California Median Home Price, $373,000: Maximum federal government loan limit of $729,500. Does that Make Sense?
One of the flip sides of the major reversal in housing fortune is how quickly the market deteriorated. As many of you know, the new federal government loan limit enacted in March of this year raising loan caps to a new $729,500 ceiling was designed to help jolt the market in higher priced areas including California. The problem with this strategy is that it did not take into account the rapid decline in the market. The speed in which the market reversed is astounding. The argument for raising caps was also to allow homeowners in bad mortgages to refinance into a more typical government loan. The caveat of course is that people have positive equity in their home and now that California is down statewide 21 percent from peaks reached not too long ago, many of these mortgages no longer qualify for refinancing options.
Negative equity limits the options homeowners have. For one, they no longer qualify for many of the best government refinancing options. Second, if they were to sell they would need to come to the table with money or get the lender to pre-approve a short sale. Given the current state of the market short sales are being granted on a more rapid basis given the more costly and lengthy foreclosure ordeal many lenders would undergo. Take a look at this DataQuick release regarding California sales:
“A total of 20,513 new and resale houses and condos were sold statewide last month. That makes it the slowest February in DataQuick’s records, which go back to 1988. Sales were up 7.1 percent from 19,145 in January and down 34.3 percent from 31,228 for February last year.
The median price paid for a home last month was $373,000, down 2.6 percent from $383,000 for the month before, and down 21.0 percent from $472,000 for February a year ago. The median peaked last March/April/May at $484,000.
Around half the drop in median is due to shifts in the types of homes selling, and how those homes are financed. Last month 15.5 percent of the state’s financed home purchases were purchased with “jumbo” loans over $417,000. A year ago it was 37.3 percent.
The typical mortgage payment that home buyers committed themselves to paying last month was $1,665. That was down from $1,743 in January, and down from $2,196 for February a year ago. Adjusted for inflation, mortgage payments are back to where they were four years ago. They are 22.2 percent below the spring 1989 peak of the prior real estate cycle. They are 32.8 percent below the current cycle’s peak in June 2006.”
We should carefully examine each paragraph to see what is occurring. First, sales are down by 34.3 percent from last year on a statewide basis. Early market indicators such as pending sales and inventory are pointing toward a very lackluster spring performance. We need to remember that in good and bad housing cycles, real estate has its own internal cycles. That is, fall and winter sales typically slow down and perk up during the spring and summer. Last year, we knew that the market was in for a challenge even before the credit crunch simply by looking at the invisible spring and summer bounce.
The next item we should examine is the median home price. The median home price on a statewide basis is down by $111,000 from the peak reached last spring. This is an incredible figure considering that in many states you can purchase a starter home for this price or slightly higher. Incredibly, the previous conforming loan caps were at $417,000 which made sense when the median was $484,000 and some areas were much higher but now, we are below the old standards. Amazingly, they are not planning on revising the caps lower which makes no sense at all and if anything, tries to create an artificial bottom. Of course the massive bubble in California was fueled by ARMs in particular the 2/28 mortgages and the pay Option products. How good were these products? Well Wachovia just took a beating today because of these loans and in particular, to the loans here in California:
“The most compelling reading, however, concerns the former Golden West Financial, which Wachovia acquired in 2006 for $24.6 billion. And by “compelling,” we mean cringe-inducing.
Golden West was a leading issuer of so-called option adjusted rate mortgages (ARMs) - loans that give borrowers the right to pay less than the full bill - with a portfolio now valued at roughly $120 billion. Wachovia’s holdings of those loans are getting painful: Wachovia said its reserve for possible loan losses on Golden West’s portfolio of Pick-a-Pay variable rate mortgages surged in the latest quarter to $1.1 billion, while late payments nearly doubled to 3.1% of the portfolio.
While a possible $1.1 billion loss hardly seems newsworthy in this era of multibillion writedowns, the fact that 58% of Wachovia’s option ARM portfolio is based in California is problematic. Independent research boutique CreditSights argues that a new computer model put into use for Wachovia’s risk management is implying losses of between 7% and 8% for the Pick-a-Pay portfolio. That could mean another $2 billion of potential losses. The bank estimated that 14% of the loans appeared to have negative equity, or loan-to-value percentages of greater than 100.”
58% of their option ARM portfolio in a state that has dropped 21 percent in one year! They are being incredibly optimistic if they think this is the end of their write downs. Inventory is still at record levels here in California. You’ll also notice the massive drop in the monthly payment borrowers are now committing to:
Current (02/2008): $1,665
January of 2008: $1,743
February of 2007: $2,196
Of course buyers are now being more cautious and conservative on the amount of a loan they decide to chew off. Let us now take that median home price of $373,000 and run a few scenarios with various interest rates for the principal and the interest:
This is assuming a 5 percent down payment and 30 year fixed:
Amazingly, you notice that from a low of $2,124 for principal and interest the payment shoots up to $2,851 with a 9 percent interest rate (which in the past has not been uncommon). This is the problem with trying to keep rates artificially low. We don’t have much room to go but up. The difference in payment from a 6 percent to a 9 percent rate is 34 percent. That tiny 3 percent sure makes a big difference.
One thing that has been lost in all of this quick money pyramid is how much money people will pay in interest over the life of the loan. Let us take a look at the above scenarios again. Let us look at the total interest over the life of the loan:
6 percent
Total interest paid: $410,472
7 percent:
Total interest paid: $494,349
8 percent:
Total interest paid: $581,684
9 percent:
Total interest paid: $672,074
So from the lowest payment to the highest, we are talking about a difference of $261,602 in interest! This assumption that people will keep flipping houses will go away in down markets and these numbers start playing a factor in buying a home. Keep in mind we did not factor in maintenance, insurance, or taxes above. The point is that we are at rock bottom rates and we have pushed ourselves into a corner. By looking at the above scenarios, you realize that even a slight move of rates up to 7 or 8 percent will mean billions in extra money diverted to interest payments. Raising caps while the data is showing borrowers are committing to smaller payments. Wall Street and Washington are simply operating under different assumptions from most Americans.
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California Mortgage Rates Still High: Examining Actual Mortgage Products in Today’s Market and the Family Budget Impact.
As the housing market continues to slump forward, there are many unintended consequences cropping up all over the country. For one, the intent of the Federal Reserve to inject liquidity into the markets was to bring back confidence in an environment that is cautious about credit. As we are approaching another 1 percent interest rate policy ala Alan Greenspan, the only difference this time is that mortgage rates are not responding like they did during the earlier easing during the Greenspan tenure. There is a couple of reasons for this including the secondary market which was buying up all kinds of new and creative mortgage products that have now turned on the market. Yet your bread and butter 30 year fixed products are still high priced even after the Fed is attempting to induce lenders to be more willing to lend.
The reason that rates are going up across the board on credit is because there is a legitimate reason to be concerned. For one, all indicators are pointing to a recession. In years past, housing has always fallen during these times. Next, we need to explore the nuanced fact that much of our economy this past decade was built on real estate and all things surround the housing market. Let us take a quick look at some rates for a $500,000 home here in California with a 5 percent downpayment from one of the larger lenders:
Incredibly, the menu is still full of loans that got us into this mess in the first place. The pricing range is anywhere from $3,018 for a 5/1 ARM to $4,170 30 year (10/20) mortgage. Our mainstay 30 year fixed will come in at $3,618 for principal and interest only. Keep in mind that the taxes and insurance on a $500,000 place will run you anywhere from $500 to $650 per month. If we are to assume that a person buying in today’s market will go with a 30 year fixed, the monthly payments work out as follows:
PITI: $4,118
Now how does this factor into the budget of an overall family? First, let us look at some key monthly expenses with national averages:
Healthcare: $500
Gas/fuel: $300
Auto Payments: $400
Food: $500
Utilities: $200
Now the subtotal including the above items is $6,018 or $72,216 per year. Keep in mind that $500,000 does not buy you as much as you think in California although prices are falling drastically across the board. Now you see why such a rapid market correction is occurring. In the above, for essentially basic necessities and a starter home the average family will spend $72,000 per year; which is much higher than the median gross pay for the entire state of California. That is why when prices reached a peak of $550,000 in Los Angeles County it simply was not sustainable. For those of you who don’t think fuel is expensive simply look at this chart:
Regular gas in the United States since November of 2006, less than two years ago is now up by a whopping 58 percent. With oil staying over $100 a barrel and the summer driving season coming up, the only place fuel can go is up. Now why is this a bigger factor in California? For one, many people live driving distances away from their work. One need only look at the congested freeways for this data point. Also, fuel cost in California are higher than national averages. So it is a double hit here. We also did not factor in automobile insurance in the above budget which can cost anywhere from $150 to $300 a month depending on the cars one may have.
As we discussed in the previous article that the current system is setup to punish savers, we are also seeing a system that understates inflation and forces consumers into debt. After all, the elasticity of your driving to work is nearly vertical. You have to get to work. California is notoriously bad in the public transportation market. And just to show you that the previous rate sheet from a large bank isn’t unique, take a look at another rate sheet:
The reason rates are holding steady and not moving downward in the same fashion as when Alan Greenspan took rates to 1 percent historical lows is that many of these products are simply reflecting the actual risk inherent in the market. What is now out, is the teaser intro rates of 1 to 2 percent. Also, we are not seeing the 5 percent mortgages either. Yet we may be seeing more of those 40 year fixed products but they do very little in really denting the monthly payment. I’ve also noticed a trend in some of the auto commercials that when you read the fine print at the bottom of the screen, they are now offering 84 month terms. Absolutely insane and financially imprudent. You’ll be paying a loan for years after the asset is no longer worth much. And how do you think that higher fuel cost is impacting auto sales? Everything is interconnected and nothing is contained. When credit is ubiquitous a contraction in this market hurts everything. When you spend more than you earn, you eventually have to pay the bill and it is coming due quickly.
