Flim-flam financing in the housing Industry

It’s 2004. You are finally doing OK. You have good credit, your family has two incomes and together you are grossing over $100,000 a year as you cruise into the 2004 election. The ’90s boom has been pretty good for you, and you have high hopes. Sure, there are rising child care costs, commuting expenses, college funds to think about. You think: maybe the Republicans were right about “middle class” tax relief.

You find yourself gazing with real interest at those magnificent McMansions blossoming all over the outer limits of suburbia. Just out of curiosity, you stop into one of the mall real estate offices. There, as if some astral entity had read your mind and leaked it onto the Internet, the friendly agent takes one look at your preliminary application, notices exactly which half-million-dollar home photo you had been staring at, and says, “So, when do you want to move in?”

The agent is actually in pretty much the same boat as you. She too had been doubtful how she was going to move these high-priced properties until her boss unloaded some dark secrets of the modern real estate market to her.

Now suppose, before you walked into the agent’s office, you had used a mortgage calculator to find out your monthly payment for a 30-year $500,000 mortgage. Your payment, at a 7.0 percent interest rate, making minimal homeowners insurance and tax assumptions, would be: $3,511.51. Assuming you had minimal external debt (like a car loan) of $450 a month, you would have to make at least $150,000 a year to qualify for the loan.

Why is the agent smiling?

Then the agent lets you in on the first secret: the “interest only” loan. Under this kind of loan, you never own the house. Your equity consists only of the speculation that the home’s value will rise in the housing market. A risky loan over the long term, the ordinary person might think — what if prices go down? “Never,” asserts the real estate business! Unfortunately, you are still $20,000 short in annual income. But in reality, you just dodged a bullet.

But the “interest only” mortgage is not why the agent is smiling. It turns out she can get you in your dream house for only $1,500.00 a month! It’s called the “option adjustable rate mortgage” or “option ARM.” This gimmick allows you to defer a big chunk of ordinary interest payments and make minimum payments. What happens to those deferred payments? Well, they get added on to the mortgage principal. But, she says, seeing the worried look in your eye, you don’t really have to worry about this down the line because home values are rising faster than the amortized interest.

You’re hooked. You’re in the dream house. You voted for Bush to get the tax cut too.

Then, 29 months later, the bill for not reading the fine print of both decisions (the mortgage, and Bush) comes due. The interest added to your mortgage principal from paying the minimum is now $50,000. The lender has exercised his right to “reset” your loan. Your new payment is $4,100 a month. Looks like the tax cut won’t cover that! Oh, and that Bush tax cut — well, if you earn between $100,000 and $200,000 a year, the Alternative Minimum Tax rate kicks in and your taxes go up, not down.

Chickens are now coming home to roost in the housing market. Option ARMs have risen from under 1 percent of deals in the ’90s to at least 12.5 percent in 2005. Business Week likens option ARMs to the neutron bomb: the people are blown up but the houses are still standing.

This observer submits that it is largely due to the culture of corruption spawned by the Bush era that economic forecasters do not have the true state of housing market affairs in their figures as they estimate the impact of the already acknowledged coming downturn.

jcase@steuber.com