Murderous Mortgages By William Cate
Lenders are in the business of making money. If they offer anything that seems to violate this rule, the consumer should carefully read the fine print in the contract.
When mortgage rates drop by more than one point (1%), homeowners flock to lenders to refinance their homes. In most cases, the only reason for the homeowners’ decision to refinance is their desire to pay a lower monthly mortgage payment. Most homeowners realize that a 30-year fixed mortgage is far less risky than an adjustable rate mortgage (ARM).
A better reason to refinance a 30-year fixed mortgage is to pay a mortgage rate below the prevailing inflation rate. The balancing consideration to refinancing your home is the fact that if you refinance a 30-year fixed mortgage, your mortgage starts over and it will take you 30 years to own your castle. The offsetting advantage is that your mortgage interest payments are tax deductible. All lenders require that the borrower pay most of the interest in the first few years of their 30-year fixed mortgage. This gives the homeowner a major tax write-off. It gives the lender far more interest profit.
Between February and July 2003 and January to April 2004, 30-year fixed mortgage rates dropped below 6%. In 2005, 30-year fixed rates ranged between 5.77% and 6.02% until October 2005. Until January 2005, the inflation rate for nearly a decade was averaging about 6% (double the Government’s Consumer Price Index (CPI) to determine the roughly estimated annual inflation rate. Homeowners, who refinanced a 30-year fixed mortgage at interest rates below 6%, will pay less in inflated dollars than had they paid cash for their house, thirty years earlier. The 2005 inflation rate was about 8% and it will be higher in 2006. These 30-year fixed rate mortgage homeowners are the winners in this game.
Nonconforming loans are usually mortgages where the buyer puts down less than 20% of the property’s sale price. They are almost always adjustable rate mortgages (ARMs). In the early stages of a Bull Real Estate Market, ARMs are a good gamble. The house appreciates so that the down payment combined with the increased value of the house allows the buyer to refinance with a 30-year fixed mortgage in two or three years. Toward the end of a Bull Real Estate Market, nonconforming loans are very dangerous. The value of the property eventually drops. The homeowner is locked into an adjustable rate mortgage for several years. If interest rates go up, the monthly mortgage payment goes up and squeezes the homeowner.
After October 2005, as 30-year fixed mortgage rates slowly climbed, the mortgage refinance industry focused on lowering monthly mortgage payments to attract homebuyers and encourage homeowners to refinance. To lower the monthly payments required using an adjustable rate mortgage. It meant that the lower payments would be limited to two or three years and then the adjustable rate at a far higher interest rate would become effective. In many cases, the low monthly mortgage payment was achieved by adding part of the unpaid ARM payments to the principal of the mortgage. The homeowner or buyer would own more money for their house at the end of the discounted ARM period than they did when the initial ARM payment was made.
The discounted front end ARMs are fueling the Real Estate Bull Market into the spring of 2006. However, home prices peaked in 2005 and while they haven’t started to fall, few homes are now sold above their asking price. The inventory of homes on the market is steadily increasing as the demand for homes is steadily falling. 2006 is the beginning of a Real Estate Recession. The last Recession was between 1987 – 1991. During that period home prices in the San Francisco Bay Area fell about 25%. However, the potential real estate problem is far worse today than it was in 1987.
Experts estimate that those discounted front-end ARM mortgages will create about one million foreclosures in the next two or three years. The belief is that many American families won’t have the extra money to pay twice as much for their monthly mortgage. If we assume the 2005 average home price was $300,000 [http://www.sellersequity.com/], the middle class is about to lose $300,000,000,000. That’s murderous!
A million foreclosures means that in a depressed real estate market a million homes will be added to the homes for sale inventory. A million foreclosures will be 12% of the 8,352,000 homes sold in 2005. The result is that the Real Estate Recession may become a Real Estate Depression that lasts for years. After all a million middle-class families face the loss of their most valuable possession, their homes.
Home foreclosure usually puts a family on the path to bankruptcy. In 2005, the Republican government in Washington revised the Federal Bankruptcy Law. The new Law reflects the interests of lenders and makes it very difficult to impossible for middle class Americans to get out from under their debts. The result is some of these families who have lost their homes will never recover financially.
The best possible way out for families with ARM loans that are about to double in monthly payments is to refinance into a 30-year fixed mortgage. Given that home prices will soon start to fall, it would be wise to consider acting now. If this isn’t an option, read the fine print of your ARM Agreement. Determine your probably monthly payments when the discount period ends. Adjust your finances and lifestyle so that you can meet those payments. The alternative for too many Americans is foreclosure and poverty.
As I’ve told the Global Village Investment Club membership, this isn’t the time to speculate in the American Real Estate Market.…