Earlier today, the Mortgage Bankers Association reported that mortgage applications dropped another 1.2%, declining for the sixth consecutive week and the 10th of the past 11, which has all but put a nail in the coffin of the housing "recovery" (for some perspective on why, read this). But does that mean that as demand for mortgages dries up on even the smallest bounce in interest rates, that unless one is flush with cash, one is shut out of the housing market? Not at all. The reason for that is that as demand for conventional mortgages plunges, demand for unconventional ones - those which marked the mania phase of the last housing bubble, Adjustable Rate Mortgages, are back to 2008 levels.
According to Bloomberg: "In the last week of June, the dollar value represented by ARM applications accounted for 16 percent of mortgage requests, the highest share since July 2008, two months before Lehman Brothers Holdings Inc. collapsed, according to Mortgage Bankers Association in Washington." Oops.
Just as we reported yesterday that the second to last puzzle piece in the credit bubble clicked into place now that second-lien loans are raging just like they did in 2005, so today perhaps the final missing piece in Bernanke's second great debt bubble has been found as Americans now scramble to buy that house, oblivious of what may happen down the road. And why worry - after all Bernanke will bail them out too when the time comes.
Jung Lim plans to offset the cost of rising mortgage rates by using an adjustable-rate loan to buy a home for his expanding family. For the California endodontist, the money he’ll save makes up for the ARM’s risky reputation.
Lim, 38, whose wife is expecting a second child in December, is leaving a two-bedroom condo in Los Angeles’s Hancock Park to buy a four-bedroom house in the city’s Sherman Oaks neighborhood for $1.12 million. His lender offered him a rate for an adjustable mortgage that is about a percentage point cheaper than a fixed loan.
Why does Jung want an ARM? The same reason millions of other Americans wanted ARMs back in 2005: it provides a shortcut to a "get rich quick, flip that house" dream.
“If I could have gotten a 30-year fixed at the interest rate I’m getting the ARM for, I would have felt a lot more comfortable,” said Lim, who’s also a professor of endodontics at the University of California, Los Angeles. “But I’m hoping to refinance in five years or less. And we’ll be in the house for about 10 years so we could also sell. Hopefully prices have bottomed so we won’t be underwater then.”
Like during the last housing bubble, when everyone was "hoping" for a positive outcome, so this time around hope is the only strategy. The outcome, like last time, will be anything but hopeful.
In the second year of the U.S. housing recovery, the loans that helped trigger the housing bust are making a comeback. Applications in late June rose to the highest level since 2008 after the Federal Reserve sent fixed rates surging by signaling it may curtail bond buying credited with pushing borrowing costs to the cheapest on record. The average 30-year fixed-rate mortgage jumped 1.2 percentage points in mid-July from May to the highest level in two years, adding about $200 a month to payments on a $300,000 mortgage.
Here is a reality check for anyone who thought that the fear of rising mortgage rates would force Americans to rush and buy homes to lock in low fixed rates - it never happened. Instead, the slow trickle of mortgage applications merely rerouted itself into an even riskier debt product, one which promises easy terms for a while, then all hell breaks loose especially if and when the Fed finally loses control of the treasury curve.
“We’ve seen a shift in the way people look at adjustable-rate mortgages,” said Cameron Findlay, chief economist of Discover Financial Service’s home-loan unit. “They’re still skeptical about using ARMs, given the role they played in the financial crisis, but the sticker shock of what fixed rates have done is making them look for alternatives.”
ARMs, loans with interest rates that adjust after initial fixed periods, usually of five, seven or 10 years, helped fuel the housing bubble and contributed to soaring defaults in 2008 that sent the economy into a tailspin.
In addition to loose underwriting standards that extended mortgages to people who couldn’t pay, variations included loans that had interest-only periods or initial teaser rates that became known as exploding ARMs when the rate spiked. Lending was based on the presumption that house prices would keep rising and the debt could be refinanced before onerous terms kicked in.
Ah yes, the infamous #Ref! that crashed every excel spreadsheet any time a rating agency plugged in an assumption for dropping prices. Sadly, we are there once again.
So whose balance sheet will be wrecked when the second housing and credit bubble pops this time around?
The biggest ARM lenders are Wells Fargo & Co., based in San Francisco, JPMorgan Chase & Co. in New York, PHH Corp. in Mount Laurel, New Jersey, and Bank of America Corp. based in Charlotte, North Carolina, according to Cecala.
Why wrecked? Because for those who have forgotten, "Since the rules for ARMs usually allow borrowers to qualify on the loan’s initial rate, some may not be able to afford their mortgages after the fixed period ends. For now, ARMs are helping borrowers lower interest payments and reach for more expensive homes after financing costs rose." The good times always end though. Just as they will end for Mark Baudler.
Mark Baudler, a San Francisco attorney, last month traded a 30-year mortgage with a 4.5 percent fixed rate for an adjustable loan at 2.5 percent, cutting his $5,500 monthly mortgage bill almost in half.
“I’m going to take the money I save and plow it right back into the mortgage,” said the partner at Wilson Sonsini Goodrich & Rosati, a law firm that specializes in securities and intellectual property law. “If the rates go nutty when the loan adjusts, I’ll be able to handle it.”
One can't decide if laughing or crying is more appropriate at a statement as naive as that. Others are merely hoping that things remain stabel for the next 5 years and all works out according to plan.
Cohn doesn’t see the threat of a rate change as a problem. When she retires in two years, she and her husband are moving to Panama, Cohn said. If they can’t sell the house at that point, they’ll rent it for the following three years and sell then, before the loan adjusts, said the 60-year-old human resources manager at a Silicon Valley company.
“A fixed rate isn’t for everybody,” Cohn said. “We know we’re moving so there’s no point in paying for a guaranteed rate if we won’t use it.”
Regardless of how confident borrowers are of their plans to stay in a home for a limited time, there are no guarantees home prices will provide them the opportunity to refinance or sell, said Erin Lantz, director of Zillow’s Mortgage Marketplace, an aggregator of loan rates.
“On a national basis, home prices probably will continue to rise, but it’s more difficult to predict by region,” Lantz said. “If you go underwater, you’re going to have to bring money to the table to get out of that mortgage.”
Another assumption of ARM applicants is that their income will be higher by the end of the loan’s fixed period so they can handle higher payments if they can’t sell, said Henry Savage, president of PMC Mortgage Corp.
“When you start making those calculations, you’re playing golf in the dark,” said Savage.
"But what's wrong with that?" the Fed Chairman will ask - he does it all the time, only in his game the cost of losing is hundreds of millions of lives. What is one person's ARM blowing up in their face by comparison.
And since the most frequently used word in this article is hope, here is to hoping. Hoping that this time will be different even though everyone knows it never is.