Thursday, May 11, 2006

Reality Foreclosing in on San Diegans

A couple of years ago, the Indigent Girlfriend and I were astounded by a friend of ours who bought a $380 thousand home with no money down. That friend has since sold that home and moved to Texas. She was the smart one. Our other friends that have recently purchased homes have done so with no money down and something called an adjustable rate, interest only loan.

I'm not about to explain all of these mortgages in detail because I don't really know that much about them. However, when I was in Waveland, MS last year, there was a mortgage banker from Illinois a few bunks down, and he seemed to believe the loans being approved in California were way out of balance in terms of mortgage-to-income and other indicators. He predicted that as interest rates rose, so would foreclosures.

The rate at which borrowers are foreclosing on their mortgages has doubled since last year, as high-risk financing has become the norm for home buyers in San Diego County. Local experts wonder whether the recent spike in foreclosures is a harbinger of horrors to come or of the much-hyped "soft landing" for the local real estate market.

Perhaps even more indicative of the state of the housing market, in January 2005 no properties were seized by lenders through the foreclosure process in San Diego County. Every one of the homeowners who had defaulted on their loans managed to offload their property without the bank closing in on them. But last month, lenders seized 66 properties through foreclosure processes. That's almost as many as in the whole of 2005.

Obviously! Of course foreclosures are going to rise along with interest rates, and the Federal Reserve has just raised the rates again yesterday, to five percent which is a six-year high. It stands to reason that some people will not be able to afford the effect that will have on their adjustable rate mortgage payment, and they will have to sell the house or be foreclosed upon.

Having said that, there is a greater problem in San Diego and southern California in general. People are getting what I would classify and complete sucker loans. I personally know people who have purchased homes with interest only loans, and now I read that some San Diegans are using something called a negative-amortization loan where the home-owner doesn't even make a complete interest payment, the balance of the loan actually increases each month.

In 2005, more than 70 percent of home loans in the county were interest-only or negative-amortization loans, according to Loan Performance LLC, a San Francisco-based firm that analyzes lending statistics. With interest-only loans, a borrower only pays off the interest on their loan every month for an initial time period. With negative-amortization loans, the borrower actually pays less than their interest payment each month, meaning that the amount they are borrowing grows over time.

Loan Performance reported that in 2005, 26.7 percent of loans made to homebuyers and those refinancing their mortgages were negative-amortization loans. In 2004, that number was 9.9 percent. In 2003, it was 1.1 percent.

In addition, the vast majority of loans issued in San Diego County in recent years have been adjustable-rate mortgages. The interest rates for these loans are indirectly tied to short-term federal interest rates. Those rates have been rising recently, which means many people's mortgage payments have been increasing, leading to an increased chance that they will succumb to foreclosure.

In other words, 96.7 percent of all home loans in 2005 were made to people who could not really afford to buy a home. Home buyers have gotten away with this in the past because the value of their property has been sky-rocketing, allowing them to refinance and ease the burden of the rising mortgage payments. However, property values have flattened out in San Diego. The equity fairy isn't going to come riding in a white stallion to save anyone, not for a while at least. That will mean more foreclosures and more foreclosures will mean more properties on the market. It becomes a self-sustaining problem until all the would-be home owners who cannot afford a home in San Diego have been weeded out.

To be fair, some of the folks who go into these sucker loans were speculators. They thought they were going to make a fortune in real-estate and bought properties with adjustable rate interest only loans expecting a reasonably profitable short-term turn-around. These amateurs will be cleaned out of the market in the next couple of years.

It used to be that speculators could at least become land-lords and rent their properties if they had to hold on to it for longer than initially planned, but that is no longer the case. For example, the 1550 square foot house I am living in goes for about $525 thousand on the market, but I pay $1,625 per month in rent. That is admittedly a pretty good deal, but nobody in this neighborhood is paying more than $2,000 per month in rent. That's the ceiling on what the market will bear from renters. Now, by the time you add mandatory insurance and taxes to a 30-year $525 thousand loan, it starts looking a lot like $2,700 or $2,800 per month. So, speculators and distressed home-owners can no longer count on renters to come in and save the day.

This gap between rents and mortgages will only get worse until mortgages come down, especially since residents are fleeing San Diego County.

For the first time in more than three decades, the population of San Diego County declined last year, joining other California coastal counties that are losing their allure as high housing prices drive home-buyers to more affordable regions.

The surprising reversal of the county's long-standing population gains is revealed in U.S. Census Bureau estimates released today showing thousands more people leaving the county than moving in from other parts of the state and elsewhere.

In terms of real estate, this is a perfect storm. However, I don't believe this is going to be that big bursting bubble that everyone keeps talking about. I don't think that is going to happen. Don't get me wrong, I would be doing back-flips if I woke up to tomorrow and San Diego housing values were half what they are today (that's not real popular at parties). So, in addition to flushing under-funded speculators and home-owners, the flattening of real estate values will also dry out the other equity-based spending that has been happening in the county. All those people who have been refinancing once a year and splurging on big screen TVs and new cars will no longer be able to do so.

I don't pretend to know to what extent this is happening nationwide, and I don't know what impact this will have on the economy, but it can't be good.