Seattle Bubble

“The interest rate on their mortgage had risen to 9.5 percent, from 3.5 percent three years ago. They didn’t have the equity or good credit to qualify for refinancing at a lower rate.”

This quote was from Ben’s ‘the housing bubble’ blog this morning and it perfectly illustrates the misconception that I hear all the time: “my interest rate is adjusting soon, but can only go up or down by the 2 % cap.” Sort of. Keep reading your promissory note!

The error in understanding is due to focusing on just one cap rate. But there are two. One cap rate is the maximum rate the loan can achieve, the ceiling–usually 5-6% over the start interest rate. The other cape rate centers on how much it can adjust each adjustment period, typically no more than 2% up or down. But here’s the kicker: the 2% cap rate is triggered ONLY AFTER the 1st adjustment period. Thus, your interest rate can skyrocket at the first adjustment all the way to the maximum full interest rate cap (ceiling) on the note.

In the above scenario you can see the borrowers recently hit their 1st adjustment period and were shocked that the rate adjusted up to the full 9.5% ceiling, which was 6% over their initial starting interest rate.

Head up to the attic and find the box where your closing papers are and start reviewing your promissory notes so you can plan accordingly. Loan programs vary and the above scenario may or may not apply to your situation.

I’ve commented on this before at Inman News and other blogs, but it deserves it’s own post. Here is an exerpt from my letter to the editor:

To help borrowers qualify for a home loan and to get payments in line with a lenders loan program, it is necessary for the taxes and insurance to be dropped as a portion of the monthly payment. The term PITI (Principle, Interest, Taxes & Insurance) does not apply to throngs of borrowers across the country. For many today, the term is “I”. They only pay the interest, literally.

For borrowers that could not qualify under the lowered standard of just Interest only(but still pays taxes and insurance as part of the monthly payment) , some lenders dropped it lower and eliminated the taxes as part of the payment. The line in the sand was drawn: either qualify this way, or, no new home.

The lending standards of “low, lower, lowest” gave me a chuckle. It reminded me of the Seattle Mariner vetaran pitcher Jamie Moyer who baffles batters with his slow, slower and slowest wizardry of pitches.

But where does this leave the borrower? Obviously, they must budget for paying property taxes on their own. Taxes are not cheap. If a borrower is stretched to the limit without property taxes included in their mortgage payment what is the probability of budgeting and paying property taxes when due? Many probably won’t, or can’t.

Today, in the Orange County Register, county officials announced that property tax delinquencies have reached an 8 yr high while sending out bills to the sweet tune of $3.8 Billion in tax revenue, the largest bill for property owners in 15 yrs. Well, it’s not a big deal in Organge County. You can skip payments for 5 yrs before they can take your home—if the lender doesn’t beat them to it.

A perceptive reader pointed out a post at Calculated Risk that pointed to a 29-page report by the Federal Deposit Insurance Corporation (pdf). The interesting piece of information is contained on page 25, in Chart 4, reproduced below.

Click to enlarge

And here’s the money quote from the write-up:

Nontraditional loan products can be appropriate for financially savvy borrowers with low credit risk. Indeed, many of these products have been offered for years to such borrowers, and credit quality generally has been good. What has changed, however, is how these loans have been marketed and used in recent years. Lenders have targeted a wider spectrum of consumers, who may not fully understand the embedded risks but use the loans to close the affordability gap.

The degree to which mortgage market innovation, fueled by significant MBS liquidity, boosted home sales last year is unknown. Anecdotal evidence suggests that affordability and financing played a strong role in extending the volume component of the mortgage credit cycle last year. For example, there is a correlation between nontraditional mortgage loans and home price growth. An analysis of state-level data from LoanPerformance Corporation shows the penetration of IOs and pay-option ARMs for nonprime borrowers into areas with strong price appreciation and reveals a strong positive relationship between the concentration of such loans and home price growth (see Chart 4). This analysis illustrates the recent development of borrowers increasingly using IOs and pay-option ARMs to purchase homes they might not otherwise have been able to afford. A June 2006 study by Harvard’s Joint Center for Housing Studies also confirms this trend.

Analysts are concerned that higher-risk borrowers are more likely to be affected by a major payment shock during the life of their mortgage and may be more likely to default. Compounding this possibility is the fact that the increasing availability of mortgage credit is occurring at a time when mitigating controls on credit exposures have weakened.

A number of readers agreed with the FDIC’s statement. You would expect that more “nontraditional” mortgages would mean more defaults (and therefore more foreclosures). However, that hasn’t really panned out in Washington State (yet). Although we’re 6th-highest on the graph above, with around 55% of mortgage originations being nontraditional, we are down at number 18 for foreclosure rates, with 1 for every 1,460 households. Not only that, but as reader Christina pointed out, many of the states with the fewest nontraditional mortgages have surprisingly high foreclosure rates. (For example, Texas, Indiana, Ohio, Oklahoma, and Tennessee all have less than 30% nontraditional mortgages, but higher foreclosure rates than Washington.) Christina asks:

I want to know why on the chart of negatively amortizing loans, the states on the low end of the line have the highest percentage of foreclosures.

Sarah gives a possible explanation:

Christina- here’s my guess, those areas did not appreciate as wildly as some others, so people were not able to unload as quickly and for ever greater amounts of $ and wound up in foreclosure.

CA foreclosure rates have only recently been starting to go up, now that the market has finally turned there.

It’s the areas with the greatest amounts of appreciation that were forced into using the neg am loans as houses became increasingly unaffordable.

But the flip side of that is that those same areas, for a time anyway, were able to sell homes quickly and at a profit to avoid foreclosure. Since everyone was on the mania train and there were buyers aplenty.

As the market turns, my guess is they’ll be plenty of foreclosures in the most egregiously overpriced markets, Seattle included.

I agree with Sarah’s analysis. The big question is what will happen if/when appreciation levels off (or heads into negative territory), while interest rates continue to climb. I’ll leave that as an exercise for the reader.

(FDIC, Summer 2006)
(Press Release, RealtyTrac™, 05.16.2006)

And Paul Moulo has this from National Mortgage News:

“According to a new report by the Mortgage Asset Research Institute, “stated-income loans” deserve their nickname of the “liar’s loan.” MARI says that almost 60% of the stated-income amounts are exaggerated by more than 50%.”

Is this for real? Does this suggest that nearly 60% of those borrowers who “stated” that their income was $8000/mo., really made $4000/mo.?

A few notes about some style changes I’m making to Seattle Bubble. The most noticable change is that there is now a more obvious differentiation between posts written by myself and those written by Seattle Bubble team member S Crow. As you can see, posts submitted by S Crow will have a dark blue dashed border around them. Also, the “posted by…” bit at the bottom of each post now contains a link to the profile of the person that submitted it, making their name pop out a bit more. Lastly, the title of each post is now a link to that post’s individual page.

There have been a few comments recently requesting additional features on Seattle Bubble, such as something similar to “Flippers in Trouble” or “Lowball!” seen on other blogs. While I would love to add such content to Seattle Bubble, my time is limited (it’s not like I’m getting paid for this). However, my invitation still stands for anyone who would like to join up as a contributor to Seattle Bubble. So far S Crow is the only person to take me up on the offer. Just shoot me an email if you’d like to become a team member of Seattle Bubble.

Of course, I will be maintaining a certain standard for posts on this blog, so I reserve the right to revoke posting privileges of anyone if I don’t feel that they’re meeting those standards.