The Economist has an article about the global housing boom which has some interesting historical data and seeks to dispel the housing myth which states that "what goes up keeps going up".
They rely on historical data from around the world and point out that the ratio between housing prices and rent has risen and is substantially above historical levels and also that housing prices as compared to incomes have risen as well. The Economist does a good job of supplying data to back their assertions.
This has certainly become a more carefully watched trend over the past couple of months, but to me the most worrying trend is that towards riskier loans. The Economist states:
Interest-only mortgages are all the rage, along with so-called “negative amortisation loans” (the buyer pays less than the interest due and the unpaid principal and interest is added on to the loan). After an initial period, payments surge as principal repayment kicks in. In California, over 60% of all new mortgages this year are interest-only or negative-amortisation, up from 8% in 2002. The national figure is one-third. The new loans are essentially a gamble that prices will continue to rise rapidly, allowing the borrower to sell the home at a profit or refinance before any principal has to be repaid. Such loans are usually adjustable-rate mortgages (ARMs), which leave the borrower additionally exposed to higher interest rates. This year, ARMs have risen to 50% of all mortgages in those states with the biggest price rises.
This adds an extra level of volatility to the market - especially where I live as I've heard that locally interest-only loans account for 75% of new loans. A negative change in market value or interest rate can quickly put those people underwater and force sales, leading to a downward spiral.
Comments (6)
Interest only loans have been around for decades. Same with negative amortization. We have an interest only loan. Negative amortizaiton is probably not be good idea. I have no intention of "owning" my house. It grows in value with or without my contribution to the principle buydown, so why put money into a fixed asset? Keep the principle and invest it in a more liquid asset - SEP IRA, 401K or the like. The bank gets their interest, the IRS writes it off, the mortage payment is half.
Posted by Glen B Alleman | June 28, 2005 9:28 PM
Posted on June 28, 2005 21:28
Glen,
They certainly have. Perhaps I should have been more clear. To be a bit more specific I should mention that I'm talking about interest only loans with a monthly payment of several thousand dollars a month on a house worth a million or two. When you are stretching to make that payment there is no money being invested in a more liquid asset. All your eggs are in one basket. Now add in the fact that your loan may be adjustable and your loan was made at a period of historically low interest rates. It is difficult to imagine that interest rates are going to decline. Now, when interest rates go up what do you do? You may be tapped out. Interest rates rising may create a spike in home sales as people try to close before they rise, but after that it puts a damper on sale prices. So the value of your asset is declining. Your payment is increasing. You are in trouble. You can't borrow more because your equity is reduced. You pretty much have to sell. Now that would be fine if it was just you. But if 75% of the people who have bought houses in the past year are in the same boat and they are all trying to sell then prices drop further and you become more desperate. It is a spiral. Does this make sense to you? Perhaps things are different where you are, but around here the prices are a bit wacky.
Posted by Jack | June 28, 2005 9:44 PM
Posted on June 28, 2005 21:44
Sounds like you live in a good place for someone looking to invest in foreclosures =)
Posted by Rob S. | March 2, 2006 3:41 PM
Posted on March 2, 2006 15:41
Well, now with numerous mortgage companies going out of business and large lenders such as New Centruy being denied anymore credit from banking institutions, I think we'll start seeing a big drop off of all the "creative" lending practices and get back to Fixed Rates and ARMs for well qualified individuals.
Posted by Chandler | March 18, 2007 12:05 AM
Posted on March 18, 2007 00:05
Yes there could be a downward spiral but I think there would have to be a significant increase in mortage interest rates to force people to sell their homes. After all, Banks should take into account possible interest rises when assessing the mortgage and an individuals capacity to pay (and therefore capacity to borrow). A fall in equity values (which form the investment part of the interest only loan) will unlikely result in people "selling out", as any good financial adviser will tell you that equity is a long term investment and you shouldn't panic at the first downward movement in share values. But who really listens to financial advisers anyway ???
Posted by Neil Simmons | June 22, 2007 12:07 AM
Posted on June 22, 2007 00:07
Having worked in real estate for Asia for a number of years, I think that there is a ratio between how developed a country is and that countries average rental yeilds. This would imply that as time goes on, yeilds will slower wither.
Posted by Bob Simpson | January 27, 2008 3:28 AM
Posted on January 27, 2008 03:28