Commentary on the Real Estate and Housing Market as of 10/10/07
by Peter L. Zachary, MAI
I concluded in last month's "Commentary" that pricing pressures on home prices will continue.
The publicity and public outcry about the sub-prime mortgage crisis has abated somewhat although our legislators are busy trying to pass legislation to prevent mortgage abuses from happening again. On September 24, 2007, the New York City Metro Chapter of the Appraisal Institute held an appraisal seminar where Senator Charles Schumer of New York (D-NY) was the keynote speaker. I was impressed by his knowledge of the abuses that have occurred in the home finance industry. He cited an example of how a man refinanced his home for an additional $50,000 and walked away from the closing with a check for $5,700. He is working on a legislation to stop the abuses in the mortgage market. On September 27, 2007, the Appraisal Institute held a Washington Summit in Washington DC and a speaker from Congressman Paul Kanjorski's office, Todd Harper, spoke about the proposed legislation Congressman Kanjorski is planning to propose.
I have advised both of these politicians of the need to eliminate the "mortgage broker's premium", which is a fee paid to the mortgage broker by the mortgage lender who is providing the financing. The fee is paid because the mortgage broker convinces the home owner that the interest rate they have to pay is higher than the prevailing interest rate. The lender pays the broker a fee of 1% to 8% of the mortgage amount depending on the interest rate agreed to. It works like this, if a homeowner (through the mortgage broker) agrees to pay the lender ¼% more than the prevailing interest rate, the lender pays the mortgage broker 2% fee. The homeowner doesn't pay the broker, the lender pays the broker. However, the homeowner's agreement to pay a higher interest rate is the reason the lender paying the fee. They pay this fee because the homeowner has agreed to pay a higher interest rate than normal.
For example, on a $500,000 loan where the interest rate is 6¼% versus 6%, the increase in annual interest, for a 10-year period is as follows:
$500,000 x 6.25% = $31,250 x $10 years = $312,500
$500,000 x 6.00% = $30,000 x $10 years = $300,000
Additional Interest Cost Over 10 Years: $12,500
The above shows that over 10 years the homeowners pay an additional $12,500 interest. This is why the mortgage lender pays the mortgage broker the extra fee of 2% or $10,000. The lender pays the broker the majority of the additional interest paid by the homeowner.
Interest rates are interest rates. Mortgage brokers make all borrowers equal to the lender's by "fixing" credit reports and lying about income on the mortgage applications. As far as mortgage lenders are concerned, if a borrower qualifies for a 6% interest rate but the broker convinces the borrower to pay 6.25%, they are making a profit, which they pay to the mortgage broker. This is a "Dirty Secret" about the mortgage industry that I have never read about. This is, however, the profit motive for mortgage brokers to be slick fast taking con artists. If a person qualifies for a 6% mortgage, there is no reason to pay a higher interest rate. I believe any legislation should incorporate my suggestion to eliminate the "mortgage broker's premium". In addition, I think that all income sources must be verified. Currently, only the primary source of income is verified by the mortgage company. If an additional source of income is listed on the mortgage application to entitle the homeowner to qualify for the mortgage, it is not verified by the mortgage lender. In hindsight, the mortgage lender was complicit in providing financing to borrower's who could not qualify for it.
Hopefully, the above potential legislation will prevent a future sub-prime mortgage crisis from occurring. But the reality is that banks, retailers, and economists see the decline in housing prices as the source of preventing a weakening economy from improving. The September 11, 2007 issue of the NY Post cites Washington Mutual's CEO, Kerry Killinger, as blaming the tight credit and declining housing values "for creating what we call a near-perfect storm for housing". That same issue of the Post refers to a report from Moody's, which predicts the downward pressure on house prices will continue until 2009. Home Depot's CFO stated, "the company doesn't expect housing to improve until the end of 2008". The New York Times, on September 28, 2007, cited the Commerce Department, which said that the median price for a new house was down 7.5%, from a year earlier. They also cited the National Association of Realtors, which reported a 4.3% drop in the August sales of existing homes. The Wall Street Journal, on September 26, 2007, reports that the second longest home builder, Lennar Corporation, reported a new loss of $514 million for the quarter ending August 31, 2007 and has cut its work force by 35%. The Chief Financial Officer (CF) of Lennar Corporation is quoted as saying, "The days of no verification, no down payment, and low credit scores are past".
In my opinion, the decline in housing and real estate prices will have a ripple effect in the economy as already seen by the decline in consumer spending. It rose 1.4% in the second quarter versus 3.7% in the first quarter. As the months go by, I feel the statistics will show a further slowdown in consumer spending. The September 12, 2007 issue of the New York Times had an article entitled "Shopping Centers Begin to Feel the Ripples of Housing's Ills". They state, "According to investors, brokers, and analysts, deals are taking longer to complete and prices – at least for the second and third-tier properties – are declining by as much as 10%.
And the high end residential market may have its problems too. According to the New York Post on September 17, 2007, Dolly Lenz of Douglas Elliman stated that "The high end has been stagnating for almost two months. It's taking a longer-than-usual pause. The big boys seem to have already bought their trophy properties".
This is a dangerous time for homeowners and appraisers because we don't know where the market bottom is. Economists are projecting pain for over one year until the beginning of 2009. For appraisers, sale comparables do not reflect today's value since even a comparable that sold yesterday was a result of a deal made 30 to 60 or 90 days ago.
From the diminished activity in the market place, it appears that sales activity is down because people do not know the correct pricing of homes. Sellers do not want to reduce prices further since the market may improve. Buyers do not want to pay yesterday's prices since the market may go down further. Federal legislations should ease the mortgage crisis somewhat but the old-fashioned ways of obtaining a mortgage will be a borrower's only alternative. If they can't afford the mortgage and don't have the down payment, they will not be able to obtain a mortgage and will therefore be precluded from the real estate market. Supply and Demand states that the lower the demand, the lower the price.
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