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Archive for Sunday, October 31, 2004

Despite Fed chair’s optimism, mortgages could be haunting

October 31, 2004

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It was a soothing message: The United States is "not in the midst of a home-price bubble," Federal Reserve Chairman Alan Greenspan said, arguing that soaring home prices were not at all like the soaring Internet stocks that collapsed four years ago.

Hopefully, Greenspan's right. But even so, I'd be leery of grabbing the biggest mortgage I could get. There's plenty of risk in today's high-priced housing market.

Big gains in home prices have led Americans to take out larger mortgages, with the total amount of mortgage debt rising by about 12 percent in each of the past two years.

Ten years ago, the typical household carried overall debts equal to about 80 percent of its annual disposable income. By the end of last year, that figure was 108 percent, thanks mainly to bigger mortgages.

Some economists warn that high debt levels could come back to haunt homeowners if housing prices fall, since some homes then might not be worth as much as their owners owe.

Not to worry, Greenspan said in a recent speech to bankers, observing that "measures of household financial stress do not, at least to date, appear overly worrisome."

Of course, if the nation were in a housing bubble, Greenspan would bear some responsibility. By pushing interest rates to four-decade lows in recent years, he enabled people to borrow more, and that caused them to bid housing prices up at an extraordinary pace. Hence, Greenspan has a vested interest in discouraging talk of a bubble.

Fed statistics show that at the end of June, homeowners spent 9.87 percent of their disposable incomes on mortgage principal, interest and property taxes. That figure has fluctuated from a low of 8.15 percent early in 1980 to 10.41 percent in 1991; it doesn't seem exceptionally high today.

This debt-service cost has been relatively steady, despite rising debts, because interest rates are so low.

Moreover, Greenspan said, the rise in mortgage debt partly is due to good causes: More people have switched from renting to buying; lenders now approve applicants they used to turn down; and homeowners are using low-cost home-equity loans to clear away high-cost credit-card debt.

About three-quarters of borrowers make down payments of at least 80 percent, Greenspan said. And because prices have gone up so fast, outstanding debt on the typical home equals only about 45 percent of the property's current value.

Thus, even if a home's price falls dramatically, the owner could sell for enough to pay the mortgage off.

While all that is undoubtedly true, it nonetheless would pay to do a reality check before taking on an enormous mortgage.

Some parts of the country -- especially the hot markets on the East and West coasts -- may, indeed, be in bubbles, even if the country as a whole is not. Greenspan acknowledged as much.

Many people justify big home purchases as investments. That's fine, so long as you consider the downside. To get your money out of a home, you have to sell or take out a new loan, which means paying interest to get at your own money.

And, of course, you have to have a place to live. The profit you make on one home may well be needed to buy the next one, unless you're prepared to downsize.

Even if you intend to move to a cheaper place someday -- in retirement, perhaps -- there's no guarantee you'll make a killing when you sell the old homestead. Will the next generation have enough prosperous buyers to take over all the McMansions being built today? I don't know. ...

Today's high home prices are the result of low interest rates. Should rates rise, as most experts expect, buyers won't be able to borrow as much. That could cause a drop in demand that could make home prices fall.

Lots of people paying top dollar for homes today may some day find they jumped in at the peak -- just as the dot-com investors did in the late '90s.

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