health care technician w/ I/O loan in $1.1 mil house

[powayseller]

Okay, did anyone notice I was limping at the meetup? I have a bone fracture, and waited 2 weeks to do anything about it. They say it happens to runners all the time. Great! During the course of my late-night visit to Urgent Care, I started talking with one of the techs (company and occupation to remain anonymous, to protect the identity).

The young man told me he had purchased his LaCosta house for the high 600’s in a couple years ago with a 5 year I/O loan. He had some money he put down from the sale of a prior home, but here you’ve got a health care technician living in a $1.1 million house. Only in California! The prices of homes on his street peaked sometime in 2005 he thought. Now, seeing his half dozen neighbors trying to sell to no avail, he doesn’t know exactly what it is worth. He would like to sell, but thinks it’s too late because of the competition of homes for sale, so he wants to ride it out.

He realizes his predicament in 3 years, when his introductory interest only rate expires, depends on interest rates. He was musing aloud, “new president”, (i.e. lower interest rates)… I don’t know how a president can affect interest rates, but somehow he thought there is a connection. He probably knows he needs to start paying back principal too or get another I/O loans. Either way, his initial idea that the appreciation would build equity is shot.

I gave him a couple other things to consider, which had not occurred to him.

First, if he wants to wait it out, he needs to be prepared to hang on for 10 years or longer, judging from the last cycle.

Second, is he financially able to make those higher payments starting in 2007 assuming interest rates are the same or higher and emotionally prepared to handle the drop in equity that he will probably face over the next few years. He said he didn’t think he could handle the latter.

Third, if home prices keep declining, will he have the equity he needs to refinance in 2007? He considered and thought definitely yes. No way will this go back below his 2004 purchase level. It’s all about the location, and no way will LaCosta lose a lot of value.

I figured there must be thousands of people like him. Middle class borrowers with exotic loans, in over their head, knowing what is going to happen when their loan resets, and deciding they will just wait it out, because they don’t want to sell into a weak market.

[sdduuuude]

You should have him write that reporter Rich mentioned – the one at the LA times looking for people with suicide loans.

[PerryChase]

Yes, I also know middle class families who are living in million dollar houses. They can’t really afford them and are stressing out now. One family I know was “lucky” and they were able to trade up from another house right at peak. They felt that RE could only go up so they bought a $1 million house with I/O loan. I simply don’t think they’ll make it in a downturn.

Someone should also track the divorce rate in this coming downturn. Sad as it is, financial problems generally lead to divorce and broken families. That might happen under a democratic administration who will be blamed for the mess resulting from the excesses of the RE boom. People have very short memories.

[sdrealtor]

From what you explained he lives in a 600K home that at one time had a value he perceived as $1.1M. My guess is he’ll be fine if he wants to stay there. As you said he had some equity from his previous property so lets say he owes about %500K in which case he’s got plenty of equity and should be able to withstand anything but a crash of more than 50%.

I dont see the problem here? I know of retired blue collar workers on the east coast living in multi million dollar properties they bought years ago. It’s not only in CA. People have built wealth in RE for all of time that they could not build any way else. The fact that he is a health care technician is meaningless.

[sdduuuude]

If I’m not mistaken – the problem is that his payment is going to grow from interest only to interest and principal.

He may be barely able to afford the payment now.

Yes – he has equity and won’t be upside down, but he may still be forced to sell.

[sdrealtor]

If he wants to stay and has equity he can. Here’s how: He does a cash out refi and pulls out 10 to 20 K to pay 2 to 4 points which reduces his rate drmatically. I just heard about someone getting a 10/1 I/O loan at 6% which converts in 10 years to a 30 year fixed at 6%. Not sure whether it amortizes over 20 years or another 30 years but they paid about 2.5 points to get this. With equity there are always options, IF YOU WANT TO STAY!

[KingKong]

I think the title is very misleading. This technician lives in a house worth 1.1M but only pays interests on less than 700K. He is enjoying a profit over 300K. This is a great investment!

If he sells even below the market, he can reapp a big fat profit that is not to be laughed at. He made a smart financial decision four/five years ago. I want to applause his financial smarts.

Now the issue is if he could not afford his new payment in 2007, the best choice for him is to sell, even below the market. This will allow him to take the profit and run. In a declining market, preserve your gain/capital is the #1 priority.

[waiting hawk]

One of my friends is a realtor out of Ontario’s Century 21 town and country. Only ever sold my property and his wifes mom’s house which is in escrow right now. He went out yesterday and bought a brand spanking new Corvette for 43k. 700 a month 250 insurance. No other buyers or sellers lined up atm. Guess how this one wil go? I drove it today. It is nice though 🙂

My website tracking Temecula and South Riverside County

[powayseller]

A health care technician earning probably $60K/year is paying interest only on a $500K mortgage, and nobody sees a problem? He’s at 5x income and not even paying any principal. How will he start paying the principal? Will he be forced into I/O loans his entire life? Even if his wife works and they earn $120K together, he is in over his head with that mortgage, IMO. I also think it’s amusing that he lives in a $1.1 mil house, because some from out-of-state think that you have to be rich to have a $1.1 mil house, and obviously he is not.

So he could refinance now with another I/O loan? He would pay $20K for the privilege of negatively amortizing his loan for another 10 years? Well, it doesn’t seem financially prudent to me, but at least he would be able to keep his house.

The question is: if he got his I/O loan in 2004 when the rates were 4%, and they are 6% now, that would be a 50% increase in his payments and can he qualify for that?

Most people won’t be able to refinance with a funny money loan, because they can’t swing payments at today’s higher interest rates.

KingKong, welcome back to the forums. He seems like he doesn’t want to sell, because he can’t stomach “losing” the equity that he had one year ago. He hopes that interest rates will be low in 3 years, so he can refinance at the same or lower rate he had in 2004. For all I know, he could incur penalties for refinancing early, and he could have some HELOCs.

[sdrealtor]

I take it you saw his w-2 and know what he makes and what his loan balance is? Also the loan I mentioned is not a Neg Am loan it is an I/O that converts into a fully amortized loan in 10 years at a guaranteed 6% rate. Perhaps his wife works and makes more than he does or he’s going to school for a better job or he comes into an inheritance or a thousand other scenarios. I just think its a bit irresponisble trying to spread the fear of God into people that could be fine without knowing the full details of their lives. I’d even say telling everyone that a 50% crash is just as irresponsible as saying RE always goes up.

[waiting hawk]

“I’d even say telling everyone that a 50% crash is just as irresponsible as saying RE always goes up.”

I like this saying actually..

My website tracking Temecula and South Riverside County

[sdrealtor]

Corerction for my poor typo skills if you’re gonna quote me.

“I’d even say telling everyone that a 50% crash is in the bag is just as irresponsible as saying RE always goes up.”

[rankandfile]

Therein lies the underlying problem: taking out a loan to pay on a loan. Homes in SoCal, or even La Costa, will never see the levels of appreciation that we’ve witnessed over the last 5-10 years, IMHO…at least not in our lifetime. Same goes for the price of money (interest rates). Moreover, technician-level wages typically remain flat. They certainly don’t rise to the level that we’ve seen homes rise over the past few years. Increasing wages = company relocation. I feel sorry for this person. Hey, at least he got to hob-nob for a while and brag about his $1.1 million mans.

[powayseller]

An I/O loan is interest only, so he is not paying any principal. When will he EVER pay the principal on this loan? He told me his original loan was $500K, but did not deny or say if he has any HELOCs.

In a market of rising interest rates, anyone who is not converting to a loan that is FIXED and PAYING PRINCIPAL, is in over their heads.

[Anonymous]

I think it is important to point out that not every one has the same views on money and just because someone’s view is different from yours, does not make it wrong. When it comes to financing, loans products such as interest only, negative amortization, stated income, and no doc have been around for a while and each serves a purpose. The concern lies with the number of people that are currently using these products. We all receive the postcards in the mail regarding refinancing to a 1% interest rate with little to no disclosure regarding the type of loan that it is. For clarification purposes, an interest only loan is a 30 year loan that allows the borrower to pay only interest for a certain period of time. A negative amortization loan allows the borrower to pay less than the interest owed. The interest that is not paid is added on to the loan and becomes additional principal owed. The loan balance actually grows with time.

Having one of the loan products above does not mean that the borrower cannot afford their payments. Some people with interest only loans place the amount that they would have paid toward principal in other investments where their return is greater than the interest rate that they are paying to borrow the money. And some people use neg am loans for cash flow purposes. The problem is that many people are in neg am loans because that minimum payment is all they can afford to pay.

I don’t think that any of us can look at the type of mortgage that someone has and make a judgement regarding their financial well-being without knowing more regarding their total financial picture. While I agree that the popularity of these loans has become a concern, I believe that each serves a purpose to the group for which it was intended and just because someone has one of these loans does not make them a financial trainwreck.

[Author]

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