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Aaron N. Tubbs

Dragon chaser.

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So for a long time I’ve feared that we’ll see people loading up leveraged on adjustable rate mortgages when the rates rise are going to have to bail and flood the market with supply. I try to remain optimistic (hell, we’re buying a house!) about the market, but then I read stupid shit like this (link defunct).

I’ll summarize: Rachael Herron, god bless her soul, has bought a condo she cannot afford, with no down payment, and a monthly mortgage payment she can just barely handle. Worse yet, it’s an interest-only ARM that’s going to explode on her in three years when principal paydown and rate increases start happening. That is, of course, unless Mr. Greenspan knocks rates down. Right, that’s going to happen. So, best case, she ends up with negative amortization. That’s not a good best case. Realistic case? Her mortgage payment rises again by a third. But, and here’s the kicker, she’s not worried, because she “has a stake in California’s sizzling real estate market.” The author continues: “As her home increases in value, she plans to use some of that equity to pay down her credit cards.” Keep in mind she’s just barely managing her mortgage now with overtime.

So she’s leveraged way beyond her means, cannot afford any of the potential adverse reactions of rate rises and principal repayments, has absolutely no equity at all, and in fact is running a bundle of credit card debt on the side, with her only strategy for repayment being if somehow all of the planets align, the rates don’t rise, she’s able to keep her job for at least five years, and the value of her house rises dramatically, she can then leverage herself even further.

I understand that she wants a home, but to my risk-averse thinking, this is about the dumbest thing this lady could do.

Back in the day, to get a mortgage, you had to have certain income/mortgage expense ratio, a good credit rating, not a lot of outstanding debt, and so forth. Like I say, I understand the desire for a home … but somebody, and it should be the banks, needs to step in as a voice of reason, and say “Ms. Herron, we’re sorry, but you’re just not in the appropriate financial situation to be leveraging yourself like this right now.” Shame on you to whatever mortgage broker hooked this lady up — you are just as much to blame when the market floods and everybody and their mother forecloses because they’re holding a mortgage with three times the value of their property.

The Federal Reserve regularly queries banks about whether they’re tightening or loosening credit standards for home mortgages. In four of the last five quarters, standards were loosened. The combined drop was the biggest in more than a decade.

I know, drawing analogies between the housing boom and the late nineties is already out of favor, but this reminds me of the late nineties and the difficulty (rather, the lack thereof) in securing gobs of venture capital with no product. As the Times pointed out a few days ago, houses are different than the stock market, in that there is something physical at the end of the day, which is not there for most investors, but I’m beginning to think it’s time for the fed to step in and say “all right guys, enough is enough — stop being so goddamn stupid!” But, as we all know, banks are in business to make money, not to be a social conscience or to behave rationally in the markets.

For that matter, we know that when/if we get our condo, we’re not planning to be in it indefinitely. Sooner or later we will outgrow it, and most likely that will be in less than 5 years. So, the thinking goes, why not just get a 5/1 or 7/1 ARM?

Because they scare the shit out of me.

What if we do hold for ten years, or if the market does crash, and we’re holding some huge libor-biased ARM that’s hitting us at 11% each month (11% was an example figure of the “maximum cap” such ARM’s may reach in certain scenarios). 11%! Holy pope! So we’ll talk with our mortgage broker, and while we don’t plan to be here forever, I’m still thinking “they may be extinct, they may not be sexy, we may pay another eighth at the beginning, but a fixed rate 30-year sounds pretty nice right now.”

But, to play the devil’s advocate, maybe this is all just my risk-aversion talking. Maybe Ms. Herron has it all right, and she’s taking a calculated risk, but she knows what she’s doing. The condos we are looking at have risen in value roughly 23% in the last six months, based on comp prices. If one was playing the market and they knew they could expect these returns, the most rational thing on earth would be to take out an IO ARM and leverage themselves to hell and back, buying a place twice as large as they can afford, knowing that they can spin it in 24 months. One could then build up a fantastic amount of equity with no personal stake whatsoever. There’s something to be said for that.