Jul212014
With flattening house prices how will 300,000 SoCal loanowners get above water?
When lenders began denying short sales, underwater owners were forced to wait for higher prices to sell, and with flattening prices, they are stuck.
Lenders caused the housing market to bottom and to rally in 2012 and 2013 by favoring loan modification over foreclosure and by denying short sales to greatly reduce distressed inventories and overall supply. It worked fabulously for them, and prices rocketed upward for nearly 18 months. The abrupt rise in interest rates in mid-2013 lowered the ceiling of affordability, and the house price rally was stopped dead in its tracks.
When lenders began denying short sales, both they and the borrowers believed they would all be above water in a few years, and the loanowners would sell for enough to pay off the promissory note. This mutually held belief in rapid appreciation leading to an equity sale dissuaded many strategic defaulters and prompted many borrowers to accept loan modifications to play along. But what happens if prices stop going up? Will borrowers still wait patiently — for years — for prices to reach the peak? Will lenders extend loan modification after loan modification to keep borrowers in their homes?
Southland housing market may finally be getting back to normal
By Tim Logan, July 15, 2014
The housing recovery looks to be losing steam. But that may not be a bad thing.
Unless you’re a banker or an underwater borrower who needs to see peak pricing as soon as possible. For those two groups, a stalling recovery is a disaster.
In the latest sign of a market that’s plateauing well below its past highs, home prices in Southern California grew at their slowest pace in two years in June, capping a spring selling season that never quite took off.
The median price of a home sold in the six-county Southland hit $415,000, according to real estate service DataQuick. That number is the biggest in four years, but 18% below the market’s high point in mid-2007.
And the furious gains seen this time last year are a thing of the past. In the last 12 months, home prices climbed 7.8%, barely one-fourth their pace in the prior year.
A plateau suggests there is fundamental support beneath prices. I prefer the ceiling analogy because prices are being limited by the cost of the debt-air beneath prices. If rates go down, the ceiling will go up and so will prices, but if rates go up, the ceiling will go down, and current prices will be under pressure from the weight of inventory above.
But if the market’s highflying days are over, housing in Southern California appears to be entering a healthier phase of growth, real estate agents and economists say.
“I think we’re getting back to a very normal market, finally,” said Syd Leibovitch, president of Rodeo Realty in Beverly Hills.
That depends on how you define normal. The new normal doesn’t look much like the old normal.
Tight credit standards and a still-soft economy are keeping a lid on prices, and Leibovitch said he expects that they will stay flat through the rest of this year.
Indeed, a report last week by real estate website Trulia said asking prices in Orange County — a leading indicator of the sales figures DataQuick measures — grew just four-tenths of a percent in the second quarter. But sellers, at least those with proper expectations, are still drawing multiple offers from buyers who are able to get historically cheap loans.
“This is a balanced market, and that’s a good thing,” said Rich Simonin, chief executive of Westcoe Realty in Riverside. “It is solid for sellers if their price is reasonable. And buyers can still get good interest rates.”
It’s no longer a seller’s market.
Those buyers have a lot more to choose from. With prices higher than they were a year ago, investors and all-cash buyers have backed away, constituting their smallest share of home sales in four years, according to DataQuick. And banks appear to be loosening the tap on loans just a bit; DataQuick’s tallies of jumbo loans and overall mortgage lending are at their highest level since 2007.
“Many of the market indicators we track continue to ease toward normalcy,” said Andrew LePage, an analyst with the San Diego data firm.
That means more of the market consists of “regular” buyers purchasing houses from “regular” sellers, said Stuart Gabriel, director of UCLA’s Ziman Center for Real Estate. And they’re buying houses that they plan to live in, not investment vehicles that they plan to flip for profit. That will insulate them from ups and downs in the future.
What is he talking about? What is giving him this insight into people’s buying motivation? During the housing bubble, people were foolishly buying houses because they believed they were good investments and that they could flip them for a profit even if that took several years. The profit motive was part of every buying decision, actually living in the property was a secondary consideration.
“That would be a good outcome all around,” he said. “Housing’s not just an investment good. It’s a consumption good. You buy a house you like and enjoy living in, and plan to live in for a while.”
Housing should never be viewed as an investment good as that’s what caused so many problems. People dump bad investments and walk away from them. Do we want to see that again?
The price slowdown, though, could leave one segment of the market stranded: the roughly 300,000 Southland households that still owe more on their homes than they’re worth.
That’s 300,000 potential sellers waiting for higher prices. Those properties are off the market today, but they will reappear as prices go up — if they go up.
Two years of rising prices have pulled many of these so-called underwater borrowers back above the surface. But at the end of the first quarter, 8.1% of home loans in metro Los Angeles remained underwater, according to data firm CoreLogic. In the Inland Empire, that figure is 17.3%.
Few of these borrowers are falling into foreclosure anymore, real estate experts say, but few can afford to sell their homes either. If prices stall, there’s little they can do but wait out the market and keep making their monthly payments, Simonin said.
“They might as well hang on,” he said. “You’ve waited out five years. What’s another?“
What’s another year, or another five years? That’s the big question not answered by his statement.
For the rest of us, Simonin said, this leveling off is a welcome break. For the first time in 15 years, he said, it doesn’t feel as if the housing market is either soaring or plummeting, and there’s no pressure to buy — or sell — now, lest you miss out on a windfall.
Buyers and sellers can focus on deals that make sense for all involved. In the boom-and-bust Southern California housing market, Simonin said, that’s a nice change of pace.
“This is boring and that’s OK,” he said. “The train will wreck eventually. It always does. But for now, we can enjoy a smooth ride.”
So should these underwater borrowers be looking to sell at their earliest opportunity because a train wreck is imminent?
Bubble reflation will fall short of the peak
Lenders reflated the housing bubble to the degree they can. With restricted inventory, buyers in most markets around the country pushed prices up as high as they can. Since lenders are bound by prudent lending standards, they simply can’t push prices any higher unless mortgage rates go down again or unless buyer’s incomes go up; neither alternative seems likely.
At this point house prices will rise at the rate of wage inflation at best, but if mortgage rates begin to rise, which seems likely, them house prices may not rise at all. This leaves 300,000 underwater borrowers in SoCal and nearly 10 million around the United States trapped in their houses, perhaps for a very long time.
There are only two solutions to the underwater borrower problem: either house prices must go up, or debt levels must go down. As housing markets across the country reach the limit of bubble reflation efforts, the only alternative is for borrowers to pay down their mortgages.
Fortunately, at very low interest rates, more of the payment goes toward principal than at higher rates, and we’ve had near-record low interest rates for several years. Those borrowers are amortizing their loans quickly, and any of them who are underwater will not be underwater for long. This prompts many to erroneously believe amortization on loans will solve the underwater borrower problem in time because whether or not house prices move up, loan balances are going down. Unfortunately, that is not the case.
Many of those most deeply underwater borrowed too much money at the peak either to buy or to refinance. Most couldn’t afford a fully-amortized payment on the loan, so when they borrowed, they either used interest-only or negative amortization loans. Many of those loans blew up and were foreclosed, but many more were modified. Most private-label modified home loans do not amortize, and of the 7 million modified loans, about 5.5 million are private-label. These loans were designed by lenders to benefit lenders, as I documented in Lenders benefit from loan modifications, homeowners not so much.
Loan amortization will not solve the underwater borrower problem because far too many of these loans don’t amortize. The borrower is making no progress on reducing their loan balance. In my opinion, today’s loan modifications are tomorrow’s distressed property sales.
So when will these distressed sales occur? Will all those underwater borrowers wait for the market to come back? Will some strategically default or demand a short-sale approval? Will lenders ultimately be forced to foreclose?
I believe we will see an increase in foreclosures again as first borrowers and then lenders give up on endless can-kicking. Borrowers will again default, and lenders will be forced to foreclose. Without strongly rising prices to give borrowers hope, there is little reason for them to struggle and keep renting from the bank.
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Debt-to-income ratio can sink mortgage application
A new survey by credit-score giant FICO offers buyers a rare peek inside the heads of credit-risk managers at financial institutions across the country and in Canada. Researchers asked a representative sample of them what single factor in an application makes them most hesitant to fund a loan request — in other words, what’s most likely to prompt them to say no.
Debt ratios for home loans have two components.
The first measures your gross income from all sources before taxes against your proposed monthly housing expenses, including the principal, interest, taxes and insurance that you’d be paying if the lender granted the mortgage you sought.
As a general target, lenders like to see your housing expense ratio come in at no higher than 28% of gross monthly income, though there is flexibility to go higher if other elements of your application are viewed as strong. In May, according to mortgage software and research firm Ellie Mae, the average borrower who obtained home purchase money through investors Freddie Mac and Fannie Mae had a housing expense ratio of 22%. Federal Housing Administration-approved borrowers had average housing expense ratios of 28%.
The second DTI component — the so-called back-end ratio — measures your income against all your recurring monthly debts. These include housing expenses, credit cards, student loans, personal loan payments and others. Under federal “qualified mortgage” standards that took effect in January, your back-end ratio maximum generally is 43%, though again there is wiggle room case by case.
Most lenders making loans eligible for sale to Fannie or Freddie prefer not to see you anywhere close to 43%. In May, according to Ellie Mae, the average approved home purchase applicant had a back-end ratio of 34%. Even at FHA, which tends to be more lenient on credit matters than Fannie or Freddie, the average back-end ratio for buyers was 41%. The average for denied applications was 47%.
The results provide practical insights to anyone who is thinking about applying for a mortgage. Tops on the list? Surprise, it’s not your credit scores. It’s not how much you’ve got for a down payment or what’s in the bank. It’s your “DTIs” — your debt-to-income ratios. Nearly 60% of risk managers in the FICO study rated excessive DTIs their No. 1 concern factor — five times the percentage who picked the next biggest turnoff.
NAr says you better sell now
There were two more interesting comments made by Yun in the report:
“Rising inventory bodes well for slower price growth and greater affordability, but the amount of homes for sale is still modestly below a balanced market.” In real estate, there is a guideline that often applies. When there is less than 6 months inventory available, we are in a sellers’ market and we will see appreciation. Between 6-7 months is a neutral market where prices will increase at the rate of inflation. More than 7 months inventory means we are in a buyers’ market and should expect depreciation in home values. As Yun notes, we are currently in a sellers’ market (prices still increasing) but are headed to a neutral market.
“New home construction is still needed to keep prices and housing supply healthy in the long run.” As new construction begins to be built, there will be increased downward pressure on the prices of existing homes on the market.
Takeaway: Supply is about to increase significantly. The supply of existing homes is already increasing and the number of newly constructed homes is about to increase.
Bottom Line
If you are going to sell, now may be the time.
The large supply of new homes in the Irvine area appears to be affecting prices. Most of the $1m+ new homes in Pavilion Park were selling very quickly with each phase release, but now with Orchard Park open for business in a better location with many $1m+ options, Pavilion Park sales have slowed. I received my first “sales event” email with incentives from Rosemist in Pavilion Park a couple weeks ago.
I went and looked at the huge models in Orchard Hills. Some of those houses are amazing. I couldn’t even afford to furnish 7,000 SF much less pay for the house.
The competition at the high end should slow sales and price hikes from the builders. We should start to see more incentives soon too.
These propped prices are going to go down unless the Federal Reserve takes even a larger communists stances on controlling prices.
My bet is that they won’t, until it is too late. At this point the debt destruction will be deeply rooted and the FED will have much less influence than in the past.
Home prices dropping is going to surprise a lot of unsuspecting loan owners.
Right now, many of them are holding on with the belief they will not be under water in a year or two. When the reality of another 5 to 10 years of loan ownership sets in on them, I think we will see more strategic defaults.
I think prices are going down again … therefore I believe there will be many more loan owners who are trapped and underwater in the coming years. This is going to happen … the FED cannot keep private debt this high (in relation to GDP), for this long, without series future ramifications. This debt to GDP must be reconciled … either with inflation or debt destruction. So far inflation is losing.
Rising inventory alone isn’t enough to cause a housing crash.
I would agree that now isn’t a bad time to sell if you had no plans of purchasing another property. The problem is most people need to buy another place to live in, so the decision to sell ends up being neutral to their financial position.
At those higher price points, that is certainly true. Those buyers have equity from a previous sale. What they need is more first-time homebuyers to pay the high prices they need to bid up the next rung on the property ladder, and that market is still weak.
NAR: Big banks exiting FHA loans is a “bad trend”
JPMorgan Chase debates stopping FHA-backed loans
As the Federal Housing Administration celebrates its 80th anniversary, the big banks are debating ending their lending relationships with the administration.
After attending a panel discussion for the FHA at the White House on Friday, National Association of Realtors President Steve Brown spoke highly of the FHA to HousingWire saying, “The housing market and overall economy benefits from the program. It not only brought to the market buyers who can now buy homes, but it also has brought many jobs. It is because of this financial program that the economy revived.”
But despite NAR’s positive outlook, this second-quarter earnings season is shaping up to show that the big banks do not feel the same way.
JPMorgan Chase (JPM) CEO Jamie Dimon was quoted in a Bloomberg article, “He questioned whether his bank should end its decades-old relationship with the Federal Housing Administration, a last resort for lower-income Americans seeking mortgages.”
The problem: “These guys continue to lose market share to the smaller guys because the smaller guys are able to take more risk and the bigger guys keep giving cookie cutter mortgages,” FBR Capital Markets Managing Director Paul Miller said.
Currently, the nation’s largest two originators made 21% of home loans in the second quarter, the smallest combined share in more than a decade, down from 30% a year ago.
Instead, nonbanks are swooping in and grabbing the extra market share.
However, Brown noted, “I think that is a very bad trend, if it is a trend. You are clearly eliminating very clearly qualified borrowers from the opportunity of buying a home. The major obstacle for borrowers is accumulating enough money to make the down payment. The FHA is the only one with a 3.5% down payment. It would significantly hurt the down payment market.”
Consumer Sentiment Drops to Four Month Low
A preliminary measure of consumer sentiment released Friday shows confidence in the economy has dropped to its lowest level in the last four months.
The Thomson Reuters/University of Michigan Index of Consumer Sentiment measured 81.3 in its first July reading, falling more than a point from its final June reading of 82.5.
Analysts surveyed before Friday’s release had predicted the index would climb up slightly to 83.
Paul Diggle, U.S. economist for research group Capital Economics, said it was fuel costs that brought down the latest measure.
“The rise in gasoline prices was behind the dip in consumer confidence in July,” Diggle said in a note. “But rising equity prices and the improving labour market should help consumer confidence to increase before too long.”
The decline in the headline index came from a decrease in the consumer outlook index, which fell 2.4 points to 71.1.
Redfin hired an unqualified chief economist who is supposed to have the courage to make big calls. So how does she start? She joins the chorus calling for an improving market later this year based on nothing but optimism.
Analysts See Reasons for Housing Optimism
Even though the first half of 2014 didn’t live up to the hope and hype, industry insiders are still calling for better days in the housing market for the rest of this year. On Friday, Redfin released its latest market summary, which sees the combination of sales, prices, foot traffic, and inventory as positive signs heading into the fall.
“After an abysmal first quarter that drove a disappointing first half, housing will be playing catch-up for the year,” said Nela Richardson, Redfin’s chief economist. “Though it won’t be a seamless transition, we believe the housing market is positioning itself for a stronger finish in the second half of the year.”
Granted, you may have heard the same kinds of optimism in January. The first quarter of 2014 was supposed to show a steady climb in all areas of housing, but hopes were battered by harsh winter weather, a drop in residential construction starts, and a shortage of qualified construction workers.
Things also were supposed to pick up in the second quarter—and they did, but only enough, by most accounts, to stanch the disappointing Q1 numbers.
But entering quarters three and four, Richardson is hanging her predictions on four key points.
First, home sales are catching up to 2013’s highs, which were the strongest since the recession. June sales (114,240) were only shy by 2.5 percent from last June’s, and sales were up year-over-year in eight of 30 metro markets, including Atlanta, Charlotte, and Oakland, each of which were up more than 8 percent, Richardson said.
Second, foot traffic is on the rise. According to Redfin, the number of customers going on tours with the company’s agents in June was up 27.1 percent from a year ago. “Tour growth is bucking seasonality trends, which tend to peak in May,” Richardson said.
Whether this trend will translate into stronger sales numbers hinges on whether mortgage supply from banks can meet the increase in demand or whether buyers with large amounts of cash on hand will continue to dominate the market, she said. Cash deals reached their peak in 2011 and have been declining steadily since, but the percentage of cash deals remains higher than the norm and is especially popular forlower-cost homes.
Third, price growth is becoming more sustainable. Even though the median sales price in urban markets topped $300,000 in June, price growth reached a two-year low of 6.4 percent, Richardson said. The stability is most welcome. “Prices over the past three years have been an expensive roller coaster for both buyers and sellers,” she said.
According to Redfin, the fluctuation between 2011 and 2012 was depreciation followed by double-digit growth, and price growth through 2013 averaged 14 percent. “In June, the median sales price grew at half that rate, much more in line with a sustainable rate that won’t have the market panting to keep up,” Richardson said.
Lastly, housing inventory is returning, albeit slowly. Between 2009 and 2012, the number of homes for sale plunged 44 percent, bottoming at 411,555 homes at the end of 2012, according to Redfin. At its highpoint in 2013, inventory rose to just 477,000 homes for sale and then dropped to 411,761 by year’s end. Last month, and for a second month in a row, the number of homes for sale was above 500,000, which was up 8 percent from this time last year.
The biggest year-over-year increases in homes for sale were in Riverside-San Bernardino and Orange County, California, and Phoenix, where figures were up at least 24 percent for all areas.
“Metro markets continue to get a boost from pent-up demand caused by the low inventory that plagued housing for the past two years,” Richardson said. “The second half will not be without its wobbles. But the housing market can maneuver around the juggernaut of subpar long-term economic fundamentals. Housing is now edging back to normal.”
I think the deep dark, secret for most organizations is that Chief Economist is interchangeable with PR Spokesperson. None of them have actual economic credentials, nor do they have a team of economists that report to them. Their job is to pick and choose data points to write a narrative about that will generate free publicity for their organizations.
This forecast does seem very run-of-the-mill. Nothing bold about it. I liked when their CEO Glenn Kelman was the one doing PR. He used to be very hands on. In fact, I think he scolded me on Lansner’s blog one time because I said Redfin had the potential to put the traditional realtor out of business. He didn’t want that kind of attention back when they were a start-up in 2008.
No matter what is going on in the economy it’s always a good for the housing market according to people who’s paycheck relies on it.
Glenn Kelman was certainly more interesting. If they wanted bold calls in a new economist, this certainly doesn’t qualify.
Flattening? They are going down, right now.
http://www.deptofnumbers.com/asking-prices/california/orange-county/
The last time prices decreased from June to July, it was 2011. There were 6 consecutive months of declines that followed.
“If” rates start creeping up, look out below.
I wonder how all this coming supply and price/demand cooling will affect local rents… As a renter with virtually no hope of buying anytime soon, the bottom line is the bottom line.
Additional rental supply is coming on the market with all the investment into multi family construction. When you add to the fact wages are not seeing much growth and the systemic high unemployment in California I would image the rate of rental growth will be poor.
I think rents are about to go up. The cooling of demand is largely from investors who aren’t willing to pay the higher prices. Without those investors, the inventory of rentals will dry up.
I purchased a condo in Huntington Beach at almost the exact peak for that neighborhood in May 2006. If prices just stay flat, my unit will be back above water in 2 years time simply due to the loan amortization. The current LTV is 107% but about 3.3% of the balance is being paid off per year at this point due to the low interest rate on the loan. At it’s worst in 2011, the LTV was about 225% and if I had listened to the perma-bears on these blogs, you would think that I never had a shot at regaining equity ever again.
Thankfully, I’m a firm believer in the OC housing cycle and I knew that 2012-2014 would likely be good years with double digit price gains. I tried to share this news on housing blogs repeatedly from 2009-2011, but I was usually shouted down by know-it-all housing bears that haven’t been right about anything. They were the true sheep of this housing bust, following the consensus of the herd (housing bubble blogs) and ultimately getting slaughtered.
You can still read the writing of some of these poor saps over at Dr. Housing Bubble. They missed the opportunity of a lifetime and their anger has grown exponentially because of it.
I bought a SFR as a rental in another state in 2005. I paid way too much at the time. I financed it with 100% financing (80/20) with a 6.75% first and 10.5% second (both ARMs). By the time we refinanced in 2011, the house was 20k lower than we bought it, and we were already about 50k invested since the rent didn’t cover the expenses (so much for appreciation).
So, we had to pay down the mortgage by doing cash-in refinancing. But we were able to pay off the second, and refi the first into a 4.25% 15yrFRM. This dropped our interest by about $1000/mo., so it was the best investment at the time.
Fast forward three years, and the value is up 50K, the mortgage has fallen another 30k, and we are about break even on the whole deal. It only took 9 years of hard work to learn a hard lesson: it’s much easier to get into a bad deal than it is to get out of it!
Not every deal is going to be a great one, but you can make the most out of what you have. I think we are paying off about 6% of the mortgage each year on this rental (gotta love the 15yr mortgage). If it wasn’t for the deferred maintenance, this lemon would finally be starting to produce lemonade.
Amortization will help you and the others like you that either didn’t get loan modifications or got them from HAMP. The private lavel loan modifications generally don’t amortize, so they won’t be above water any time soon.
“With flattening house prices how will 300,000 SoCal loanowners get above water?”
The old fashioned way… they’ll earn it.
Either they pay down the loan they took out, or they won’t. If they don’t pay it down, they won’t be selling and that will be one less house on the market. And so one more multiple bid situation drives prices back up to a new “underwater” market pricing.
If they have a fixed-rate loan, they will benefit from rising wages even with low inflation. If they have an ARM, then they are paying less interest to the bank every month and they can pay the loan balance down even faster. Either way, these 300,000 homes aren’t currently on the market, and likely won’t be for a long time.
Is that such a bad thing? We seem to be conditioned to think that rising house prices are good and falling are bad. But is it true? Sure it’s bad for realtors as volumes will fall, but is it bad for everyone else? An argument can be made that underwater homeowners benefit the most from being underwater since they are learning a valuable life-lesson about looking before they leap. And if anyone needs to learn that, it’s them.
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