Judges will determine the comparative economics of the NPV (net present value) of foreclose versus modifications. This fear should rightfully strengthen the mortgage underwriting process.
Let’s look at a few general methods of measuring the economic value of residential real estate. The first is affordability. The
mortgage payments and operating expenses should not exceed the 30% to 40% range of the buyer’s gross income. Operating expenses include real estate taxes, insurance, utilities and any condo or HOA dues. The range should also consider other debt and credit score. The old rule of thumb was the purchasers should not consider homes costing more than three times their annual income. This means a couple earning $60,000 should not pay more than $180,000 for a home. With operating costs greatly inflated, the Fed’s interest rate lever is much less a factor on affordability.
The second general valuation factor is rental return on the property. The Fed considers owners’ equivalent rent rather asset value in calculating housing inflation. But, the Fed did not consider negative rental returns an indication of a housing bubble. The last general valuation factor is appraisals. I consider appraisals to be the least dependable indication of economic residential housing values. In many instances, prior sales are more of an indication of emotional values rather than economic values. The rent verses buy calculation provides a much stronger support level.
The Fed and Treasury believe that they can create equilibrium of supply and demand by freeing up mortgage credit and lowering rates. If they can tempt enough buyers to enter the market based on artificially low rates, they believe a floor in housing prices will be maintained. I say they’re wrong. Housing prices will have to fall to their economic value based on expected longer term interest rates and inflated operating expenses. The free market was tempted by artificially low interest and got burned not too long ago.
What good is it to
buy a house because you can afford the mortgage payments, only to find out that you will have to sell it at a loss later?
Disclosure: Author is long FNM and FRE.
