Interest-only loans changing house price targets?

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norcal_to_socal_IHB

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i've got a question: has the interest-only (IO) loan changed the house price equilibrium point in Irvine at all? prior to the housing bubble, IO loans were for someone with large bonuses at the end of the year, but I believe they're being used more and more in CA simply to afford houses..





see the current example, if you consider a 5-year period, a person could buy a house with IO loan can afford about 13% more house price (with the same down payment) for the same monthly payment.





don't get me wrong, this strategy has many downsides, many IO loans revert to principal payments after 5-years (similar problem to ARM resets), and you're still left with a principal at the end (which can be devasting in a depreciating market). i'm not advocating this strategy to get into a house you can't afford with IO loans, but i'm wondering if even after the mortgage industry learns it's lesson on subprime loans, will people still be taking advantage of IO to drives up house prices when we get close to the housing market bottom.





does the 35-40% expected house price drop, consequentially level-out 13% higher because of IO loans?










<col width="64" style="width: 48pt;"></col> <col width="192" style="width: 144pt;"></col> <col width="96" style="width: 72pt;"></col> <col width="86" style="width: 65pt;"></col> <col width="64" span="2" style="width: 48pt;"></col>







$800000

house price













20.00%

down payment













1.60%

Property tax













7.00%

interest rate













5

year period for interest averaging









28.00%

tax bracket































30 year fixed

IO - 5-year














House price

$ 800,000.00

$907,166.67

13.40%

higher







down payment

$ 160,000.00

$160,000.00











principal

$ 640,000.00

$747,166.67











monthly mortgage payment

$ 4,257.94

$ 4,358.47











principal after payments

$ 602,442.18

$747,166.67











average interest

$ 3,631.97

$ 4,358.47











property taxes

$ 853.33

$ 996.22











deduction

$ (1,255.89)

$ (1,499.31)











effective payment

$ 3,855.38

$ 3,855.38








 
I suggest you read the posts linked below. I have explored these relationships in some detail. In short, interest-only and negative amortization were at the heart of the bubble.





<a title="Permanent Link to Your Buyer?s Loan Terms" rel="bookmark" href="http://www.irvinehousingblog.com/2007/05/07/your-buyers-loan-terms/" linkindex="13" set="yes">Your Buyer’s Loan Terms</a>





<a title="Permanent Link to The Anatomy of a Credit Bubble" rel="bookmark" href="http://www.irvinehousingblog.com/2007/05/14/the-anatomy-of-a-credit-bubble/" linkindex="14" set="yes">The Anatomy of a Credit Bubble</a>





<img src="http://www.irvinehousingblog.com/wp-content/uploads/2007/05/ihb-post-amortization-value-table.jpg" alt="" />
 
I know I saw this chart before when I read your analysis but thank you for posting it again here because it is finally hitting home. Even with exotic loans there still would be a limit to how high prices could go - and according to this graph we had started reaching that limit - no matter which way you slice it people can only afford so much each month.
 
I remember Morgan Stanley/Dean Witter agents pushing interest-only loans on me. LoL.





"Let us help you generate positive cash flow..."





Yeah right.





My advice to people... buy a smaller/cheaper house if you have to, but get a traditional 15 or 30 year fixed rate loan. Don't touch the exotic loans.
 
so with the bubble bursting, the subprime mortgages, no doc loans, etc have dried up, but i'm wondering if the IO loan is still used in large numbers. the subprimes are a big problem for a lot of people because of rate resets after the teaser rate expires, but you could get a 30-year fixed IO loan, so you don't have the problems with a rate reset, and you would *hope* for some home value appreciation over 30-years.





again, i'm not pushing this as a strategy, but I'm worried it would permanently shift the house price model if the IO loan is still a significant part of mortgages issued. Are there any statistics on percentage of new loans that are IO in the OC?


















 
<p>NOCAL TO SOCAL, </p>

<p>Your IO calculation should use higher interest rate (may be .25 or .5% more at least) and add PMI since $160000 is less than 20% down payment. </p>

<p>Many loan and RE agents pushed IO loans so people can buy more expensive houses or just pay higher prices for the same house by bidding up. Affordability should be over the entire term of the loan not just to qualify for the first month buy a house. Whether it is 15 or 30 years, no matter what happen, you should be able to meet the payment obligation (theoretical of course tragedy happens but not the ones from greed and pure speculation). That is why until some 7 to 10 years ago, banks and lenders wanted to see a few months of cash reserve beside 10 to 20% down payment, 28% DTI ratio, 2 months of pay stubs and 2 years of W2s. </p>

<p>In this way, when a home owner, let's say, looses his/her job, he/she has a few months to make a decision whether to sell it, look for another job, refinance with better term, or rent out. In my opinion, all sellers should have these options which means the housing price level close to fundamental value as a function of income and comparable rent as Irvine Renter and other have been shouting to our ears regularly... As long as house don't become another way gambling and buyers buy what they "truely" afford, there should be very few foreclosures if not none.</p>
 
<p>Many people use the argument that 50% or more of homeowners have a fixed mortgage. That's fine and may be true, but if it is the case then those people had nothing to do with the bubble. Someone who bought a home prior to 2001-2002 with 20% down or more and did not refi to suck out cash, did NOT contribute to the housing bubble. The only reason homes went up in value was because of aggressive financing which allowed people to buy multiple properties or purchase with 95% & 100% financing. The cheaper the financing the more homes you can buy. The looser the guidelines, the more "qualified" buyers.</p>

<p>The smart people who bought homes 6 + years ago and didn't refi saw home prices escalating and said F that! Therefore they did not contribute a single penny to the housing boom. It was the combination of low rates, aggressive programs (2,3,5 year IO's and neg ams), and non-existent underwriting guidelines. Anyone who says otherwise is an idiot, to put it bluntly.</p>
 
Take a look at the Marketwatch Nov 2, 2007 article this past weekend: Jumbo loans still scarce in high-cost areas

California prices could plunge 35%, costing $2.6 trillion in lost wealth.



Talks about true valuation of homes based on Goldman Sach's estimates: http://www.marketwatch.com/news/story/scarcity-cost-jumbo-mortgages-portend/story.aspx?guid=923EE799-2A5C-416D-BEAC-E4874C21098F&dist=SecMostMailed



If Goldman [Sachs] is right, the typical home-owning household in California has about $200,000 less in home equity than it thought it had. Instead of living in a home that's worth $589,000, it's probably worth $380,000.
 
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