Economic Malady
U. S. economic expansion is dependent on low interest rates and high productivity.
Corporate earnings growth is a by product of a strong economy.
Lender payment can consist of Principal (P) and Interest (I), Interest Only
or a partial Interest payment against a negatively amortizing ARM loan.
A full glass will over flow with a single drop of liquid. An empty coffee pot left over a continuous flame will either burn the bottom of the pot, crack the pot or both.
An economy with serious mortgage foreclosure issues will eventually cause an economic slow down. If there is economic stagflation beginning in 2007 and carrying through 2008, it will be the result of to many available homes for sale and to few qualified buyers.
The primary culprit responsible for any 2007/08 housing crises will be a declining economy (+0.6% 1st qtr. 2007 growth) brought on by increasing interest rates, high gas prices, declining productivity levels (+1.0% 1st qtr. 2007), higher taxes and out of control government spending.
The current 2007 home sale slow down is not a direct result of the flawed subprime industry's underwriting practices. The current foreclosure issue rest with the type of financing chosen by the borrower and approved loan amount. A good credit borrower with AAA credit scores and 33/40 ratios at time of closing could be facing foreclosure, if the chosen loan program in 2004 was an Adjustable Rate Mortgage (ARM) with a fixed rate for the first three years. From 2004 to present, ARM "Indices" have risen by 3.0% to 4.0%. Adjustment caps will slow payment increases.
Those real estate borrowers that chose a 3/6 or 3/1 fixed rate ARM in 2004 will be facing a dramatic monthly payment increase begriming with the 2007 interest rate change date. The fully indexed interest rate will cause the monthly lender payment to increase by 30 to 55% at the time of first adjustment. This monthly payment increase will push the monthly housing expense, as a percentage of net monthly income, up from 42% to 60%. The ability to maintain the home, make the monthly house payment and handle all other monthly expenditures will put extreme pressure on the monthly net household income. Lower interest rates, sale of the home or foreclosure will be the only solutions to the problem. This is a tough reality for the fixed ARM borrower.
Flawed financial planning in 2004 will cause many homeowners hardships in 2007 and 2008. As of January, 2007, there was approximately two (2) trillion dollars in ARM loans, representing ten (10) million or more ARM borrowers. Approximately 600,000 of those ARM borrowers were having monthly payments problems. As of 6/2007, home foreclosures were on the rise and a majority of those foreclosures were ARM loans. This is an economic problem in the making.
A percentage of the U.S. economy is dependent on homeowners spending money to maintain their home. Excluding lender payment, property taxes, property insurance or association fees, the homeowners spend approximately $2,000 or more annually on their home. If the lender forecloses and the property becomes lender owned real estate (REO), that $2,000 home expense is removed from the system and thus has an impact on the U.S. economy.
But remember the extra drop of liquid example. If the Federal Reserve increases their fund's rate (as of 6/1/07 - 5.25%) and continues to restrain the nation's money supply in their fight to contain inflation, the housing sector issue could lead the nation into an economic malaise. Add the U.S. government's out of control spending and we have a U.S. economy ready to take a nose dive.
Mortgage interest rates will move higher over the remaining months of 2007 and early 2008. The impact on the housing sector will be severe. The ARM fully indexed rates will climb to 9.0% or higher for AAA borrowers. A worst scenario for the credit challenged home borrower will be no credit available at any price. Employment in the hosing sector will decline and the economy will stagnate. In this environment, property values will decline.
The Fed must take some responsibility for any economic collapse, but government spending and increase taxation will be the ultimate reason for higher interest rates and the resulting high ARM foreclosure rate in the U.S. The real tragedy will be the impact on home ownership in the U.S. Home buyers with a credit history that contains a foreclosure will find it difficult to finance any future real estate purchase. The question that begs to be asked is:
"How long will it take to recover from this disaster?"
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