Greenspan gave him $275K, and he spent it all
Posted by Frugal on December 12th, 2006
I just read this story from LaTimes.com. Some guy had an equity of some $275K in his home, and he spent through it all. Here are some interesting excerpts from that link:
In the first eight months of 2006, even as the real estate market began to weaken amid fears of a downturn, the appeal increased again. Nearly 1 in 3 California loan applicants are now choosing them. The state boasts about 580,000 active pay option mortgages, about half the U.S. total.
Hertzberg’s home equity paid off his credit cards, financed trips around the world that allowed him to indulge his passion for photography, bought a $32,000 Toyota Avalon and enabled some lousy investments. He bought dot-com stocks and lost money. To recoup those losses, he bought commodities — and lost money faster.
But the day of reckoning is arriving early. By paying the minimum, Hertzberg has increased the size of his loan in a little over a year from $320,000 to $332,616. His lender, Calabasas-based Countrywide Financial Corp., recently sent him a letter warning that when his loan hits 115% of its original size he’ll run out of credit with the company.
The article said that his “life line” will run out in two years. But my calculation shows that it should be another four years (about 3% every year). Maybe I’m not using the correct current interest rate. In any case, such loans get recast every five years. So looks like he delayed his time bomb to 2010, assuming that he can get through annual 7.5% increase in the minimum payment year after year.
If you think his case through, don’t you wonder where the funny money comes and goes? It’s a house in 1995, and it’s the same house, but older in 2006. Just the valuation of the house has changed, but no economic productivity has increased. The flood of cheap money is coming from Asian savers and central banks, while Americans spent thru it. When Asian savers retire and start to withdraw money from the system, where will the “money” which is already spent come from?
When the wealth of a society is created primarily based upon a higher valuation of the assets, the wealth can go away as easily as it comes (when the valuation changes).
I’m guessing that at the end, the creditors/savers cannot get their saved (paper) money back, since the debtors/spenders would either have no money to pay back, or print more worthless ever-depreciating paper money for the savers.
As far as the real estate market goes, I’m still in the camp of slowly unwinding from the height, since the lending standards have not tightened much (this guy Hertzberg was able to refinance last fall). The housing market may rise up again if
- wage income inflation catches up with the past housing inflation, or
- long term interest rate falls even further, hard to imagine, but that’s the current forecast by the bond king Bill Gross (down to 3%).
I’m guessing that scenario #1 is more likely, if $US undergoes an orderly decline. But the outsourcing trends will probably cap the wage increases.
I don’t believe that scenario #2 will happen. I believe that along with the turn of housing market, the bond market has also turned. The sentiments among foreign central banks have turned, and diversification out of $US has been the key messages.
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December 12th, 2006 at 12:38 pm
I believe this is called a negative amorization loan, which is the worst loan you can get.
People get it because they can get alot of house for a low monthly payment. I blame the mortgage lenders for luring this people into this type of loan. They know it’s near impossible for them to ever own the house. I cannot believe this practice is legal.
December 12th, 2006 at 7:52 pm
Sadly, many American took advantage of the “home ATM” during this recent boom. It will be interesting to see how these cases will effect the market. Heavy losses could be on the horizon for many lenders, as ARM’s reset and home values decline.
December 12th, 2006 at 9:24 pm
moneymonk Says:
December 12th, 2006 at 12:38 pm
I believe this is called a negative amorization loan, which is the worst loan you can get.
Larry Says: SPEAK FOR YOURSELF PLEASE.
December 12th, 2006 at 10:36 pm
The problem is that most people do not know how to compute mortgages. If they do, not only will they see that this is a bad deal, but they may even find errors, too. Yes, banks make mistakes. I was overcharged thousands. It took me 6 months to rectify due to personnel incompetency.
December 13th, 2006 at 3:07 am
You’re crazy if you think long term bond yields won’t decrease more. Maybe not in the near future, but they will. (Gross was early, but I think he’s more correct than not.) As for wage inflation catching asset deflation (because honestly, both of those need to occur in fix the affordability problem), it may happen but probably not enough to get as many people back into the housing market as were swept in in the last 5 years.
I was planning to say something witty about that bogus “savings glut” but I lost it. That’s what I get for blogging at work. I’ll be back.
December 16th, 2006 at 3:08 pm
I think Khyron may be right - the effect of the asset deflation in housing could cause the Fed to ease, further encouraging borrowing short to lend long. Plus, if long term assets are deflating, then 3% is actually a relatively high real rate (since asset prices are falling, the rate at which they are doing so has to be added to the nominal interest rate to determine the real rate).
But your point about globalization is a good one and the Fed has a real problem in lowering rates, which is why they are jawboning about inflation. The dollar is already weakening at a pretty good clip, and the impact is being felt in many places, if not so much in consumer prices. Wouldn’t sharp easing lead to further devaluation, further increasing prices of imports and commodities that are traded globally? I suppose that other central banks could also “competitively devalue” and lower their interest rates to prevent their currencies from rising, but Japan is already just at 0.25% and China is trying to reign in lending, too.
Ultimately, bad lending ends badly, so I suspect that one way or another this will end quite badly. When it does, I think Bill Gross will be right. I think it will take until 2009 before the impact of the housing bust in the US really hits the US economy, but when it does the overall reduction in economic activity and consuption will mean that credit will be cheap in nominal terms, but still hard to come by, because most potential creditors won’t be creditworthy given their existing obligations (think Japan for the last 15 years).
December 18th, 2006 at 9:26 pm
Khyron, Doug,
You’re making very good points on the interest rate. The main reason that I believe long term interest rate will not go down to 3% is that I believe inflation will be higher than 3%, due to peak oil (energy inflation) & US dollar devaluation. Short term rates will almost definitely go down to 3%, but NOT necessarily long term rates. I believe that in the next round of Fed lowering interest rates, bond holders & US dollar holders will not cooperate very nicely.
We will see how it unfolds, and it is definitely possible that both scenarios are true, and staged one after another, instead of happening in the same timeframe. By that, I mean, long term actually goes lower, but goes right back up after inflation kicks in high gear.
December 20th, 2006 at 6:24 pm
When you get a mortgage like that, would it not be easier to hit Vegas and blow it all in one shot, or strike it rich? It would save you alot of time, and the markets would correct faster.
December 20th, 2006 at 8:28 pm
I like your humor, Snap Up Real Estate.
It may be even better in terms of odds of winning, comparing to speculating in futures market.