Interest Rate Squeeze

The Boston Globe is reporting Some squeezed as interest rises, home values sag.

Squeezed by rising interest rates, homeowners who stretched their finances to buy properties while the market was hot are scrambling to pay higher monthly payments on adjustable-rate mortgages that were the least expensive option at the time they purchased their homes.

An end to years of double-digit appreciation in Massachusetts home values has shut the door on refinancings that bailed thousands of homeowners out of bad financial decisions, said mortgage brokers and counselors as well as homeowners.

"The bottom line is so many people took the fashionable mortgage rather than the right mortgage," said Harry Brousaides Jr., president of NorthStar Mortgage Corp. in Westwood. Now, he said, "they're sweating it and not knowing what the future will bring."

"A lot of people live paycheck to paycheck, and they're losing a couple hundred bucks a month" due to higher rates, said Edmund Poli of Poli Mortgage Group in Norwood. More homeowners are coming to his firm for help, but "sometimes there's not much they can do because they have 100 percent financing."

If housing values fall sharply, said Thomas Callahan, executive director of the Massachusetts Affordable Housing Alliance, the current pinch on some homeowners may be the tip of the iceberg. "I have a sense it could get ugly soon," he said.

In March 2004, John Ryan, a postman in Brighton, received a no-down-payment loan for his $430,000, three-family home in Framingham. He and his wife, a nursing student, live in one unit. Rents from two apartments cover all but $900 of their $3,600 monthly payment, which increased after renovation expenses -- for new bathroom tile and kitchen cabinets -- were rolled into the second mortgage.

Ryan has what is known as an "80-20" mortgage. The loan's advantage: it eliminates the need for mortgage insurance that can add at least $100 to monthly payments. The bulk of Ryan's home purchase price -- 80 percent -- was financed with a primary mortgage loan. A second loan financed the 20 percent balance of the purchase price.

Typically, at least one of the loans -- usually the smaller one -- has an adjustable interest rate. The introductory rates on both Ryan's loans were fixed, but for only two years. He currently pays a 6.4 percent fixed rate on the large loan and 9 percent on the smaller one.

His grace period ends in March when the 6.4 percent rate -- and payment -- will adjust and begin floating. The new rate will be based on the prime rate, which was 4 percent when he purchased his home. But it has spiked to 7.25 percent as the Federal Reserve Board raised rates in recent years.

Ryan is the type of consumer who always looks for the hidden costs when someone is selling to him, but he agreed to an 80-20 loan because he had no intention of living in the house long term.

Now Ryan's plan to refinance to get himself out of a tight spot is clouded by worries that a loan appraiser will not value his property high enough. Last June, an appraiser told him the house might be worth $535,000. Since then, two similar properties on his street sold for $450,000 and $460,000, which may pull down his appraisal, he said.

"Because the market's dropping and rates are going up, it's affecting refinancings and appraisals," he said. "You have to hang on and wait for things to swing up again."

Ryan's situation is "very common," said Steven Stolovitsky, Boston director of the Neighborhood Assistance Corp. of America, a national organization that counsels and finances home buyers. Lenders charge higher rates for no-down-payment loans -- even for customers like Ryan with good credit -- to compensate for the risk of a property with no equity.

Let's look closely at this situation

• Brian did not "intend" to live there long.
• Brian was willing to leverage himself 100% on the belief that home prices ONLY go up in a short period of time.
• Brian took out a loan tied to the prime rate. That is a very speculative endeavor to say the least.
• Last June the house was "appraised" for $535,000
• Similar houses are now selling for $450,000
• Assuming he could unload now for the full amount, a 6% commission on a sale at $450,000 would be $27,000
• $450,000 - $27,000 = $423,000
• Brian took out a 100% loan for $430,000
• It seems there may have been an additional but unstated renovation expense for new bathroom tile and kitchen cabinets which were rolled into the second mortgage.
• Brian is very much underwater whether or not renovation expenses are included in that $430,000 figure.
  
• He currently pays a 6.4 percent fixed rate on the large loan and 9 percent on the smaller one.
• Prime has now gone up from 4% at the time of the loan to 7.5% now
  
• If Brian pays the full adjustment (it seems he was in a prime + 3.5%) his new payment on 20% of that loan will be 11%. Yikes!
  

Ryan's situation is "very common," said Steven Stolovitsky, Boston director of the Neighborhood Assistance Corp. of America, a national organization that counsels and finances home buyers. Lenders charge higher rates for no-down-payment loans -- even for customers like Ryan with good credit -- to compensate for the risk of a property with no equity.

In a sense Brian is lucky. He is renting out a couple of rooms. But what happens if those renters leave? What happens if Brian loses his job? It is possible that Brian can sell now for a small loss. If he holds on and it seems he will based on this statement: "You have to hang on and wait for things to swing up again.", Brian and those like him are going to be in a world of hurt if prime keeps rising and/or housing prices keep falling.

Getting stuck in a mortgage rate tied to prime is sickening. Even if the FED starts cutting rates, there is no guarantee prime rate drops. Perhaps it even rises if defaults pick up. Those that thought housing was a one way ticket up might be in a serious shock over the next few years.

Not only is the interest rate squeeze on, home prices are falling as well.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/