Your lucky I got into the office early this morning and have some extra time… 
I hope your prepared for a long tirade. ;D
My $0.02 on where interest rates are headed
In the next 6 -12 months I expect the 30 Year rate to be between 6.95% and 7.125%…This calculation does not take into effect any major geo-political events and discounts the success of an Iran Oil Bourse. While major geo-political events add considerable volatility to the market it is hard to say what affect any one event would have on long-term U.S. interest rates.
If there is a run on the dollar in 2006 I would expect interest rates to range between 7.75% and 8.50% on a 30 Year Fixed mortgage.
I expect a growing number of foreclosures as early as spring, but I expect them to really pick-up in winter on 2006/2007 as higher interest rates find support, property taxes in particularly heated markets are reassessed and home heating bills again reach record highs.
The current danger in my opinion
In the last year I’ve originated a large number of I/O, Adjustable Rate Mortgages (and Pay Option ARMS) with LTVs generally above 95% to stated income borrowers. In many cases these borrowers’ actual Debt-to-income ratios are 60%+. Keep in mind that the DTI ratio used by lenders does not take into account; utilities, gas for vehicles, insurance for vehicles, health insurance, groceries, child care, or local, state and federal tax liabilities!
Example:
In July of 2004 John Doe purchase 123 Main Street for $150,000. The property taxes are $100/month and the home insurance is $50/month. The average annual utility bills total $1,500. The borrower purchases the home 0% down on a Two-Year ARM with a start rate of 6% and a principal and interest payment of $899/month. The PITI payment is $1,049/month. John Does gross monthly income is $2,700 a month and his FICO score is 720. He has a car payment of $250/month and other monthly liabilities on his credit report of $140/month. His DTI is 53%…two high for the 100% financing at the rate he desires so he goes “stated”. John closes the deal…. Did I mention John is a single father of two?
Let’s look at the real numbers (2004):
GROSS Income: $2,700/month
Principal & Interest: $899/month
Taxes: $100/month
Insurance $50/month
Credit Cards: $140/month
Car payment: $250/month
Vehicle Ins: $50/month
Groceries: $300/month
Utilities: $125/month
Gas: $120/month
Misc. $200/month
Remainder $466/month
……Oh wait….I forgot….Johns employer withholds 20% of his paycheck for taxes, Social Security, etc.
Adjustment: $540/month (don’t worry since John is obviously poor his taxes will be refunded at the end of the year)
Actual Remainder -$74/month
So, if John’s actual cash flow is negative what does he do to get by? That’s right….He charges it!
Now let’s look at the numbers for 2006 and let’s assume that:
A. John was a real asset to his company the last two years and they increased his pay by 15% over 2004.
B. Taxes increase by 10% since John bought the property…after all it is a hot market.
C. Insurance stayed the same.
D. All that charging over the last two years and the new BK laws increased John’s monthly min payment on his credit cards to $275/month
C. Johns car in still 2 years away from being paid off.
D. Johns vehicle insurance has remained the same
E Due to higher transportation costs johns grocery bill has increased by 15% over 2004
F. John’s average annual utility bill has increased 30% over 2004
G. Johns monthly vehicle fuel bill has increased by 20% over 2004
H. Johns misc. spending has stayed the same.
John’s income has increased by $405/month…$324 after taxes.
John’s expenses have increased by $251/month…
Now John only has a net monthly negative cash flow of $1.00….But wait we forgot about that mortgage.
People like John don’t pay taxes. People like John have no chance of saving for retirement. People like John face total financial ruin should they no longer be able to finance their personal deficit spending with their homes….People like John are EVERYWHERE!
What I think it means for the Real Estate Investor
- Energy efficient properties located close to major employers (preferably exporters) in urban settings are great buy-hold investments.
- High LTV ARM’S should be avoided at all costs…unless it’s a buy-flip with a hold time of less than 6 months.
I think a lot of the “First Time Homeowners” and “Newbie” real estate investors from the last 3-4 years are going to be renters. This is great for buy-hold investors who bank on cash flow, NOT APPRECIATION.
The caveat is this: If you agree and you think energy costs are going to continue to climb as well as core inflation does it makes sense to own properties where your renters have to commute a ½ hour + to work everyday? DO NOT include you tenants’ utility costs into the rent!
I’M NOT A “BUBBLE HEAD” BUT I AM WATCHING THE MARKETS WITH GREAT INTEREST/CONCERN THESE DAYS.