April 25, 2006 at 9:22 AM #6522powaysellerParticipant
“These simple first-year-ratio bank-qualifying formulas may be behind the entir worldwide bubble in residential real estate prices.” Banks qualify lenders based on their ability to make a payment, not on their ability to make the fully indexed payment.
When inflation was high and wages were rising, the debt/income ratio of your mortgage payment kept dropping, rather quickly. In today’s environment of lower inflation, and lower wage inflation, this ratio is constant. Add an ARM, and the ratio can go up, so that in year 5, your mortgage/income ratio could have moved from 30% to 66%.
During periods of high inflation, the qualifing formulas underlend, because they do not take into account the higher salaries of future years. Thus, the banks lend less money to homebuyers, thus causing a retraction in consumer spending and the economy. The banks actually exacerbate the next recession.
“Banks underlend to homebuyers during periods of high inflation and overlend during periods of low inflation. This explains an explosion in housing prices worldwide over the last ten years as inflation has eased, nominal rates have declined, and lending has mushroomed.”
“…banks should require a smaller percentage of one’s salary go to mortgage payments during periods of low inflation solely because we now understand that your salary is not going to magically grow you out of debt. But banks today are doing just the opposite.”
“A simple regression analysis across many cities performed by the author shows [that the wealthiest cities have undergone the largest appreciation]…A statistical analysis at 95% confidence level demonstrates that those cities that made the greatest use of interest-only mortgages also experienced the greatest price appreciation over the five-year period.”
He goes on to say that housing prices should have declined 20% over the last few years, because during periods of lower inflation and lower interest rates, the tax deduction is worth less.April 25, 2006 at 9:23 AM #24560powaysellerParticipant
Sell Now, John Talbott, Chapter 7.
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