By MIKE HEAYN is a Washington Mutual multi-family loan consultant. Contact him at (310) 428-1342.
Although prices on the Westside are not dropping like bricks out of the sky, some believe it is only a matter of time until they do. Due to the recent subprime meltdown, lenders have tightened underwriting guidelines, making it more difficult for many first-time homebuyers to get a home loan.
With less people able to qualify, the pool of homeowners shrinks. In theory, if less homebuyers can purchase homes, less demand is placed on the inventory on the market. Homes begin staying on the market for longer periods of time and sellers begin reducing prices to move them, causing a decline in property values. For the first-time homebuyers who are able to meet a lender’s underwriting requirements, the issue becomes one of purchasing power — how much money a person can borrow to purchase a home. Over the last four weeks, interest rates have increased 50 basis points, or half of a point causing a decrease in the amount of loan dollars they can get. For example, a homeowner who could afford a loan of $500,000 at 6.50 percent can only afford a loan of $475,000 at 7.00 percent and roughly $450,000 at 7.50 percent.
Many variables affect a real estate market, but few have as much of an impact as a person’s ability to borrow money. If an individual cannot borrow enough money, they have to wait until the price of a home drops to an affordable level before they can swoop in and make the purchase. The problem is, prices do not initially drop to meet an increase in rates, but once they do, prices tend to drop significantly more. A few years ago, a type of lending known as subprime lending gained in popularity. Essentially, subprime loans were for borrowers who could not meet a lender’s standard underwriting criteria. However, these loans became more exotic with interest only options and low interest rates for short fixed periods. Many borrowers who met lender’s standard underwriting criteria began taking subprime loans instead because they could afford a more expensive home for the same payment. The problem is many borrowers bit off more than they could chew, and when their rate adjusted, their payment went with it, often doubling and in some cases causing the home to go into foreclosure. Many lenders who sold subprime loans to investors on the secondary market were forced to buy back the loans that went into foreclosure, causing a liquidity crisis due to cash reserves that needed to be placed with the bad loans. Many subprime lenders went under, causing all lenders to tighten underwriting guidelines. Today, many first-time homebuyers are having problems meeting these new guidelines such as higher credit scores and larger down payments, causing the dream of a new home to remain just a dream. However, a silver lining does exist. More often than not, lenders will overcompensate for losses like those experienced in the subprime meltdown and will relax underwriting guidelines after a period of time.
So, should a first time homebuyer wait on the sidelines? This question is not easily answered, since everyone has different circumstances. If you purchase a home in a good area, such as Santa Monica, a demand will always exist even if values drop. The old adage of location, location, location holds true in this case. If you can afford a home the tax benefits alone may make it worth buying in today’s market. Remember, values tend to go up over time. If you purchase a home for the long haul, it is hard to go wrong buying at any time.
Originally published in the Santa Monica Daily Press print edition on June 20, 2007. Read the original PDF.