A sinister visitor from outer space wants to wreak havoc in the financial affairs of Americans. So he learns everything there is to know about our economy and devises a sinister plan …
The Set-Up
First, he makes debt abundantly available in order to get as many people hooked as possible …
Second, he pushes interest rates down to abnormally low levels. And he gets more and more banks to loosen their mortgage standards requirements (see chart below).
Third, he encourages people to sink all the money they can into real estate. He gets them to buy bigger homes than they can really afford, cajoles them to invest more in home improvements than they really need, and persuades them to buy vacation homes or rental property.
Fourth, he targets people who already own a home, enticing them to refinance with cheap second mortgages.
Fifth, when buyers are stretched to the limit, he pushes them into Adjustable Rate Mortgages (ARMs), getting 35.2% to sign up for ARMs — the largest percentage since 1994.
The Attack
Finally, after he’s got millions of households trapped, he’s ready to attack. His primary method: To make homes suddenly a lot less affordable to the average person.
Starting in March of this year, he finds the weakest link in the market: 30-year fixed mortgage rates. They’re at 5.41%. So he jacks them up a bit — to 6.35% by May. On a typical $200,000 mortgage, that means the monthly principal and interest payment rises $120. Not much — but enough to start making homes less affordable.
The National Association of Realtors tracks the affordability of homes with a special index dedicated to that purpose. Sure enough, the index (based on fixed-rate mortgages) plunges from a peak of 144.9 to 125 in June, the lowest reading since 2000.
Lenders and borrowers reach a breaking point. Sales start to peak out. New home sales fall 5.6% in June and 6.4% in July. Existing home sales, which tend to lag behind, drop only 2.9% in July, but are likely to fall more sharply in August.
The worst is yet to come …
Once the buying starts cooling, hot-money owners — those who are quick to run at the first sign of trouble — rush to put up “for sale” signs.
Here in our area, we see that happening already. My associates and I have seen more “for sale,” “for sale by owner,” and “house for rent” signs popping up than we’ve seen in many years.
Meanwhile, just recently, we saw a lot of buyers buying new homes for pre-construction prices with the hope of flipping them later. But now, many of them have suddenly stopped submitting bids.
Result: A glut of homes.
Indeed, right now the supply of new homes for sale (blue line in chart below) is at almost a 25-year high. But the new homes sold (pink line) is beginning to tumble.
Bad sign.
Why are sales going down? One key factor is that renting is so extraordinarily cheap right now, while buying is so extraordinarily expensive.
And why are rentals so cheap? Because the national rental vacancy rate is literally going through the roof! Look at this chart …
Throughout the 1990s, it was rare for the vacancy rate to exceed 8%. Then, during the early 2000s, it hit new highs at close to 9%. That was understandable. The economy was slumping and the stock market was getting killed.
But now look! The vacancy rate has surged to 10.4% DESPITE the fact that the economy supposedly is recovering.
Next phase: If this trend continues, expect a wave of nasty foreclosures, defaults, and loan losses.
Indeed, the risk is obvious that even Alan Greenspan is finally expressing some worry about a housing bubble. His own words: “This observation raises the possibility that real estate prices, at least in some markets, could be out of alignment with fundamentals.”
Translation: Beware of a real estate bust. It may not happen immediately, and each region is different. But you must take action to prepare.
SIX Steps I Recommend As Soon As Possible
Step 1. Don’t buy. As long as the market is weakening, you are bound to get a better deal on a similar property later on. Even if mortgage rates are higher by then, the amount you can save on the price could be several times greater than the extra interest you may have to pay.
Step 2. Seriously consider selling commercial properties. Their values are typically the first to fall in a real estate bust. Seek to price the properties aggressively to move them quickly without giving away the store.
Step 3. Seriously consider selling a second home. Vacation homes could be among the first residential properties to go down.
Step 4. Get out of rental properties. Don’t assume your tenants — regardless of their income level or apparent job security — will renew their leases or even continue paying their rent on a timely basis.
Step 5. For your primary residence, ponder these questions carefully:
(a) Is your residence primarily a home with no other available place to live? If so, selling is not even an issue for you. Stay where you are.
(b) Were you already thinking about moving anyway? If so, the best time to sell is when you have a good reason to believe that prices may be going lower, such as now.
(c) Are you near or past retirement age? And are you counting on your real estate to finance a substantial portion of your retirement or long-term health care? If so, consider selling now. If not, stay put.
Step 6. Find out whether you’re in a “bubble zone.” Other factors aside, the sharper the recent price rise, the sharper the decline when housing values do fall. To find out if you’re in a bubble zone, log on to the Office of Federal Housing Oversight Web site at www.ofheo.gov.
Go to the House Price Index and find the table that lists the percent change in house prices. This is a list of major U.S. metropolitan areas, with stats on national house-price increases for the most recent quarter, one year, and 5 years. If homes in your area have appreciated by 25% or more in the last five years, it’s likely that your home value is at greater-than-average risk.
Don’t procrastinate.
Good luck and God bless!
Martin D. Weiss, Ph.D.
Editor, Safe Money Report
Chairman, Weiss Ratings, Inc.
martinonmonday@weissinc.com
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