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Friday, September 01, 2006
Mortgage Bills Come (Past) Due
While wage increases have failed to outpace inflation, real housing prices have nearly doubled in the past ten years. Astronomical housing prices made it impossible for many families to purchase a home. The market responded by introducing and aggressively marketing new mortgage "products" like ARMs (adjustable rate mortgages) and interest-only loans. These mortgages made monthly payments affordable, but their continuing affordability hinged on two things: 1) that interest rates would not rise and that 2) the housing market continued to sizzle. Of course, what goes up, must come down (or in the case of interest rates, what goes down, must come up).
BusinessWeek:
The bill is coming due. Many of the option ARMs taken out in 2004 and 2005 are resetting at much higher payment schedules -- often to the astonishment of people who thought the low installments were fixed for at least five years. And because home prices have leveled off, borrowers can't count on rising equity to bail them out. What's more, steep penalties prevent them from refinancing. The most diligent home buyers asked enough questions to know that option ARMs can be fraught with risk. But others, caught up in real estate mania, ignored or failed to appreciate the risk.
One may be tempted to blame gullible buyers for the plethora of outstanding ARMs and IO mortgages, but that would be a somewhat shallow analysis of history.
So how did these unusual loans get into the hands of so many ordinary folks? The sequence of events was orderly and even rational, at least within a flawed system. In the early years of the housing boom, falling interest rates made safe fixed-rate loans attractive to borrowers. As home prices soared, banks pushed adjustable-rate loans with lower initial payments. When those got too pricey, banks hawked loans that required only interest payments for the first few years. And then they flogged option ARMs -- not as financial-planning tools for the wealthy but as affordability tools for the masses. Banks tapped an army of unregulated mortgage brokers to do what needed to be done to keep the money flowing, even if it meant putting dangerous loans in the hands of people who couldn't handle or didn't understand the risk. And Wall Street greased the skids by taking on much of the new risk banks were creating.
But it won't be just unfortunate borrowers who will feel the pain; the housing boom has been the cornerstone of the current economic recovery. As interest rates increase, less spending on new housing construction, and shrinking growth in home equity set in, we can look forward to a cooling economy.
BNA (sub. req'd.):
In 2004 and 2005, housing as a whole accounted for more than one-fourth of the nation's economic growth--equal to nearly 1 percentage point of increase in real gross domestic product, Zandi said. Half of the contribution to GDP came from new homebuilding, while the other half came from the wealth effect "generated from rapid appreciation in housing values and aggressive mortgage equity withdrawal," he said.
In 2006, homebuilding has declined, home price appreciation has slowed to single digits from double-digit growth in 2004 and 2005, and credit problems are likely to mount because of higher interest rates, Zandi said. As a result, he predicted housing will contribute "very little" to economic growth this year and "will be a substantial negative in 2007 as homebuilding contracts and the wealth effect turns negative," reducing growth in consumer spending.
Posted by Craig Jennings
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