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Thread: A Growing Tide of Risky Mortgages

  1. #1
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    A Growing Tide of Risky Mortgages

    http://www.businessweek.com/bwdaily/...4924_db016.htm

    The link is to an artilce discussing something that a few people here have mentioned as being a factor in the housing boom/(really a bubble). This is going to be a nasty little suprise for many people. Some of the numbers for interest only loans is shocking, and definately is a large factor in the rising cost of housing.

    Here are some scary statistics: In 2004, fully 50.4% of the mortgage loans issued for purchases of single-family homes in Georgia were to pay interest only. That made the Peach State No. 1 in the nation in its share of interest-only mortgages. But a whole bunch of other states were not far behind: California was second, at 47.1%, Colorado third, at 45.5%, Nevada fourth, at 44.7%, and the District of Columbia, fifth at 43.8%.

    snip

    WRONG USERS. Interest-only mortgages were designed for wealthy families who used the loans as cash-flow management tools and could, if necessary, pay off the entire sum by liquidating some stocks and bonds. They can also be a good choice for people who have irregular incomes and strong self-discipline.

    Such families can pay interest only in the lean months, then voluntarily make big principal payments in months when they have lots of income. Other natural candidates: People who are quite sure that their incomes will be rising sharply, like young doctors just out of medical school.

    Trouble is, the sheer numbers indicate that the loans are also being taken out by a much bigger sector of the public -- people who are struggling to get into a rising housing market and feel that they couldn't get the properties they want any other way.

    "BUYERS HAVE NO IDEA." Often, interest-only borrowers argue that they will refinance or sell their homes before the principal payments start coming due. But the risks are high. If they refinance, the new payment could be higher than the old one. And if they sell, they need to hope that prices have kept rising. Otherwise, they won't even recoup all of their downpayment
    Admittedly, the concept of the Straussian text is one susceptible to intellectual mischief in the form of wild claims about the esoteric meaning of texts, not to mention rather off-putting for anyone who doesn’t like know-it-all elites.
    Orthodox Judaism, not to mention other religions: there is a small number of men who know the detailed truth; the masses are told what they need to know and no more

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    People who are on the edge of being able to afford a house or not should not be using this type of mortgage. To count on further increases in the price of homes to pay for yours is a horrible mistake for those that cannot afford even a slight decrease in the value of their homes.

    All signs say bubble, and all bubbles burst.
    Admittedly, the concept of the Straussian text is one susceptible to intellectual mischief in the form of wild claims about the esoteric meaning of texts, not to mention rather off-putting for anyone who doesn’t like know-it-all elites.
    Orthodox Judaism, not to mention other religions: there is a small number of men who know the detailed truth; the masses are told what they need to know and no more

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    I sadi the same thing when the banks and mortgage lenders started offering the "no down payment" plans. People started buying houses and condos like it was going out of style.

    Yes, now everyone can buy a house, but that doesn't mean that everyone can actually afford a house. Especially not the kind of houses people are buying.

    On top of that, I've been amazed at how free the banks are with their money for mortgages lately, they've been giving people sums of money that I would never have imagined they'd get, and IMHO, some people out there, far too many I'm afraid, are getting in way over their heads.

    Waxy

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    One could argue that this is supremely stupid. On the other hand one could argue the opposite. The advantage would be that it would be a huge tax write-off during income tax season. I once had two mortages going at one time (about $20,000 interest) and it made a good sized dent in my taxes that year. But I don't recommend it. On balance I would give this a big thumbs down.

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    While tax write offs are certainly nice, a $20,000 writeoff becuase you spent that on debt service is not nice at all. You would be better off to still have the $20,000. Unless you are banking on a never ending rise in the housing market, there is no real advantage to interest only housing loans except as a wealth management tool.
    If ye love wealth greater than liberty, the tranquility of servitude greater than the animating contest for freedom, go home from us in peace. We seek not your counsel, nor your arms. Crouch down and lick the hand that feeds you; May your chains set lightly upon you, and may posterity forget that ye were our countrymen. —Samuel Adams

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    Quote Originally Posted by daewoo
    While tax write offs are certainly nice, a $20,000 writeoff becuase you spent that on debt service is not nice at all. You would be better off to still have the $20,000. Unless you are banking on a never ending rise in the housing market, there is no real advantage to interest only housing loans except as a wealth management tool.
    It was not my intention to have two mortgages.

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    Quote Originally Posted by Missouri Mule
    It was not my intention to have two mortgages.

    I realise that. My post kind of twisted off in a differnt direction than intended. I was trying to clarify why an interest only mortgage was a bad idea, despite the ability to deduct the interest payments from your taxes.

    I have heard peopel argue that interest only mortgages are the only way to go, since it essentially makes your WHOLE mortgage paymernt tax deductible. The problem is that if you have an intersat only mortgage, and only pay the minimum, you are nto making a mortgage payment, you are making a debt service payment. That is akin to flushing money down the toilet with no return. The exception to this would be if you can affrod to pay cash for your house. In that case, you can lock tyour mortgage in at a low rate, then invest the cash wisely and show a return. Maybe not the best idea right now with the uncertian economic climate.
    If ye love wealth greater than liberty, the tranquility of servitude greater than the animating contest for freedom, go home from us in peace. We seek not your counsel, nor your arms. Crouch down and lick the hand that feeds you; May your chains set lightly upon you, and may posterity forget that ye were our countrymen. —Samuel Adams

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    Quote Originally Posted by daewoo
    I realise that. My post kind of twisted off in a differnt direction than intended. I was trying to clarify why an interest only mortgage was a bad idea, despite the ability to deduct the interest payments from your taxes.

    I have heard peopel argue that interest only mortgages are the only way to go, since it essentially makes your WHOLE mortgage paymernt tax deductible. The problem is that if you have an intersat only mortgage, and only pay the minimum, you are nto making a mortgage payment, you are making a debt service payment. That is akin to flushing money down the toilet with no return. The exception to this would be if you can affrod to pay cash for your house. In that case, you can lock tyour mortgage in at a low rate, then invest the cash wisely and show a return. Maybe not the best idea right now with the uncertian economic climate.
    I just want to make clear that I do not support over extension of debt obligations. One can make the case that if the interest payment for a mortgage doesn't exceed the rent payment that would otherwise be made if they didn't own the property that it would be economically sound. Assuming that the property appreciated in value, the owner would receive a benefit at the time the property was sold as well as the tax write-off. But on balance I don't like the idea UNLESS the person has sufficient wealth that it doesn't matter. Then it would make perfect sense and would be somewhat analogous to the financial transactions of our federal government. Our government can afford to increase the national debt so long as our GDP rises commensurately. A Warren Buffett could have a thousand homes with interest only mortgages and it could be seen as a good investment vehicle.

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    This makes me curious, and you all seem knowledgable on the topic, so I want to ask.

    I myself recently purchased a place with a 5-year interest-only mortgage. The place is out of my reach, franky, because I live in the Washington DC area and housing costs around here are outrageous.

    The thing is, I've only been out of school for a few years, and expect to be working my way up the pay scale in the next few years. I'm also engaged and will be married in the next year or so, and my fiancee works and actually makes more than I do, so my income will become "our" income and payments will be much easier to make.

    The real justification I was given by my financial advisor for the interest-only deal was that I am unlikely to be staying in this place for more than a few years (the reason for buying it was that I was tired of paying $1000/month to a landlord when it could go to a mortgage). Also, at the moment I'm not having any trouble making the monthly "minimums", and actually wind up paying substantially more that that, so that at the end of the year I'm managing to pay down the prinicipal too. At any rate, since I will likely sell this place in the next few years when I move on, my financial advisor recommended this sort of mortgage for me, especially since in the DC area housing prices have done nothing but climb for as long as anyone can remember.

    Was I a good candidate for an interest only?

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    Quote Originally Posted by RedMoon
    I myself recently purchased a place with a 5-year interest-only mortgage. The place is out of my reach, franky, because I live in the Washington DC area and housing costs around here are outrageous.
    I can sy,mpathise with that. My sister recently moved to baltimore and paid $500,000 for a house that would go for $70,000 in the midwest.

    The thing is, I've only been out of school for a few years, and expect to be working my way up the pay scale in the next few years. I'm also engaged and will be married in the next year or so, and my fiancee works and actually makes more than I do, so my income will become "our" income and payments will be much easier to make.
    the question at this point is will the real estate market hold out long enough for you to sell the place? I am not sure there is anybody credible out there still claimingn that we are not seeing a real estate bubble. If you can get out from under the place with a profit before it bursts, you are in good shape. If not, you could wind up badly upside down in your house.

    The real justification I was given by my financial advisor for the interest-only deal was that I am unlikely to be staying in this place for more than a few years (the reason for buying it was that I was tired of paying $1000/month to a landlord when it could go to a mortgage).
    This depends again on how long th emarket lasts. I know a guy who owns 15-20 apartment buildings around the coutry, condos, rental homes, the works, and in the last year he has comletley liquidated residential properties (outside of apartments). Last month, he sold his personal residence for 4.8 million dollars and moved into a penthous at one of his apartment buildings. His explanation for this action was that he could get 4.8 million for his home this year, but would be lucky to get 3 for it a year from now.

    This would also depend on your mortgage payment. If your minumum (interest) payment is cheaper than rent, you are not really loosing anything as long as the home does not drop in value. If all you are paying is interest, you are essentially renting your home from the bank anyway.

    Also, at the moment I'm not having any trouble making the monthly "minimums", and actually wind up paying substantially more that that, so that at the end of the year I'm managing to pay down the prinicipal too. At any rate, since I will likely sell this place in the next few years when I move on, my financial advisor recommended this sort of mortgage for me, especially since in the DC area housing prices have done nothing but climb for as long as anyone can remember.

    Was I a good candidate for an interest only?
    Frankly, no. Interset only loans can be good wealth management tools. Most of the conjecture I have seen as far as home values in the DC area put them apporximatly 40% over value. Unless you have enough cash on hand to make up 40% of the value of the home, you could find yourself in hot water (or 40% equity in the home).

    There is a guy who lives across the section form me that recently refinaced his home with an interest only mortgage. He was a good canidate for such a loan. His home is valued at around $150,000 and he has $400,000 in convertible investments. His note on his house (before the refinancing) was only $14,000 at around 5%.

    His average investment return is around 20%. So he refinanced his home with an interest only mortgage at say 6% (I don't know what kind of rate he got....probably lower than 6%) and he ends up with an extra $150,000 in cash that he can invest with an average return of 20%. This means he is making 14% by financing the home, or, viewed another way, makes 6% of his return tax deductible. If something happens and his home revalues, he will certainly take a hit, but estimated revaluation is not great in our area so it is unlikely that he would see even a 10% hit.

    These are the kind of folks who are supposed to be using interest only morgages.

    If indeed we are facing a real estate bubble (and all current indicators seem to show that we certainly are), the answer to your question is essentially "it depends on when the bubble breaks".
    If ye love wealth greater than liberty, the tranquility of servitude greater than the animating contest for freedom, go home from us in peace. We seek not your counsel, nor your arms. Crouch down and lick the hand that feeds you; May your chains set lightly upon you, and may posterity forget that ye were our countrymen. —Samuel Adams

  11. #11
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    I think we've been through this, interest only loans have been around for as long as money. Virtually every successful business uses them for inexpensive operating capital and there would be little home building without them. Mortgage companies started using them for consumer loans because lower payments allow qualification of a new sector of borrowers. They opened markets to lower income qualification and middle market allowing people to step up to something conventional qualifying ratios couldn't justify.

    As Daewoo points out, the big danger is an inevitable RE market adjustment where the borrower is upside down. For that reason, they were always considered a leverage tool utilized to make money, not finance the purchase of a personal residence.

    I've long carried interest only loans on my homes every time rates have offered a positive spread against short-term investments. But I never exceed 50% of assessed value and stay liquid enough to pay them off if economic conditions do change. And change is guaranteed.

    On the subject of financial advisers, I recommend caution in every instance. Unless it happens to be your tax CPA or lawyer who knows your financial circumstances and derives primary income from a profession where ethics or lack of can be grounds for a lawsuit, deep pockets, most 'financial advisers' get a piece of whatever they recommend. That includes loan finder fees, brokerage referral fees, bank referral fees and anything else that can be nicked. An individual simply won't see it, focusing on the hourly or flat rate advisement charge. I'd strongly recommend that any young professional establish early relationships with both a recommended CPA who specializes only in tax matters, not a bean counter, and a trust lawyer. And not classmates, choose people who have at least ten solid years of experience with an established firm and are or nearing partnership in those firms. Both will save a lot of money and grief over the long haul and you'll also meet a better class of people for future connections if upward mobility is in your plan.
    These are my principles. If you don't like them I have others. ~Groucho Marx~

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    The latest Economist presented a very interesting fact.

    Goldman Sachs estimates that 7.4% of Americans disposible income last year was from taking equity out their homes. That of course would have been fueled by the high growth in housing prices. When the rapid increase in housing prices stops ( as it can not increase faster then the rate of inflation for an extended period of time) you should expect that people will stop taking equity out of their homes lowering disposable income.
    Admittedly, the concept of the Straussian text is one susceptible to intellectual mischief in the form of wild claims about the esoteric meaning of texts, not to mention rather off-putting for anyone who doesn’t like know-it-all elites.
    Orthodox Judaism, not to mention other religions: there is a small number of men who know the detailed truth; the masses are told what they need to know and no more

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    Quote Originally Posted by lord tammerlain
    The latest Economist presented a very interesting fact.

    Goldman Sachs estimates that 7.4% of Americans disposible income last year was from taking equity out their homes. That of course would have been fueled by the high growth in housing prices. When the rapid increase in housing prices stops ( as it can not increase faster then the rate of inflation for an extended period of time) you should expect that people will stop taking equity out of their homes lowering disposable income.
    7.4% reduction in consumer spending will make a noticeable hiccup.
    These are my principles. If you don't like them I have others. ~Groucho Marx~

  14. #14
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    There was an article on CNN Money a while back which stated that 90% of the US GDP is consumer spending and housing related transactions (i.e. homebuilders, contractors etc.)

    Even when the housing bubble just levels off instead of bursts it will make more than just a dent in the GDP.
    Eh, what's this? A Republican from Texas that actually makes sense and can speak English?

    http://www.ronpaul2008.com/html/Issues_fx.html

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    Quote Originally Posted by gamehuis
    There was an article on CNN Money a while back which stated that 90% of the US GDP is consumer spending and housing related transactions (i.e. homebuilders, contractors etc.)

    Even when the housing bubble just levels off instead of bursts it will make more than just a dent in the GDP.
    Here's an article stating that the housing industry alone is 14% of total US GDP:

    http://www.clamericas.com/content/homebuilding.asp

    With US GDP 'growth' forecast at 3.9% for 2005, even a 2% drop in housing combined with a corresponding decrease in disposable income flow-through from equity financings and profit would signal negative growth, leading to failing consumer confidence on all other purchases, including vehicles. That's a seriously fragile situation.

    But that's OK America, keep financing those overvalued shoddy crackerboxes with 100% interest only loans and pull the equity out of existing residences to buy more consumer goods. You're experiencing the 'American Dream' middle class style, better known as riding the tiger.
    These are my principles. If you don't like them I have others. ~Groucho Marx~

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