Friday, March 25, 2005

Free Money!

by Calculated Risk on 3/25/2005 03:45:00 PM

Come and get it. Price doesn't matter. Interest rates don't matter. They're giving away free money, right here in Orange County, California. Just buy a home, wait a year, and put the cash in your pocket!

At least that was my reaction to this story in the OC Register: "Loan rates on the rise". The story quotes Gary Watts, a Mission Viejo "real-estate broker and economist" as expressing

... his enthusiasm this way: The recent \$100 increase in monthly payments - or \$1,200 a year - is nothing compared to what he predicts is Orange County home-price appreciation potential: as much as \$70,000 a year.

"There's too much emphasis on interest rates in the marketplace," Watts said. "Who wouldn't trade \$1,200 for \$70,000?"
A simple calculation: The median home price in OC is \$555,000. With 10% down, a buyer's monthly payment for P&I would be \$2997.97 (plus property taxes of about \$500 /month). This is based on a 30 year fixed rate loan at 6.01% (see FreddieMac)

By my calculation, a speculator's first year risk is: \$41.5K + their \$55.5K down payment = \$97K (minus the utility of the property), not \$1200. Of course, with a 1 Year ARM (currently 4.24%) a speculator is only risking \$35K + \$55.5K = \$90.5K (minus utility). And if the speculator can obtain a no money down loan, they are only risking the monthly payments minus the net rental income (or other utility if they occupy the house).

And what is the likelihood that houses in OC will appreciate \$70K over the next year? Is there always a greater fool?