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What do the Recent Mortgage Market Woes Mean for San Carlos Real Estate?

August 20, 2007

Its the question of the day….make that the month. First, let me say that it is impossible for anyone to predict the true effects, if any, the recent trouble experienced by some lenders will have in the San Carlos market. This much we do know: (1) If history is any indication, any investment in San Carlos real estate over the long haul is a very good investment; (2) Trying to equate the real estate market on the peninsula to what the rest of the country is experiencing is a mistake.
With those two factors in mind, lets examine the recent mortgage market disruption. The majority of the disruption in the mortgage industry centered on the sub-prime market. The sub-prime market refers to loans that are made to people with below average credit/and or people who are making purchases with either 100% financing or very little down. The sub-prime market, by its very nature, is subject to above average defaults and foreclosures. From 2002-2004 many of these sub-prime borrowers took out 3 and 5 year ARM loans.
An ARM loan refers to an Adjustable Rate Mortgage. In other words, the interest rate is fixed for 3 or 5 years, depending on the length of the ARM. At the end of the 3-5 year period the loan interest rate corrects to the then prevailing interest rate plus what lenders refer to as a “margin”. A margin is usually around 1.0-2.5 points. The margin is then added to the prevailing rate and the borrower now assumes the new rate. For example, Mr. Smith took out a 5 year ARM with an interest rate of 5.5% in 2002. Now, 5 years later his interest rate is about to change, as he has reached the end of his ARM period. His interest rate will now be 5.5% plus the increase in the prevailing rate, which is 1% plus the margin, which is another 2.5%. Mr. Smith will now be paying at an interest rate of 9%, instead of 5.5%. Many sub-prime borrowers are in a financial crisis because of the increased interest rates, thus the reason for more defaults and foreclosures.
The good news is that the overwhelming majority of San Carlos homes were not purchased on sub-prime loans so we should not expect a direct effect of the fallout in the sub-prime mortgage sector. Thus, the question is how much of an indirect effect will we feel in San Carlos.  I think it would be foolish to say that there will not be any effect….there will be.  Currently, and just prior to the mortgage sector news of a few weeks ago, the San Carlos housing market was very strong.  Reasonably priced properties still move quickly.  It will take a few months to straighten out the mortgage sector issues and the severity of the credit crunch.  However, I believe we will need to wait until early Spring of 2008 to make any type of reasonably accurate forecast on the San Carlos market. In the mean time I do not see much of a change in our current market.

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Bob Bredel

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