This is probably the umpteenth article I’ve written about the subprime lending mess and for some reason, I still find something else to say about it. It seems that nary a day goes by without some mention of the doom and gloom hitting the property market.
In the past, I covered the causes of this crisis at the personal level with stories from people who’ve lost out. This time, I wanted to cover the causes at the macro level as well as the subsequent fall out from this situation.
Let’s start with this question: Do any of these people look familiar?
- You have debt and want to borrow money.
- You are a house bubble sitter, one who’s waiting for the chance to buy at lower home price levels.
- You need to refinance your mortgage.
- You are an investor in the stock market.
- You are an investor in the real estate market.
- You are a homeowner.
If you see yourself in any of these people, you’re in good company. It looks like we’ve all taken a hit by subprime lending gone sour. Whether we like it or not, current real estate woes are actually affecting the lot of us more than any of us realize.
To understand the effects of the bust, let’s see how this supposed “financial contagion” has transpired. It’s all cyclical you see, since it starts right after the last bubble bursting episode in March 2000.
How The Housing Boom Unraveled
In short, this is what happened: the 2000 dot com bust led to a mild recession which subsequently led the Federal Reserve to cut rates low enough. These actions triggered borrowing and cheap money to fuel asset inflation and housing prices eventually heated up. After many years of this, the usual complacency and desire to keep the bubble going caused folks in the lending industry to resort to exotic loans and riskier practices. Credit got looser, enticing less qualified people to become heavily leveraged homeowners.
I remember how a few of my friends happily overextended themselves to own their half million-to-million dollar homes by cobbling together several loans to make it work. Things worked out for them since their homes are now valued at 50% higher than what they originally bought them for, so they’ve been rewarded for taking the risk. They were the lucky ones even as the financial climate changed and the central bank reversed its course by raising rates. Those less lucky who were carrying risky loans started to feel the squeeze, causing them to default on their mortgages and eventually foreclose.
Without expert photoshop skills to aid me, here’s my attempt at describing how the ugliness transpired:
risky loan products got eliminated —> hedge funds were hit (as they held suddenly cheaper mortgage-backed securities) —> home sales declined —> people panicked and at the end of it all —> the stock market did tank (though it has bounced back since, in reaction to the last rate cut).
This is yet another cycle of boom to bust. With history repeating itself, it shouldn’t be a massive surprise. In fact, it’s said to be a good thing for its financial health restorative effects.
So what’s next for us? We’ve got to live with some changes now. And they appear to be across the board.
The Consequences of The Subprime Collapse
Credit got tighter.
With interest rates higher, money just got more expensive to borrow. There are also tighter restrictions for getting loans: you need a higher down payment to qualify for a loan plus you need to have very good credit to get a good mortgage deal these days. A friend of mine who is a real estate investor is not thrilled by these developments at all. He tells me stories of people with perfect credit who are now at the brink of foreclosure due to tighter rules or unlucky circumstance. These people have “upside-down” homes that are now cheaper than their purchase price and are therefore unable to find refinancing for their adjustable rate mortgages due to stricter refinancing terms. Since they are unable to refinance, they become stuck with existing mortgage payments that simply grow larger with interest rate hikes. When payments become prohibitive, they are forced to default.
Buying a house got tougher.
If you’re a house bubble sitter happy to wait for lower priced homes, you may be less excited about today’s cheaper housing market. That’s because borrowing to buy a house is now under greater scrutiny. With credit drying up, all those fancy, exotic loans that allowed just about anyone to attain a new house disappeared with a whiff. “Stated-income” loans allowed borrowers to declare but not submit documentation of their income in order to qualify for these loans. These loans used to make it easier to borrow but they are now extinct. There are stricter requirements for purchasing a house today: higher interest rates on jumbo and non-conforming loans (greater than $417,000), better credit scores required, down payments of 10% or more to snag the best loan rates.
Selling a house got much harder.
For sure, you don’t want to sell your house now if you can help it. Have you checked out the comps in your neighborhood to see what kind of hit your house’s value has taken and what kind of discount you’ll be shaving off your home today? There’s more to this cycle to ride out.
The stock market got scarier.
We all know how much this market sucks. I hope you’re keeping your powder dry to buy in on the dips. I’d expect this downturn to work itself out over a period of several months. If this is a summer cyclical swoon, then come November, there could be a recovery. But don’t count on my predictions…. I don’t have a crystal ball. If you’re well diversified and have a long term view, you need not be too concerned.
Subprime Is The New Ugly But It’ll Get Better
So it looks like we’re all sharing in the pain here. Each one of us alike — debtor, buyer, seller, investor — have lighter pockets than we used to have. We’ll need to see how long this drama plays out. In the meantime, check out the following articles I’ve written to share my own thoughts about how to ride these bucking markets without feeling too dizzy:
- Shrug Off A Stock Market Slide! How To Reduce Market Anxiety
- 5 Ways To Survive A Volatile Stock Market
Hang on tight!
Image Credit: TruthDig.com
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