – think almost everyone associated with home building. Think how that trickles into the rest of the economy.
So my thought is this… If you can afford to buy a house and see it depreciate in value over the next several years, then maybe it is ok for you to buy. If the desire to have a house that you will live in long term outweighs a $10,000, $15,000 or $20,000+ drop in value, then maybe you are ok. (If you live in some parts of the country, the drop may be measured in the $100,000s, not $10,000s.)
And by long-term we’re talking fifteen, twenty, thirty years here, folks, not flipping in five years.
So that’s why I think this may be a bad time to buy a house. I could be completely wrong. And if I am, I will admit it. If I’m wrong, I don’t figure David and I have much to lose. We stay in our house, keep making our payments, and our house continues to appreciate in value. But if I’m right and we bought an overpriced house, it really could be a financial disaster.
So that’s the quick version. I’m sure I’ve probably left a lot out, but I wanted to keep this brief to just raise the question in people’s minds.
Oh, speaking of people’s minds. Some people might say that this whole housing bubble thing is just happening because people like me are writing about it. If people would just stop writing about it, it wouldn’t happen.
Um, no. (And the explanation of that answer is another post.)
But even if you are right, remember that when it comes to something like this perception is reality. If people perceive there is a problem, there will be a problem because people will act accordingly. So you can argue there is no bubble, but if enough people believe there is a bubble, there will be consequences. Almost two years ago when I wrote about this the first time (and then a second time), almost nobody even knew the term housing bubble. I venture most people have heard of it now. In fact, I would guess most people know someone in trouble with their house and it is just getting started.
So, do your homework and pray, pray, pray. Make sure you know what you are getting into and be sure that you have the confidence God is leading you to make the right decisions.
Edited to add: Here is a link that will take you to a great post with details like I am talking about. These details are all from the mainstream media and are actually worse than the scenarios I discussed above. Warning: Comments after post have pr*fanity.
Good explanation, although I have to point out that there are many markets in the country in which appreciation is still climbing steadily. These markets (Seattle, Portland, Boise, Salt Lake City, Austin, Charlotte, and Raleigh) are markets in which a strong tech, aerospace, or banking industry is contributing to a steadily growing job market. These are also markets that were generally skipped over by all of the real estate “boom” speculation that other markets experienced. Seattle and Portland are two locations in which sub-prime borrowers make up less than the national average of borrowers. Just some food for thought. Oh and I don’t work in the real estate industry (I work in aviation insurance), so I have no financial reason to mention the above, it’s just the result of some recent research.
In response to the mainstream media reporting on the subprime fallout and the real estate “bust,” I have to say that I am truly skeptical of the mainstream media when it comes to anything real estate related. These are the same people that couldn’t stop talking about how much money everyone was making a few years ago. It’s not like anyone didn’t know about the dangers of the subprime mortgage then, they just didn’t choose to report on it- to the general public’s misfortune. My parents have a philosophy regarding real estate that I think is rather wise and time tested. They bought a house that was within their means and paid it off as fast as they could and then they bought another house and paid that off as fast as they could. They don’t check home valuation websites to see how much their house is “worth,” and they don’t count on their homes as their retirement fund. They see them as places to live and because they are in it for the long haul they don’t worry about temporary market conditions. My mom always says two things, 1. you have to live somewhere and you never know what’s going to happen with the market, and 2. so what if my house is worth $XX, if I sell it where am I going to move?” She likes her house, she likes her town, which are the two reasons she bought her home there in the first place. 🙂
I hail from Denver, where the RE market has been overpriced for years and is really hitting a crisis. We recently moved to SC – the house we are renting is worth 90k but in Denver would fetch 300-350k depending on where it was located! (1300 sq. ft, I kid you not!) It would go for half a million in Boulder, CO.
My husband used to joke you couldn’t buy a crack house for what we could afford (150k) – but a sibling in Houston bought one with marble, jacuzzi tub, and 4 bedrooms for LESS than that. Add in the big population of immigrants in Denver who, I think, were grossly taken advantage of in the subprime lending market, and it is not uncommon to find 3 or 4 foreclosures in a row on a street there. My friend lost her house, and she is college educated with a good job!
One thing I think you left out was the baby boomer aspect. For example, my parents have maybe 10-15 years of working life left (okay, my dad. My mom spent her ‘career’ raising 8 children). They bought a house 20 years ago – but due to the ATM mentality, still owe almost THREE times the amount they purchased it for in the 80’s. They justify it by the rising house prices – but last year, the house across the street sold for 50k LESS than what my parents still owe – and that was after 9 months on the market. Now they have bought a new house (without selling the old house. They are sure it will be snapped up as soon as they put it on the market). My sister and I are worried about what is going to happen to them when they retire (and which one of us they are going to be living with), or even next year when they are trying to pay two mortgages.
What’s going to happen when all these people try to retire in the next 10 years, counting on their home equity to see them through – equity that doesn’t exist? Is social security going to help out (don’t hold your breath!)
As someone that is in the middle of the very mess that you are desribing, thank you for getting this information out there.
As far as ARM’s go………DON’t do it unless you are going to flip the house quickly or have a guarentee of a higher paycheck in the near future. They are BAD news.
Anyway, that is my two cents.
Katie, Milehimama and Amie –
Thank you for leaving your comments and adding to the discussion. You brought up points that I didn’t and I’m glad. It is such a complex issue with so many factors that a person could write post after post about each different aspect – baby boomers, etc.
Re: areas where appreciation seems to still be happening and whether you might live in one of those areas. Median incomes and median home prices need to be in the same ballpark and I would be surprised if they are in line, even in the areas that Katie B. listed. If the median income in an area is $50k, then the median home price should reflect that and be in the neighborhood of generally $150k – $200k. When the median income in an area is $50k and the median home prices is $300k or even $250k, there is a big problem. Who is going to be able to buy the houses there? If people don’t have wages to match the houses, who in their right mind will move there? Employers is some parts of the country are already having a terrible time finding people to relocate for jobs. If a company offers you $60k a year and a crack house like Milehimama said is $450k, are you really going to take that job? I think not. So if you are thinking of buying, look into the median home prices and the median incomes in that area. That will be a good place to start.
Re: mainstream media. I don’t trust them either. I mentioned that because some people might think I’m making this stuff up out of my head. But when every paper is telling the same story of woe and readers here can pop on and tell the same stories in their circles of influence, you know it isn’t just that I’m being paranoid or making these things up.
Re: the baby boomers. Yes. This is another huge aspect of the whole thing. They are starting to retire now. They plan on cashing out the equity in their houses and cashing out their 401ks. So what happens when they have no equity or they have a little equity and their house value drops to $100k less than what they owe? Or what happens when they start getting out of the stock market? Who is going to buy their stocks? The Gen Xers and beyond? Most of them don’t have the resources to do it if they wanted. So if the Baby Boomers are forced to keep working, what does that do for the possibilities for vocational advancment for the younger generations? And if they aren’t advancing vocationally, how can they afford to move up the housing ladder?
See how complex this can be? And so much of it becomes psychological. If people see things really starting to take a dive, will they panic and send prices even lower more quickly? Who knows. I don’t know what will happen. Maybe things will happen that we couldn’t even begin to possibly predict and it will play out differently. But the term “sheeple” (sheep + people) has become widespread and I think with good reason. We don’t live in a country of citizens any longer. We live in a country of consumers and sheeple and that is becoming more and more obvious.
Just my two cents!
I’m in the Austin market and not a home owner because I don’t have the downpayment (grin), although my income is just above the local median. Austin housing prices are being predicted to appreciate at 6% per year for the next several years; there is no sign of a bubble. There is a periodic softness in the market for homes over $500,000, but even during the “crash” after the last tech bubble there was no sign in price evaporation in houses that cost less than $200,000. I don’t think that the issue that you raise about median housing income in relationship to average housing prices is valid in the Austin market because there is a constant influx of good earners into the area who can afford the prices, and there are still many many people who are at the median or below who will snap up any house under $150,000 they can get. There is still too much money chasing too little goods in Travis County (it affects not only housing prices but traffic patterns and the prices of other goods), which leads to weird things like being able to qualify for periodic city programs intended to get people below the media income into housing with an annual income up to $60,000. The only thing I can see happening eventually is that if there were another tech crash there would be a shortage of people coming into the market to buy new homes, and potentially a group of people who need to sell their homes quick. But even so, these are not people who are in the subprime loans group–they may be equity burners, but they tend to have fixed mortgages.
Sallie, this was an interesting read. We bought our house just shy of 2 years ago, and we have a traditional mortgage. We stayed clear of ARMs, even though the interest rates were lower (initially, of course). I don’t see the houses on our street going up in value by much, but we do have to have a roof over our heads. 🙂 When houses in our neighborhood sell, I like to go through them if they have an open house, see how much they cost, etc. Two years later, the houses in our neighborhood are still going at comparable rates to our house.
I like to watch several shows on HGTV, and I’m always astounded by housing prices. AND THEN they put in a $50,000 kitchen! Eeeks. That is another area that you didn’t mention, but many home owners are going overboard with the finishes on the inside of their houses – they will most likely never get it back when trying to sell their house (or their house will have to be on the market for a long time). Not only do they have a huge mortgage payment, they also are paying off loans for home improvements. My kitchen is not perfect, there are many changes I’d like to make. But until we save up the money, we are just going to live with it the way it is. And be satisfied. We live in a credit card society. When the desire for something comes, someone will finance the charges and we can have it NOW.
Sallie, you hit the nail right on the head. I work in the development business and I’m seeing this all the time. I think what’s almost as bad is people paying $200,000 with ARMS for DIRT!! Not a house, just plain dirt!
People out here (So. California) are buying up 10 acres of land for for $200,000+ in hopes of splitting it into 4 pieces of property to turn around and sell those 4 pieces for $200,000 each. Three years ago, they could get away with it because property was selling like crazy, but now it’s slowing way down. People are freaking out because they bought property for more than they can afford in hopes of making a huge profit in the end.
When ever someone calls and complains to me about how long we are taking on their project (which is another complaint in itself)and how many thousands of dollars they are losing because they can’t sell their property, I just want to tell them that they should have really thought all this through before they bought a piece of property for more than they can afford.
Back to the topic at hand, it really is sad to open up the real estate section in the paper and see pages upon pages of forclosed homes for sale.
Lindsey @ enjoythejourney
Sallie you just said EXACTLY what is happening in my neighborhood. (the comps dropping the value part and people being over their heads)
Our house is for sale. WHY? We are moving out in the country and building our own with cash (aka: no mortgage). So the whole mortgage thing is not a problem for us….IF we can sell our house, which I doubt more and more every single day due to what you so smartly and wisely described in your post. We are NOT going to let our house go low just to unload it. If we cannot sell it for what we need to sell it for (which is priced below our tax value and it is worth every cent) we will just stay here longer and forgo our country house dreams for a few more years.
It amazes me the people who are in a heap of trouble from these ARM’s. It is scary. My county where I live in NC is a very rural county but it has some of the highest foreclosure rates in the state due to those suburban folks living off the equity line!!!!
Sallie, Are you using the 1/3 rule for calculating the mediam home price in comparison to the median salary?
I live in the Seattle area and we definitely live in an economic bubble. Housing prices are still going up.
I find it amazing that people fall for the ARMs. That does make for a scary scenario!
As for the appreciation, we live in a military town with BRAC causing a housing shortage. Housing values have increased by about 30% in the past ten years and are expected to contine to rise. When the demand for housing is met, well, guess we’ll see how that pans out! We just bought a modest home (less than double our annual income) but are hoping to stay in it at least till retirement.
Good post, excellent comments.
I do think it is important to know your market, know honestly what you can/can’t afford, your lifestyle and how long you plan to be in a house. This is important regardless of what is happening in the market.
One other point, I think it is virtually impossible to generalize an entire market. For instance, we are in the Indianapolis MSA. Indy has the second highest foreclosure rate in the nation. It also has several communities within that MSA that continue to post double digit value increases. What has slowed down is new home starts (to which I say thank goodness, since this will positively affect my value!) Austin is another good example. There are definitely pockets within Austin that continue posting high value increases (Tarrytown, the areas around Seton etc.) but the surrounding counties are seeing the same housing problems that much of the rest of the country is.
So, if you are in the market for a house. First off KNOW your market and be honest about what you can afford.
Sallie, excellent post. I didn’t know about mortgages that were interest only, or Adjustable Rates until about 2 years ago. Both sounded like a bad idea to me, and I didn’t even research them at the time. Now I know more (husband works in the banking industry) and even some of those employees have interest only mortgages.
What are they thinking? That’s a whole lot of trust(or foolishness) to put in the future. Some call it the risk involved in making a lot of money in a short amount of time. Even I am guilty of buying a house and making 50K on it in less then 1 year. We moved out of that area, and we miss that house to this day. Now we live in what I understand to be the largest income to price of housing disparity in the country. Average income is 23k, and the cost of a 3 bed 2 bath in the WORST part of our area is still well over $250,000. How does that work? ARM’s and interest only loans. And people wonder why we pay extra on our mortgage every month….
My brother began seeing this in his neighborhood in Orlando last year. He bought his home in 2003. Within 13 months it doubled in value. Then, within 1 year,it dropped 50% in value. Orlando is one of the best examples of the sub-prime issue due to the lower wages & uneducated labor workforce. However, here in Metro Atlanta it’s the opposite. Very few homes are in foreclosure. In fact, home prices rise consistently every year. However, our new home starts are down, so the economy is hitting us to some degree. One thing to remember in this situation, if you are wise with money and live within your means, and save, you can snap up those foreclosures and turn them into rental property. That becomes a real deal since so many people are forced to sell their homes, and can’t really buy – they are then forced to rent.
We purchased our house 5 yrs ago for CASH!!! (sold our old one moved in with my mom until we found what we watned and then used the profit from our oldone to buy this one!) Was the worst house on the block (yes, we did this on purpose!) have been fixing it up slowly, bought it cheap all our friends and neighbors thought we were nuts but now the house is worth about what they paid for thiers and we are in an area of our city that holds its value very well. My sister bought hers (in another city) and has gotten hit by the ARMs (we told them to avoid an ARM at all costs but she knew better…buying her first house!) now she is stuck working in a job she hates because they cannot afford the car payments, house payment and credit card payments unless she works and now she is wishing she had listened. At least they plan on staying there for a long time and they are refinancing to a fixed rate now (they have learned their lesson)
In my area you have to careful because their are older neighborhoods that hold their value (and have weathered this before) and then their are newer areas that are overvalued and will not make their money back on them, as with anything you have to do your homework. It caould be a great time to buy if you find something that is down now and in an area that will be back up (do your own research though…not every realtor out there does theirs!) We have a small house (three bedrooms, one bath added a two and half car garage but we have a 1/4 acre of land too!)
Our inlaws are doing the foreclosure buying right now they own three other properties two of which they are renting the other they just redid and are trying to sell (they have an offer but it is contingent on the other people’s house selling and with gas prices so high they may be holding this house for awhile) they are thinking of selling their house in the country and moving into that one but they have been talking about that for years and it would take them a LONG time to clean their present home out (she is a major packrat!)
Yes, the housing bubble will burst just like the internet (tech) bubble a few years ago and all the others before that one…it is all cyclical nothing stays THAT high for that long, they key is if something seems to be too good to be true, is probably is too good to be true. Now would be a good time to buy, provided interest rates stay down (which at this point htey should becuase raising them coupled with the prices of gas and food would raise inflation rates and that is BAD!), there is a fine line here as to when to buy and when to hold. jmho