FHA loans now make up 25% of the mortgage loans in the U.S. That is up from 3% just a couple years ago.
I smell a bubble.
Meet Phil Phorclosure. Phil meets the minimum requirements for an FHA (government) home loan.
Phil had a bankruptcy in 2006, and a foreclosure in 2005. He’s only been able to hold a job for two years and he’s never gotten a raise, doesn’t look like he’ll get one either. He’s not making much money and doesn’t have a savings or checking acount. He doesn’t have the 3% to put down on a house, so he decided to use the $8,000 Federal Tax Credit as his downpayment. He qualifies as a first time home buyer since he’s been renting since the foreclosure. His FICO is just above the lowest scoring range.
Phil is about to take out a loan with no-money down that is proving to be new fuel for the re-inflation of the housing bubble. Sound familiar? The ending will be too.
If you can look past my clearly lacking artistic capabilities, I’ll explain why I believe there is a mini bubble in the housing market that began this summer and should be ending soon, and let me add one caveat – not all markets are equal. The markets with the largest run-ups, like Orange County in California, have the greatest distance to fall. Some markets that did rise some, but not excessively during the bubble, are at or already near the bottom. That is not most markets, however.
There are three main ways the housing bubble is being re-inflated.
And as usual, government intervention is leading the way in manipulating the marketplace.
The first is the widespread expansion of the use of FHA loans. FHA loans only require a 3% downpayment. That’s like no down payment at all, and consider that the $8,000 Federal Tax Credit can be used as part or all of the downpayment. So again, like the original bubble, buyers have no skin in the game, none of their own money invested. In fact, the typical broker fee of 5% if they try to sell the house is more than the 3% they put down, so before they even start, they are upside down on the property.
If they get laid off, or decide the continued depreciation of the house is not worth sticking around, these people will walk away just like those who did during the first bubble.
FEDERAL AND STATE TAX CREDITS
Federal and state tax credits only distort market pricing, like all subsidies do. The price of something is based on what someone will, or can, pay for it. If I am willing to pay at most, $2 for an apple, and the government offers me a credit of $8 towards buying an apple…if you were the apple seller, what price would you make the apples? I know you’d make them $10. Why not? You’d take my money and the governments, it’s all the same green to you. And as far as me the buyer…no difference to me…I’m still out only $2.
The Federal Tax Credit is $8,000. Right off the bat, that means that homes are $8,000 higher than they should be because the seller is already baking in the $8,000 to their asking price. If you can afford a $200,000 house…you will look for a $208,000 house, so the seller who would have had to settle for $200,000 will gladly sell it to you for $208,000 so that is where they will put their price.
When California was also doing their $10,000 tax credit this summer, home prices were automatically $18,000 over valued when you combine both tax credits.
There is a significant amount of homes that have been foreclosed on that are not being listed. This shadow inventory prevents the prices of surrounding homes to be readjusted to the real market value based on the available inventory of homes for sale in the area. Consider why this happens. You are a bank. You already have a raft of foreclosures on your financial statements and you are trying to sell them for whatever you can get for them. What you can get for these properties is based on what other properties in the area are selling for. As your properties, and others, begin to go through short sales, they pull down the prices (value) of surrounding homes, whether they are for sale or not. As you try to get what you can for these homes, more homes in those neighborhoods go into foreclosure. As a bank, you don’t want to put even more short sale properties on the market which will only further reduce the homes you are already trying to sell for as much as you can. This is shadow inventory. Foreclosed homes that the banks are not listing to artificially inflate the value of surrounding properties.
ADDITIONAL FORECLOSURES ON THE WAY
I’m saving this for another post, but to be sure, another wave of loan recasts has been occurring this summer. It takes 6-12 months for recast homeowners to begin missing their mortgage payments and the entire foreclosure process to move through the pipeline. There is another wave coming and this will put even more downward pressure on prices.
Categories: Housing Market