patrick.net

Yet new assumptions:

1. Buyer has 20% cash down
2. Buyer's parents will provide another 20%
3. Loan sharks will provide 40% financing regardless of income
4. Remaining 20% from organ sales

Required income to qualify: $0
Buyers must be able to give up two kidneys.

Or should I have said 1 kidney per $50000 financed? :lol:

My personal assumptions:
(1) I should be able to put a downpayment of at least 50%.
(2) The rest I could borrow, but I should always remember to be a LOAN, which is a dangerous thing and I should spend sleepless nights until I pay it off completely.

The reason I say this is, growing up in India, when my Dad built our house, this is how it was. Offlate, American style lending has become popular in India as well, but I prefer the old school style.

Maybe it is just me...

I have a question.... Doesn't the assumption of a 10% down payment instead of 20% actually tend to make housing *less* affordable since the mortgage is a greater percentage of the financing?

I have a question…. Doesn’t the assumption of a 10% down payment instead of 20% actually tend to make housing *less* affordable since the mortgage is a greater percentage of the financing?

Yes. But not a lot.

Glen, many folks will not have 20% available to put down. They would be the unaffordables.

Lowering the downpayment requirement helps CAR portray such folks as within affordability range.

More assumptions:
1. FB will lease front yard to billboard company to advertise new housing developments.
2. FBs will work 30 hours of overtime each at the car wash and taco bell, respectively.
3. FBs will get a 40% cost of living salary adjustment before ARM adjusts.

Glen, many folks will not have 20% available to put down. They would be the unaffordables.

Lowering the downpayment requirement helps CAR portray such folks as within affordability range.

I just assumed that when they compiled their numbers the 20% down was taken as a given. If you actually looked at the percentage of buyers who have even 10% of the median California home price in savings (eg: around $45 or $50K), I suspect the number would be far less than 23%. Maybe closer to 1 or 2%.

funny thing, I punch their new (and quite ridiculous) new parameters into my Bubblizer (blah blah, if you're a new reader click my name). The results?

The prices are still WAY too high for affordability. Hint: think about the next buyer after you sell, when you are buying. If you're going to be there say 5 years, then think about how much salary that next sucker has to make in order to buy your home at simply break-even. Second hint: you have to figure in the total holding costs, which will kill you when equivalent rent is a third or PITI.

FBs will use $40K cash advance from their Visa to come up with the downpayment.
FBs will declare bankruptcy right after the sale closes so they can discharge the credit card debt and continue making mortgage payments.
FBs will prevail upon family and friends to provide grocery money and free daycare.
FBs will continue to go without health insurance, but will never get sick.

My comment got locked....could it have been the mention of a certain credit card company?

How about 30 year mortgages which are negatively amortized for the first 10 years, interest only for the next ten years and fully amortized over the last 10 years. I call this the 10-10-10 mortgage, the choice of the smart home buyer.

The only problem I see is that banks will be effectively making an un-secured loan if the negative amortization results in outstanding debt greater than home values. But house prices in the SF Bay Area only go up so the home buyer will always have some equity.

If prices only went up then why not bypass the middle-man. Banks could always buy homes directly and rent them out instead of loaning money to a buyer. If banks are too conservative to get into this business how about hedge funds. Instead of investing in complex financial instruments and having to hire high priced MBAs and Phds how about just going out and buying single family homes in the Bay Area.

I don't see hedge funds investing in single family homes so it is likely the smart money thinks they are a bad investment. A financier with deep pockets and high risk tolerance needs to be involved. How about getting the Federal government involved in making the 10-10-10 smart choice mortgage? Since deficits don't seem to matter whats another few hundred billion to fund the mortgages?

LiLLL

You can rest assured that the abandoment of the gold standard was not a unilateral action by the US, nore were the reasons simple. The same holds true for M3.

Instead of investing in complex financial instruments and having to hire high priced MBAs and Phds how about just going out and buying single family homes in the Bay Area.

I don’t see hedge funds investing in single family homes so it is likely the smart money thinks they are a bad investment.

So you'd be exchanging derivatives portfolio managers, equity traders, market quants, hedge fund risk managers, financial fund management mbas

--- for ---

real estate portfolio managers, real estate buy/sell associates, real estate econometricsts, real estate risk managers, real estate investment and operations management mbas

Doesn't seem like a place for smart money to go, given that RE is immensely illiquid.

I have discovered that an evil company I have investents in has some of my money in Japanese real estate. We’ve been doing really well with our money there since about 2000.

I love evil companies. :twisted:

Real estate "professionals" are by and large rather ignorant and useless. the incentive structure for their services is completely misaligned. Start paying them as financial advisors or attorneys, and then I'd consider buying through one.

I don't believe in evil companies, but I find there's plenty of shortsighted ones. It's best to stay away from the shortsighted ones unless one is willing to speculate.

Why would you want to make affordability 100%

If anything, the CAR should try to state numbers as being 5% affordable.

Let's face it, the more exclusive and impossible something gets, the more desirable it is.

Someone called this the Yogi Berra phenomenon: "Nobody goes there anymore; it's too crowded."

A "Vice" fund compared to a "SRI" fund. One invests in cigarettes, gambling, alcohol, and oil companies, to name other sins.

The other invests in happy, fluffy, puffy bunnies.

http://finance.yahoo.com/q/bc?t=1y&s=VICEX&l=on&z=m&q=l&c=CAAPX

My take on the report was this: The report was for the entire state, and not the Bay Area. I could see how 23% would be the average for the state, given into account that most of the major metropolitan areas are possibly in single digit levels even now. I could see how making this ever-slight change in the reporting would make things sound better even though 20% is outright pitiful.
Doesn't matter to me anyhow, I'm one of those guys that can't afford, so I took the initiative. I'm outta' here! yay!

Speaking of moving elsewhere... I can't resist. I found this place. Looks right up my alley, walking distance from downtown nashville, costs 90k.
http://nashville.craigslist.org/rfs/190577076.html

LiLLL

Maybe a little bit of all the above? Things are headed the wrong direction. Things are always headed the wrong direction, but usually never seem to quite get there, thankfully.

Paradigms do change. It's not that fact I deny, but rather that people cannot usually tell when these changes occur until well after the fact.

Indeed, the definition of ownership, conservative, and debt have changed over the years. Some changes have been bad, others not so bad, and some good.

I guess what I'm saying is that it's one thing to disagree with the CAR's methods in this refactoring attempt. It's an entirely different thing to simply disagree with any refactoring.

Without recognition of change and the inherit risk of getting this wrong, there can be no progression; usually only stagnation and regression.

There problem with the CAR methodology is not that it has CHANGED but that there is no recognition of RISK.

The old standard assumed 20% down, 30-year fixed mortgage and 30% of income (if I remember correctly). The new standard assumes 10% down, adjustable-rate mortgage and 40% of income. (if I understand the new standard)

The new mortgage is just more risky to a home buyer than the old mortgage. If CAR were doing this honestly they would compensate for the higher risk possibly by using a higher mortgage rate.

There problem with the CAR methodology is not that it has CHANGED but that there is no recognition of RISK.

From a homeowner's perspective, I would say that 10% down is less risky than 20% down because you have less equity to lose. From a bank perspective, the 10% down is obviously riskier. CAR is right that most people can now easily get financed for 90%. However, whether that is a safe assumption going forward is an entirely different matter.

I'm guessing that when the market really tanks, many of the aggressive lenders currently offering 2nd mortgages will get creamed and it will be a lot harder to qualify for a 2nd to finance your puchase without sterling credit and verified income. The big question is whether the interest rates that are being charged by the lenders offering those loans are sufficient to compensate them for the risk they are taking on. If the market goes down by 15 or 20%, there will be a lot of underwater "secured" second mortgage lenders.

puchase = purchase

"From a homeowner’s perspective, I would say that 10% down is less risky than 20% down because you have less equity to lose. "

I totally disagree. The homeowner with 10% down is much more leveraged than the homeowner with 20% down. Risk should be calculated in pure dollar numbers but in the amount of impact any price drop would have on the homeowner's lives. The current lending practice and CAR's standards are irresponsible because it ropes in buyers whose financial lives could be utterly destroyed by even a 10% drop in the market.

I totally disagree. The homeowner with 10% down is much more leveraged than the homeowner with 20% down. Risk should be calculated in pure dollar numbers but in the amount of impact any price drop would have on the homeowner’s lives. The current lending practice and CAR’s standards are irresponsible because it ropes in buyers whose financial lives could be utterly destroyed by even a 10% drop in the market.

California home ownership is an unusual kind of leverage, though. Due to California's non-deficiency statute, a lender can not go after the FB for a deficiency judgment if the debtor willingly gives up the keys in lieu of foreclosure. Thus, owning a home in California is like owning a call option on future appreciation. If you put 10% down on a $500K house and you are willing to walk away with bad credit for a few years, you only have $50K at risk. If you put 20% down, then you have $100K at risk, even if you are willing to sacrifice your credit rating.

Suppose you have $100K of cash to invest and you have to buy a piece of real estate in California. Would you rather sink all $100K into your s**tbox, or would you put $50K into the s**tbox and put the rest in your ING account? Which option is riskier?

One of the few (only) rational explanations that I could imagine for the increase in house prices in California was that current home buyers are treating a home purchase as a call option because of non-recourse loans. And since the downpayment has dropped from a traditional 20% to a smaller 10% or 5% the premium for the call option has dropped increasing demand.

There are many objections to this view
1. Purchase money mortgages in California have always been non-recourse. There is no good reason to explain why today's homeowner decide to take advantage of this feature but home buyers a decade ago did not do so.
2. Most home-buyers are ignorant about the difference between a recourse and non-recourse loan
3. There does not seem to be any hesitation to refinance and lose the non-recourse feature
4. From a talk with someone who had 30 years experience dealing with foreclosed bank owned properties I got the impression that it does not matter much to a lender as a homeowner facing foreclosure is unlikely to have any assets anyway so a recourse or non-recourse loan makes no difference.

I don't think the non-recourse factor plays a part in most buyers risk calculations. So putting 10% down instead of 20% is riskier and using 40% of income instead of 30% is certainly more risky. Using an ARM is also more risky than using a fixed rate mortgage. The CAR is just plain wrong when they neglect to account for a riskier mortgage in their affordability statistics.

For a reductio ad absurdum example imagine using a negative amortization adjustable rate mortgage instead of a 30-year fixed to calculate affordability. You could dramatically improve affordability but there is no denying that the former is RISKIER than the latter for a home buyer when all other factors are the same.

Gavin,

Very well argued.

Glen,

Sorry, I put in a should there when I meant "shouldn't". That must have made my whole response completely incomprehensible.

I agree that if everything was the same and if the buyer financed in a way to take advantage of CA's anti-deficiency law, then less down means less risk for the homeowner. However, in reality, the buyers with 10% down have a higher risk profile than the buyer with 20% down. Overall, this current market simply push people to take extremely risky gambles that will ruin their life if the gamble goes bad.

"Destroy financial lives?
What?
Real estate always goes up!"

Yeah, we're all Lex Luthors now.

There are many objections to this view
1. Purchase money mortgages in California have always been non-recourse. There is no good reason to explain why today’s homeowner decide to take advantage of this feature but home buyers a decade ago did not do so.

Pure greed and speculation...and because they can (lenders are willing to underwrite these foolish ventures).

2. Most home-buyers are ignorant about the difference between a recourse and non-recourse loan

True, but whether or not the consumer is aware of a risk does not factor into the actual riskiness or safety of a transaction.

3. There does not seem to be any hesitation to refinance and lose the non-recourse feature

Stupid, desperate FBs willingly surrender the best feature of CA homeownership....the ability to walk away.

4. From a talk with someone who had 30 years experience dealing with foreclosed bank owned properties I got the impression that it does not matter much to a lender as a homeowner facing foreclosure is unlikely to have any assets anyway so a recourse or non-recourse loan makes no difference.

They may not have assets, but they may very well have a job (or get one in the future). In many cases it would be worth it to pursue a wage garnishment, if you could. (Especially, eg, in foreclosures where the foreclosure is the result of one of the family breadwinners losing a job, going on disability, becoming a drug addict, or divorcing the other earner--but there is still one family member making a decent salary.)

Gavin,

Your points are well taken... I was partly just being facetious because it has occurred to me that CA FBs can get away with taking fairly insane risks and can come out relatively unscathed (except for the loss of their credit and their home). People in other states are not always so lucky.

As you point out, all of the serial refinancers have lost their anti-deficiency protection. I would not be surprised, therefore, if the bursting of the bubble results in a lot more bankruptcies this time around--if people can not get antideficiency protection then the only option for avoiding paying back their bubble debt for decades is likely to be personal bankruptcy.

Yeah, we’re all Lex Luthors now.

Not evil enough.

Whether you put 10% down or pay all cash, if your home declines in value you have lost the same amount of equity.

Putting less down does provide the possibility of walking away with less lost - but only at the destruction of your credit.

Glen or Gavin,

Could you elaborate on how refinancing eliminates the built in anti-deficiency option? Is this a legal artifact or financial artifact? Before selling to bubblesit in 4/05 I pursued fixed-rate refinances fairly aggressively, however, always carefully re-amortizing the duration to continue or shorten the schedule. I think after four years our original 30yr term was on a 22.5yr amort.

When a theory indicates that what is happening is not possible, there is a problem with the theory. The CAR affordability index is such a theoretical construct.

The old CAR affordability index (like most others) was a terribly inaccurate measure. The new index is also inaccurate. While they have attempted to remedy the prior errors, the index continues to compare apples and oranges.

Affordability should measure the ability of likely buyers to be able to buy the house they are likely to buy – using a financing structure that is both common and sustainable. Even if constructed perfectly it could only represent one type of buyer – whichever type is selected for the index. Should that be the first-time buyer or a trade-up buyer? If a trade-up buyer, should it be a first trade-up or a subsequent trade up? Each of these buyer types has very different down payment capabilities. Generally, index publishers focus on the first-time buyer, even though about 70% of all buyers are trade-up buyers.

Focusing on first-time buyers is useful for gauging the sustainable health of the market. However, it is not useful for evaluating the median price level because first-time buyers generally do not buy the median-priced house – they buy starter homes, and later trade-up to a median-priced home.

Median income and median price are a mismatch because the median price relates to only a subset of all housing, while median income relates to all households. They need to compare either the 65th percentile income to median prices, or compare median income to the median price of ALL housing units of any kind and quality (including condos and all rental units). This would likely be a nicer starter home or a low end trade-up home.

While selecting 85% of the median price might reduce the magnitude of the mismatch between buyer profile and property it is still a mismatch. The measure remains inaccurate and unreliable.

Stating the index as a percentage of people who can afford the home exacerbates the problem because it is overly prone to assumption errors, and it is rarely reflective of reality. I much prefer to see a measure that states how much income (as % of median income) is needed to buy a median priced home. This measure is less prone to assumption errors.

Any index using a general median, or a segmented median without adequately adjusting for curve distortion is ultimately doomed to irrelevancy.

The Brookings Institute published a 36 page report on the difficulty of measuring income distribution curves; and this data is half a decade old. It is ostensibly even worse today.

http://www.brook.edu/metro/pubs/20040803_income.pdf

Just browsing this report should convince you that comparing a home buyer in a metro area to a home buyer in any other metro area, or in a non-metro area is erroneous.

CAR would have to do a lot of real work if they intended to create any meaningful indices.

Or one could always use the HSBC research to determine metro affordability.

http://randolfe.typepad.com/Documents/HSBC_frothfindingmission.pdf

This covers income and affordability from multiple angles, and factors in present value of holding costs and real rent yields. But it doesn't match the CAR's desired conclusions, so they had no choice but to create their own synthetic index.

Could you elaborate on how refinancing eliminates the built in anti-deficiency option? Is this a legal artifact or financial artifact? Before selling to bubblesit in 4/05 I pursued fixed-rate refinances fairly aggressively, however, always carefully re-amortizing the duration to continue or shorten the schedule. I think after four years our original 30yr term was on a 22.5yr amort.

Randy,

This is going to be a long one...

This is purely a legal artifact. California has a very complicated set of rules regarding mortgages. After the biggest real estate bust in California history (the depression) rules were put in place to protect borrowers. One of these rules is the "anti-deficiency rule" embodied in California Code of Civil Procedure Section 580d:

No judgment shall be rendered for any deficiency upon a note secured by a deed of trust or mortgage upon real property or an estate for years therein hereafter executed in any case in which the real property or estate for years therein has been sold by the mortgagee or trustee under power of sale contained in the mortgage or deed of trust.
Cal. Civ. Proc. Code § 580d.

Thus, if the bank forecloses on your house, your house may be sold by the bank, and they can keep the proceeds of the sale (up to the amount of your debt, including interest, penalties, cost of collection, etc.) but they can not come after you personally for your other assets, your kids or your dog. My understanding is that this was put in place because RE values got slammed in the depression and big evil banks were suing all the depression-era FBs who owned anything that wasn't nailed down.

An interrelated rule is California's "one form of action" rule:

There can be but one form of action for the recovery of any debt or the enforcement of any right secured by mortgage upon real property or an estate for years therein, which action shall be in accordance with the provisions of this chapter. Cal. Civ. Proc. Code § 726(a).

This basically means that if the FB has a first and second mortgage and a HELOC, they will not face three separate lawsuits when they go into default. Any one (but only one) of the creditors can foreclose upon default and force a sale of the property. Once the property is sold the proceeds will be used to pay off the secured creditors in order of priority. If the proceeds are insufficient to pay off all the debt, though, the FB is off the hook because of the "anti-deficiency rule."

This creates a problem for the "sold out junior." This is the lender who loaned you the funds for the "20" portion of your 80/20 financing. When the holder of the first mortgage forecloses and the sale proceeds only cover the first mortgage (because property values are down 20% and/or because the first lender is willing to conduct a fire sale and sell out for the exact balance of the first mortgage) the "sold out junior" becomes a FL (f'd lender). To avoid this, sold out juniors will often bid at foreclosure sales to protect their position and make sure that the holder of the first does not sell the property for the exact balance of the first mortgage. But the "sold out junior" can not sue the FB for their losses--even if the FB has five other properties with positive equity!

This is one of the reasons for the grandfather's dying advice to his grandson "Don't date showgirls and don't buy second mortgages." (I don't know about the showgirl part of the equation.)

But, getting to your question (finally), the anti-deficiency rule is limited in its application. There are a ton of exceptions and limitations. The primary limitation is that the protection only applies to a "purchase money" loan. That is, a loan that was used to acquire the property.

So in the 80/20 example, the lender in the second position can not come after you. However, if you refinance into a new loan (or HELOC), all bets are off. I think this is because it is presumed (unrealistically) that holders of second position purchase money mortgages will demand a sufficient down payment by the buyer to protect themselves in the event they need to bid on the property in a foreclosure sale (as outlined above). The MBSs that own all those California second mortgages are in for a rude awakening one of these days. Or at least they would be, if there were anyone left in California who had not already refi'd at least once. In reality, they can probably go after 90%+ of the FBs for anything they own...

So, as an aside, when the CA RE market finally crashes, it will trigger a wave of defaults just as massive as the wave of equity locusts which preceded it. But this time the banks will be foreclosing on the AZ and NV flips owned by the CA homedebtors... Just my guess.

*By the way, I'm an attorney but I don't practice RE law, so please do not consider this legal advice. It is just based on my recollection about some research I did a while back.