If the current housing market could be produced into a prime time serial TV drama, chances are it would run for several seasons. Just when it appears that the drama is over, the plot thickens and the script is rewritten with a new cast of characters for the next several months. In the tradition of Dallas and Dynasty, come Fannie and Freddie. Big oil is replaced with foreclosures, bank failures, and government takeovers. Since life imitates art, this happened before anyone could write such a non-believable script. Art does not imitate life.
When will it End?
Last year when the first wave of bad news hit regarding Sub-prime, it was analogous to a tidal wave coming ashore and destroying everything in it’s path. While the first wave continues to move up shore and to higher ground it is followed by smaller waves that follow the path but are far less destructive, but gradually raise the water level. The question becomes “How much higher will the water level go before we begin to see some dry land?”
The enclosed graph depicts the spread between a 30 year fixed interest rate and a 5 year adjustable. The spread or advantage that adjustable rates offered began to diminish in early 2006, but until then many people took advantage of these lower initial rates and corresponding lower payments. Adjustable rates offer you a couple of options such as (1) refinancing or (2) allowing it to adjust to a higher payment.
Therein lies the other proverbial shoe that will drop. Once these rates expire, where will that leave the borrowers who were not a credit risk and did not finance their purchase with 100% financing or sub-prime loans?
Borrowers Catch -22
The big variable, the trump card, will be “What happens to home values”? In the past refinancing a home was not a problem simple because the mortgage balance was less than the market value of the property. Homeowners had this forgotten thing called “equity”. That cannot necessarily be said of today’s homeowner. Many homeowners’ previously withdrew the equity from their homes as they refinanced for the second or third time. This brings us back again to the declining value conundrum. Refinancing will not be an option if the market value is less than the balance owed. Refinancing may not even be an option with 5 to 10% equity!
It appears that housing will continue to make the evening news as this current situation still has legs and a ways to go before it plays itself out. If only it were one hour per week.
About Doug Willis
What You Have To Say