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Wednesday, May 17, 2006

Typical Seattle Story

Thanks to reader Dukes for pointing me toward this story. When CNN wanted a typical story about a young couple getting in over their heads with ARMs and HELOCs, where did they turn? Seattle, of course.

Shortly after they were married, Aaron and Lacey Blank, now 25 and 27, wanted just what you'd expect: to buy their first home and start a family.

But like many young couples, the Blanks had trouble scraping together a down payment for a house in pricey Seattle.

By the time they found their three-bedroom, newly built home 40 minutes from downtown last year, they had set aside just $16,000. "We weren't planning to buy a place so soon, but we fell in love with the home and the area," says Lacey, a family therapist.
...
Though Lacey and Aaron, who works in public relations, earn a combined income approaching six figures, their $90,000 in student loans made it hard for them to qualify for a fixed-rate loan.

Their solution amounted to a financial high-wire act.

The Blanks took out a $271,000 interest-only hybrid ARM with a rate of 6.4 percent and monthly payment of $1,440 for five years. To cover the rest, they used a $51,000 variable-rate home-equity line of credit.
...
"I want to build some equity, but we haven't really been making much headway," says Aaron. The rate on their HELOC has already hit 10.6 percent, or another $115 a month. The $1,900 Aaron and Lacey spend on their home loans every month is still manageable, but with their first child due any day, they are understandably nervous.

In theory, the Blanks could see their mortgage rate jump as high as 11.4 percent in 2009. Add in principal payments and a 14 percent rate on their HELOC, and their worst-case scenario is a monthly nut of $3,445.

The solution: Refi with a fixed-rate loan; pay down the HELOC
So let me see if I've got this scheme straight.
  • Step 1: Buy a house you can't afford—use suicidal financing if necessary.
  • Step 2: Ride the market up until your house has appreciated 25% for no good reason.
  • Step 3: Refinance your suicidal 100% loans into a new 80% traditional loan.
  • Step 4: Keep riding the gravy train of equity up and up, forever!
  • Step 5: Profit!
It's a flawless, can't lose plan! Every one of you should go out and buy a house right away so you too can take advantage of this amazing opportunity.

(Cybele Weisser, CNN Money, 05.17.2006)

37 comments:

Anonymous said...

I don't see any problems with what they did other than paying for the HELOC 2nd when fixed rate 2nd would be about the same rate. Most young people or in fact most people do not reside in the same place for more than 5 years. Provided had they chose fixed rate 2nd, $2000 is decent monthly payment for a home they cannot say no to. Beats renting for $1500 and knowing that you wouldn't even have ANY chance of gaining equity.

Explain to me how interest-only is a bad loan if the monthly payment is relative to your rental income and tax deductible? In this case other than their HELOC 2nd, how is it bad?

Don't tell me that 5 years later when they're ready to sell the house, their house is gonna be half of what it's worth because of the "bubble"

meshugy said...

These people obviously made some poor choices...I wonder where they bought that house? 330K is actually a pretty low price in King County.

But the 6.4% interest rate is really high...I assume they bought about a year a go. With a near 6 figure income, they should have been able to get a better rate (below 6%) AND it should have been fixed. I got a 6.125% 30 year fixed last April....and it would been a lot lower if I wasn't self employed (lenders really stick it to you if you're a small business owner.)

Although, they didn't put much down. That probably hurt them....

My guess is that they also had a lot of credit card debt. And maybe a few luxury cars they can't really afford...

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Anonymous said...

Why on earth would u pay for a fixed rate?

If you're young, chances are you will move within 5 years. why would you pay for the highest rate on the market? Ok, so then you argue the interest-only part. If you think they're screwed with the bubble, then paying few thousands off their principal isn't gonna save them either.

They found a house they like with a mortgage payment they can afford, which is relative to rent after tax deduction, so what's the problem?

get a boarder said...

Anon 2:40-

Let's be realistic and add property taxes and property insurance into that monthly payment okay?

Ah what the heck, these people will be just fine no matter WHAT happens- they haven't yet tapped other solutions. Like taking in boarders or getting another family to go in on the house with them.

Peter Taylor said...

You don't see any problems?

Next up, the Blanks should lock in the rate on as much debt as they can. Taking out a new, 30-year fixed for $304,000 (the full 80 percent of their current home value) would let them pay off their ARM, shrink their HELOC to $18,000 and start paying down equity. (Many lenders will do a lower-cost refi to keep your business, so ask.)

This proposed solution to their problem depends on a $50k rise in their property value IN ONE YEAR.

If it's smart to lock in now, after the house has increased in value $50k in one year, wouldn't it be even smarter to wait until the last possible moment and lock in when the house has appreciated $150k, $200k, $250k? No? Why not? I thought all houses did was appreciate.

Anonymous said...

how much you think tax + insurance would be for a 250k to 300k county assessed house? Less than 250 combined.

emcityjill said...

Meshugy,
I think it's likely they're somewhere other than King county. It said they were 40 minutes from downtown Seattle ...just a guess.

Anonymous said...

The people who don't see a problem with this scenario (and , on top of it are hoping for, or even EXPECTING appreciation) are precisely the people who are going to get burned when this bubble, like all other bubbles, unravels.

There are a lot of people waiting on the sidelines with cash now to pick up the pieces, at massive discounts of course. We will not make the same mistakes you did.

The Tim said...

"40 minutes from Seattle" could easily be as far as Everett, if you don't qualify when those 40 minutes take place.

emcityjill said...

Ha Tim! So true....40 minutes from downtown Seattle at 8:00 am could be Northgate!

It's funny 'cuz it's sad.

emcityjill said...

Another thought for Meshugacoat: When you're 25 and 27 with no cash, no collateral, and 90K in debt, you're not about to qualify for better interest rates.

That's just my experience. My credit's great, but I didn't start qualifying for low rates until I started paying down some school loan debt and racking up face time at a J-O-B.

Anonymous said...

I stumbled upon your site and was surprised to see such a different view than what's been painted. It seems like everywhere you read they talk about the housing bubble popping...oh, except in Seattle.

We’re about to put our house on the market. There is nothing forcing us to move, we just want to upgrade our neighborhood and maybe get a slightly nicer house. We're not going to double our SQFT or buy new or get a McMansion. Just want a nice(er) home in a nice(er) neighborhood. We’ve made a bunch of money in our existing home (Bought for $260 and expect to sell for $375 2 years later) and are in a financial position to afford more than we could 2 years ago. We’ll be putting down 15% on our new house vs the 0% we did on our existing mortgage. A bubble is going to affect all housing prices, right? So, does it matter if we are in our existing home or in a new home? Is now a horrible time to buy a new house? I understand there are lots of factors to answer the question, but generally, it seems like I could either ride our a bubble-burst in my existing home which I don’t like or ride out the bubble burst in a home that I do like?

Any thoughts would be appreciated…

Anonymous said...

Anon 4:10-

First, let me say, you have a terrrific attitude so I expect you'll do fine no matter what.

Yes, when prices begin to move down, they eventually move down everywhere. So you should be able to upgrade if you stay and wait it out. ie. you'll sell lower but everything else will be cheaper too.

There are a loot of people who think the best way to go is to 1)sell now (hopefully you can still get the high price you are expecting) and then 2) bank the money for a bit and rent and then 3) wait for bottom at which point you can upgrade a lot more.

The problem with that is it could take a couple years. So you may be renting longer than you'd like.

Personally, I think prices will be quite a bit cheaper by Fall. But you need to do your own research and come to your own conclusions.

That said, do some research. Check to see what the houses in your neighborhood and the one you'd like to move to are actually selling for. I think there's a link to the King Cty Parcel viewer here.

Make sure you price your house right. Friends who have overpriced for this weaker market have not been able to sell, going on 2 months now.

Good Luck!

Eleua said...

I'll take a stab at why an I-O loan is a bad idea.

It is variable, and when it resets, they are in for a payment shock of a 40% increase, if not more.

Now, if the house has gone up in value, or stagnated, they could wince and pay it. This assumes that they are not in the prime "stay-at-home-and-have-kids" years (which happens in your late 20s - early 30s). If they have kids they want to see more than an hour a day, chances are they will drop to single income. This happens at the time they have a payment adjustment (and a healthy one at that).

Perhaps interest rates will have declined, or remained at historic lows when they refi. That is about as likely as the Seahawks winning the Stanley Cup. In case anyone didn't notice...the inflation genie slipped out of the bottle on Wall Street.

This portends much more FED tightening. Cynics (that's me) think the FED will loosen when inflation is roaring, lest they lose the economy. The bond traders will crank your mortgage up for you.

Stretching to buy a house at historic highs, while rising rates coupled with a delecate economy loom in the rear view mirror is not a particularly wise thing.

$90K isn't bad (it's just a whisker under the Mercer Isl median household income), but they are probably in debt on other things. $16K savings is nothing.

Someone told me: when all you have left is hope - sell.

Anonymous said...

Lord, that is good advice and sums it up completely:

When you have nothing left but hope, sell.

meshugy said...

For those of you who have seriously thought about selling, renting, and then buying again later, how do you deal with capital gains tax? When you roll your profits of one sale into another house purchase you don't get taxed. But if you pocked the profit it can be as high as 50% (i think).

If anyone can elaborate on this please do...

'm

shakaboom said...

I/O scenario is like this:

After initial period, if the rate goes up, it's because the index has gone up. Why would the index go up? Better economy and nothing bad has happened. So if that's the case, expect your house to sell well, and expect your employment to be making more.

If the rate went down...there's nothing to say about that. Chances are it's leaning that direction as well with all the bubble talk. If the bubble pops, index will very possibly go down, so you might end up with lower rate after your 5 year period.

Overall, I don't think there's that much risk, because for worst case scenario to happen, there has to be huge economic boom to drive up the index.

Anonymous said...

re capital gains, you have a couple years before you need to reinvest-correct?

seattle long term buyer said...

If you live in a median or below home now and want to move up, it might be a ripe time for you...

When bubbles burst, it starts at the top (that's where most homes are overpriced)

So you could get into that 650K home for 575K now while still get full price for your current home (full reasonable price).

Another thing with interest rates... they don't always reflect a healthy economy... it just means that the FEDS are meddling less than before...

shakaboom said...

not always, but index doesn't rise without decent economy that's for sure...

as far as capital gain, if I remember correctly. less than a year you pay 20% or according to your bracket, a day after a year and under $250,000 proceed is nothing, above that is the same as under a year. After two years, nadda.

Dukes said...

Shakaboom said: "Overall, I don't think there's that much risk, because for worst case scenario to happen, there has to be huge economic boom to drive up the index."

That's not exactly true. If we are entering into a stagflationary environment, which I believe we are then Bennie B. (Bernanke) is going to have to keep pressure on rates.

As Eleua said "the infiation genie is now out of its bottle."

This has huge implications, not the least of which is having to maintain higher rates in order to protect the US Dollar.

Now, long term rates can decline, and that is what you were probably thinking. But, for that to happen, the genie would have to go back in the bottle.

I don't see that happening. Higher food, gas, clothes, insurance, tuition, health care, industrial metals, commodities, road pavement, rubber, lumber, drug costs etc...are here and they are here to say.

Dupont came out the other day as well as (I believe it was Dupont) and said it HAS pricing power and it WILL pass along its rising costs to consumers. This is NOT good news for rates.

Anonymous said...

After initial period, if the rate goes up, it's because the index has gone up. Why would the index go up? Better economy and nothing bad has happened.

Bzzt! Wrong!

Fixed-rate mortgages are usually indexed to the yield on the 10-year Treasury Note. Adjustable-rate mortgages are often indexed to the yield on shorter-term Treasury bills.

In case you haven't been paying attention, our "good economy" is being scared out of its wits by the threat of inflation. As a result, investors are fleeing bonds and Treasuries, causing Treasury yields to rise.

This is econ 101 stuff. Get yourself to a library, before you start to look foolish.

shakaboom said...

I am all ears when it comes to economic trends. However, I don't see how index could rise when economy isn't improving, just like what happened during the last recession and refi boom.

shakaboom said...

no kidding, I read the MTA and libor trends just as much as anyone. Look at last 6 years, MTA and libor has been dropping and increasing following the economic trends.

Why has MTA and libor rising? better economy with lower unemployment rate and better overall numbers, especially with the housing boom.

Where am I wrong so far?

Anonymous said...

Why has MTA and libor rising? better economy with lower unemployment rate and better overall numbers, especially with the housing boom.

Where am I wrong so far?


You're wrong because you assume that rising bond yields are necessarily the result of a growing economy. Inflation is primarily the result of monetary control mechanisms -- and in case you haven't noticed, we just went through a period of historically cheap money.

Anonymous said...

You're also wrong because you assume that a "good economy" means that people will be earning enough to make their (increased) loan payments.

There are many things wrong with this assumption, but a big one is that wages are stagnant in this country. Hence, "the jobless recovery."

Perhaps you've heard of it.

seattle price drop said...

Shakaboom-

In answer to your question about what's wrong with the economy, you've answered it yourself.

Here's what you said: "Better economy and better overall numbers, especially with the housing boom."

An economy that is dependent on a housing housing boom, with wild appreciation from one year to the next, is sealing it's own death warrant.

At some point, either houses stop appreciating or people stop buying.

It is not a growth model that is sustainable forever. Sit down and think about it.

This economy became too dependent on an unsustainable, narrow model and product.

The importance of the housing boom to the economy is precisely why many economists are very concerned.

seattle price drop said...

Do you get it?

We are producing nothing and it's all dependent on massive amounts of debt, a lot of which may never be repaid.

Christina said...

hahaha... wait until they learn that daycare here will cost $1200/month for their bundle of joy.

shakaboom said...

Of course I know that economy isn't relying completely on growth, but there has to be some strong supporting factors, which for the last few years it's the housing boom. So when the housing boom stops, economic growth will, too, which will trenscend to decrease in index. Index won't rise if there's a recession, and there is not likely to be inflation if there is recession.

Ya, exactly like you said, economist believe that this increase in economic grown is relying on the wrong factor, which is housing boom. So when the ballon inflates, which most of you believe will, and so will the growth in economic indicators, which will end the growth of indices.

So ya, I do believe that economy will become stagnant after the housing boom and thus the indices won't go up. Refute my statement with some evidences that indices will continue to rise.

Anonymous said...

Refute my statement with some evidences that indices will continue to rise.

Oil prices. In case you haven't noticed, the price of a barrel of oil is somewhere near an all-time high.

It's hard to hold back inflation when the cost of powering everything is shooting through the roof.

Anonymous said...

Re: selling your house and capital gains http://www.bankrate.com/brm/itax/news/taxguide/home-gain1.asp?caret=12

Anonymous said...

sorry that previous url didn't work: http://www.bankrate.com/brm/itax/news/taxguide/home-gain2.asp?caret=12

Anonymous said...

First Quarter '06 National RE stats:

median US price: 217,900

change from one year ago: + 10.3 %

change from 3mos. ago: - 3%

---------------------------------------

What this says is that we should not be paying attention to YOY any longer.

It is the monthly and quarterly change that tells us what is really going on.

A few more quarters like this and all of '05 appreciation gets wiped off the top.

Anonymous said...

stagflation.

Anonymous said...

".Step 1: Buy a house you can't afford—use suicidal financing if necessary. Step 2: Ride the market up until your house has appreciated 25% for no good reason.Step 3: Refinance your suicidal 100% loans into a new 80% traditional loan"


Actually, that's almost exactly what I did. Man did I get lucky. I bought a house for 260k a few years ago (in city, in a quiet neighborhood but near downtown, like I said I got lucky) with an 80/20. A year later I rode the bubble up to being able to refinance to 80/0 and locked in 5.5% forever.

I'm not convinced I could rent a similar house for the monthly payments I make.

I'm not going to claim that I had some sort of master plan (other than being extremely conservative with my loans and not going adjustible when loans were at all time lows) as much as lucky timing, but the bubble wasn't bad for everyone.

Jackson Wallace said...

2001 and 2002 were lower-priced times to buy with great interest rates to match,
so I dont think anyone who bought then did too badly. Unfortunately, I got my down through an inheritance in 2004, and all I've been able to do is watch this market and rates go inexorably up, which has caused some second-guessing believe me. Unfortunately, I have and earn just enough to
get me into serious trouble or an outlying neighborhood. Shoreline and the south end seem to have plateaued in that there's plenty showing up for sale in the 260-350k range and I dont see the quality going down particularly. In fact, sometimes, it looks like kongtime residents are cashing out of those areas, since prices there were 200k only 2-3 years ago. If we keep getting this spectacular CA weather, then people may keep moving here in droves, and all those people may have sold 500k houses, so they'll have cash on hand to drive our areas up, including the exurban retirement locales like Anacortes, etc. With boomers retiring with not much money, though, what is called a multi-billion dollar shortfall, I just dont see how they wont cash out their houses in the more expensive areas to retire. At that point, some sort of panic should begin, as people who are late to the party drop into the glut. Unfortunately that could take five years to materialize. Whether the area appreciates like Money mag says has a lot to do with hom much outsiders still covet it. I dont see locals paying 400k to live in an average existing home in shoreline
or pac hwy south (crackville), sorry.