Rising Rates Flood Markets with Foreclosed Homes
Rising interest rates are conspiring to halt the real estate bull market in the U.S. But the trend is good news for those shopping for foreclosures like the ones listed in growing numbers on sites like ForeclosedHomes.com.
Many homeowners bought at extremely low interest rates that shattered records that had not been approached since before the 1970s – and they banked on living with such unprecedented rates for years to come. To maximize purchase power and leverage, most of them bought with no money down, interest only mortgages, or adjustable-rate mortgages offering initial “teaser” rates that later expire. The net result is that a nation of homeowners helped themselves to homes they could not actually afford, a classic investment mistake that creates more paupers than it does millionaires.
"People were gambling that their income would grow” Greg McBride, senior editor at Bankrate.com – one of ForeclosedHomes.com professional partners – explained recently. "They also were gambling that the market would help them build enough equity that they could refinance if they needed to.” But those gambles aren't paying off.
According to the National Association of Realtors (NAR), home sales dropped more that 4% in July 2006, and the inventory of unsold houses continues to accumulate.
"The one thing that's changing my forecast is the Federal Reserve," said David Lereah, the Association’s chief economist. The Fed has raised interest rates 17 times in two years, shifting mortgage rates 180 degrees from their recent historic lows. And Lereah and his colleagues at the NAR predict that the trend will continue into the foreseeable future. "The market is expecting several more interest rate hikes from the Fed,” he reported.
Rising interest rates affect adjustable-rate mortgages
Rising interest rates hurt homeowners with adjustable-rate mortgages the most. The New York Times reported that variable-rate mortgages swelled in popularity during the last five years to keep pace with rising housing costs. And Moody’s Investors Service reported that 19 percent of all mortgages originated in 2003 were adjustable-rate mortgages, but then the number nearly doubled the following year, before settling to 31 percent in 2005.
Because ARMs often adjust after three years – when the great initial rates expire – 2006 spells trouble for many who took out loans in 2003. And the troublesome trend is just starting to pick up steam.
FOX News reports that approximately $400 billion in loans will get a new rate this year, and another $2 trillion are set to move in 2007. Just two years ago, the prime rate stood around 4 percent; today, it is more than twice that. As a result, payments on some ARMs will double. The current forecasts from a number of experts have defaults on those loans increasing by 10 percent.
The San Francisco Chronicle ran a recent story quoting Jared Bernstein, senior economist at the Economic Policy Institute in Washington, D.C., told the San Francisco Chronicle that "A lot of the ARMs are starting to adjust. When those terms end and they need to be reset, mortgage rates are going to be a percent or two higher. You're talking about a few hundred dollars per month and as much as $1,000 or $2,000 more per year. This, in a climate where family incomes have been flat relative to inflation and people are getting pinched at the pump, when you look at a few extra hundred dollars going out the door, that's going to pinch."
Many homeowners bought more than one home
To add insult to injury, many bought more than one home, betting on continued price inflation. The NAR reported a 16% increase in the sales of second homes in 2005, but also reported a mind-boggling fact: 40 percent of home sales in 2005 were not primary homes, but second homes. The housing market has steadily eroded in the past year, however, prompting owners to flood the market with for sale listings as they dump their second homes and try to come up with enough cash to hold on to their primary residences. Household expenses for mortgage interest are expected to jump by nearly 18 percent this year, according to the federal Bureau of Economic Analysis.
“This will be one of the steepest year-over-year jumps in household interest expense since 1981,” said John Lonski, the chief economist of Moody’s Investors Service. “It’s worth noting that [1981] was part and parcel of a relatively severe recession, which has to be on the minds of the Fed policy makers.”
Refinance to a fixed-rate loan
One way to avoid the impact of such a trend is to refinance out of an adjustable-rate mortgage and into a conventional fixed-rate loan. With a fixed-rate mortgage you may pay a slightly higher rate than you now pay on your adjustable mortgage, but as rates on ARMs adjust, fixed-rates will begin to look like real bargains. Some lenders even offer new mortgages that extend for more than 30 years, for those who want to pay the lowest possible monthly payment without getting trapped by the risk of an adjustable-rate mortgage. Lenders have seen their business fall off significantly as the housing markets cool, so if you shop for a fixed-rate loan now, you will probably be offered extra perks and cheaper closing costs, in order to gain and retain your business.
As the inventory of homes is fast approaching record levels, climbing as much as 20 percent per month in some neighborhoods, the foreclosure markets are becoming the hottest game in town. When you can still lock in a great fixed-rate and use it to buy a home at a discount price, it is the best of both worlds. And ForeclosedHomes.com helps you to take advantage of this unique historical opportunity, by providing up-to-the-minute listing of foreclosed property all over the U.S.