I got the following response from one of my client’s after he read the article, I posted on the Blog, about declining real estate prices.
“Dan, interesting news in my county in Virginia, one of the fastest growing and having high household income in US---the news was that the number of home foreclosures in the county in 2005 was 14—the number of foreclosures in 2006 was 139---the number of foreclosures through June of 2007 has already tripled all of 2006. Very concerning”
Let us say that the Fed does cut interest rates on the 18 by 25 basis points or even 50 basis points. What can we expect in the housing market as a result of these interest rate cuts? Not Much. Many of the problems in the housing market have been widely discussed, but I do not think you have heard about this one.
A young couple takes advantage of the special mortgages in 2006. They buy a condominium with virtually no money down. They can afford the mortgage payment, their income an excellent. Therefore, when the Fed drops interest’s rate by 25 basis points and as a result adjustable rate mortgages rates fall-- they think that at some point it will make sense to refi their existing mortgage thus saving them money with a lower interest rate.
With the concept of no money down and by the way an interest only mortgage, they will find that they have negative equity in their home. The bank will not lend them money on the property for a mortgage because the value of the condominium is less then the outstanding amount of the mortgage remember interest only mortgages do not reduce loan principal.
In order for them to refi the existing mortgage they will have to come to the closing with cash to payoff the difference between the current appraised value and the outstanding mortgage amount. I suspect that there are a great number of homeowners that are trapped like the young couple in my example.
Why are they trapped?
If they do not have the cash to make up the difference they are stuck unless they can get the cash or the price goes up to an amount greater than the mortgage including closing costs. If I am right and the worst is, yet to come in the price decline of real estate, they could be stuck for a long time. If the real estate market does not bottom until the end of next year, I do not expect that prices will start rising off the bottom. The young couple in my example may be in the condominium for many years.As people with excellent income see that a decline in interest rates may not help them, they will have to begin to save not for the down payment for the next house, but in addition they money to get out of the existing mortgage.