Someone forgot to refill the Real Estate ATM

There’s always a first for everything so I’m going to link to the New York Times:

Drop Foreseen in Median Price of U.S. Homes

I don’t really consider myself a pessimist, but I do pride myself on looking at the facts and coming to my own conclusions. To me the outlook of the housing market and the economy as a whole have some troubling times ahead. Somebody finally realized you can’t loan hundreds of thousands of dollars to people who couldn’t afford the payment at normal interest rates.
Don’t have a down payment? Just take out another loan for it.

Need some easy cash? Turn your house into an ATM and cash out your equity.
Prices went up so quickly because there were lots of people in the market with easy access to credit through risky loans. Would you give half a million dollars to someone without any income documentation? Equity is determined by the appraised value of your home, the only problem is that equity isn’t realized until you actually sell your home. That’s all fine and dandy in a world were home prices never go down, but without congruent increases in income those prices can’t be sustained.

Fast forward a little bit: lenders start tightening up loose standards, foreclosures go up, supply goes up, demand goes down and prices start to follow. Cashing out your equity combined with decreasing prices puts you in the predicament that the outstanding loans on your home could be more than the market price. Hello negative equity. Now what happens when you can’t make the monthly payment on a house that is worth less than you owe? You try and sell or end up foreclosing which has the double wammy effect of ruining an individual’s finances and if it starts happening enough, effects the lenders, banks, and economy.

Where do I think we are? I think we’ve just seen the tip of the iceberg, but the iceberg isn’t enough to sink the economy. The people that weren’t suppose to get loans in the first place will default on their loans, there will be a surplus in inventory and then prices will drop and stagnate for a while until wages can catch up. The bigger issue at hand though is our nation’s infatuation with spending money we don’t have. If things keep going the way they are we’ll probably be in a world of hurt in a few decades.

Thank you reading my somewhat organized and logical rant.

11 Replies to “Someone forgot to refill the Real Estate ATM”

  1. Some people are going to be majorly screwed when all is said and done. People like myself that actually took out a mortgage they could afford, I don’t think we’re in too bad of a boat. It’s also highly dependent on the area too. Places like Riverside will take a much bigger hit than suburbs closer to downtown LA/OC.

    What I’ve heard mentioned a few times that drives me BONKERS, and you didn’t touch on, is that some Democrats think the government should bail out the poor defenseless people that got loans they couldn’t afford. Those evil lenders should be thrown in jail! Give me a break, if people made stupid financial decisions, I shouldn’t have to pay for it.

  2. So you’re saying I shouldn’t have taken out a $100,000 equity loan to buy an Escalade, 192″ screen TV, and diamond shoelaces?

  3. haha…diamond shoelaces. so, what does this mean for someone like me who has not yet taken out any kind of loan to purchase any kind of real-estate but who probably plans on it sometime within the next…whenever?

  4. Trying to time the real estate market is super hard. Obviously buying right now isn’t the best time if you can avoid it, but prices change over such long periods of time, it’s not like you can jump in and say “Oh! Today is the bottom of a down cycle, and tomorrow it’s going up!”

    What you want to do is put yourself in a situation where you can save up money for a down payment (whenever that may be). And when you do finally plan on purchasing a home, make sure it’s something you can afford. House prices could drop 50% if they wanted to, but if people can still afford their mortgage, it simply means they’ll have to stay in that house longer.

    The people that are screwed took out variable loans, or really bit off more house than they could afford. My house could drop to a value of $0 tomorrow (which would suck) but it wouldn’t change where I’m at this moment. I still have the loan to pay off, I can still afford it, it would just mean I can’t move. Of course there would be implications for the economy in general if everyone’s house became worthless, but if at an individual level you’ve made sound financial decisions, it’s not the end of the world.

  5. Thing you also have to look at is the difference between owning and renting. If they’re close then it is probably a good idea to own. Once the difference starts to grow then you really have to think about it. If it gets to the point where owning costs 2, 3 or even 4 times more than renting, would you be better off taking the difference and investing it in something like a index fund.

    Say renting costs $1000 but a mortgage would cost you $3000 a month, that’s $2000 a month, $24000 a year you could invest. Over 30 years you could easily have well over a million dollars after your money doubles and triples. Is the house going to be worth that much? Who knows.

    I look at it this way, if you buy a home and you live in it, it isn’t an investment, it is a monthly cost. If you buy another house and rent it out then yes that is an investment. The people who got into the market thinking they could flip their house in 2 years for a nice 20-30% profit (because home prices always go up 10-15% a year right) are the ones in real trouble.

  6. As I understand it, part of the reason a house is an investment–in the ideal situation–is that you can make a good return for (and this is key) comparatively low investment. In other words, say you’ve invested $30,000 down, you still receive interest/appreciation on the entire price of the $300,000 home. All that interest is yours, not just interest on the 30K. So if you’re getting the normal california 5% appreciation a year on a 300,000 house for which you have sunk in a modest down payment and for which you make an affordable mortgage (comparable to rent), it’s a good investment. After the last 5+ years when houses appreciated 15% a year instead of the normal 5%, now things are very expensive, and it’s not feasible for most people to make $4000 mortgage payments. Which means other investments are better for the time being.

  7. I’ve got a follow up post publishing tomorrow, but just wanted to reiterate why a primary residence shouldn’t be considered an investment. In Denise’s example she assumed housing prices never go down, but in 2009 we will see the average home price approach 2000/2001 levels. With the gains of 7 or 8 years completely wiped out it really weakens the case for owning a home for less than 15 years at a time.

    With the amount of interest you pay in the first quarter of a loan and the costs associated with selling a house, you gotta be sure you’ll be there more than 7 years in a healthy market and 10-15 if there’s any sort of significant decline.

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