Where's the Kaboom?

Two years before the hot air began escaping from the housing market, some real estate economists and pundits were eagerly anticipating the explosion of the real estate bubble. Bubble theorists believed property values were so inflated that they developed the KABOOM theory. The BIG KABOOM would be heard all over the country and since California real estate had the most amount of inflationary hot air, the KABOOM would be the loudest and the ripple effect would be devastating.

Real property values were going to fall like a rock. The collapse of the housing market would result in a severe recession. There would be a plethora of bankruptcies, mortgage defaults and foreclosures. Builders would be standing in long unemployment lines with their buddies, lenders and real estate agents, who were all somehow responsible for the inflated housing market and its subsequent downfall.
It was the summer of 2005 when the number of home sales began to fade. Homes were taking longer to sell and some (surprise) didn’t. Builders quickly adjusted to the changing market dynamics by offering incentives and price reductions. When investors and flippers realized that the market had peaked, they dumped their properties, acerbating the problem of too much inventory and too many skittish buyers. Had the doomsday predictions of the BIG KABOOM come to pass? After a year and a half into this market correction a realistic look at its severity may provide us with a sense of its duration.

Between the summers of 2000 and 2006 the median selling price for a home in El Dorado County appreciated 158 percent or 26 percent for each of the last six years. The Capital region’s average of 103 percent over 5 years was also unprecedented. The median selling price for a regional home has declined 10 percent from last year while the median for El Dorado County continues to hold near last year’s levels. Nationally, housing values are expected to decline 1.7 percent from last year but remain 45 percent above 2000 levels. Although most housing prices have settled below last year’s level, 90 percent of all home values are far above their original purchase price.

To the disappointment of the KABOOM theorist, the housing recession isn’t having the devastating effect on our state or national economy. According to the most recent economic reports from the experts at UCLA and the University of the Pacific, things aren’t so bad as most people predicted. Economic expansion isn’t growing at the same rate as it did in 2004 and 2005 but our economy remains healthy with no recession in sight.

State statistics reflect a 30-year low unemployment rate of 4.5 percent and payrolls continue to grow. Residential construction employment is down but commercial construction is lively. Chuck Williams, dean of the University of the Pacific’s School of Business, said the housing slowdown would continue to curb the rate of job growth but only slightly. Nationally, job creation continues at a healthy pace, inflation is low, the stock market is at an all time high, consumer spending is above last year; economic growth is good by any measure.

The number of home sales is sluggish but they continue. Thirty-five hundred homes were purchased in the region last month and over 35,000 families have closed escrow on area homes since the first of the year. The number of foreclosures is still negligible and bankruptcies are lower this year than last. The real estate market has settled down to a more sustainable pace and the positive economic signs and growing population in the region is a good indication that the worst is behind us.

Declining home sales continue to be the anchor weighting down home prices. Buyers have been paralyzed with uncertainty, much of which can be attributed to the media hyping the BIG KABOOM theory. No one wants to buy a home and watch its value evaporate. There are signs, however, that potential homebuyers are getting weary of the media’s continued emphasis on the free-falling housing values that are not materializing. When more buyers realize that the sky isn’t falling, their confidence will begin to move our market forward.

Housing Predictions for 07

Existing-home sales are expected to rise gradually in 2007 from current levels, with annual totals comparable to 2006, while new-home sales will continue to slide, according to the latest forecast by the National Association of REALTORS. David Lereah, NAR’s chief economist, said there are mixed conditions around the United States. “Roughly three-quarters of the country will experience a sluggish expansion in 2007, while other areas should continue to contract for at least part of the year,” he said. “Most of the correction in home prices is behind us, but general gains in value next year will be modest by historical standards.”

Nationally, new-home sales in 2006 are expected to fall 17.7 percent to 1.06 million, the fourth highest total on record, before sliding an additional 9.4 percent in 2007 to 957,000. Much of the contraction in the new housing market results from cuts in builder construction to support pricing for current inventories. In addition, high construction costs in many areas are minimizing potential profits.

The 30-year fixed-rate mortgage is forecast to gradually increase to 6.7 percent by the fourth quarter of 2007. Last week, Freddie Mac reported the 30-year fixed rate dropped to 6.11 percent.

I would settle for a little expansion in housing sales, fewer new homes and interest rates below 7 percent. That would be something to look forward to next year.

Another tax deduction for homeowners

A federal tax deduction for mortgage insurance is all but assured after bills which include the provision were passed last week by both the House of Representatives and the U.S. Senate. Only borrowers who close loans during and after 2007 and make less than $100,000 a year will be eligible to deduct the private or government mortgage insurance paid for the year.

During the past five years, about one in five new loans have included mortgage insurances but the number of new policies has fallen. The group's "2006-2007 Fact Book &Membership Directory" reports nearly 1.6 million private policies and about 700,000 government policies (for FHA and VA loans) were written in 2005. In 2002 there were approximately 2.3 million private policies and about 1.6 million government policies written.

The growth in the use of piggy-back loans, down-payment assistance programs, other creative financing and rapid home price appreciation that allows home owners to refinance have all contributed to the declining number of policies.
Because buyers with down payments of less than 20 percent have higher default rates, the insurance is typically mandated on low down payment loans or first loans that don't also come with a second or "piggy-back" loan to bring the down payment to 20 percent. The insurance protects the lender from default, but the premiums are paid by the home owner.

The premiums can be $100 or more a month but the extra cost can help a home buyer qualify for a home that otherwise could have been out of reach. The insurance can also help a buyer buy a larger home, buy a home sooner and hold onto some cash after they've purchased a home with a smaller down payment.
Mortgage insurance has been around in some form since the late 1800s, but it wasn't until 1999 and the federal "Homeowners Protection Act of 1997" when home owners gained disclosure reforms and broader insurance cancellation rights.

Since 1999, private mortgage insurers must annually disclose the amount of insurance paid and automatically cancel mortgage insurance when a homeowner pays down the mortgage to 78 percent of the original purchase price. A lender also must cancel the insurance if a home owner requests it and the mortgage balance is 80 percent of the original value of the house.
In both cases, the borrower must be current on mortgage payments and meet other requirements. Refinancing to a loan that's 80 percent or less of the home's value remains an option.

With a presidential signature, which is likely, the new law will allow the tax deduction for all mortgage insurance -- private and government -- paid by qualifying tax payers.

When Catastrophe Happens

I believe that most of the time when we get ourselves into a jam we can usually figure a way out. My grandfather, who was a small town minister, used to tell me “When the devil slams a door in your face, the Lord always has a window open somewhere. All you need to do is look for it.” He would always blame the devil for whatever disagreed with him and thanked the Lord for his blessings. I was reminded of his simple mid-western philosophy when a former client called me last week telling me he was three-months behind on his house payments.

I had helped Bob buy his first home a little over a year ago. It was a small 2-bedroom condo priced under $200,000. Bob didn’t have any money saved for a down payment and closing costs, so I structure a 100 percent loan and had the seller pay most of the closing costs. Bob’s total move-in cost was less than $2,500. He was a happy guy. What happen to change all that?

Over the last year Bob had made some poor life decisions. As soon as Bob closed escrow on his home he was besieged with offers from merchants and credit card companies with promises of quick money and easy repayment terms. He failed to consider the long-term implications of consumer debt. With his new credit cards he proceeded to furnish and decorate his new home with top of the line electronics. Since the garage had so much empty space, he filled that too with big boy toys. He was enjoying the toys so much, work became of secondary importance. After he lost his job, depression set in and to avoid facing the consequences of his past follies, decided to travel. Unemployment insurance wasn’t nearly enough to travel first class so he used his credit cards. When he finally came home and to his senses, he called me.

The lender had already started the foreclosure process and once in motion, stopping it was unlikely. I knew that the condo wasn’t currently worth the money Bob had paid for it eighteen-months ago. There was no chance of selling it quickly and with a mortgage default, no chance of obtaining a home equity loan. I felt a little responsible for getting Bob into this home and remembered having lobbied the lender into making him a loan. I wasn’t about to watch a financial catastrophe happen.

The first thing I made Bob do was the thing he had been avoiding the last few months. He needed to call the lender. He would be required to fax or mail them a letter naming me as his trusted advisor. Lenders will not discuss or negotiate a borrowers position with another person unless they have a borrower’s written permission or power of attorney. Bob didn’t have a clue about short sales or negotiated settlements and I could not have him making commitments that he could not keep. Bob had some options but they all required the lender’s approval. Lenders hate foreclosures as much as borrowers and this one gave us 10 days to come up with a plan to cure an $8,500 problem.

We needed to show some immediate good faith and demonstrate that this loan and borrower were worth salvaging. Bob needed some money quickly. As much as he hated it, I had Bob put everything up for sale in the condo and garage that he couldn’t wear or eat. Most items were financed on credit cards. The credit card issues could be dealt with after we stopped the hemorrhaging. Next I had him contact every friend and relative, confess his stupidity and beg for money. While he was busy parting with his toys and eating humble-pie, I had him get his old job back and take another part-time job after the first one ended. Since Bob was going to be busy working two jobs he wouldn’t be spending much time at home. He needed a roommate. After a week, Bob had raised $6,500 and had a roommate who was paying him $800 a month rent. It was a start.

The lender took the $6,500, waved the delinquency and attorney fees but not the back interest. The lender charged Bob $500 to rewrite the note and added the $2,500 shortfall to the note. It will take Bob a year to work off the credit card debt. He is still working 65 hours a week and not thrilled with having a roommate. He misses his plasma 50” HDTV and his Harley but knows he made the right decision. When bad things happens, look for a window.