SO, WHAT IS GOING ON WITH THIS “mortgage meltdown” and how does it affect us here on the Westside of Los Angeles? To break it down simply, lenders have a relatively small cash reserve. Their cash comes from their ability to sell the rights to collect on the mortgage debt to a secondary investor. When a homebuyer borrows money from a bank to buy a house the bank then sells this loan on the secondary market at a profit. After the bank has sold this loan the bank recoups their initial investment with profit and sells the money again to a new borrower.
These lending banks have two sources of liquidity, or sources of cash for them to sell the loans that a borrower buys. One is Freddie Mac and Fannie Mae, federally backed organizations who buy the loans from companies, like Wells Fargo and Countrywide who sell loans to borrowers. These organizations only buy conforming loans — this means loans that are under $417,000. The majority of mortgages in Los Angeles require dollar amounts greater than $417,000. Lenders need to sell the loans that they sell to the majority of Los Angeles borrowers to alternative investment groups such as mortgage backed securities and institutional investors. These alternative sources have stopped or slowed considerably buying mortgages from lenders, making it harder for the banks to turn a profit.
The hesitation to buy these loans is due to the relatively high level of buyer default from loose monetary lending practices. It used to be that you could tell the bank what your income was with no proof and get a loan that was 100 percent of the value of the property you were purchasing. Loans like this are now very rare.
With lenders not knowing what the secondary market will pay for their loans, they have little choice but to raise interest rates to mitigate their risk. At Countrywide, a nonconforming loan used to sell about.25 percent higher than a conforming rate. That difference is now.5 percent. Wells Fargo has increased their 30-year fixed mortgage from 6.875 percent to 7.875 percent. It is important to note however that every lender is reacting differently to this situation. Most mortgage professionals are quoting rates that are about.5 percent higher than what they were selling at earlier this year.
At the end of the day, what will inevitably change property values in Los Angeles is the ratio of supply to demand and the cost of renting versus owning your home. The mortgage on an $800,000 property with 20 percent down at 6.375 percent is $3,922 while the mortgage on the same property at 6.875 percent is $4,204. If the value of a property was directly related to the cost of mortgage debt service then the value would drop 7 percent. If the price of a mortgage stays at these levels, the increase in demand should mitigate a drop in value. If you account for an increase in values of anywhere from 3 to 10 percent a year, values could go anywhere from a 4 percent drop in value to an increase in value of about 3 percent. Since the 1950s, real estate values have increased at an average of 9 percent a year in California, particularly along the coast. If there is a drop in value due to increases in the cost of a mortgage, it likely won’t be anything drastic, but a slowing in appreciation is likely.
SIMON SALLOOM is a REALTOR with Coldwell Banker who specializes in Santa Monica and Brentwood Real Estate. Learn more or make comments on this article at SantaMonicaSimon.com.
Originally published in the Santa Monica Daily Press print edition on August 8, 2007. Read the original PDF.