The Effects of Various Real Estate Loan Scenarios:
Let's look at what happens to the borrower of $300,000 under the following loan programs:1. 30 Year Fixed at 5.94% = $1787.09 monthly payment
2. 5-1 ARM fixed for first 5 years at 5.69% = $1739.30 monthly payment (fully amortizing)
3. 5 (or 10) year Interest Only at 6% = $1500 monthly payment. No reduction of loan balance and no negative amortization (no higher loan balance when sold or refinanced)
4. 40-year ARM at 5.5% = $1547.31 monthly payment (lower with negative amortization loan)
5. OPTION-ARM with a teaser start rate of 1.6% = payment of $1049.81 per month (first year). Interest payment based on 7.45% would be $1862.50. (the difference of $812.69 is added to the loan balance each month). The house would have to appreciate $9752 per year to keep up with the increasing loan balance (3%). Add about $150 to get to a fully amortizing payment. This program remains a great loan, when handled properly, for the self-employed, for investors with short time horizons and for bonused employees.
Read A CALL TO A.R.M.s
NOW THE DEVASTATING IMPACT OF HOUSING'S BIG BUST ON MY RENTAL HOUSE IN BERKELEY:
1. Before the bubble -
- Purchased a SFR in 1994 for $120,000
- 2005 Market Value - $670,000
- Original Loan $96,000 (80%)
- Loan Balance today $83,069 (6.64%)
- Original rent $1050
- Today's rent $1900
- Today's PITI $900 ($1000 / mo. net income)
2. After the bubble -
- Purchased a SFR in 1994 for $120,000
- 2006 Market Value $637,000 (if use a 5% drop from high)
- Loan Balance today $83,069
- Today's rent $1900
- Today's PITI $900 ($1000 / mo. net income)
Folks, if bubble enthusiasts continue to tell those who don't sell that your "gains are on paper only", and that's true, then aren't their (short term) losses just on paper as well?
Ben Stein: "Buy at the bottom in real estate (and in everything else -- read on), or as close to the bottom as you can see, and patiently wait for the boom to come back. In the meantime, live in your house and enjoy it. A house is a machine for living, as the famed architect Le Corbusier said. It's not a machine for making money. If it does make you money that's all to the good, but it's not the main function."
posted by Larry Nusbaum at
10:00 AM
7 Comments:
Real estate is not a game for short term trading. Sure people do buy and sell properties (flipping) but the transaction costs are huge and the tax consequences (depending on where you live) can also be expensive. If you have purchased a good property at an attractive price, why be in a hurry to sell and share the gains with the agents, lawyers, tax collectors etc?
As a private investor I am quite content to buy good quality properties, sit back and watch the value of my investment and the rental income grow over time. Paper gains and losses over short periods of time can be distracting but should not affect the longer term investment strategy.
If I was a developer I would think differently - but I am not a developer. I am a small private investor saving for his retirement.
A stock is a click of a button or a call and you are out. How do you adjust on a house, especially if it is bought with an exotic financial instrument? The "clicking" can hurt stocks on the way down. There is no clicking in RE transactions. These "exotic" loans ARE NOT NEW! They just happen to be getting a lot of press because so many were used in California over the past 12 months. I make no predictions about a so called bubble. I make it my job to know the markets that I play in. However, let's say the bubble pops next week......my property still exists, the land still has value, my rent still gets paid and my mortgage payment remains the same. And, if it does pop, the fed will have to lower rates again in the face of a bad economy and rates on ARMs will head back down.
Let's say the bubble doesn't pop. Rates rise. You can't raise rents. Your exotic loan is at the end of the fixed rate period.
Let's say mortgage rates are now at 12%. You can:
1) Refi to another I-only loan and the payment will be $3,000 per month.
2) Refi to conventional 30yr FX and your payment will be $3,086 per month.
What are we going to do then?
1. Most ARMs come with maximum rates. Ones taken out in 2002-2005 range from 8-11% only.
2. Think about an economy in which rates were on their way to 12%: Rip Roaring with hard assets appreciating, including real estate and unemployment at 3%.
3. Either way: Rental rates go up. In fact, vacancies are going down and rental rates going up as we speak.
4. Many people are taking action right this minute. The re-fi boom is (back) on. The lenders knew what they were $ doing $ taking everyone out of 30 year fixed, into ARMs so the can take people back into fixed!
I don't think of an ARM as an exotic mortgage. I think of your favorite one: the interest only.
I remember seeing the buildings in Houston in the mid-eighties. They called them see-through, because you could see all the way through them. They weren't finished. Hard assets like real estate were going down. Unemployment was HIGHER than today. You could not have raised rents. Things don't always happen the way they "should".
Back to the mortgage. In the case of the interest only. Not sure if they have caps, but I don't think so. I believe when the fixed-no pricipal period time is up, you go to P+I mortgage at the then prevailing rate.
I think of OPTION-ARMs as the only risky loan (exotic) and not the I/O. One is scary and one is not. One is mis-understood and one is not. One can hurt the market and the other won't.
I/O would have no cap since most come with fixed interest and payments for a period certain such as 3, 5 or 10 years.
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