In the next couple of post I'd like to highlight a couple of items that I think have received all too little news attention with respect to the condition of the real estate market in the country. I'm going to start with the so-called 'creative mortgages' issue and their positive impact on the housing market, housing affordability, and ultimately as an insulator to major bubble-bursting price shocks.
The short hand argument is that lenders are unscrupulous and will lend to unqualified buyers, the whole real estate business is in collusion trying to push up prices by keeping demand high. Everyone is using these interest-only loans to buy too much house, gambling that the underlying value will go up, and when the bubble bursts, it's going to be ugly. It's easy to find news and vocal critics the interest-only loan. Calculated Risk is one of my regular reads on the subject.
What I haven't seen is any discussion of the positive, long-term effect of the 'creative mortage.' Wells Fargo (a lender, natch) released a survey last week gently pointing out silver lining of this cloud.
Let's look at what the survey found:
About 8 percent of home owners carry "interest-only" mortgages.
Remember that "interest-only" mortgages does not mean you only pay the interest on the loan and you gamble the principle. It means you have the option to pay the interest-only. This is a huge distinction. This option means that if you lose your job for a few months, you don't have to be stuck with a massive payment. You can immediately reduce your cash flow requirements. Now couple this with the fact that previous cyclical home-price drops are tightly correlated with the job-losses of recession (in Silicon Valley, the last dips were associated with massive defense-spending reductions and the Nasdaq bubble burst.) You see where this is going: the increasing use of these creative loans actually insulates against cyclical economic trends. Increased flexibility and liquidity in any financial market is a good thing.
But what about using the loans to over-extend yourself? Well it turns out that a fraction of buyers are doing this. According to the survey:
73 percent of [the 8%] pay both the principal and the interest at least some of the time.
So that leave a couple percent of homeowners just getting by. That's not insignificant. Of this group, some are over-extenders, some are speculators. Some will win (their equity will be up when they sell), some will lose (they will have negative equity when they have to sell.)
But by and large, people are using these instruments as tools for their own financial benefit (that is, improve their return and decrease their risk.)
Respondents were asked about their reasons for choosing an account with an interest-only payment feature and the primary responses were to direct their funds into more profitable investments and to lower their monthly payments. Choosing this type of loan to be able to buy a more expensive home was not the most popular reason cited, according to San
Francisco-based Wells Fargo (NYSE: WFC).
"It's obvious from the survey that homeowners understand the loan
options they choose and how they manage what's likely their largest
asset -- their home," said Doreen Woo Ho, president of Wells Fargo's
consumer credit group.
This jives with my annectdotal experience. Everyone I know that has purchased a home in the last few years gets an interest-only loan. And why wouldn't you? It doesn't cost a thing, but protects your downside. A great deal for everyone involved in the market!
The point here folks, is that the cyclical housing boom is a function of the convergence of a vast number of factors. They start with the securitization of mortgages in the 1980s which decreased the risk of lending and thus the cost to borrowers. This is an extension of that trend. Efficient markets benefit all participants. The instruments also provide room for speculation. Sometimes speculators win big. Sometimes they lose big. These tools are as likely as not to be preventers of a bubble burst.
Next post, however, is about what really scares me: the possibility of losing the mortgage interest tax break!
