Wednesday, September 9, 2009

Purchasing power

From the "I meant to post this a couple months ago" file , a graphic from the Joint Center for Housing Studies annual The State of the Nation's Housing report:

From 2004 through 2007, homebuyers were able to chase prices higher without adding to their initial monthly payments by taking advantage of various affordability products. In fact, more than one-third of borrowers took out adjustable-rate (ARM) loans n 2004 (Table A-3), while nearly one-fifth took out interest-only or payment-option loans in 2005. Instead of reducing their payments as a share of income, though, most borrowers used the loans to keep up with rising prices—especially in markets with rapid appreciation and heavy speculation. In California and Nevada, for example, more than 40 percent of loans originated in 2005–6 had payment-option or interest-only features.

The impact on purchasing power was profound. In 2005, a household with the median owner income of about $57,000 and spending 28 percent of income on mortgage principal and interest could qualify for a 30-year, fixed-rate loan of $225,000. But if the same household took out an adjustable-rate loan with a discounted interest rate, the maximum loan amount increased to $263,000 (Figure 20). Adding an interest-only feature to that ARM and qualifying the household based on the initial interest-only payments raised the potential loan to $356,000. And under the common practice at the time of allowing the borrower to spend 38 percent of income on mortgage costs, the amount the household could borrow with an interest-only ARM jumped to some $482,000.

After regulatory guidance issued in 2006 pushed the industry back towards tighter, more uniform standards, interest-only and even some adjustable-rate loans became hard to get. By mid-2007, teaser discounts on adjustable-rate mortgages began to shrink and the spread between fully indexed fixed- and adjustable-rate loans hit zero and then turned negative. As a result, households can no longer use these loan features to leverage their incomes to buy ever more expensive homes. With a 2008 median owner income of about $64,000 and prevailing interest rates through April 2009, a household spending 28 percent of income could qualify for a 30-year, fixed rate loan of just $277,000.

Borrowers can still push the front end ratio even today. Fannie/Freddie will max out DTI at 45-50%, they look at total debt not just housing debt and group it into one ratio. As for the boom time ratios simply didn't matter. Stated income got around any ratio issues, all you had to do is make sure you stated a income high enough to make the ratios work. Lending is very lax today. The issue many have as far as restricted are related to needing "stated" income because they cheat on their taxes. Now that lenders are pulling 4506-T and checking that incomes are in the ballpark it has removed or reduced the buying power of a swath of borrower who, technically, has the cash (at least until Uncle Sam figures it out).

The interest only "affordability" product was very popular in California, people were only building equity through appreciation and in a down market that isn't working out for them. They can't afford an amortizing loan even if they could refinance. Decisions will have to be made.

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