Saturday, October 9, 2010

Halting Foreclosures will only Hurt the Housing Market

In my article, "The Forest Fire" (9/23/10), I use the analogy of a forest to describe how foreclosures will help to repair the housing market. Today's foreclosure is tomorrow's first home for a family that a few years ago couldn't afford to buy a home at inflated prices.

Just last week I closed a home loan for a single mother of two that works as a social worker. If not for the wave of foreclosures and the free-fall in housing prices, the benefits of home-ownership would still be out of reach for her.

Foreclosures also represent investment opportunities, and not just for the wealthy. Many middle-class Americans are purchasing houses as investments. By renting them to tenants, they earn income and provide affordable housing.

More affordable housing is vital as incomes have suffered in the Great Recession. While foreclosures represent the loss of unaffordable housing for someone, they lead to affordable housing for someone else.

This past week, there has been much news about loan servicers halting foreclosures in the 23 states that have judicial foreclosures. In addition, the largest servicer, Bank of America, has stopped foreclosures in every state. Sloppy and inaccurate paperwork seem to be the root cause. Servicers are dealing with such high volumes of foreclosures with systems that were never designed to manage such volume.

Shame on the servicers for not performing their roles properly in regards to foreclosures. But now self-serving lawyers smell blood in the water and are quickly jumping on money-making opportunities to sue the servicers.

I met one of these lawyers at a political event last week. It is clear that he will not let facts get in the way of a profitable lawsuit. Unfortunately these lawsuits, combined with political pressure will result in more servicers halting foreclosures.

The result will be a longer and more painful recovery for housing, less available affordable housing, and further losses for banks and investors that own the mortgages.

Tuesday, October 5, 2010

How Much Do Low Rates Reduce Housing Costs?

That sounds like a simple question. Of course a lower rate means a lower monthly payment. But how much of a difference does that really make. I’ve heard people overly-simplify the issue by saying that a 1% change in rate is roughly the same as a 10% change in price. Let’s look into this a little closer and see if it holds up.

We’ve all heard that interest rates today are at all-time lows. I think we take that for granted, so it helps to include this chart that goes back to 1975. It shows a 36-year average of mortgage rates. The blue line is 30 year fixed rates and since that is the most popular program, that is what we will focus on. As you can see by the graph, mortgage rates in 2010 are truly lower than anything we have seen in our lifetimes.

Current average conforming 30 year fixed mortgage rates are around 4.375%. If you were to purchase a home with a $400,000 home loan, the monthly principal and interest payment at that rate would be $1,997.

Now let’s see how raising the rate to the 2000 average of 8.05% affects the payment. That’s not all that long ago. The payment at same loan amount at the 2000 rate is $2,949. We increased the rate by 3.675% and that resulted in a 48% increase in payment! That seems worse than the 1% rate to 10% price ratio, but let’s look at it from a price perspective.

That increase in payment from $1,997 to $2,949 is the same as raising the loan amount from $400,000 to $590,646. That is also a 48% increase in loan amount. If the down payment is the same percentage for each example, then it also results in a 48% increase in sales price.

So for this example we discovered that a 3.675% increase in rate equals a 48% increase in price. It also means a 1% increase in rate is equivalent to a 13% increase in sales price.

Don’t think I chose a year with an exceptionally high rate. I could have used 1981 where rates were 16.63%. In fact, the average rate over the 36 years is 9%. I chose 2000 because it wasn’t that far back in history. The lesson here is that we must recognize what an amazing opportunity we have to borrow money at this specific point in history. Years from now we can look at an updated version of this graph and see the low point, and remember what a great deal we got in 2010.