Todd Crane
Sunshine Mortgage
When Alan Greenspan says that Adjustable Rate Mortgage (ARM) loans were a better choice than fixed rate mortgages, people start to pay attention. So if ARM loans could have saved homeowners very significant amounts of money, why have Fixed-Rate products been the overwhelming favorite? The answer could be in the borrower’s lack of understanding, experience, or perhaps it is unjustified fear. Additionally, many loan professionals may not have adequately and articulately walked their customers through the pros and cons of an ARM loan. Once a borrower gains a better understanding of the proper way to make comparisons between loans that can adjust vs. those that are fixed, as well as the historical data, they may be much more open to selecting an ARM loan and reaping the benefits.
There are lots of ARM loans to choose from and the features can vary quite a bit. The time that an ARM will remain fixed before adjusting and the factors governing the future adjustments, including the maximum amount the rate can change are important points to consider. The future adjustments are based on an index, so understanding what will cause the index to fluctuate as well as historical data on the index are both important to know. Let’s look at one popular type of ARM…a 5/1. This loan will remain fixed for the first five years but then adjust every year thereafter. A common misunderstanding that many consumers will have is that they feel they should only consider the 5/1 ARM if they plan to be in their home for five years or less. They often fail to recognize that the savings made in the first five years will offset future years of possible higher payments if the rate on the ARM increases. The best way to illustrate this is to look at a specific example. It is very common for the rate of a 5/1 ARM to be about 1% lower that the rate on a 30-year fixed loan. Assume the loan amount were $300,000. The 1% savings on the 5/1 ARM would save the borrower about $200 each month for the first 60 months (5 years). That would net them a hefty savings of $12,000 during that time. But most borrowers worry about what will happen after the initial period. If the $12,000 savings during the initial five years were just placed in a piggy bank, there would be enough funds there to draw upon to cover future worst case increases for the following 2-3 years. This assures the borrower of coming out ahead by selecting the 5/1 ARM for 7-8 years. Compare that to the average life of a mortgage loan, which is four years (because people will refinance or sell their home) and the odds become stacked in your favor that the ARM will save you money.
Let’s Get Creative
Another strategy that can be used for the above mentioned example is to take the $200 monthly savings and use it to reduce the balance on the mortgage. The pre-payment of principal will have an even greater effect because the borrower is now skipping down the amortization schedule and paying more principal and less interest on each subsequent payment. After the initial 60 payments made during the first five years, the borrower would have approximately $17,000 more equity in their home because of the reduced principal balance. Because the borrower has this extra $17,000 in equity, they would be better off with their 5/1 ARM for approximately 10 full years. This is true if rates moved higher after the initial five years…even in the worst-case rising rate scenario. And, it just so happens that the National Association of Realtors states that the average period of time that people sell their residence is every 10 years.
Another benefit when using the strategy of reducing the principal balance happens at the time of the initial adjustment. When an ARM loan adjusts, it essentially becomes a new loan where the payments are based upon the remaining years, the new interest rate and the remaining balance. Because the remaining balance is significantly lower when the savings are used to reduce principal, the payment can actually go down even if the interest rate adjusts higher.
I Am Not a Gambler
Many borrowers say they refuse to take a gamble on their selection of a mortgage product so they stick with a fixed rate. Well, like it or not, whatever their choice is, it’s a gamble. Selecting a fixed rate still means they are betting that, during the time they are obligated to pay the mortgage, the fixed will perform better than the ARM. Either way, they are rolling the dice and making a bet. The only difference is they will know the result of the fixed payment. The key here is to get the odds to work in your favor. That is where understanding and guidance from the loan originator can be worth its weight in gold.
Back to The Future
They say a picture is worth a thousand words. The chart below may be worth thousands of dollars. Over the past 200-years, interest rates on the US 10-year Treasury Note have, for the most part, remained fairly tame. The average has been close to 6%, but many fear the chance of runaway double-digit rates. Rates have remained in the single digits for all except 8 of the 214 years shown below. The rampant inflation of the late 1970′s had to be reigned in. So rates were pushed higher during the 1980′s. The result…low inflation and rates over the years leading to the present time. The lesson learned by the Fed was to use an ounce of prevention instead of a pound of cure. In other words, the Fed acts quickly now to hike rates a little so that inflation will remain in check, which helps keep rates from running significantly higher. The sky-high rates of the early 1980′s will probably never be seen again.

I Agree With You But…
“OK OK”, says the borrower, as they appear to finally see the benefits of utilizing an ARM loan. But…”Even though I know I will have saved the money in cash or equity during the first five years, I still may be faced with significantly higher payments to make. Where will I come up with the extra cash flow to pay the higher payment of, perhaps, $500 per month?” The answer is simple but not obvious at first. Let’s understand what would make rates skyrocket for 8, 9, or 10 years. The overall economy would have to be very strong, almost too strong, to see inflationary pressures causing rates to ascend and remain very high. Much of those inflationary pressures would come from employment wages rising at a torrid pace…perhaps 10% per year or more. But let’s assume the borrower is on the very low end of pay increases, and only sees an average increase of 4% each year. If their household income were $80,000 today and they were concerned about the possibility of a $500 increase in monthly payment 9 years from now, it sure would appear scary against today’s income. But they really need to consider what their future income will be. Even at a very modest 4% annual gain, which could be less than half the average annual gain in a hot economic climate, their $80,000 annual income will swell to almost $110,000 in 9 years. That means they would have an extra $2,500 each month to help pay the additional $500 possible bump in their mortgage payment. Sound far-fetched? An easy way for your clients to relate to the increase in their future income is to work backwards. This same formula would mean that their income 9 years ago was $58,000…Not very hard to believe.
Void Where Prohibited, May Cause Drowsiness and Your Mileage May Vary
Almost all of the above examples were given under the worst-case scenario for the ARM loan. And the worst-case is not likely to occur. Even so, the results appear quite favorable when compared to the fixed. But, that said, the wide variety of ARM loan types and their specific features require that each loan option be examined individually…thus, the above disclaimer. But the key is for borrowers to have an open mind and explore the many options. Even a great rate on the wrong mortgage selection can be far more costly than a fair rate on the right mortgage product to fit the individual’s needs.
Remember…it’s not getting what you want that counts…it’s wanting what you get.

Todd Crane, Sunshine Mortgage
Anyone watching or reading the financial news over the last few weeks has seen a lot of angst and consternation over the state of the mortgage industry. In fact, one of the larger lenders in the US, American Home Mortgage, was forced to shut down operations recently. But why? What is happening, what does all this mean to you and most importantly… what should you be doing do right now to make sure you are protected?
Here’s the scoop.
Over the past several years, many loans were made to homeowners with somewhat non-traditional or “non-conforming” situations, be it a poor credit history, inability to document income, or any number of factors that do not fit within the traditional “box” for home loans. These loans are often called “Sub-Prime”, or “Alt-A”, meaning that they were somewhat riskier in nature than A credit, prime, or traditional loans. Another type of “non-conforming” home loan is one where the credit and income might be perfectly fine, but the loan amount is higher than $417K, which is the current maximum loan that can be done using pools of money from mortgage giants Fannie Mae (FNMA) and Freddie Mac (FHLMC). If the loan amount is higher, it can certainly be done – it’s called a “jumbo loan” – but the end money comes from private institutions, not from the large government sponsored entities of Fannie and Freddie.
Most non-conforming loan product rates popped significantly higher recently. Here’s what happened.
The end investor for Subprime or Alt-A loans will charge a premium for taking on a pool of these loans, because they know that traditionally, they might have a higher rate of default and delinquent payments within that risky pool. But lately, default and foreclosure has been on the rise – partly due to the fact that with credit tightening and a soft real estate market, many troubled homeowners are unable to refinance or sell in order to get out of trouble. So now, these end institutions are demanding a much higher “risk premium” for taking on these pools of loans, as they see the rates of default are climbing higher.
But since these institutions are purchasing these pools of loans sometimes months after the borrower has actually closed at a given rate, this increase to the risk premium means that instead of paying $101K for a $100K loan that will bear interest, they may only be willing to pay $95K for that $100K mortgage to account for the risk. Multiply that times thousands upon thousands of loans…and you have millions upon millions of dollars in loss for the company trying to sell the pool at a much lower price than they were expecting. This is called a “liquidity crisis”, and is exactly what happened to American Home Mortgage – there was no mismanagement, but they simply got caught holding too many “hot potato” loans, forced to sell them at massive losses…and eventually they had to make the decision to close the doors and stop the bleeding.
Further, even when a lender is able to take some losses, they may be subject to a “margin call”. This means that as their losses and risk premiums increase, the value of their loan portfolio decreases. As the value decreases, the credit lines that are secured by those portfolios begin to issue margin calls as the value of the asset that they are secured on is now diminished. This is exactly like margin calls in the Stock market. If you have a loan against a Stock that is losing value, you will get a “margin call” and need to pay down the loan, as the underlying Stock is losing too much value to be considered adequate collateral any longer. So for the big lenders, as their portfolio is losing value due to increased risk premiums and losses…the margin calls start coming in, and they are required to pay down their balances. In turn, this means that they have less availability to fund their new loans, which then exacerbates the problem.
In response to seeing this situation play out in the demise of American Home Mortgage, lenders of other non-conforming loan products increased their interest rates dramatically almost overnight to be better prepared – and likely over-prepared – for increased risk premiums down the road. Even though loans above $417K are not presently suffering from increased delinquencies like the Subprime and Alt-A loans are, these rates popped higher as well, because they are being purchased by smaller private entities that can’t afford to take on any margin of risk.
What happens next? The major damage is probably already done, and the present situation will likely settle out over the coming year. Lenders will stop pulling products off the shelf, and the rates on products that have moved so significantly higher now should trend lower down the road as delinquency rates stabilize.
But here are a few important things YOU should do right now:
ONE: Even if you are not presently in the market for a home loan of any type, make sure that your credit standing is as solid as possible. Many people in the market for a home loan didn’t expect they would have a need, and didn’t plan in advance to ensure their credit would qualify them for the best possible financing. With no immediate need for a home loan, time is on your side… why don’t we take a few minutes together and just make sure you are prepared, should a need arise down the road? Call or email me right away.
TWO: If you are in the market for a home loan, or know someone who is – understand that now is the time to be working with a real qualified professional who can keep you informed of changes in the market and get your loan funded quickly. Now is NOT the time to be playing the risky game of trying to scour the entire nation to find someone who promises to save you a paltry amount on costs, or deliver a rate that seems too good to be true.

The Housing Crisis Is Over
By CYRIL MOULLE-BERTEAUX
May 6, 2008; Page A23

The dire headlines coming fast and furious in the financial and popular press suggest that the housing crisis is intensifying. Yet it is very likely that April 2008 will mark the bottom of the U.S. housing market. Yes, the housing market is bottoming right now.

How can this be? For starters, a bottom does not mean that prices are about to return to the heady days of 2005. That probably won’t happen for another 15 years. It just means that the trend is no longer getting worse, which is the critical factor.

Most people forget that the current housing bust is nearly three years old. Home sales peaked in July 2005. New home sales are down a staggering 63% from peak levels of 1.4 million. Housing starts have fallen more than 50% and, adjusted for population growth, are back to the trough levels of 1982.

Furthermore, residential construction is close to 15-year lows at 3.8% of GDP; by the fourth quarter of this year, it will probably hit the lowest level ever. So what’s going to stop the housing decline? Very simply, the same thing that caused the bust: affordability.

The boom made housing unaffordable for many American families, especially first-time home buyers. During the 1990s and early 2000s, it took 19% of average monthly income to service a conforming mortgage on the average home purchased. By 2005 and 2006, it was absorbing 25% of monthly income. For first time buyers, it went from 29% of income to 37%. That just proved to be too much.

Prices got so high that people who intended to actually live in the houses they purchased (as opposed to speculators) stopped buying. This caused the bubble to burst.

Since then, house prices have fallen 10%-15%, while incomes have kept growing (albeit more slowly recently) and mortgage rates have come down 70 basis points from their highs. As a result, it now takes 19% of monthly income for the average home buyer, and 31% of monthly income for the first-time home buyer, to purchase a house. In other words, homes on average are back to being as affordable as during the best of times in the 1990s. Numerous households that had been priced out of the market can now afford to get in.

The next question is: Even if home sales pick up, how can home prices stop falling with so many houses vacant and unsold? The flip but true answer: because they always do.

In the past five major housing market corrections (and there were some big ones, such as in the early 1980s when home sales also fell by 50%-60% and prices fell 12%-15% in real terms), every time home sales bottomed, the pace of house-price declines halved within one or two months.

The explanation is that by the time home sales stop declining, inventories of unsold homes have usually already started falling in absolute terms and begin to peak out in “months of supply” terms. That’s the case right now: New home inventories peaked at 598,000 homes in July 2006, and stand at 482,000 homes as of the end of March. This inventory is equivalent to 11 months of supply, a 25-year high – but it is similar to 1974, 1982 and 1991 levels, which saw a subsequent slowing in home-price declines within the next six months.

Inventories are declining because construction activity has been falling for such a long time that home completions are now just about undershooting new home sales. In a few months, completions of new homes for sale could be undershooting new home sales by 50,000-100,000 annually.

Inventories will drop even faster to 400,000 – or seven months of supply – by the end of 2008. This shift in inventories will have a significant impact on prices, although house prices won’t stop falling entirely until inventories reach five months of supply sometime in 2009. A five-month supply has historically signaled tightness in the housing market.

Many pundits claim that house prices need to fall another 30% to bring them back in line with where they’ve been historically. This is usually based on an analysis of house prices adjusted for inflation: Real house prices are 30% above their 40-year, inflation-adjusted average, so they must fall 30%. This simplistic analysis is appealing on the surface, but is flawed for a variety of reasons.

Most importantly, it neglects the fact that a great majority of Americans buy their houses with mortgages. And if one buys a house with a mortgage, the most important factor in deciding what to pay for the house is how much of one’s income is required to be able to make the mortgage payments on the house. Today the rate on a 30-year, fixed-rate mortgage is 5.7%. Back in 1981, the rate hit 18.5%. Comparing today’s house prices to the 1970s or 1980s, when mortgage rates were stratospheric, is misguided and misleading.

This is all good news for the broader economy. The housing bust has been subtracting a full percentage point from GDP for almost two years now, which is very large for a sector that represents less than 5% of economic activity.

When the rate of house-price declines halves, there will be a wholesale shift in markets’ perceptions. All of a sudden, the expected value of the collateral (i.e. houses) for much of the lending that went on for the past decade will change. Right now, when valuing the collateral, market participants including banks are extrapolating the current pace of house price declines for another two to three years; this has a significant impact on the amount of delinquencies, foreclosures and credit losses that lenders are expected to face.

More home sales and smaller price declines means fewer homeowners will be underwater on their mortgages. They will thus have less incentive to walk away and opt for foreclosure.

A milder house-price decline scenario could lead to increases in the market value of a lot of the securitized mortgages that have been responsible for $300 billion of write-downs in the past year. Even if write-backs do not occur, stabilizing collateral values will have a huge impact on the markets’ perception of risk related to housing, the financial system, and the economy.

We are of course experiencing a serious housing bust, with serious economic consequences that are still unfolding. The odds are that the reverberations will lead to subtrend growth for a couple of years. Nonetheless, housing led us into this credit crisis and this recession. It is likely to lead us out. And that process is underway, right now.

OUR OPINIONS: ATL spared worst of home crisis

The national housing malaise continues, there’s no doubt about that. And there are plenty of “for sale” signs planted in yards of both new and existing Atlanta homes.

It’ll likely be a year or more before we again see a booming residential real estate market in this country. But compared with the nation as a whole, things don’t look quite as dire in Atlanta and the South, at least by one measure reported recently.

Thanks for that, in part, go to a relatively healthy local economy that’s still creating jobs and luring newcomers to this region.

Nationally, sales of new homes slammed downward in March to lows not seen in more than 16 years. The national median home price in March was 13.3 percent lower than it was a year ago. And this is at the start of the traditionally hot spring sales season.

In the Northeast, where the market had been boiling hot only a couple of years ago, prices declined 19.4 percent compared with March 2007. That gives new, and painful, meaning to the term “market correction.”

By comparison, the South saw the smallest dip in March new-home sales —- 4.6 percent.

Generally, lower home prices and the lack of big price run-ups in past years surely played a role in the South’s relatively good showing. Local real estate watchers say the Atlanta market is gradually reconciling the supply of homes with demand, which should help things recover. It was a rough but necessary market adjustment as home builders cut construction schedules and sellers of existing homes dropped prices.

Fewer homes on the market will match up more closely with the number of potential buyers.

Eugene James, Atlanta division director for Metrostudy, which surveys the housing industry, expects to see sales pick up coming out of the historically slow winter months.

He says local home builders are starting to report more prospective buyers looking around subdivisions.

And more “under contract” stickers are being slapped on “for sale” signs, Realtors say. “Contracts are starting to happen as we’d hoped they would happen,” said James.

Realistically, we’re a long way from the hot housing market to which we’d grown accustomed. Still, Atlanta should count itself lucky that the region’s still packing in home buyers moving here to fill the jobs we continue to create.

—- Andre Jackson, for the editorial board (aajackson@ajc.com)

Housing market: With its robust growth rate, Atlanta is set to bounce back sooner, stronger than many areas.

By Seth Weissman, Dan Forsman
For the Journal-Constitution

Published on: 04/14/08

The reports of the demise of Atlanta’s housing market have been greatly exaggerated.

The much publicized housing bubble was never more than a small bump here in Atlanta. In parts of Florida, California and Nevada, housing prices doubled and tripled between 2001 and 2006. During the same period, home prices in Atlanta increased a slightly higher than normal 4 percent to 5 percent per year. Price increases in other parts of the country were unsustainable, and what went up eventually came down. Not surprisingly, where prices went up the most, they also came down the most. For all the bad press about housing, home prices in the Atlanta region fell less than 5 percent over the last year.

While fear and uncertainty have caused the number of overall home sales to fall sharply in Atlanta and around the country, home prices here have not fallen anywhere near as much. This is because while housing is a commodity, it is also a place where people live. The majority of home moves are discretionary. If the market is unfavorable, discretionary buyers and sellers sit on the sidelines. This can cause a decline in the number of homes sold without having much of an effect on prices.

Home prices in the Atlanta region are somewhat immune to a large price drop because we benefit from a wonderful safety net. Our metro region adds about 150,000 people per year. Between 2000 and 2006, our region added 856,266 people, a growth rate that was the highest in the nation. Almost 2 million additional people are expected to move here over the next 12 years. With so many new families moving to Atlanta, the demand for housing will remain strong.

While there are more than 100,000 homes on the market today, it will not take long to absorb them based on our current rate of growth. This is particularly the case since homebuilders started cutting back on new construction three years ago and permits for new homes have now fallen dramatically.

Home buyers are confused about getting a mortgage and the large number of homeowners at risk of being foreclosed. Despite all the hoopla about a credit crunch, it is surprisingly easy to get a mortgage if you have decent credit. While the same cannot be said for buyers with bad credit, this represents less than 10 percent of the market.

The degree to which foreclosures will stress our local market will depend on what actions our federal government takes to solve the problem. However, foreclosures are highly concentrated in certain neighborhoods rather than being evenly distributed throughout the metro region. As a result, housing markets in desirable neighborhoods with low foreclosure rates are already showing signs of strengthening.

Less desirable neighborhoods hard hit by foreclosures may limp along for years in a recurring tale of rich neighborhoods getting richer and poor ones getting poorer.

Smart housing decisions tend to boil down to a focus on location. While there are many factors that make a neighborhood desirable, the more important ones include quality homes, good schools, low tax rates, low crime rates and good access to work centers and shopping. Driven by traffic congestion, an aging population and changes in consumer preferences, what is considered a good location is also changing. There is a reason that all those condominiums and mixed-use developments are being built —- they are filling a demand from aging baby boomers and young professionals. While developers may have gotten a bit ahead of themselves in this area, the smart money is on the demand for this type of housing to grow exponentially over the next decade.

Housing prices in Atlanta, not having fallen much, should not have far to go to predictably rebound. In a few years, due to the health of our local economy, housing prices should be higher than at the peak of the previous cycle.

Sellers whose homes are worth less than they were a year ago and who psychologically feel poor should not have to wait too long to feel better about their circumstances. Of course, rather than waiting to sell until prices recover, savvy sellers have figured out that if they can get an equally good deal in purchasing another home, they are still ahead of the game.

A $200,000 home in Atlanta in 2001 was likely worth $260,000 in 2006. With a 5 percent drop in housing prices, that house today would be worth $247,000. While a $47,000 increase may not seem like much, as a rate of return on the typical buyer’s cash investment, it is very healthy. Housing is and will continue to be a tremendous builder of wealth for buyers who can ride out the periodic cycles in the market.

A strong buyer’s market and low interest rates are allowing buyers to get great deals on housing. As the spring market gains momentum, the best deals are being snapped up. The advice of “buy low, sell high” has never been more apt. Buyers should act accordingly.

> Seth Weissman is senior counsel to the Georgia Association of Realtors. Dan Forsman is president and CEO of Prudential Georgia Realty.