Let's get serious. Here's another "the sky is falling" example from the press. Today's Post has a good article on some condo projects that have been canceled, and how that situation leaves buyers in the lurch. Sure they get a refund, but no place to live, and no compensation for their efforts. (A good warning on the risks of buying new construction.)
Delta Associates is quoted in the article saying that developers had canceled plans for 22 projects in the 2nd quarter alone! Really...22?! I just don't buy it...unless they're using "plans" pretty loosely. (As an aside, it's not a bad thing that condo projects get cancelled--it keeps inventory reasonable and supports prices.)
I've been hearing about these conversions back to apts for a year or more. And the same developments are always mentioned: the Joule in Arlington, View 14 in DC, the Bellmeade in Leesburg (Leesburg? That’s a VERY different market than Arlington or DC), Four Winds at Oakton, and a few others. Those conversions happened months and months ago. So where are the 22 from THIS QUARTER? Someone please find this list so we can map them out. I'll bet they're further away than this article would leave you to believe. And what counts as a "planned" development? My guess is most of these "plans" are on paper--units were years away from delivery anyway. We'll never see that list in the Post though, because alarmist headlines sell more papers.
Wednesday, August 15, 2007
Saturday, August 11, 2007
Interest Rate Jumps; Unfortunate, but not Catastrophic
I'll be writing on this quite a bit, and I'll start off by saying that, as regular readers know, I do NOT think recent interest rate jumps are the end of the world. I'll get to why in a bit, but first, a recap.
Last week, large mortgage lender American Home Mortgage shut its doors. That made the markets very panicky and led to an increase in rates for two specific loan types: "Jumbo" and 2nd trusts.
"Jumbo" loans are loans above $417,000--the limit for "conventional" loans set by Fannie and Freddie, who buy mortgage loans from originators. Fannie and Freddie exist to create a “secondary market” for mortgages—that is, they buy loans for cash, and then originators use that cash to make more loans to homebuyers. If they didn’t exist, then banks would only be able to loan as much cash as they had on hand, and would have to hold the mortgages until each homebuyer sold or paid it off. (That’s a bit of an over-simplification, but for our purposes it should suffice.) Fannie and Freddie are government “sponsored” (though not technically government-insured), and so the loans they can buy have certain restrictions, i.e., are under $417K. Because there’s an easily available secondary market for this size loans, they typically have a lower interest rate than the larger, or “jumbo” loans.
Now, $417K doesn’t buy you much in this area, so lots of people end up with “jumbo” loans. And since even the smallest place is usually in the $300s, many people in this area don’t put 20% (or about $60K+) down. That hasn’t been an issue until now. You can put 5% down, take out two “trusts” (or loans)—one for 80% and one for 15%, and be on with your home purchase. Those second trusts are becoming an issue, though. Read on:
The second impact of this panic is a big jump on the 2nd trust rates. 2nd trusts have always been riskier for lenders—they’re junior liens, after all, and so carried a higher interest rate. But that rate is the other important change in the past week. It jumped significantly.
Two impacts on this market are clear, but in my opinion, neither is catastrophic. At least not yet.
1) For most buyers, they can afford less. So if you were shopping at the top of your affordability range, chances are you can no longer afford that payment, regardless of how much you were putting as a down-payment. How much less? We’ll have to see where the rates stop. According to the Post, rates are up almost a full percentage point since May. So for every $10,000 borrowed, that’s $100/year.
Let’s use an example. Let’s say a buyer was looking at in the $600,000 range starting in May. Rates jumped up a point since then. That means that if there is NO room in their monthly budget (and why would any responsible person be looking at that price if there was absolutely no room in their budget?!) then now they can only afford $500,000. Another way to say it is that having the same $600,000 mortgage now costs them an extra $6000/year (which, making some assumptions about income bracket, is about $4000/year out of pocket after taxes.)
My guess—and I certainly could be wrong—is that people shopping for $600,000 homes have just a little bit of wiggle room in their budgets, maybe even up to $4,000/year. I think most people in that income and affordability bracket will make the trade-off, see their home as an important investment, and forgo a few discretionary items to get the house that they still want. I believe that the majority of the people are NOT going to change the range in which they’re looking, at least not by much. Again, maybe I'm naive, or maybe I'm just lucky that my clients tend to be responsible purchasers (or, not to pat myself on the back too much, but maybe I do a good job counseling them up front and introducing them to reputable lenders who counsel them too).
In my experience, the people who tend to stretch their budgets to the breaking point are the people who are buying their first place, which is often under $417K, and therefore not impacted by the jumbo rate jump. They are, however impacted in another way. They usually have less of a down-payment (because they’re not rolling over equity from a previous home), and are borrowing more than 80% of the purchase price.
2) For all borrowers planning to finance more than 80% of the purchase, you can afford less. This one worries me less—one, because only 15% of the loan is going to have a significant jump in rate, and that’s a whole lot better than having it hit the 80%. Second, there exists an option to borrow 95% as one trust and pay PMI. PMI, which historically was a dirty word for borrowers, is more acceptable now because in 2007 it’s tax deductible, same as interest. Boy, did they pick a good year to change that rule! So the 95% trust, as long as it’s not jumbo (see impact #1) should keep the payment roughly what a borrower was planning two weeks ago.
I’m sure this will continue to be a front-page crises for a few weeks. I’ll write more as the situation evolves. But I still stand firm in my conviction that if you are:
- Financially able to buy: good credit, a reasonable budget, about 8% of the purchase price in savings, and
- Your life situation calls for buying instead of renting: will be in this area for 3 or more years, you have reasonable expectations of what you get for the money, and you recognize that even a flat return on an investment is better than rapidly increasing rents (see Rent vs Buy calculator post),
Then this is still a good time to seriously consider buying.
Last week, large mortgage lender American Home Mortgage shut its doors. That made the markets very panicky and led to an increase in rates for two specific loan types: "Jumbo" and 2nd trusts.
"Jumbo" loans are loans above $417,000--the limit for "conventional" loans set by Fannie and Freddie, who buy mortgage loans from originators. Fannie and Freddie exist to create a “secondary market” for mortgages—that is, they buy loans for cash, and then originators use that cash to make more loans to homebuyers. If they didn’t exist, then banks would only be able to loan as much cash as they had on hand, and would have to hold the mortgages until each homebuyer sold or paid it off. (That’s a bit of an over-simplification, but for our purposes it should suffice.) Fannie and Freddie are government “sponsored” (though not technically government-insured), and so the loans they can buy have certain restrictions, i.e., are under $417K. Because there’s an easily available secondary market for this size loans, they typically have a lower interest rate than the larger, or “jumbo” loans.
Now, $417K doesn’t buy you much in this area, so lots of people end up with “jumbo” loans. And since even the smallest place is usually in the $300s, many people in this area don’t put 20% (or about $60K+) down. That hasn’t been an issue until now. You can put 5% down, take out two “trusts” (or loans)—one for 80% and one for 15%, and be on with your home purchase. Those second trusts are becoming an issue, though. Read on:
The second impact of this panic is a big jump on the 2nd trust rates. 2nd trusts have always been riskier for lenders—they’re junior liens, after all, and so carried a higher interest rate. But that rate is the other important change in the past week. It jumped significantly.
Two impacts on this market are clear, but in my opinion, neither is catastrophic. At least not yet.
1) For most buyers, they can afford less. So if you were shopping at the top of your affordability range, chances are you can no longer afford that payment, regardless of how much you were putting as a down-payment. How much less? We’ll have to see where the rates stop. According to the Post, rates are up almost a full percentage point since May. So for every $10,000 borrowed, that’s $100/year.
Let’s use an example. Let’s say a buyer was looking at in the $600,000 range starting in May. Rates jumped up a point since then. That means that if there is NO room in their monthly budget (and why would any responsible person be looking at that price if there was absolutely no room in their budget?!) then now they can only afford $500,000. Another way to say it is that having the same $600,000 mortgage now costs them an extra $6000/year (which, making some assumptions about income bracket, is about $4000/year out of pocket after taxes.)
My guess—and I certainly could be wrong—is that people shopping for $600,000 homes have just a little bit of wiggle room in their budgets, maybe even up to $4,000/year. I think most people in that income and affordability bracket will make the trade-off, see their home as an important investment, and forgo a few discretionary items to get the house that they still want. I believe that the majority of the people are NOT going to change the range in which they’re looking, at least not by much. Again, maybe I'm naive, or maybe I'm just lucky that my clients tend to be responsible purchasers (or, not to pat myself on the back too much, but maybe I do a good job counseling them up front and introducing them to reputable lenders who counsel them too).
In my experience, the people who tend to stretch their budgets to the breaking point are the people who are buying their first place, which is often under $417K, and therefore not impacted by the jumbo rate jump. They are, however impacted in another way. They usually have less of a down-payment (because they’re not rolling over equity from a previous home), and are borrowing more than 80% of the purchase price.
2) For all borrowers planning to finance more than 80% of the purchase, you can afford less. This one worries me less—one, because only 15% of the loan is going to have a significant jump in rate, and that’s a whole lot better than having it hit the 80%. Second, there exists an option to borrow 95% as one trust and pay PMI. PMI, which historically was a dirty word for borrowers, is more acceptable now because in 2007 it’s tax deductible, same as interest. Boy, did they pick a good year to change that rule! So the 95% trust, as long as it’s not jumbo (see impact #1) should keep the payment roughly what a borrower was planning two weeks ago.
I’m sure this will continue to be a front-page crises for a few weeks. I’ll write more as the situation evolves. But I still stand firm in my conviction that if you are:
- Financially able to buy: good credit, a reasonable budget, about 8% of the purchase price in savings, and
- Your life situation calls for buying instead of renting: will be in this area for 3 or more years, you have reasonable expectations of what you get for the money, and you recognize that even a flat return on an investment is better than rapidly increasing rents (see Rent vs Buy calculator post),
Then this is still a good time to seriously consider buying.
Friday, August 10, 2007
Entrepreneurship
This is the first post I've written that's not about real estate. Well, not exactly about real estate anyway. It's really about helping others to help themselves. I recently learned of kiva.org -- a microfinance site that allows you to make very small ($25) loans to people in need across the world. I was intrigued by this site for a number of reasons, but mainly because I just got back from a trip to Vietnam and Cambodia. It was an amazing trip--more of an "education" than a "vacation," really. I won't take up space here with details (though I'll happily discuss off-line with anyone who's interested.) Suffice it to say that there are pockets of extreme poverty, yet in the midst of that, tremendous courage and a pursuit of something better. Entrepreneurship is everywhere. People do what they can to earn a living and provide a better life for their family. People all over the world, deep down, really do want the same things.
I started thinking about my adventures in real estate, and how lucky I am to have been given so many opportunities in my life -- education, careers, mentors, financing. It's so easy to take it for granted. On kiva.org you read profiles of people who are asking for so little, to try to get to the next stage of their lives.
Most people don't know this, but real estate agents are all independent contractors (1099 for all you payroll types.) We front money out of our own pockets for all our start up expenses--advertising, licensing, computers and cell phones, MLS access, business cards, etc. People always ask me who I work for, and the answer is "myself." Though affiliated with a broker, they don't provide health benefits, retirement benefits, equipment, clients, salary or draws, or many other things that people assume are provided. Being in real estate really is being a one-woman show (though in my case, I work with an amazing team!) That's probably why so many people fail. It's starting a business from nothing, with nothing.
When I think about where I am today, I'm so grateful that, truth be told, it was easy enough to get started in this business--some money, some time, some effort. And then I compare it to people trying to build a better life in other countries and I feel so, so lucky.
This isn't nearly as eloquent as I was hoping to be, but I hope you get a sense of where I'm coming from. And thank you to everyone who has ever given me an opportunity: parents, teachers, managers, co-workers, clients, and friends.
See more at www.kiva.org
I started thinking about my adventures in real estate, and how lucky I am to have been given so many opportunities in my life -- education, careers, mentors, financing. It's so easy to take it for granted. On kiva.org you read profiles of people who are asking for so little, to try to get to the next stage of their lives.
Most people don't know this, but real estate agents are all independent contractors (1099 for all you payroll types.) We front money out of our own pockets for all our start up expenses--advertising, licensing, computers and cell phones, MLS access, business cards, etc. People always ask me who I work for, and the answer is "myself." Though affiliated with a broker, they don't provide health benefits, retirement benefits, equipment, clients, salary or draws, or many other things that people assume are provided. Being in real estate really is being a one-woman show (though in my case, I work with an amazing team!) That's probably why so many people fail. It's starting a business from nothing, with nothing.
When I think about where I am today, I'm so grateful that, truth be told, it was easy enough to get started in this business--some money, some time, some effort. And then I compare it to people trying to build a better life in other countries and I feel so, so lucky.
This isn't nearly as eloquent as I was hoping to be, but I hope you get a sense of where I'm coming from. And thank you to everyone who has ever given me an opportunity: parents, teachers, managers, co-workers, clients, and friends.
See more at www.kiva.org
Sunday, August 5, 2007
FAQ: Earnest Money Deposits
I love the Post's Saturday Real Estate Mailbag. There's always something interesting in there. (Though if you read it long enough, you do start to see the same questions over and over.) Here's a good tried-but-true one that I often get from clients -- how much should you put as earnest money? What IS "earnest money," anyway?
Simply put, earnest money is a personal check that you write (payable to your real estate broker or another third party) that accompanies your offer on a property to indicate to the seller that you are sincere, or "earnest," in your endeavor to buy their property. It's a "good faith deposit" on the property. Once you agree to terms, the seller will be removing their property from the market and passing up potential future offers, so it's only fair that they have something more tangible than your signature to rely on. It's a buyer's way of putting "skin in the game."
The check gets cashed upon contract ratification, and the deposit is held by that third party until settlement, at which time it is applied to your downpayment or closing costs. In the event of any overage, it's refunded to you at settlement. In the event of a default by the buyer, the seller theoretically can claim that deposit (though in reality it's extremely difficult to make that happen.) Here's a great FAQ from the mailbag:
Simply put, earnest money is a personal check that you write (payable to your real estate broker or another third party) that accompanies your offer on a property to indicate to the seller that you are sincere, or "earnest," in your endeavor to buy their property. It's a "good faith deposit" on the property. Once you agree to terms, the seller will be removing their property from the market and passing up potential future offers, so it's only fair that they have something more tangible than your signature to rely on. It's a buyer's way of putting "skin in the game."
The check gets cashed upon contract ratification, and the deposit is held by that third party until settlement, at which time it is applied to your downpayment or closing costs. In the event of any overage, it's refunded to you at settlement. In the event of a default by the buyer, the seller theoretically can claim that deposit (though in reality it's extremely difficult to make that happen.) Here's a great FAQ from the mailbag:
DEAR BOB: What is the normal earnest money deposit that should be offered by a buyer for a $350,000 condominium? Is it a percentage of the sales price, or is it based on something else? -- Ottilia C.
DEAR OTTILIA: There is no "normal" earnest money or good-faith deposit for the purchase of a residence. At a minimum, however, it should be 1 percent of the sales price to show serious intent. That would be $3,500 in your situation.
If you are making an offer substantially below the seller's asking price, a larger deposit can impress the seller. However, your deposit should not be more than 5 percent of the purchase price. Always make your check payable to the firm you want to handle the closing of the sale, such as a title-escrow company or perhaps a real estate lawyer -- not the seller.
Of course this column is syndicated nationwide, so may not represent the typical transaction in this area. Though there is no specific requirement, in my experience and in the current buyer's market, you should be prepared to put about $5000 as a deposit for a transaction value up to about $350K, $10,000 up to about $600K, and for anything higher than that $20-25K would likely be considered sufficient. Obviously the more you put down, the more seriously your offer will be considered, particularly in a competitive bid situation (yes, they still happen!)
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