Cause and Effect in the Housing Sector

The main causes are high foreclosure rates, excessive losses to the funding sources, a decline in property values (in several large markets), a much greater number of “exotic” mortgages held by consumers, and the adjustment of many ARM loans to levels too high for homeowner’s to maintain. You may be wondering what is an “exotic mortgage”? This is the term that federal regulators have come up with to describe both Interest Only mortgages and Negative Amortization mortgages. Interest Only loans have a time period where you only pay the interest of the mortgage- The monthly payment is less than a normal mortgage, however the balance of the loan remains the same. A Negative Amortization mortgage goes a step further by offering the borrower the opportunity to make an extremely low payment each month, but the difference between that low payment and the actual amount of interest on the loan is added to the balance of the mortgage. Basically if you make the cheap payment, you end up owing more than where you started.

The Cause:             All of the causes above could really be expressed as one cause, but the media likes to break them up because it makes for better headlines, and they can talk about a different cause every day of the week. I’ll use an example to illustrate the basic chain of events that has caused a huge mess- Meet John and Jane our homebuyers/homeowners. John and Jane are shopping for a home in late 2005. They employ a real estate agent to help them. Eventually John and Jane buy the absolute biggest house that they can afford at the advice of their Realtor; they use a 100% Interest Only (Exotic) Loan to be able to afford it; they had some credit issues to start and no savings so their loan is a “non-conforming” loan; they initially got the loan with intent of refinancing it before the adjustment date; during the 3-yr fixed period on their loan, the INDEX that drives the adjustment increased over 4%; the public sees that rates are increasing, so home sales slow down; John has some bad luck and gets laid off his job; the ADJUSTMENT DATE comes… This is were it gets ugly- Their interest rate increases by 4% and there payment changes to a PRINCIPAL and Interest payment rather than an INTEREST ONLY payment. During that 3-yr period, John and Jane only paid the interest on the loan, so they own the same principal balance as when they began. Since they got a 100% loan, they, in effect, owe 100% of the market value of the home. Add to that the fact that sales have slowed in their area; houses sit on the market; sellers lower prices to get rid of them; the value of John and Jane’s home has just decreased. This scenario happened millions of times across America as every joined in the housing boom that carried our economy through out the recent recession.

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