THE BASIS POINT

Setting Your Property Strategy Mid-Credit Crunch

 

Last quarter, we showed how dropping home prices create opportunities for buyers even if rates are higher. Now, we’ll continue that discussion in the context of the global credit crunch which has had a big influence on home prices and rates.

Overview of The Credit Crunch
The ‘Credit Crunch’ that hit mortgage markets in early August froze the lending system overnight. The system had been strained all year because of leveraged loans that borrowers stopped paying. So investors that buy loans from mortgage lenders stopped buying, and warehouse banks that enable mortgage lenders to fund loans stopped providing funds. As a result, more than 100 mortgage companies have closed their doors, and more than 100,000 mortgage-related professionals have lost their jobs.

Since August, the Fed pumped about $80 billion into the banking system by buying securities nobody else would buy. They lowered the Fed-to-bank Discount Rate by 1%, giving large global banks a place to go for funds after their normal sources froze or hiked rates significantly. And they lowered the bank-to-bank Fed Funds Rate by .5%.

The only consumer mortgages affected by the Fed Funds Rate cut are HELOC second mortgages, which are now .5% lower. All other mortgage rates are pegged to open market trading, and haven’t dropped because rate markets are betting that more aggressive Fed cuts are less likely in the near term.

So in a market where rates are higher and the credit crunch has contributed to declining home prices, it’s critical to understand the relationship between rates and prices.

Lower Prices vs. Higher Rates
Home price data comes in many forms from many sources, but one highly credible source is the S&P/Case-Shiller National U.S. Home Price Index, which tracks prices of existing single family homes in 20 U.S. cities. For broad illustrative purposes, it’s the most useful because it excludes more volatile condo and new construction pricing.

As of tody, this index’s newest data shows home prices fell 3.9% in the 12 months through July. This means that if you were buying a $700,000 home today, that same home would have been $728,407 one year ago. We also know that today’s rates are .5% higher than they were 12 months ago.

So with 20% down on $728,407 and a 6.5% rate last year, your mortgage interest would be $3156. With 20% down on $700,000 and a 7% rate this year, your interest would be $3267. This year’s higher rate means $1332 more interest per year. But the $28,407 you’re saving in purchase price far outweighs the $1332 in extra interest cost.

When Do Home Prices Bottom Out?
If you conduct this price-versus-rate analysis with your mortgage planner and neighborhood-level pricing analysis with your Realtor, it will show you that a lower price is more important than a lower rate right now. Then you need to figure out where home prices are going.

In 2008, there is an estimated $1 trillion of ARMs due to re-set. First are the 5-year ARMs established at all-time low rates in 2003. Then there are the 3-year subprime ARMs from 2005 and the 2-year subprime ARMs from 2006. The 5-year ARM adjustments aren’t as big of a concern because these borrowers tend to have better credit quality and their home values had a strong run of appreciation. But the much steeper subprime adjustments may force borrowers with little to no equity into selling which would put a drag on home prices.

Conversely, the economic picture is surprisingly upbeat so recently after the credit crunch, and most stock indices are trading near record highs. The upcoming holiday shopping season will be the true test to measure consumer strength.

If you’re a buyer who thinks home prices will drop further, consider negotiating down the list price now instead of waiting. By the time prices drop in desirable markets such as the Bay Area, new buyers rush in and push prices up.

If you’re a seller who needs to list now, you should use this same neighborhood pricing and home-price-versus-rate analysis to choose a price. For sellers who don’t have to sell right now, do you have to sell in a few months, or do you have as much time as you need? Your Realtor is the best advisor here because they know your immediate market area the best. Your mortgage planner can provide more details on the broader 12-24 month economic projections.

 

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