100% Financing Doesn’t Help a “Frothy” Housing Market

Plenty of people in the real estate and lending industries are worried about a bit of “froth” in the housing market. Prices of homes throughout the country have been rising steadily for the last five years, but the concern seems to be that the market will take an abrupt hit very soon. Part of the problem stems from the fact that investors have been pouring millions of dollars into property instead of stocks and bonds as they have in the past. The uncertainties of the stock market have driven these investors towards property, and they have been buying houses on speculation at a furious pace. Another cause for the increases in price is the rampant examples of mortgage fraud.

It really doesn’t matter who is buying the property or what they are doing with it, as long as the mortgages get paid. The problem with that is the types of mortgages being used by speculative buyers. With prices increasing in some areas at 30% per year, investors are trying to buy as many homes as possible. They will buy one, rent it out and then buy another. Some investors, starting with a modest investment funded by the equity in their own houses, have created little real estate empires valued at several million dollars. In order to keep buying, the amount of money paid out for each house has to be as small as possible. For this, the investors look for certain types of loans - Option ARM mortgages, which keep the payments as low as possible, interest-only loans, which don’t require payment of any principal for several years, and loans that allow the lender to provide 100% financing, with literally no risk to the buyer.

These loans are just fine, as long as the bills are being paid. But we are a nation of homeowners, not renters, and some cities are already seeing a glut of rental property. A neighborhood can only support so many rental houses, because most people would rather buy. The only way that an investor can keep buying property is if he or she can keep renting property, and if the renting stops, the buying stops. Worse, once the renting stops, the owner has to make the payments out of his or her pocket. This can be quite a difficult proposition if the owner is already seriously leveraged. This scenario is already playing out in a few cities. In parts of Massachusetts, property foreclosures are up nearly 30% over last year, as more and more owners simply walk away from their investments. It’s easy to do when you have put nothing down and have no money risked.

It’s unlikely that we will see a nationwide crash in housing prices. After all, everyone needs a place to live. What we may see in the short term is an increase in available property in certain markets and a bit of a correction in prices. Along with that will be a long period, perhaps a decade or more, of no increases in property values.