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| The Basics | Cheap home loans today, trouble tomorrow
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Anyone with a pulse can now get a home loan. But higher interest rates in the future will mean fewer buyers and surplus inventory.
By Scott Burns
If advertisements in the Rocky Mountain News are any indication, Denver is the place to buy a house. Like the old Dire Straits song, it's "money for nothing" in this city.
Three tabloid pages have 12 advertisements for home mortgages at rates of 1% to 2%. Several offer no payments for six months. Others offer nothing down, no closing costs and interest-only programs. About the only offer missing is a single-payment loan, made posthumously from the borrower's estate -- but that doesn't mean some lender isn't working on it.
Then again, Denver isn't unique. You can get this kind of financing anywhere in America. Millions do.
And that's the problem. The same home-finance industry that has extended homeownership to millions of Americans is now threatening future home values with its generosity.
When anybody can get a loan
Skeptics should consider recent comments by Federal Reserve Chairman Alan Greenspan. Speaking in tranquilizing tones to the America's Community Bankers Annual Convention in Washington on Oct. 19, he reassured lenders that we weren't in a debt-financed housing bubble.
His most interesting comment, however, was: "In addition, improvements in lending practices driven by information technology have enabled lenders to reach out to households with previously unrecognized borrowing capacities."
Don't you just love it! Join hands with me, reader, and we will explore our "previously unrecognized borrowing capacities"!
What that means, in translation, is mortgage lenders will now finance anyone with a pulse. People with no down payments, poor work records, uncertain incomes and significant other debt can now go to a mortgage broker to be embraced, not rejected.
So while some worry about housing bubbles in the obvious places -- Boston, Florida's West Coast, most of California, Las Vegas, etc. -- all of us, wherever we live, should be worrying about the long-term effect of irresponsible lending. My thesis is simple: Much of the future appreciation today's homebuyers are counting on has been discounted into today's mortgage financing practices.
Tomorrows appreciation today
If you own a home with a low-rate mortgage, you're getting tomorrow's appreciation today -- in lower mortgage payments.
A rise in mortgage rates would bring two major dangers:- Inventory overhang.
- Fewer qualified buyers.
You can understand by examining two possible events.
First, consider supply and demand. With nearly 108 million households in the United States and 68% of them homeowners, we have more than 70 million homeowners. According to the National Association of Realtors, we're currently selling/buying existing houses at the rate of 7 million a year. That's nearly 10% of all homes. Reduce the buying pool from the largest in 40 years and homes will go unsold.
A sales slowdown would mean rising inventory and flat to sinking prices.
Second, consider the impact of rising interest rates. In a conventional mortgage, an increase from 5.5% to 6% causes the monthly payment to rise by only 5.6%. Not terrible. A full percentage point rise to 6.5% causes only an 11.3% increase in the payment.
The interest-only mortgage, however, starts from a lower base and reflects the full increase in the interest rate. The same 0.5% rate increase has a much larger impact on the monthly payment. If a 2% interest-only loan rises to 2.5%, the increase is 25%. If it rises to 3%, the increase is 50%.
Since a rising interest rate will turn some homeowners with variable-rate mortgages into sellers while turning some potential buyers into long-term renters, we could see a very rapid shift in the balance between buyers and sellers. It won't be a crash like the stock market, but millions of homeowners will get hurt.
Protect yourself
What can you do?- First, pray that rising oil prices and a falling dollar don't translate into higher short- and long-term interest rates.
- Second, if you own your home, pay down your debt as fast as you can. If you have a variable rate, convert to a fixed rate.
- Third, if you don't own a home but want to, don't let easy money talk you into buying more house than you could buy with a traditional fixed-rate mortgage.
- Fourth, if you're thinking about buying, think about how much house you really need, not how much house you want.
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MSN Money's editorial goal is to provide a forum for personal finance and investment ideas. Our articles, columns, message board posts and other features should not be construed as investment advice, nor does their appearance imply an endorsement by Microsoft of any specific security or trading strategy. An investor's best course of action must be based on individual circumstances.
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