My 1st Million At 33 – yes, you can do it too

Most of the housing market bears clamor about the 2 trillion dollars reset of adjustable-rate mortgage in 2006 and 2007 (and beyond too). Such a resetting event to a higher interest rate will potentially create a havoc and dramatically increased foreclosures in the housing market. While personally I prefer the housing market to tank, objectively I must say that an immediate fallout from such events is NOT necessary.

The main reason for me to say this is that through refinancing, it is actually possible to save the homeowners. One of my friends was shopping for mortgage, and the bank was willing to refinance his ARM into another ARM loan at 80% loan-to-value ratio, and another 20% loaned as home equity loan, totalled at 100% LTV. It’s unbelievable how low the lending standards have gone down. I read an article in which the mortgage officer said that anyone who can breathe and can sign their name, can get a mortgage. All of these irresponsible lendings have led to the current overblown housing bubble, and eventually will end badly (unless US government devalue $US to cause inflation to take care of the debt problem). Despite the fact that there are some signs of lending tighting this year both in terms of the regulation advisory and the actual market interest rate, in general lending is still quite lax. With a sufficient home equity to fall back, a successful refinancing deal can be made and save the doomsday of the people in ARM.

Currently, the only bigger ARM problems are the 3-year ARM, since ARM didn’t become very popular until 2002/2003. Supposed that you buy a house of $500K in year 2003 in the state of California. After two years of 15% to 25% of appreciation (possibly more), your property is now worth $780K (25% in 2004, 25% in 2005, 0% in 2006), a $280K gain, or 56% total gain. Assuming that originally, you paid $100K downpay, and took out an ARM loan of $400K.

For a 3/27 or 3-year fixed ARM, the payment will increase from $1686.42 to $2393.54 for an initial interest rate of 3% to 6.25%, or from $1909.66 to $2417.97 for an initial interest rate of 3% to 6.25%. The payment shock is big, about 42% or 27%. Furthermore, because of all the home equity in the house, they can easily refinance (and cash out) into another 3-year or 5-year ARM at an interest rate of about 5.75% right now at a payment of about $2334.29. Assuming that they can somehow fake the income (which is illegal to do) or use low-doc loan, getting approved for a $400 to $650 additional loan should not be a problem. In the extreme case of no-doc cash-out refinance, and using a LTV (Loan-to-value) ratio of 70% (a quite conservative ratio for cash-out refi loan), they can take out about $780K * 70% – $400K = $146K. The refi loan amount will be $546K, with payment of $3186.31 (at 5.75% interest) enough for them to pay out the difference of $1500 to their original payment for 8 years. A truly house ATM machine! The reality is probably anywhere in between the full cash-out, and zero cash-out. As long as the homeowners can get approved or fake through cash-out refinancing process, they are certain to obtain sufficient amount of cash to repay the monthly income difference.

As you can see from the above examples, through refinancing (or re-refinancing most likely), it is possible to delay the ultimate pain by refinancing into a new ARM. This is one of the major reason for arguing that the housing market won’t falling much for another 2 to 3 years in my previous article of Unconventional Strategies in this Housing Market. This is especially true for bubble areas that that have enjoyed substantial appreciations. In my next real estate example, I will look at interest-only and option ARM (negatively amortizing) loans.

For some other views, you can read the followings:

1. Re-refinancing, and putting off mortgage pain. This story from NY Times is no longer free. You can only read a small segment from that link.
2. Will adjustable-rate loans lead to record foreclosures? from USNews.