"Homes traditionally have sold for about 20 times what it would
cost to rent them for a year. In 2006, houses were selling for 32 times
annual rent...
The end of inflated leverageAn extreme relaxation of lending standards inflated the housing bubble.
"Shoddy underwriting on mortgages" is the
primary cause of the housing crisis, says York, the Wachovia economist.
"People got caught off-guard by how bad it was."
Millions of home buyers — poor, rich and middle
class — were approved to buy homes at prices that had been out-of-reach
just a few years earlier. Lenders offered low introductory "teaser"
rates on adjustable rate mortgages and approved borrowers based on
artificially low mortgage payments, not the higher ones that took
effect later.
What else changed:
• Optional payments on principal —In
2005, 29% of new mortgages allowed borrowers to pay interest only — not
principal — or pay less than the interest due and add the cost to the
principal. That was up from 1% in 2001, according to Credit Suisse, an
investment bank.
• No verification of income —Half of mortgages generated in 2006 required no or minimal documentation of household income, reports Credit Suisse.
• Tiny down payments —In 1989, the
average down payment for first-time home buyers was 10%, reports the
National Association of Realtors. In 2007, it was 2%.
Low down payments and ARMs gave homeowners
enormous financial leverage to pay high home prices. Leverage boosts
buying power through debt, the same way a 100-pound woman uses a lever
to jack up a 3,000-pound car.
Consider a couple with $20,000 cash. In 2006,
they easily could get a 5% down mortgage to buy a $400,000 house.
Today, a 10% down payment would limit the couple to a $200,000 house.
"Leverage matters a lot when you buy a house,"
says University of Wisconsin economist Morris Davis, an expert on
housing prices and rents. "We're not going to go back to the days of
only 20% (down payment) mortgages, but the days of putting nothing down
are long gone."
Easy access to borrowed money reset all housing
prices, even those paid by cautious borrowers. People of all income
classes moved up a notch, Census Bureau housing data show.
The sale of new homes costing $750,000 or more
quadrupled from 2002 to 2006. The construction of inexpensive homes
costing $125,000 or less fell by two-thirds. The biggest boom was in
the middle. Homes costing $200,000 to $300,000 became affordable to
millions of families.
Lessons from the Depression
The Great Depression of the 1930s was preceded
by a real estate bubble, also fueled by loose lending standards and
shrinking down payment requirements. Those real estate problems — and
solutions — echo today's.
Florida real estate was the epicenter of
speculation in the mid-1920s. Developers ran up prices by selling to
borrowers who put as little as 10% down. Those were shockingly risky
loans at a time when the standard mortgage lasted five years and
required a 50% down payment.
The risky loans went bad first, but it was the
spread of credit problems to the supposedly safe loans — five years and
50% down — that caused the housing market to collapse.
The five-year loans required no payments to
reduce principal. Homeowners expected to refinance mortgages when the
loans expired, usually with the same lender. The stock market crash led
to a "liquidity crisis" — no money to borrow — that dried up mortgage
refinancing.
Millions of families lost their homes to
foreclosure. Falling prices on nearly everything — homes, farm crops,
wages — made consumers reluctant to buy and banks afraid to lend.
As part of the New Deal, the government took
control of millions of loans and restructured them into something new:
the modern mortgage, with 20% down and principal that is repaid over
the life of the loan. The government extended the mortgages to 15
years, then 25 and finally 30.
When World War II ended in 1945 and the Baby
Boom began the following year, the 30-year, fixed-rate mortgage became
a cornerstone of society and led to unprecedented levels of
homeownership."
(USATODAY.com)
