And today, I wanted to start to show off– because I read an article, and I know Robert read it too. And it’s the fact that single family homes, there are companies investing billions in single family homes to rent them. Robert, interest rates are low. We’ve recovered from the crunch. Why aren’t people buying their homes?
So this article talks about these big companies who were snatching up houses. And I want to talk about this in two different facets.
One, is everybody thought that when they quit buying homes–because they’re still buying, but not quite at the clip they were. And there was this big fear they were going to sell the homes. And when they sold the homes, it was going to crash home values.
This was the big panic, because the idea was these guys have to make money. So if they bought all these homes, and now the homes have gone up in value so much, they’re going to turn around and dump the homes. They’re going to sell the homes and glut the market.
And they’re going to flood the market. And they’re going to ruin home values. It’s going to be a disaster.
And this was probably the warning alarm 18 months ago. But these guys are too smart for that. So here’s the two things that they knew.
One, they recognize the number of people right now who just want to rent.
I think that this whole rental mentality is– we’ll call it a hangover effect from the crash.
A lot of people are still either stuck because they can’t buy yet because of past foreclosure, or past short sale. They lost a home and haven’t been able to bounce back quite yet. They haven’t met the waiting periods imposed by the government-sponsored enterprises who run lending, which is Fannie Mae, Freddie Mac, and Ginnie Mae. And so that’s the first issue.
And the other is people whose lives were affected– so people who saw mom and dad go through a bad spot, maybe people who had a brother or sister who went through a bad spot because of housing. And so there’s still some skepticism and fear on the part of the consumer and the general public. Now, who is not skeptical and who is not afraid of housing is big hedge funds, and Wall Street, and the market.
And so what these guys did was really brilliant for a couple reasons. And that’s what we’re going to talk about.
They purchased all these homes
And then the fear was, well, these guys are doing this for a profit. And they’re probably going to sell homes. And when they sell the home to take their profit, we’re going to have this big crash in home values.
These guys were really smart. What they figured out is, instead of selling the homes back to families, they would sell securities backed by the homes, effectively borrowing against all the future profits of the homes.
Two Reasons Why This is Brilliant
They do own– and continue to own– so many homes. And they’re buying homes all across the country. They buy in different markets at different times. They were really hot in Florida for awhile. They’ve kind of hit a saturation here. So they’re buying more in other parts of the country.
But, what they recognized was if they turn around and resell all these homes, they would affect home prices, which you would impact their own pocketbook.
Their own portfolio. They would be a self-fulfilling prophecy.
The income tax implications of selling those homes at a profit is huge. They would have to pay income tax on all of those gains. Well, guess what happens, Rob?
When you borrow against something, it doesn’t trigger a tax event.
Right, and so here’s what they figured out. So if they sold the homes, it would lower home values, which hurts their own portfolios. If they sold the homes, they would owe a big chunk of the income to the IRS and Uncle Sam. And they didn’t want to do that, because these are greedy Wall Street guys and they don’t want to give up a dime of profits.
And then, on top of that, there’s huge demand for rentals because a lot of people are scared to buy, think they can’t buy, or just aren’t– some really can’t. Some think they can’t. And some are just afraid to. That’s what’s going on.
And so there’s this huge demand for rentals. These guys were smart. And so here’s what they did.
They didn’t just borrow against and securitize the current value of the home. They securitized the future value of all the rental payments they’re going to receive.
I mean, this is brilliant stuff. This is high finance stuff.
So, what happens now is they actually can’t sell the houses because they didn’t borrow against the house. They borrowed against the future value of the rental income. They’ve got to keep it so they can get that rental income to fulfill what they securitized.
The risk of any of these homes going back up for sale has basically been eliminated. And think about this. The size of this offering– when you look at how much money, it was a ridiculous amount of money. This securitization I think they said was twice as large as their last one. So they did this once about a year ago and got a bunch of money.
Now they’ve done it. And they’ve doubled the amount of money. And these are huge, huge numbers, which shows that Wall Street believes in what’s happening in American housing.
These guys believe in what’s happening in American housing. And what’s going to happen is is when they fulfill the income stream that they securitized– so they securitized the next three years, five years, seven years worth of rental income into these securities to borrow against it. Once that time period has elapsed, they still own all the houses.
They’re going to try and do it again. So to me, this is just a clear indicator of what an amazing investment housing has become again. Nobody was making deals like that in 2007, 2008. Everybody was afraid.
The Consumer Should Not be Afraid
And where Wall Street has come back to be not so afraid of housing, the consumer really hasn’t. We’re not seeing millennials come out and buy the way they should. This is the whole reason for rule number seven– own real estate sooner not later– when you look at the wealth being created.
So, we had that period where there was a lot of wealth eliminated by housing. What i find from my personal experience– is most people didn’t buy the house at that high value. They re-mortgaged the house at that high value and got a bunch of tax-free cash that they used to do other things with.
Now, there are some people who bought at the top. But for most people, if you look at the number of people that are upside down and underwater, were underwater during the lowest point the market, that many people didn’t buy houses during the boom. So a lot of those people were upside down because they had gotten second mortgages. They had re-mortgaged and cashed out their property, and then the values dropped.
So when we really look at those people actually made money off the deal, they bought the house for $200,000. And then it shot up to $400,000. They borrowed an extra $100,000 against it, used it to go by whatever, a boat, a jet ski, a new car. And then lost the house in foreclosure, but probably kept the boat, the jet ski, the new car, whatever it is. That’s not everybody, but there are people who fall in that category.
Who is Benefiting?
When we look at housing over the long-term, it really only creates winners. If you look at it over 10 years, 15 years, 20 years, if you carve out the four years of absolute pain which I will say ran from 2007 to 2011– somewhere in there, maybe ’08 to ’12, somewhere in there. But people who bought after that are doing great. People who buy before that and didn’t re-cash out and raise their mortgage balance, they’re doing OK too.
Housing is a Great Thing, Here’s Why
Housing is such a key part of this country’s wealth creation and the American dream. We’ve talked about examples where if a $200,000 house only goes up in value 3% a year, that’s $6,000. Over 10 years it’s going to compound and end up being more like $70,000 because you’re getting gains on the gains.
It’s compound interest. It’s compound appreciation. Where else can the average person pick up an extra $70,000 in net worth over 10 years without putting a dime into savings, making the same exact payment they would have made if they were renting? That’s the key. If renting was way cheaper, then we wouldn’t be having this conversation.
If I could rent the house for– let’s see. So if we’re talking about $6,000 a year in appreciation on a $200,000 house, we got 12 months. You’re talking about $500 a month that your house is going up in value on a $200,000 home with a normal 3% appreciation, which we really haven’t seen. We’ve seen more than that.
We’re going to be conservative and say 3%. So that’s $500 a month. So if you could rent for $1,000 a month, and the house was going to cost you $1,500 a month for similar living conditions, then at the end of that 10 years, it would be a wash, because the renter would have saved the $60,000. The owner has gained the $60,000 in appreciation, plus whatever they’ve paid down in the mortgage. So it’s a much closer wash.
But what we’re seeing today is for a similar property the rent is actually more than the mortgage payment. Way more.
The House Renting Process
You’re in tune with what’s going on in the market. So today that house– the mortgage payments $1,500. The rent payment is probably $1,500, maybe $1,600. And, again, at the end of the 10 years, the renter doesn’t have the equity. The renter doesn’t have the lower mortgage balance.
I mean, even after 10 years you’re going to pay down probably– you would think, oh, 30-year mortgage. After 10 years, I’ll have paid down one third. It doesn’t really work that way.
Because in the early days, you pay less toward principal because it’s going toward interest. So you probably will pay down about 15% of the value. So that $200,000 house, after 10 years we’ve probably paid down the balance by $30,000.
And it’s gone up in value by like $70,000. So the reason it’s not just $6,000 a year, Rob, is so the first year it goes from $200,000 to $206,000. Well, now the next year, the 3% is off of $206,000. So now it it’s like $6,180 that it goes up.
And so it goes up a little more each year, because it’s worth more and more every year. So you’re talking probably $70,000 increase in value over 10 years on a $200,000 house using a conservative 3% appreciation. And then you’re going to pay down the mortgage like $30,000 on a 30-year fixed rate mortgage just by making your normal payments.
If you throw in an extra payment a year, you can really accelerate that and have even more equity. But you’re talking about $100,000 in wealth for doing the same thing you would have done if you were a renter– mailing in a check every month for $1,500. And then if you take into account the fact that, I don’t know about you, but I know back when I rented, I moved around a lot.
It was like when the one-year lease was up, I was off to the next place, because they usually wanted to jack the rent up so much that it just wasn’t worth it to say. So, if you take into account all the money you would have spent on moving trucks, or buying beer to bum your buddies to come over and help you move, U-Haul trucks, whatever it is, all of that adds up.
And there’s usually that period where you can’t seem to time it perfectly. So there seems to be times when you pay double rent because you can’t get out of the one place in time to get in the next place. I mean, when you look at all the cost savings of home ownership, and the power of owning real property, of owning property in this country.
The Crucial First Step, Then it is All Down Hill
The first step, that first giant leap, is to buy a house for you to live in. That’s where it all starts. Stop throwing your money away in rent, to stop renting a home, and to go out there and buy a home to live in.
You can take it so much further. And you can keep that first house as a rental. And you can move into another house. You can perpetuate this.
You can build up a portfolio of rental properties so that now you become the landlord. You become the guy who’s collecting money every month that then goes to make the payment while the asset is going up in value. So think about that.
$200,000 house, you’ve got a tenant paying you $1,500 a month to live in it. You’re taken that $1,500 a month and you’re sending it on to the mortgage company. And in ten years, it will have gone up in value roughly $60,000, $70,000. The mortgage will have gone down.
You didn’t do anything. You didn’t make the payment. You had to deal with finding the tenants. Or you had to pay a property manager. I’m not going to say you did nothing. But when you look at the potential earnings– and this is what makes real estate so exciting.
Now, again, people are scared. People saw how bad it can go. And I will tell you a lot of the factors that created that bubble are no longer legal. Most of it was caused by the mortgage industry.
Adjustable Rate Mortgage
I did a the paper on this right before the crash. And I talked about how as home prices had increased, mortgage payments did not because the mortgage industry kept coming up with creative ways to lower people’s mortgage payments. So the first thing we did is we gave them adjustable rate mortgage.
So let’s say this 2,000 square foot house, just for round numbers, it’s a $200,000 house. The payment is $1,000 a month. And it was 2,000 square foot house. So, as the value went up people, didn’t want to pay more than $1,000 a month. So the mortgage industry we said, well, how about this? We’ll put them on adjustable rate mortgages.
When the house was only $200,000, we could give them a fixed rate mortgage. And the payment was $1,000 a month. And people are willing to pay $1,000 a month for that house, in that neighborhood, with that amount of square footage.
Now all of a sudden, the value goes up to $250,000. Well, the problem is, people still only want to pay $1,000 a month. So we figured out, OK, how about this? We’ll put them on an adjustable rate mortgage.
Then we can give them a lower rate in the beginning. So they still have that $1,000 a month payment that they wanted. And even though the house costs $250,00 now instead of $200,000 it feels the same to the buyer, because all they care about is the monthly payment.
Then the house went up in value to $300,000 and we had to figure out something again. So now we said, OK, how about this?
We won’t charge them any principle. We’ll let them make all the payment toward interest. So now that same house that now cost $300,000, well, if we don’t charge them principle, and we let them just make an interest-only payment, if all they do is pay the monthly interest still on that ARM– that adjustable rate mortgage– the payment will stay at $1,000.
When we started this little exercise, a fixed rate 30-year mortgage on this house was $1,000 a month. Then the value went up and the price went up. But to keep the payment from going up, we switched them to an adjustable rate mortgage.
Now they could buy the same house with the same $1,000 a month payment. Well, then the value went up again, and now our solution as an industry was now we’re going to have them not pay principle.
Instead of a 30-year fixed mortgage we’re going to give them a mortgage that never pays off. It’s interest only. And now, even though the house cost $300,000 instead of $200,000, the monthly payment will be the exact same because they will pay interest only.
Well, then the price went up again. And so then the price went up to $350,000. And now we’re like, man, well we’ve already gone from a fixed rate to an adjustable rate. Then we went from a mortgage where they were reducing their principal and making a principal payment to a mortgage where they’re only paying the interest.
What are we going to do next? Well, the only thing left is they got to pay less than the interest. We can’t even get the interest out of them. And so this is where the invention of what’s called a negative amortization loan came from.
This is all back in– and this is what caused it, because when the value went from $300,000 to $350,000– and remember, wages weren’t going up. People weren’t making any more money. So they couldn’t afford to pay more than $1,000 a month. That’s all they could afford.
So we as an industry had figure out how to fit a $300,000 sales price into a $1,000 payment. And when the monthly interest is more than $1,000, that didn’t work very well. And so what we figured out is, well, here’s what we’ll do, because home prices are going up so fast, we will give them a loan where the monthly payment is less than the interest.
So on a normal loan, amortization– amortization, this is the word that describes as you make payments, the debt goes away. Amort comes from the Latin word to kill. And so the idea is you are killing the debt. So if you owe $200,000, if it’s an amortizing loan, every payment you make, you are killing the debt so that at the end of the scheduled payments, it will be zero. It will be dead. It will be killed.
That’s the idea behind amortization. And when you get a mortgage today, you get an amortization schedule that shows you how those balances go down. Well, negative amortization was the opposite.
So now with every payment you make, your balance went up, because remember the house price used to be $200,000. And the payment was $1,000 a month. Now the house price is $350,000. And the payments still needs to be $1,000 a month so people will buy it, because they don’t have more wages.
They can’t afford to spend more than $1,000 a month. And we as an industry had a lot a liberties back then to do whatever we wanted. And so the industry came up with the negative amortization adjustable rate mortgage where the monthly payment you made, the $1,000 you made, did not even cover the interest that was due. And the balance went up each and every month. So every month you owned the house, the balance went up, the balance went up.
The next phase in that price going up, when the home price went to $400,000, guess what? We were out of tricks.
The industry had nothing left. We went from fixed rate, amortizing, reducing balance with monthly payments loan, to adjustable rate mortgage to lower the rate temporarily, to interest-only adjustable rate, to lower the payment by not paying any principle, to negative amortization, which is making a payment that isn’t even big enough to cover the interest. So the principal increases every month. So when home values increased one more time, we as an industry had nothing to throw at it.
And this is what caused home prices to crumble because no one was ever willing to pay more than $1,000 a month for that house because we weren’t seeing the wage growth. So that’s what happened. That’s what caused the crash.
Well, this time around there are laws that prevent the industry from doing those things. And as of right now, we have not seen adjustable rate mortgages come back. We have not seen interest-only come back. And you can’t do negative amortization anymore except under a very, very tiny, tiny window that basically means it will never come back, which is good because this is how we’re going to prevent another bubble from happening.
Now what we’re seeing is people are buying houses at higher prices are having to pay higher payments, which is the way it should be. This growth in home prices is not being fueled by creative financing in the mortgage industry. This growth in home prices being fueled by people willing to pay higher monthly payments for houses because homes were too low.
They were undervalued. They crashed too far. And now we have recovered.
That is my quick little history lesson on how we got to where we were, and why we are not currently at risk of heading back there. The other big thing, the other big kicker, was down payment.
Home Down Payments
And so during pre-crisis, you could buy a home with no money out of pocket. And where this really impacted things is when we get into what we call jumbo loans. So as we sit here today, if you want to buy a $420,000 house, maybe a $430,000 house, you can put 5% down.
And you can finance $410,000. You can go all the way up to $417,000 as long as you have your 5% down. But that stops around a $430,000 house.
As soon as you go to a $500,000 house, now you’re looking at a down payment of more like $75,000, because the lending rules are different when the loan amount is over $417,000. So there’s kind of this natural cap baked in right now where it’s very difficult for a home to cross that price range, because when your house is priced at $430,000, $440,000, someone with only a $20,000 or $30,000 down payment can come buy that house. Once you cross that threshold, you’ve eliminated all those people. And now you have to have people who like a $70,000, $80,000, or 90,000 down payment.
That’s a big difference. And so because certain homes are being held there, what happens is if you go out, and if the really nice house is only $440,000 because they don’t want to cross that threshold, then the house in the neighborhood that’s just a little bit not quite as nice as that one can’t really– it can’t be the same price, because then everyone would buy the nicer house.
And so on the high end of the home price bucket, there is some constraint on how much appreciation we’re going to see. Back during the boom, you could buy a million dollar house with no money out of pocket. Today if you want to buy a million dollar house you’re talking about a $200,000 down payment.
So on a million dollar house, the monthly payment is maybe $6,000 a month. And there’s a lot of people out there that say, oh, I could afford a $6,000 a month mortgage payment. I’ll go buy a million dollar house. But then they realize they have to make a $200,000 down payment, which is like three years of the monthly payment. So now they’re going to have to take that $6,000 a month and save it for three years before they can go buy that million dollar house, which is probably the way it should be, in all honesty.
But that’s the world we find ourselves in today. So all of these protections– the protections from regulators, the protections from the new laws– the things they passed to plug the holes that the mortgage industry used to give people artificially-lowered payments have been plugged. And that is what is going to protect us from another housing crash.
And Wall Street sees this. The guys buying all these rental properties see this. The guys investing in these rental bonds we talk about, they all see this.
But, unfortunately, the average American consumer does not, because why? Because they’re not educated when it comes to all things finance. And I’m going to throw home buying into finance and financial because most of us finance homes. Very few first time home buyers are out there paying cash.
The reason we brought up this whole article is:
Don’t Fear the Housing Crash
to explain the fact that there’s not going to be a big crash in home values because the rental guys, the big hedge funds who bought a bunch of property, are going to sell it, because they’re not.
They’ve actually put themselves in a position where they can’t sell now, because they’ve already got their profit for the next five years worth of rental income. So they’re good. They’re happy. If anything, they’re going to take some of that money they just got, and they’re going to buy more houses, which will put some more pressure on home prices.
The other interesting thing we see is new construction. So builders actually started building bigger houses when the crash happened, because they didn’t want to have to sell as many houses. And so they want the opposite route.< And they said, well, instead of messing with all those people who are going to put $5,000 or $10,000 down, let's just go build mansions. And we'll steal the buyer who does have the $200,000 down away from the resale, and get them to come buy our new construction house. And so the gap between new construction and existing homes nationally is one of the largest it's been ever. It's huge. There's a huge gap right now. And so I think we, really-- a couple things our economy needs is, one, we need builders to start building some smaller houses, because now they should be able to make some profit on smaller houses because values are up high enough in that range. And then we need more people buying. We need more people out there-- and this is what's going to help GDP. This is what's going to help bring the economy back. This is what's going to help continue to move everything forward. Because, really, the labor market is good. The last jobs report was good. Unemployment is very low. Wage growth is starting to come. What's really continuing to drag the economy is-- as always, as it has been since 2007-- is housing. I want people to understand-- there's all this misinformation. And there's all this, oh, it's too hard to buy a house. It's too hard to qualify.
Why it is Not Hard to Qualify to Buy a Home
I want people to understand– there’s all this misinformation. And there’s all this, oh, it’s too hard to buy a house. It’s too hard to qualify.
And let me tell you. It’s just not true. Now, I will tell you there is one subset of people who still really struggle to get a mortgage, and will continue to struggle. And that is if you are self-employed and you do not claim your income on your taxes.
OK, there’s no solution there. If you own a business and you make $100,000 a year, but you tell the IRS that you make $10,000 a year, you will not be buying a house. Now, that is not the majority of the general public out there. That’s a very small subset of people.
That group of people cannot get a house right now. They could back in the day, because back in the day we didn’t ask them to prove their income. Today, we do ask them to prove their income. And we ask them to prove their income by providing tax returns.
A lot of the people you would hear saying how hard it is to get a mortgage, it’s because they do not have the adequate income because they do not show it on their tax returns, and they do not pay taxes. That is not most of us out there. So for everyone else listening, if you work a job, and you get paid x dollars an hour, 40 hours a week, and you get some overtime, great.
If you get a salary, if you get a salary and bonus, if you get commissions, whatever it is, if you have a good, solid job where your W2 at the end of the year has a nice number on it that’s above, say, $35,000 or $40,000, maybe even less. If you’re married, the two of you together can be around that much.
Maybe you’ve got a buddy you want to go in and buy the house together, be roommates. Whatever it is, it’s much easier to qualify. The down payments, Rob, 3.5%. $200,000 house, you’re talking $7,000 down, $100,000 house, $3,500 down. When you work with a lender like us that doesn’t charge lender fees, you’re not coming out of pocket with a bunch of other stuff. Really, all you have to worry about is your down payment.
Usually, the seller will pick up the bulk of the closing cost. We don’t charge anything. And you’re good to go.
So, yeah, 3.5%, $3,500– if you can get your hands on $3,500. It can either be a gift. Maybe mom and dad want to gift to $3,500 for the down payment. I think most parents would happily give their child some money if they know it’s going to go toward buying a house. It’s easier than you think.
You know what’s crazy? An awful lot of people listening to us right now will come up with $2,500 or $3,000. They’ll go down to a car dealership. And they’ll buy a car right now at a much higher interest rate than 3.5%, 4.5%. And it’s a $70,000 or $80,000 car or truck.
Now, why don’t they just buy a house for like $100,000 that’s going to last them 30, 40, 50, years, or however? The truck’s going to last them three years. I don’t get it.
Add in 10 years, that truck is not going to be worth $70,000 more than what they paid for it today. It’s going to be worth nothing.
All it does is get them to work and back, and maybe a weekend at the lake. But the house, you sleep in it. You raise your family in it. You’ve got tradition.
See, no one is afraid of not able to get approved for a car loan.
The Power of Misinformation in the Financial World
This is where the misinformation, and the media, and the misinformation, this is where our rule about sharing your knowledge– people here are sharing misinformation. They’re making people think that it’s too hard to get a home loan. And it’s just not.
So if you’re out there listening, and you’re on the bubble about this– maybe you’re one of these folks that thinks you can’t qualify for a home loan, you have these what I call the self-limiting beliefs that you can’t have a home. Your friend can. And this guy can. And that guy can.
And Robert on the radio, he can. And Rob on the radio can. And producer Dave probably can.
But I just can’t. I can’t. I don’t deserve that. I don’t make enough money for that. I don’t have enough good enough of credit for that. I can’t do that. You’re probably wrong. You absolutely can, and you absolutely should.