Sunday Briefing: Was The Mortgage A Mistake?

Staff writer Michael Rosenwald offers a revealing glimpse into one Montgomery County family's decision to buy a house using a risky interest-only loan:

His own!

There's lessons in the candid piece for all of us.


Tell us your mortgage story, or other personal finance adventure. You might even have some tips for Michael.

In the meantime, here's an excerpt:

Two years ago, my wife and I sat at a long conference table in a mortgage-title office in Bethesda. Sitting next to us: our real estate agent, who drew up our bid on a townhouse in Germantown two days after showing it to us. We didn't get an inspection, and I don't recall going back for a second look. We had to act fast or someone else would get it.

Our bid won the house -- our very own first home -- and now we had to close the deal. The owners sat across the table. They seemed more nervous than we did, perhaps fearing we would have second thoughts -- about our risky interest-only mortgage, about seeing them walk away with a $120,000 profit, about buying a house just as "bubble" was entering the regional lexicon.

They signed. We signed. Price tag: $459,275.

And then, as the saying sort of goes, the stuff hit the fan. The sizzling home market almost immediately began to cool off, which my wife and I sort of ignored. Interest rates started to creep up, and we sort of blew that off, too. We have time. This too shall pass. No worries. Life is good! We bought a flat-panel television, took a nice vacation, bought a dog, hired him a daily dog-walker, and then we got pregnant. We have time. This too shall pass.

But now, with our baby due in six weeks, the stock market has taken a serious drive south, with the Standard & Poor's 500-stock index dropping 6.9 percent since its high on July 19 after problems emerged for subprime lenders, who gave loans to people with spotty credit at the height of the frothy housing market. The contagion from the busted subprime sector has hit credit markets hard, and now Brian Williams and Charlie Gibson and Katie Couric are talking every night on the national news about how hard it will be to get credit, perhaps leading to more problems in the housing market.

By Dan Beyers  |  August 19, 2007; 9:48 AM ET
Previous: Saturday Briefing 08.18.07 | Next: Early Briefing 08.20.07

Comments

Please email us to report offensive comments.



You paid at least $150K too much. Add in the interest on the $150K overpayment and the extra property taxes. It must suck to have frittered away the better part of $200,000.00, talk about throwing your money away. You should have kept on renting, you would be far better off. Also remember you don't actually own your townhouse, you now rent from the bank. Enjoy your property taxes, home-debtor.

Posted by: Proud_Renter | August 19, 2007 1:45 PM

This is the typical example of why people with good credit and who are knowledgeable enough of the mortgage industry (i.e. smart enough to stay away from gimicky interest only and short ARM loans) can no longer own a house in the D.C. area. Now if I wanted to buy this home from this guy, I'd probably have to pay $150,000 over it's value so that he and his wife could sleep at night. However, I don't just blame it on the property owners, I also blame it one the home builders, real estate agents and mortgage companies who grew exceedingly greedy after the interest rates tumbled five years ago. When home builders saw that the typical home buyer, who could only previously afford a $150,000 home at a 8-9% interest, could afford a $200,000 loan at a 4.75% interest rate, they just placed a new for sale sign in the front yard advertising the new price. As a result, home building profits grew larger, real estate commissions soared, and pre-existing property values exploded. But as they say, what goes up must come down! The only question is if the Fed is going to provide some kind of relief to these people who weren't knowledgeable enough to understand what the real estate market was experiencing at the time. If the Fed doesn't rescue these people, then there will be a ton of foreclosures and people sitting in houses with mortgages that are valued at 2 times what there property is really worth. With that being said, all I can do is sit back and say, "I'm glad I don't live in D.C. anymore."

Posted by: Joker MD | August 19, 2007 2:05 PM

I too took out an interest only loan. I am an experienced investor and over the last 20 years have averaged a 13.7% yield on my investments. The math was simple I borrowed the money at 2% and that quickly went to 6.875% because of the ARM. I reinvested the money and made 13.7%. I made a fortune off the banks cheap money. I win. The interest only loans were made for intelligent people that can properly manage finances, not as a way to buy more house than they can afford. It's a shame that people with no common sense are causing these great loans to go bad.

Posted by: SmokinJoe | August 19, 2007 4:11 PM

It's common for people to let their common sense go out of the window when it comes to things that they don't understand.

I'm no real estate pro. I'm in my 20's and I work in a completely different field. But when my mother bought a house whose value appreciated 300% in 3years, I likened that growth to winning the lottery. It doesn't make sense that growth like that could be sustained when incomes aren't rising proportionately.

Posted by: kat | August 19, 2007 4:14 PM

It is unfortunate how people who have no knowledge or understanding make silly comments. First of all If you have no intentions of moving then it doesn't matter what you paid for your home! Secondly the genious renter has no tax wright off, depending on how much you make your monthly payment may be the same as his. Third, a good interest only loan (key word here is good) has an interest only period of 10 years. 10 Years from now if you have no intentions of moving you will most likely be fine. Lastly, always remeber this, if you owe more than the home is worth the bank, not you carries all the risk

Posted by: Marc | August 19, 2007 4:37 PM

Guess you should have skipped buying the flat screen TV

Posted by: Dave | August 19, 2007 4:48 PM

Marc -

You are so very, very, very wrong. First, the writer planned to sell in 5 years, counting on continued astronomical appreciation to pay off the loan and, presumably, pay for a newer and better house. Brilliant. Second, while the tax deductible is nice, renters also don't have to pay for maintenance and repairs. Finally, In Maryland, if you default or otherwise fail to pay the full principal, you must assuredly share the risk with the bank. You owe the balance on the loan, plus interest, even after you've sold the house. True, it's unsecured and you can get out of it if you file bankruptcy, but it would probably be hard for people in the writer's tax bracket to do so. They could find themselves continuing to pay for the house they aren't living in and being unable to get a loan or put together a down payment for a new home. Sheer genius.

Interest only loans are generally a bad idea for people buying their principal residence, especially if they have no plans to make principal payments during the interest only period. It would have been smarter to buy a cheaper house using a less exotic financing arrangement, or to continue to rent if they just HAD to have such a nice house.

Posted by: NotAMom | August 19, 2007 5:56 PM

Marc:

-- The price paid for a house is irrelevant? Only to those who don't care about their money.

-- The genius renter who incurs far less cost renting than buying can invest the difference . The tax write off is simply part of the rent v. buying cost analysis; the interest deduction does not, per se, mean that it is better to buy.

-- The long term interest only loan is indeed sensible for those who have the discipline to pay down principal, but the IO loans that have been a problem are the 2/28 loans that have super low teaser rates. The fools who bought more house than they can afford weren't using 10/30 or 10/40 IO loans.

-- The bank can go after your personal assets if the foreclosed house can't cover the loan balance. Not to mention the damage to your credit.

I appreciate the article writer's honesty; his mindset reflects the "can't-lose" mentality that caused real estate to appreciate beyond any measure of sanity.

Posted by: Terminator-X | August 19, 2007 6:02 PM

What I find truly ridiculous is this idea that in real estate someone paid "Too much." All real estate is somewhat different, therefore there is no equal when judging real estate. I paid $200k for my DC townhouse and all my coworkers thought I was a fool, in 2003 my neighbor sold their townhouse for $1 million and everyone thought I was a genius (even though I didn't put in the all-steel and granite kitchen that netter them $1 mill. Now houses on my block go for $800k-$1 mill. Houses dropped possibly 20%. If I sold today for $800k I would make $600k profit minus taxes and tags.

For several years before having kids we rented out our basement apartment for $1000 per month. I think we were making $720 per month after taxes on that, which covered all the utilities and extras, plus part of the mortgage. I would please like either NotAMom or the Renter guy to explain why it would be better to pay rent to someone else with no assets rather than to have someone pay you rent. I'm all ears to hear why renting my basement out made less financial sense than renting.

I rented for years and regularly had landlords, multiple landlords, refuse to repair things like garbage disposals, dryers, etc. One guy just said- You're renting from month to month, why don't you move? And pulled the washer and dryer out, renting the house to new tenants without either. True story in college park, circa 1988. I also never had a landlord who paid utilities, though my wife had.

I'll spell it out for ya accountants, when we bought our house a 2 bedroom apartment in a building in our neighborhood cost $1200 per month. We bought our house with a total payment of... $1535 (taxes have gone up, so I forget the original starting amount). We received $720 per month from our tenants (it was $1k, but we paid taxes on it). For a much more space, plus yard, we got a house at... $815 per month.

$1200 per month to rent + some utilities
$815 + utilities + repairs to own

you tell me who made the mistake renter? I'd like to hear how I made a mistake.

Posted by: DCer | August 19, 2007 8:39 PM

I beat all of youse dumbells because I live in a cardboard box in the woods I don't pay rent or nothing and there are plenty of squirrels and dear for me to eat free.

Posted by: Fred | August 19, 2007 8:56 PM

The thing that's so ridiculous about posts in this discussion is that my childhood neighbors bought rental property for $100k in 1980 and sold it for almost $500k... For convenience sake, let's say they sold it in 1990. I was seething at their BBQ where they were bragging about taking the nearly $400k they had after the sale and putting it in the stock market for their retirement. I was seething because I knew that no property in BETHESDA would ever sell for more than $500k in my lifetime. I was FURIOUS that they made the only profit our area was going to see on real estate. Ok, so at the height of the real estate boom houses on the block where they rented, which was near my school, sold for $1.2 to $1.5 million. So, despite my whining, had I somehow had the income to buy a $500k house in 1990. I could have sold it for a $ 1 mill profit in 2005! Even though it looked like prices could never go up after a 5x increase, they tripled in 15 years.

Now, neither my 80 yr old DC townhouse with my 15 minute commute nor my neighbor's ritzy midcentury Bethesda splitlevel are the same as a townhouse in far-off Germantown (location location location people!) built in the 1970s. But you does anyone really think that prices are going down for any length of time?

Posted by: DCer | August 19, 2007 8:59 PM

DCer,

Congratulations on a sensible real estate purchase. You do not mention when you paid $200K for a home that is now worth at least $800K. The value of your house has quadrupled. Would your house rent for four times as much now than it could rent for when you bought it? If the rental value of the house has less than quadrupled, I would suggest that as a possible reason why some are renting rather than jumping into an inflated real estate market. I own in Alexandria City (Del Ray), and some houses here cost more than 20X annual rent, which by historical measures is too much. At any given time, it may make more sense to rent than buy (and vice versa), depending upon relative costs.

Posted by: Terminator-X | August 19, 2007 9:05 PM

For all of you who read my first posting and named me the "genius renter", let me clarify something...I'm currently living in my second OWNED home, and no I am not renting. Fortunately, I was able to SAVE money prior to purchasing and put down 20% for my homes, rather than doing what alot of people did and buy something out of price range by accepting a teaser interest only loan.

As a Federal Law Enforcement Officer, I have investigated numerous bank fraud and mortgage fraud crimes. I don't consider myself an expert in this field, but can use common sense and reason to tell you guys that the people who used interest only loans to purchase their primary residence AND bought a house that they normally couldn't afford with a convetional loan...you are in trouble.

MARC you are totally incorrect when you say banks are the only ones that lose on foreclosures. NOTAMOM and TERMINATOR X are absolutely correct about the fact that most banks will take Civil action against you and try to garnish your assets to receive some type of compensation for your foreclosure. And in most cases, especially in a declining real estate market, the foreclosure sale won't cover the balance of your unpaid mortage...so now your paying in one form or another for a home your no longer living in! The nightmare just continues...

DCer...all I can say is you, probably unknowingly, invested in the best investment in the world. For people like yourself, who purchased a home in DC prior to the big boom, and watched their property values skyrocket BECAUSE of the advent of Interest Only Loans and the such, i.e. people can now afford a 800k townhouse, congratulations! However, in all seriousness, I seriously doubt your property will hold it's value and I know you want to be optimistic, but if you want to make a $600-800k profit, you'd better sell now! In today's credit market, with sub prime loans being chucked out the window, there just aren't that many buyers who can afford to buy a 800k townhouse! Also, I couldn't agree more about your rent vs. own comments. IF YOU CAN AFFORD IT, owning is always better than renting. The tax write offs and equity gains (in a realistic market) make it much more financially prudent to purchase. However, I'm sure you enjoy your supplemental income from your tenant, so we won't tell him:)

Posted by: Joker MD | August 19, 2007 9:29 PM

"Now, neither my 80 yr old DC townhouse with my 15 minute commute nor my neighbor's ritzy midcentury Bethesda splitlevel are the same as a townhouse in far-off Germantown (location location location people!) built in the 1970s. But you does anyone really think that prices are going down for any length of time?"

That's probably the only really important question here. Loans are loans, they will either be paid off or defaulted on. But the underlying value of the real-estate is the key issue for long-term owners. The #1 concern that you have when buying real estate is to actually build equity. Even if prices stay flat, you win. Even if prices decrease slightly, you win. Your problem is when you are paying substantially more for the house than it is worth by the time that you pay it off. You have to live *somewhere* so you can always amortize the loss as a living expense (and still, you gain equity). Prices may go up, prices may go down, all that matters is that they are relatively predicatble...the question really becomes, are we heading for a very large price-correction due to hyperinflation in the housing market, over the past 10 years? And the answer is yes, if, in the overall sense we do not have the money to pay for this real-estate! What else do you expect to happen?

The top of the market will probably remain relatively stable. The mid and lower sections have to come down. For the simple fact that no house is going to increase in real value by a factor of 10 over 10 years unless it was a craphole in a crappy neighborhood to begin with and it has become a reasonably decent piece of property in a reasonably-decent neighborhood in the meantime. But someone has to pay for that property. And unless enough income comes into the area to sustain these home values over the long term, they *have* to go down. The bidding war, the speculative bubble, is over. Why expect that these speculative peaks will become long-term levels? Wouldn't that be inherently contradictory?

Well, you do have to factor in the possibility that the Fed will lower rates to maintain the real-estate market, but that would just soak up all of these capital gains in inflation. But no matter what, if you bought recently, you have paid too much for your house, and all you can hope for is that you can continue your payments and pay off the property and that over 20 or 30 years, you can make a profit when you sell. But if people could still flip houses and make a profit, we wouldn't be worrying about the end of a speculative bubble.

But my God buying an interest-only loan near the top of a speculative bubble has got to cause some serious nightmares, and God help you if it is an ARM as well. You're renting the house for 2 to 5 years, for a substantial fraction of the value of the house, and building absolutely no equity in the house. No matter what you should get that loan converted to a hybrid loan. The bank has nothing to lose and everything to gain by locking in the current value of the house, and you are screwed now and will only get screwed even more if the market is flat or even drops.

Posted by: cc | August 19, 2007 10:23 PM

The comments to this entry are closed.

 
 
RSS Feed
Subscribe to The Post

© 2010 The Washington Post Company