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Irvine Housing Blog

Irvine Housing Blog

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Low Interest Rates Are Not Clearing the Market Inventory

Posted: 12 Aug 2010 03:30 AM PDT

Despite the lowest interest rates in over 50 years, buyer demand is still low, and increasing inventory is just sitting there waiting for sellers to lower their asking prices. 


Irvine Home Address ... 1102 TIMBERWOOD Irvine, CA 92620
Resale Home Price ...... $419,000

And the seasons they go 'round and 'round
And the painted ponies go up and down
We're captive on the carousel of time
We can't return we can only look behind
From where we came
And go round and round and round
In the circle game

Joni Mitchell -- Circle Game

The housing cycle is like a giant carousel. Prices move up and down tethered to an underlying fundamental value. Whenever we look back the cycle is rather obvious, but when we are caught up with kool aid intoxication, each rise looks different than the last. We are trapped in this endless circle game; trapped by our own greed and foolish pride; trapped by are desires for appreciation income and the consumption it brings; trapped by our denial of the obvious; trapped by wishful thinking as we cling to a real estate fantasy that doesn't really exist. 

During the down cycle, we try to resurrect the market with artificial stimulants. Like a addict coming off a heroin high, the crash is as painful as the euphoria that preceded. We try to deaden the pain with more stimulants until finally the corpse of the market remains moribund and nature takes its course.

Record-low mortgage rates fail to move market

Housing recovery stymied by nervousness about jobs, economy

By Bill Briggs -- August 11, 2010

What’s the magic number? Three? Two? One?


How about less than zero? With deflation, even a zero percent interest rate is high in real terms. Perhaps if they took interest rates negative and started paying people to borrow money, demand might increase.

Of course, the real problem in our market isn't payment affordability -- low interest rates are making that less of a problem -- the real problem is that prices are still too high and must come down.

How far must long-term mortgage rates tumble before the summer silence filling many residential real estate markets is broken by whispers of a real rebound?

Benjamin Clark has pondered the question. Despite a steady decline this summer that has trimmed the average rate on a 30-year fixed loan to about 4.49 percent – a historic low – home sales and mortgage refinancing activity remain mired in the muck of job uncertainty and underwater loans.

So Clark, head of the National Association of Exclusive Buyer Agents, told his 500 members to name a number. Given the current economic conditions, he asked, what 30-year fixed mortgage rate would “spur significant additional real estate sales?”

Many agents flashed their desperation: About one-third believe the 30-year rate must slink into the 3 percent range to fuel healthy action while about one in 10 agents feels the rate must touch the twos. But most respondents — 42 percent of the agents — said that there is no bargain-basement threshold where the rate “becomes relevant enough” to overcome larger economic worries and entice a fresh tide of transactions. 

That is despair. When 42% believe that no matter how low the rates go that nothing will increase sales, people have lost hope. Is that a sign of a bottom? Perhaps for interest rates, but not for prices.

Has the almighty mortgage rate – at least for now – lost its power and luster? Does the rate matter anymore?

“Rates alone are not the magic factor” they once were, Clark acknowledged. Based in Salt Lake City, Utah, Clark said he has remained busy this summer with buyers, although his clients are on the hunt not due to shrinking rates: This simply was the right time for them to purchase. Still, he said that if long-term mortgage rates were to trickle into the 3.75, 3.5 or 3.0 percent range, “that would help.”

“But,” Clark added, “I’m all about the zero percent!

No. He is all about the 6%. If zero percent interest rates allow him to generate a 6% commission, then he is happy.

“The rates definitely do something. If they were a little higher, the market would be even slower. If they were a little lower, things would be a little better,” Clark said.

To Clark’s point, the volume of mortgage loan applications edged higher in the first week of August, according to the Mortgage Bankers Association’s weekly survey, released Wednesday.

The buying landscape is similarly bleak despite the dwindling rates. During July, monthly purchase applications lapsed by 3 percent from June, according to the MBA. And in June, buyers’ applications declined 15 percent from May. Industry experts pin the current lack of buyer interest on unemployment or lingering worries about losing a paycheck. In Clark’s survey of buyer agents, he asked “What are (the) reasons buyers may put off buying ... in spite of very low interest rates?” The top answer, at 77 percent: “lack of job security.”

The fact that such a high percentage of potential buyers fear losing their income reveals much about the current state of our economy. People should be cautious about buying a home when they don't know if they can make the payments, particularly now that they actually have to put their own money into the deal. When 100% financing was available, there was no risk other than a credit score, but when people have to put their own money down, they are wisely more risk averse.

Refinancing activity also is sluggish.

"We are not seeing a huge impact from the lower rates in terms of refinancing and this is likely due to borrower burnout," said MBA spokeswoman Carolyn Kemp. "As rates have been historically low for some time now, the pool of borrowers who were eligible to refinance have likely already done so."

The refinance market has been over stimulated. We have pulled all the demand forward we possibly can. As interest rates go back up, refinancing activity will decline to historically low levels and stay there for a very long time.

“It’s unprecedented” that such a historically low rate has failed to incite buying or refinancing stampedes, said Greg McBride, senior financial analyst for “But at the same time it’s not a big surprise. ... I don’t view it as an oddity ... It’s the job market."

Suffice it to say that you could reduce interest rates to zero – if somebody doesn’t have a job or is nervous about income, they’re not going to plunge into ownership,” McBride said. “It just goes to show you that mortgage rates alone are not going to revive the housing market."

The fact that interest rates alone will not revive the housing market is very bad news for lenders with a huge number of delinquent borrowers. This inventory must be pushed through the system. Lenders were hoping they could clear the inventory at high prices through low interest rates. That isn't going to happen. It will require a combination of low interest rates, low prices and increasing employment to clear the market. Unfortunately, the low interest rates are likely a temporary phenomenon. Safe-haven investors buying mortgage debt insured by the US government through the GSEs has pushed rates to very low levels. As these investors find opportunities with higher yields in an improving economy, interest rates will move higher.

“I wouldn’t go so far to say (they) don’t matter. It’s just one variable. If you combine that one variable with a better outlook in the job market, people will start buying housing.”

At 4.49 percent, the current 30-year fixed rate is the lowest since Freddie Mac began tracking rates in 1971. To find a lower benchmark you would have to go back to the World War II era, when borrowers could obtain shorter-term home loans for about 3 percent.

Real estate blogger and economist Ted C. Jones contends the probability is “moderate to high” that mortgage rates will climb by 1 percent over the next 12 months as the economy improves.

That prediction is probably correct, not that this particular forecaster has any credibility....

Jones, senior vice president of Houston-based Stewart Title Guaranty Co., said U.S. workers already are “crawling off the bottom” of the unemployment floor. And he sees, within the murkiness of the larger economy, “a light at the end of the tunnel – and it’s not another train.”

Go stand out on the tracks and let us know what happens, Mr. Jones. After we scrape you off the front of the train, you can tell us about the light.

“I’m not a feel-good economist either," he said.

That's a credibility builder. So how have his prognostications been to date?

In 2007 Jones told agents at a real estate seminar: "You’re not going to believe the hurricane that’s going to hit us," he said. “But I am seeing some stable recoveries ... What is the probability of a 10 percent home-price decline over the next year? Low.”

So in 2007 he was telling people the probability of a 10% decline was low. Well, he was wrong. Prices fell more than 10% in 2007 and another 10% in 2008.

He says federal tax incentives that sparked the spring buying binge reduced some of the overstock of housing inventory. And looking ahead, he cites a predicted U.S. population growth spurt (some 100 million people over the next 40 years) as the engine that will help revive new-home construction.

“So I don’t see rates getting to the three, two or one percent level,” Jones said.

“We have to look at these rates today as the best buying opportunity in some people’s lifetime,” Jones added. “What bothers me, though, is we’re scaring people away (with gloomy economic outlooks) – people who can lock in housing costs for the rest of their lives at rates we may never see again.” 

No, you don't have to look at these low rates as the best buying opportunity in some people's lifetime, unless you live in a depressed market like Las Vegas. In an inflated market like ours, the low interest rates are merely delaying the inevitable decline. 

Higher interest rates will cause prices to drop

Many have suggested that prices may move higher in the face of rising interest rates because prices did go up during rising interest rates of the 1970s. In fact, we inflated a housing bubble in the face of rising interest rates, so the theory goes that it might happen again. Let's review a little financial history and see if you think prices will rally in the face of rising interest rates.

First, it is critical to understand exactly how and why lenders inflated the first housing bubble of the 1970s. There was a deep recession in 1973-1974. The housing recession it spawned did not end until 1975 where the chart above picks up. House prices were depressed relative to incomes in 1975, and the improving economy prompted a great deal of buying and homebuilding activity.

The Federal Reserve in the late 1970s was trying to stimulate the economy to recover from the oil shock of the OPEC embargo, and they vacillated between raising and lowing interest rates unable to find a balance between economic growth and price stability. As a result, inflation grew out of control, and coupled with the power of labor unions to negotiate higher wages, the country fell into a wage-price inflationary cycle. We do not have those powerful labor unions today (except in California government), and we are facing high unemployment. There is no upward pressure on wages, and there won't be for quite some time. 

But even if we had rising wages, it wasn't rising wages that inflated the 1970s housing bubble. It was the anticipation of rising wages and the willingness of lenders to loan at debt-to-income ratios over 32% that inflated the housing bubble. Lenders inflated the 1970s housing bubble by loaning money at unstable debt-to-income ratios (see chart above).

Federal Reserve Chairman Paul Volcker saw this occurring and decided to put a stop to it. When he raised interest rates to 20% in the early 1980s and removed all the liquidity from the system, he did it for one basic reason: he needed to stop banks from loaning money based on the anticipation of inflation. Inflation expectation is just like appreciation expectation; both cause people to overpay for assets, and both cause lenders to throw caution to the wind and allow borrowers to inflate asset bubbles.

A common misconception about inflation expectation is that it was a consumer phenomenon. It was primarily a banking problem. As we witnessed during our most recent housing bubble, consumers will borrow all the money they are offered even if it kills them. Lenders are the adults in the transaction, and it was their behavior that was the target of the interest rate increases of the 1980s.

As the anticipation of inflation was curbed, lenders quickly began to realize that borrowers were not able to sustain debt-to-income ratios in excess of 32%, so they stopped underwriting these loans -- for a while at least -- then they got stupid again in the late 80s and inflated another housing bubble.

Applying the lessons of the 70s

So let's apply the lesson of the late 70s to today. When mortgage interest rates begin to rise -- and they will go back up -- affordability will drop if prices remain where they are today. Lenders will be forced to make a choice: (1) allow borrowers to take out loans at debt-to-income ratios exceeding 32% or (2) deny borrower requests for loans at those amounts and allow house prices to fall. Which choice do you think they will make?

I don't see them as having a choice. If a mortgage is not insured by the GSEs or FHA, there is currently no secondary market for this loan. The government is not going to permit DTIs to go back up above 32% because they just spent billions in loan modification programs to bring DTIs down. Borrowers default when DTIs go over 32%. That has been proven over and over again. Only when lenders are inflating a bubble is this fact masked as troubled borrowers sell into a market rally. Once aggregate DTIs get high enough, the system becomes unstable, and prices crash back down to levels where real incomes (not liar loan incomes) are applied to a 32% DTI. That is the real estate cycle.

For those who believe prices will rise in the face of rising interest rates, you must believe lenders will underwrite loans at debt-to-income ratios exceeding 32%. That is not going to happen in the foreseeable future because the losses on these loans in default are too high, and the government controls the market. For as stupid and as corrupt as our government appears at times, they are not going to pay the losses of lenders indefinitely. DTIs at 32% or less are here for the foreseeable future.

So if we accept that market prices are going to be determined by real incomes applied to a 32% DTI, then market prices are going to be very sensitive to interest rates. If we had a market condition where supply was limited (as we have witnessed since early 2009), people may be forced to substitute downward to prop up prices, but with the shadow inventory yet to be purged, there will be no shortage of properties over the next several years.

Since we have a huge amount of inventory to push through the system, you can expect prices to be set by real incomes, current interest rates, and a 32% DTI for quite some time. That is why prices will fall as interest rates to up over the next several years.

Peak buyer walks away

The previous owner of this property purchased it for $539,000 on 8/2/2005. She used a $431,200 first mortgage, a $53,900 second mortgage, and a $53,900 down payment -- which she has now lost. 

She didn't get to squat as long as many others did, but she still got over 1 year without making any payments.

Foreclosure Record
Recording Date: 04/01/2010 
Document Type: Notice of Sale  

Foreclosure Record
Recording Date: 08/19/2009 
Document Type: Notice of Default

A flipper bought this property at auction for $372,000 on 5/25/2010. Like two of the flips I profiled last week, this flipper did nothing to renovate the property and hoped merely to put it back on the market and sell it as-is. Irvine buyers just don't go for that.

Date Event Price  
Aug 05, 2010 Price Changed $419,000  
Aug 02, 2010 Price Changed $427,500  
Jul 15, 2010 Listed $440,000

He has lowered the price 5%, and he only has another 5% to go before taking a loss. Without some cosmetic improvements, this property will likely just sit there.

If you would like to learn how you can get involved with trustee sales, please contact me at    


Irvine Home Address ... 1102 TIMBERWOOD Irvine, CA 92620

Resale Home Price ... $419,000

Home Purchase Price … $372,000
Home Purchase Date .... 5/25/2010

Net Gain (Loss) .......... $21,860
Percent Change .......... 5.9%
Annual Appreciation … 48.5%

Cost of Ownership
$419,000 .......... Asking Price
$14,665 .......... 3.5% Down FHA Financing
4.57% ............... Mortgage Interest Rate
$404,335 .......... 30-Year Mortgage
$82,561 .......... Income Requirement

$2,066 .......... Monthly Mortgage Payment

$363 .......... Property Tax
$100 .......... Special Taxes and Levies (Mello Roos)
$35 .......... Homeowners Insurance
$277 .......... Homeowners Association Fees
$2,841 .......... Monthly Cash Outlays

-$333 .......... Tax Savings (% of Interest and Property Tax)
-$526 .......... Equity Hidden in Payment
$25 .......... Lost Income to Down Payment (net of taxes)
$52 .......... Maintenance and Replacement Reserves
$2,059 .......... Monthly Cost of Ownership

Cash Acquisition Demands
$4,190 .......... Furnishing and Move In @1%
$4,190 .......... Closing Costs @1%
$4,043 ............ Interest Points @1% of Loan
$14,665 .......... Down Payment
$27,088 .......... Total Cash Costs
$31,500 ............ Emergency Cash Reserves
$58,588 .......... Total Savings Needed

Property Details for 1102 TIMBERWOOD Irvine, CA 92620
Beds: 2
Baths: 2 full 1 part baths
Home size: 1,267 sq ft
($331 / sq ft)
Lot Size: n/a
Year Built: 2000
Days on Market: 25
Listing Updated: 40395
MLS Number: P743479
Property Type: Condominium, Townhouse, Residential
Community: Northwood
Tract: Coll
Cute Townhouse in Northwood. 2 Beds 2.5 Baths with New carpet flooring, New paint, New microwave, and New Disposal. Must See!

real estate home sales


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