I was discussing yesterday just what will happen to the bottoming out of the housing market after all the tax credits, foreclosure mitigation programs, and rock-bottom mortgage rates end.

I argued the small rush of newcomers seduced by a bottom, and the improving economy (and therefore more relaxed lending) might be enough to hold sales and prices steady.

But then I found out about the administration’s plan to use 4.2 billion of stimulus funds to buy foreclosed homes and turn them into federal subsidized housing.  By my quick calculation that’s about 40,000 houses at $100,000 each, which is about 6% of current inventory, a big enough share to support the market.

Seems like a perfect plan to me: Ensure sustained recovery, put foreclosed homes to use before they fall in disrepair, help people who did the worse through the crisis, and expand a helpful government program on the cheap.

I happen to think prices are bottoming out this Summer, and have said so since February (I would only exclude the worst offenders in subprime which additionally have high unemployment, places like the Inland Empire and Las Vegas).

However most people think even with sales picking up prices have more to fall.  So let’s say I’m wrong and prices do fall another 10% into next year.

Even then this is the best time to buy.  Why?  Because mortgage rates are going up and will be way higher this time next year.  About 3 points higher.

Mortgage rates will be up sharply because U.S. treasuries are shooting up (there is, of course, a strong direct correlation between treasury yields and 30-year fixed mortgage rates).  This is not due to inflation fears, or ‘China dumping our treasuries’ or some other ominous headline, but simply because:

a) The economy will continue to improve, and there will be a massive flight away from safety into higher yield asset classes.  People, funds and companies selling their treasuries and putting their dollars into stocks, commodities, hedge funds or Silicon Valley venture funds means treasury prices will go down, and yields up.

b) The Fed will start ratcheting the funds rate up by late 2010 to mop up the massive excess liquidity and keep inflation in check.

So let’s run the numbers using this calculator.

For a $500,000 house, with $100,000 down, at the current 5.5% rate on a 30-year fixed (1.25% tax and 0.5 PMI):

Monthly payment: $2854.49

Total interest paid: $440116.16

Now let’s look at the same house, one year later, now priced at $450,000 with a $90,000 down payment, and an interest rate of 8.48% (corresponding to a 7% treasury yield per this):

Monthly payment: $3,287.99

Total interest paid: $654,925.49

Even though the down payment was $10,000 less and therefore easier to ‘get in the house’, the increase in monthly payment is $433, for 30 years! which comes out to $214,809.33 in additional total interest.  So, again, house price was $50,000 less, and yet payments will be $433 more.

Of course, if prices do stabilize, monthly payments will be even higher ($799).

Some caveats:

  • If prices do go down 10% you will lose half of your equity in the near term (50K of the 100K down payment), so this only makes sense if buying for the long term.  But really, is anyone still planning on flipping a house?
  • A higher mortgage rate and corresponding monthly payment is not so bad if you’re able to refinance after some years.  But rates are near all-time lows, so they probably won’t come back down anywhere near this for another couple decades, if ever.

So, am I missing something?

Rents going down too

July 9, 2009

As I suspected, rents are going down, same as home prices, although at a slower rate.

The Fed is right to worry about deflation.

Maybe what is happening in Phoenix gives us a clue.

I know from my friend Tom that it’s happening in Ventura, CA: He’s been putting offers on foreclosed properties the last two months but investors, cash in hand, keep snatching them.

I wander just how widespread this is.  Investors are looking for cash flow, sometimes even renting to the foreclosed homeowners.  So we probably won’t see this in communities with the highest unemployment numbers.

Nowhere near over

January 24, 2009

Seems like every day another bank needs another fresh cash infusion or fails altogether, which invariably results in another round of articles, analyst opinions and “is it over?” type queries from every financial news anchor.

The obvious answer is, it isn’t.  And it won’t be for as long as home prices keep dropping and foreclosures stay up.

It’s not rocket science: Banks still have 40 trillion of derivatives on their books, much of it CDSs and MBSs whose value declines when the value of the underlying assets they represent or insure goes down.

We have a clear choice to make as a country, do we:

a) Let home prices fall until some sort of historic affordability level is reached, in the meantime injecting another 2-3 trillion into our banking system just to keep it from imploding.

b) Stem foreclosures and stabilize prices where they are (already 20-40% from high depending on market).

I believe the first option is dangerous and maybe even impossible to achieve: If the financial system isn’t stabilized soon, the resulting deep and protracted slowdown will result in such loss of jobs and purchasing power, historic affordability figures will be meaningless.

Home prices must be stabilized, one way or another.  I hope the rest of the TARP is used this way to a large extent.

A better fix for housing

December 3, 2008

Trillions have been spent to prop up the banks, but little has been done to address the other side of the problem: home prices keep falling and foreclosures climbing.  Obama is right to keep bringing this up.  The crisis must be attacked from both sides.

Paulson has introduced some programs, to be sure, but the money allocated is a drop in the bucket compared to bank bailouts.  Much more was spent just saving Citi in one day than on all the homeowner help programs so far.

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