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September 5, 2008

Issue 3  -  Is the Housing Market Bottoming?

You may have heard talk lately of the housing market “bottoming” or leveling off, but does that really fit with the reality?  I will try to show you why this isn’t the case and why buying a house now, may not be the best course of action.

First, I want you to look at the key piece of evidence in my argument.  The chart below is a little confusing but in fact, is fairly simple to understand.  This chart comes from Credit Suisse, an international financial services corporation, which has a very high reputation in the financial community.

 
The chart basically shows a “future” of mortgage resets.  Mortgage resets are when an introductory or “teaser rate” period has expired.  For instance, you bought a house and locked your rate in for 5 years, after which, a reset occurs and your rate is (almost always) raised higher.

The bottom of the chart shows the out years with one bar on the graph representing a month.  The higher the bar, the more resets for that particular month.  On the right side is the total dollar value of these resets in billions of dollars.

Within each bar the total value is divided into various types of loans.  These are listed in the center of the chart in a key.  Agency loans are from Fannie Mae and Freddie Mac, the much troubled, and now essentially government run, entities.  Prime loans are for the best credit score customers, while the Alt-A are for those borrowers with some dings and dents in their credit.  Subprime is where it gets real murky.  These are the borrowers who have bad credit and were given loans they never could afford.  If you look at the chart, these particular types of resets are peaking right now and will quickly go to almost nothing.

The last category and where the real trouble lies are the option adjustable rate mortgages.  These are the loans where you get to “pick” your payment each month from several choices.  These choices can include a 30 year mortgage payment (amount needed to pay off loan with 360 equal payments) to interest only payments, where your principle never goes down, to the last, and lowest payment choice, negative am.

Negative am means that your principle is actually going up each month because the borrower is not even paying the monthly interest.  Obviously, this can lead to problems, especially if your home is losing value.  These loans typically have a loan ceiling clause, which limits how high the principle amount can rise.  If this limit is reached, or the house drops in price to the point where the equity is too low, the mortgage is called and is reset.

This reset is done for a fixed rate and time.  What that means is a huge jump in the payment owed each month.  I’ve read of a real-world example where a payment jumped from $1500 to $5000!  Obviously, at that point, the “home owner” would then be in an untenable position.  He would have no choice but to sell or go into default.  Since a sale would normally require the necessity of writing a big check, default is the normal course of events.

Getting back to the chart, you can see that these option arms are going to start resetting, at an alarming growth rate, starting in 2010.  Once these resets kick into high gear, and the default/foreclosure cycle generally takes 6 months to play out, the housing market will become much, much worse.  I see it being much worse than the current sub prime implosion and causing dramatic increases in home inventory (currently at 11 months supply) and incredible downward pressure on home values.

So what do I recommend?  First, if you are waiting for house values to rise before you sell, forget it, that is going to take years and possibly decades.   The chart shows the sub prime resets tailing off quickly from here on out, so there may be a break in home prices where they stabilize and possibly rise a little (although I doubt it).  This would be the ideal time to sell your house. 

So the obvious follow up question is: when do I buy?  This is trickier and is dependent on a number of factors.  Ideally one would rent and wait for the bottom.  Looking at the chart again it can be seen that the resets peak in 2011.  Allowing for the six month delay in effect, buying in 2012 would be fairly safe.  Now if you don’t want to rent and don’t mind losing money on your next house, I would look at the many foreclosures.  This would be done, and I can’t emphasize this enough, AFTER you close on the current house.  Getting stuck with two mortgages in the coming housing environment will not be very fun or profitable.

When buying a foreclosure make sure you get an independent inspector because these houses are sold “as-is”.  Discover a major problem after the purchase and you are stuck with it.

Summing up, the housing market is no where near a bottom and will most likely get much worse.  If you want to sell, I would do so now and price it aggressively.  Patient buyers would then rent and look to buy in late 2012 or 2013.  If you, or your spouse, are reluctant to rent, look for a solid foreclosure, have it thoroughly inspected, and then pull the trigger. 

As always, if you have further questions, give me a call.