Yes, those people are in trouble.
The other people who are in trouble are those people that paid highly inflated prices for a piece of property, took out an interest only ARM loan to barely make the monthly payment and, with the passage of time, now can no longer make the previously locked-in rate interest payments, plus the increase in interest rate that now kicks in plus the principal.
Add to that the fact that new buyers are starting to realize that “trees do not grow to the sky” and are no longer willing to be the next Greater Fool willing to buy a house priced at way more than can afford simply because they can afford the interest payments with ever riskier gimmicks and you have:
Home foreclosures increase 72%
Boston Globe: Suburbs flush with homes for sale Inventory rises 54%
If you took out a conventional loan and paid PITI for 2 years, you'd pay mostly interest, as you do for about 11-12 years on any home loan.
The interest only loan fad has artificially raised housing prices so much that most new buyers cannot afford the price with conventional loans.
If you had a 100% loan and had to sell, you'd be in big trouble if the market was down.
Well, the market IS down, the buyers who paid more that they should have cannot afford the greatly increased monthly payments now that grace periods are beginning to expire and, with suburbs sprouting dozens of For Sale and Foreclosed sign and the supply of Greater Fools willing to ignore value has dried up.
Those who took out a 100% no interest ARM loan are the lucky ones. Those who put down a 20% down payment and took out an 80% no interest ARM loan face losing not only their house but also their down payment.
Worse case: let's say you have an option ARM and are adding $5,000 a year to the principal because you are paying the lowest payment. In 5 years you would add about $25,000 to the principal. In that time, your home may have gone up 20%. A gain of 80,000 on a 400,000 home. The net: $55,000.
In other words, trees DO grow to the sky and the buyer must not consider concepts such as value since there will always be a Greater Fool to take the investment off your hands at a 20% profit in 5 years.
If you buy and hold, the value will increase and you'd be well in the clear.
I can buy and hold. You can buy and hold. You and I are in the position of using interest only loans as cash flow tools as they were intended and, in the very worst case scenario, we can write a check for the entire principal.
The problem today is the buyers using such loans have no such means and can barely afford the interest only grace period payments.
The difference is that you want to pay more to the bank, while I'd be buying two-three more homes.
That is one way of looking at it. The other way to look at it is that my rental income and the money that I would otherwise have given to the bank has been mine to invest in whatever other investments I chose whether it be real estate or not.
You chose to concentrate on real estate and I chose to diversify.
Plus, if I die tomorrow like my father died when I was 16, my family can keep 100% of the real estate we own instead of losing the house like my family did. There is a value to peace of mind.
I have four homes now with about 900,000 in equity. I could have paid off my one house and had $350,000.
Or, if you had not paid attention to value, you could have had one hell of a negative cash flow plus a couple of foreclosures.
Would you care to buy a $600,000 condo on Miami Beach to add to your real estate portfolio?
It is nearing completion and one of my relatives is a little nervous about having to feed that mortgage if he is not able to sell. And, no, renting it out will still leave huge negative cash flow.
I help people figure this out for a living and how to avoid being upside down. I know it works because I have done it personally and helped a few dozen others do the same thing.
It works if you buy good value.
The problem up to now is that too many new buyers were paying ridiculous real estate prices made possible only with risky loan gimmicks that they will never be able to pay off.
The same thing happened in the 1980’s during the Japanese Real Estate Bust. That brought about the Japanese Banking Crisis that followed. Here in the U.S., the situation may well bring on Savings and Loan Taxpayer Bailout Revisited.
It is an oversimplification to say that interest only should be for the wealthy. If the factors are right, anyone can reasonably take advantage of these loans and come out well ahead on their investment. That's what I help my clients figure out.
The way that article used the word “wealthy” is to mean someone who had enough assets to pay off the principal of the no interest loan if need be without losing the property to foreclosure.
Would you advise a young, two income working couple who want to have a baby in three years to buy my relative’s $600,000 Miami Beach investment condo because, after looking into an interest only ARM loan that allows negative amortization payments for the first two years, they have discovered that they can actually afford the monthly payments for those two years on their Burger King manager salaries.
I think not.
You teach clients to use mortgages as cash flow tools and they can be great cash flow tools.
The problem is that many new buyers are now using these gimmick loans to pay highly inflated prices that they simply cannot afford in the long run and the supply of Greater Fools willing to take the mistake off their hands has dried up.
