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The Mortgage Market's Incredible Turnaround

Every bubble is characterized not just by froth, but sheer stupidity. In 2005, the median down payment was 2% of a home's value -- a number that basically rounds to zero. Nearly half of first-time homebuyers bought homes with no money down. In California, 60% of mortgages were interest-only or negative amortization.

Most of that is now long gone. Mr. Capitalism was mad as hell, swung his fist, and purged the insanity. It's what happens. You probably already knew that. But many would be surprised how far the correction has gone. Not only has most of the lunacy been eliminated, but an almost cult-like level of conservativeness has entered the market.

The real estate information provider collects data on the percentage of home transactions that are done with a mortgage. The opposite of this, of course, are homes bought with all cash. I used these numbers from a collection of 10 major cities across the country to form somewhat of a composite index of all-cash purchases. It's impressive:

Sources: Zillow, author's calculations.

Not only has the percentage of all-cash buyers exploded since the housing bust, but the level is now about 50% higher than before the housing bubble ever began.

Now, a lot of cash-only purchases are concentrated in upper-end markets with wealthy buyers. In California's insanely expensive Newport Beach, 67% of all transactions are now all cash. Not only can most of these buyers afford to pay all cash, but in some cases it's their only choice. Jumbo mortgages are still hard to get as the private mortgage market -- outside of Fannie Mae and Freddie Mac, which back smaller mortgages -- is a fraction of its former self.

Many cash-only buyers are also large investors buying up foreclosed homes en masse. These people rarely know much about what they're buying; the homes are purchased on the steps of local courthouses, often sight unseen. In that sense, all-cash bulk sales are sometimes looked at as widescale speculation -- not a sign that market sanity has returned. If prices don't rebound as speculators might hope for, bulk selling could hit the market.

The good news is that whatever happens to home prices, these all-cash bulk buyers will always have 100% equity. They'll never be underwater, and they'll never have the incentive to walk away from the property if things go haywire. It's the opposite of the housing bubble.

And these buyers aren't all speculators. In Las Vegas, the average home now costs just $109,000. A pretty modest household income can easily, easily, afford that, and a good portion of households could feasibly afford a purchase that size in all cash.

The big exception
If there's still a section of the mortgage market that still gives off a stench of the bubble years, it's the Federal Home Administration, or FHA. FHA loans are geared toward borrowers the private market won't dare touch -- those with low down payments, terrible credit, and low income. The FHA currently backs low-quality loans with as little as 3.5% down, and with a perfectly ruined credit score of 500, they'll back a loan with 10% down.

What's worrying is the FHA's market share has increased dramatically over the past few years as private subprime lenders fell into extinction. The FHA, in a sense, became the new subprime. From 1993-2003, FHA had about 8% share of the mortgage market. It fell to 1.75% in 2006 as private subprime flourished. Today, it's 12.61%.

That's troubling. As much of the mortgage market regains its wisdom, the still-reckless portion is growing. If there's one silver lining, it's that the FHA's surge doesn't pose the same kind of risk as the previous bubble. Shoddy loans are piling up on the balance sheets of taxpayers rather than the private likes of Wells Fargo (NYSE: WFC  ) , Citigroup (NYSE: C  ) , and Bank of America (NYSE: BAC  ) (although taxpayers actually ended up bearing those risks as well).

Have you applied for a mortgage lately? What's your experience been? Share your thoughts in the comment section below.

Fool contributor Morgan Housel owns Bank of America preferred. The Fool owns shares of Bank of America and Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (7) | Recommend This Article (8)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On March 09, 2011, at 5:12 PM, Borbality wrote:

    Anything to help bring down the excess supply is OK with me.

  • Report this Comment On March 09, 2011, at 5:19 PM, EnigmaDude wrote:

    The FHA loan situation is indeed worrisome, however, it was the only way for me to afford to buy a home last year because I have a BK on my credit report (from 2004) and I could not come up with 20% down. My credit is under control now and I have a good paying job so I don't think that I am the typical credit risk that some FHA loans are going toward.

    But recently I have been getting letters in the mail suggesting that I refinance using a FHA Streamline loan, which is basically a 5 year ARM. It's tempting with interest rates below 4% but I have to wonder what will happen after 5 years. Will we see yet another round of foreclosures from all the people who signed up for this deal?

  • Report this Comment On March 09, 2011, at 6:12 PM, xetn wrote:

    It is estimated that there are another million or so more foreclosures in the pipeline for the rest of this year. If true, there will be much more inventory and a further reduction is sales prices.

  • Report this Comment On March 10, 2011, at 12:27 AM, WiseChoice4u2 wrote:

    In December we tried to refinance a 50K loan in Michigan on a nice country house property on one acre in a midsize city probably worth about 60-70K. The appraisers said my house was worth only 35K. We have a perfect credit score for 40 years, no creditcard debt or other debt whatsoever and a great salary. I guess that the 5th 3rd bank didn't want Wells Fargo's loan.

  • Report this Comment On March 10, 2011, at 1:06 AM, dgmennie wrote:

    Of course "most of these cash-only buyers are investors/speculators buying up foreclosed homes en masse on the steps of local courthouses, often sight unseen." This is hardly a harbinger of better times since real buyers who might want LIVE IN THESE HOMES still have no jobs, no savings, and no way of qualifying for a mortgage.

    Turnaround? Here is the only "turn around" going on here:

    Banks are never going to get back into serious long-term consumer lending so long as they can get cash (almost) free from the feds, then turn around and give a few thousand (each) to millions credit card customer while charging them 15 to 25+ percent interest plus God knows how much more in overdraft and late fees.

    I think the last real money you Fool analysts had any hands-on experience with was your ALLOWANCE!

  • Report this Comment On March 10, 2011, at 6:04 AM, dcflipflop wrote:

    Just finished a refi on our house in eastern PA. Got a much better rate and shortened my term. The house appraised for more than Zillow had it at, which kind of surprised me. It's also 25% more than what it appraised for in 2003 when we bought it. My lender (a local bank) was very thorough, but getting approved was not a problem.

    The local banks on average had much better rates than the big boys. If you're looking for a loan, I'd say don't waste your time with Citi or Wells Fargo, just walk into your bank where you can talk face-to-face with the guy who's going to loan you money.

  • Report this Comment On March 12, 2011, at 2:31 AM, chaz572 wrote:

    Thank goodness for FHA! I bought my first house just this past August, and I couldn't have done it without FHA backing. Not that I'm your typical FHA buyer. I've got a solid 6-digit salary, a great employment history, very little debt, and managed to get my FICO score above 760. My problem? Very little non-retirement savings. The absolute most I could muster was a 5% down. And so no traditional lender would touch me. If I waited long enough to save up the 20% down (and I was saving at a quite decent rate), interest rates would be through the roof already. So I went FHA. Still required tons of documentation, but approved no problem. I even got approved for about 10% more than I felt fully comfortable spending (and didn't use it -- the final purchase price I paid was just a bit below my comfort limit, and well below my approval limit). Now I'm in a great home at a 4.65% FHA 30-year fixed. I don't expect I'll ever refi that.

    Bring on the inflation! I can't wait to "laugh all the way to the bank" when my real inflation-adjusted mortgage interest rate goes negative during the inevitable hangover from QE2. Why, yes, I'll be MORE THAN happy to keep paying my mortgage, even if I'm temporarily underwater during the interest rate surge. :-)

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