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

[unbiasedobserver]

I’ve been following the SD market for many years but never posted here. I have friends and family there who confirm the market has slowed dramatically and started declining in certain areas. So I have to ask, with so much anecdotal evidence that prices in SD have been flat or even declined 10% in much of San Diego since 2004, how is it that the technician’s house in question managed a 60% gain?? I’m finding this very hard to believe. Maybe said technician was delusional in believing his house was ever worth $1.1M like so many of today’s sellers?

[bmarum]

“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.”

Blanket statements like these just make me laugh. As much as you would like the world to be black and white, it’s not. Shades of gray Powayseller, shades of gray.

[(former)FormerSanDiegan]

I agree it depends on the circumstances:

Example:
Let’s say I have an interest-only loan for $500K that I took out last year and resets 4 years from now and the current rate is at 5.625%. The interest-only payment would be 2344 per month.

Let’s say that this loan has a fully amortized rate of 7.656% if it were to reset to today’s 1-year T-bill plus a margin of 2.75%. (See E-loan.com)

Let’s compare that to todays 30-year fixed rate, NO-cost loan (for simplicity) at 7.75%. Payment is 3582 / month.

Since I am not clairvoyant I don’t know if rates will be higher or lower 5 years from now, though I’ve seen arguments both ways. Right now am I better off paying an additional $1238 per month for 48 months for a total of $59,424 ?

In what scenario would this make sense ?

Case 1. Rates stay the same. No brainer here. Better off not paying the $59K. Keep the IO

Case 2. Rates drop. Another no brainer. Saved the $59K PLUS I would pay less than what I would have with the fixed at todays rates.

Case 3. Rates Rise a couple percent
Let’s say rates go up by 2% from TODAY’s rates at the time of re-set. That would make my fully amortized rate at reset 9.656%. With 25 years left on the loan my payment would skyrocket to 4422 (from 2344 in the IO period). A payment increase of 2078. It would take 28 months (59,424/2078) to get to the point where one would break even with the fact that I overpaid for the 30-year fixed for 4 years. So, 48 months more on the IO, plus 28 months = 76 months or nearly 6.5 years, for the two scenarios to break even. This ignores the time value of the 59K. Let’s assume that amounts to the equivalent of a few more months to break even. This hurts a little, but it happens over a 6-7 year period.

In 6-7 years how much will my income increase ?
If I am on a professional career path, and interest rates are higher than they are now, it’s a safe bet that I will keep up with inflation, so assume 4% raises over 6 years, annual compounding gives me an increase in my wage of about 26% over this period. If I could service the original loan with 35% of my income, then I am in good shape.

Case 4. Rates rise explosively.
The CAP in the original IO would typically be 5% above the original rate. SO if rates skyrocket beyond that, the person is sitting pretty with a “low rate” loan at 10.5%), when everyone else is paying 14%.

[powayseller]

This man got the loan in 2004, so I assume he has a 4% IO loan, making his payments $20K/year or $1666/month. The realtors who emphasize now is a good time to buy because we have historically low interest rates, forgot that people like this technician CANNOT afford a fixed rate loan even at today’s low sub-7% rates. This is a concern. He is gambling with his house. What if rates are higher in 3 years? What if they are double his 4% intro rate, i.e. 8%? This is a big gamble, and he could lose his house. If he could afford the 6.75% rate, he would take it, I think. Since he CANNOT afford it, he is taking the gamble in waiting.

I think the “these loans serve a purpose” argument is poorly served up. 80% of San Diego mortgages last year were of this type, because people could not afford a fixed rate loan, not because they have alternative investments for all their money. There is too much data showing flat wages, increasing household debt, and bankruptcies, NODs, foreclosures. Even the FDIC is now concerned about these loans and are changing the lending guidelines.

He told me that last year they considered leaving SD for a cheaper state. He thought a $200K house in Texas would suit him, but his kids are still in high school, so he didn’t want to move yet. Now he feels he missed the boat. He was concerned about the high property taxes in Texas.

As far as me saying that a 50% drop in RE is irresponsible, I disagree. I can say anything I want. I can say that I think GDP will be 2% next year, interest rates will be 8%, housing will fall 50% over 5 years.

A realtor has a fiduciary duty, and saying that RE in CA only goes up is historically false. That is a lie. Saying that we are running out of land is misleading, because if you look at Japan, you would know that scarcity of land does not correlate with a new permanently higher plateu.

[VCJIM]

I agree with Poway. I/O and other non-conventional (although now they may be called conventional!) loans were created with a specific purpose. Take, for example, a medical student that knows he will have a significant increase in income in two years, once he is done with residency. However, he has kids and wants to purchase a house in a good school area now. This is a perfect case for an I/O loan…it allows them to get into the house and it is relatively assured they can pay the increases when the time comes.

It should be clear from the above example that these are very rare cases; the loans are being used for other than their intended purpose. What happens when a tool is misused? It breaks!

I will have to say though that this will be a real test of resiliency for many Californians. While the extravagance really came out with radically increasing home values, will we see extreme thrift as they decrease? Rented out rooms, working longer hours, eating in, less travel, using coupons? I think we will see people really stretch to make it. I, and many of the people I know have made it through tough times using these tactics.

[powayseller]

The other day, a lady was crying on a radio talk-show, saying that she and her husband lost everything in Arizona, and had moved in with her parents. Her husband was having a very difficult time adjusting to being supported by his in-laws, so he avoided the situation by going out a lot with his friends. I almost wondered if they had a NOD, and could picture that many NODs will end up moving back home with their parents.

Realtors and loan officers tend to defend these loans, but I know realtors who hate them. That’s why these loans are called suicide loans, and the professionals who track these loans, are very concerned about how our country will handle $2 tril resetting by end 08.

[VCJIM]

With the interest rate as low as it was, all banks should have been DEMANDING traditional loans, not fueling the fire with low interest rates AND psycho loans. I hold the banks and any other institutions that allowed these loans 100% responsible for the bubble.

Many on here, I believe, would hold the consumer responsible. While there will be some tough-love education coming up, most people do not educate themselves before they get a loan; they trust the bank. This puts the bank in a position of responsibility for ensuring the consumer can pay for the loan.

[powayseller]

Yes, I trusted the bank on my first purchases too. I asked the lender, “How much can I afford to borrow?”, because I really had no idea. I trusted that they would lend me only what I could afford, because they have a vested interest in making sure I make my payments. The general rule of thumb, iwth interest rates at 7-8%, was you could afford a house that was 3-3.5 x gross income.

Each time, the lender said, 28% of monthly income can go to housing. My husband and I ALWAYS got a lower loan amount than that, because 28% mortgage plus student loans plus 401(k) plus car repairs or car payments, would be too much money. With our 2nd house, we got a 15 year mortgage, opting to get a house 50% less than what we qualified for. So am the opposite of my new friend, who health care guy, who maxed out on his I/O loan. The guy has kids in high school; he’d old enought to know better.

[VCJIM]

When everyone’s doing it, it becomes accepted practice. That is when it is most dangerous!

I have two friends with 1Mil+ homes on I/O, stated income loans (this info comes from a mutual friend, I don’t know it for myself). Both with families, kids, expensive cars, etc. They are both musicians. Hmmmm….

[powayseller]

VCJIM, are you renting now too? You sound like a sensible man. I supposed we will hear back from sdrealtor that we have no idea if these musicians have an inheritance or record deal coming up… It’s almost funny to hear people defending these loans.

[PerryChase]

Well said Powayseller and VCJim. I know so many people who have large mortgages that they can barely handle. They are absolutely maxed out. That’s because they want to keep up with the Jones.

And yes, lenders are guilty for all the easy money. They should’ve demanded fixed rate fully amortized loans. They wanted to make money in the short run so they didn’t enforce their own rules. Another example of greed.

[VCJIM]

My house sold in Feb 2005, I’ve been renting since August 2004 in a much nicer area, better schools and WAY better house. My house was one year from being paid off on a 15 year fixed loan. We paid some of the principal down the first year we bought it, turning the 15 year loan into 11 or 12.

The house I am renting is in a community of similar homes (cookie-cutter), the prices have not changed much since I started renting. Strangely, though, two were recently removed from the market after about 3 months of sitting. I don’t know if they sold, going to different realtors, repos.

[bmarum]

What I suspect prompts people on this forum to defend these loans is not the fact that they think they’re reasonable in the vast majority of cases, but is instead your (Powayseller’s) constant use of hyperbole to make your point. Are the exotic loans that many people took out over the last couple of years going to be a problem for many of them? Sure. Is every single one of them going to result in a financial disaster for the borrower(s)? Of course not.

Now people can certainly disagree on the percentage of people that took out these loans who’ll end up being screwed, but you CAN’T say that ALL of them will be. (Of course, as you so aptly point out, you can say whatever you want — but that doesn’t mean anybody is going to take what you say seriously. Especially when your blanket statements are so patently ridiculous.) And, the disagreement about the percentage of people who’re going to end up screwed is probably something that we can’t resolve — I’m unaware of any data showing what percentage of exotic loans were taken out by people who really needed them to get into the house they purchased vs. those who could afford a traditional loan but instead chose a lower monthly payment. Common sense, and my perception of the American consumer, tells me that many of the people who took took exotic loans probably did so to get into a place they really couldn’t afford. However, experience with those around me is just the opposite — my friends who have taken such loans are on professional career paths that have pretty steep guaranteed salary increases. And, even some people I know who took out exotic loans in 2003 and 2004 that could have ended up being really hurt are already out of the market. All of this is to say that not EVERYONE who took out an exotic loan, or an ARM, is going to end up being financially ruined.

[rankandfile]

“my friends who have taken such loans are on professional career paths that have pretty steep guaranteed salary increases.

Bmarum, sounds like you have some very fortunate friends to be in such a cush job. I’d be curious as to what type of profession/industry they are in that “guarantees” steep salary increases. My guess is that there are not too many industries like theirs. These jobs you speak of sound almost too good to be true.

“All of this is to say that not EVERYONE who took out an exotic loan, or an ARM, is going to end up being financially ruined.”

Not everyone who drives while intoxicated will get into a car accident. Whould you still advise them to drink and drive? I’m just using your own logic.

[sdduuuude]

R&F,

“Not everyone who drives while intoxicated will get into a car accident. Whould you still advise them to drink and drive? I’m just using your own logic.”

This is a foolish comment. It isn’t the same and you know it. I expect better of you.

[Author]

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