Fiction leads the way
There's a first-season episode of The Simpsons in which Homer has to have an RV so he can keep up with the neighbors. So, he heads to Bob's RV Roundup, where the sales office is decorated with signs that read "Bankruptcy, Shmankruptcy" and "We give credit to everyone." Unfortunately for Homer, he can't quite qualify for the loan big enough to buy him the "ultimate behemoth," but he falls for a lesser vehicle. Desperate to bolster his status among men, he asks what this smaller RV costs and is told "$350 a month." He takes the deal.
The joke, of course, is that "$350 a month" is not a price, it's a fleecing. A blatant ripoff attempt. How long does this loan last? What are the terms? Only someone as stupid as Homer Simpson could fall for such a transparent ruse, right?
Don't tell that to the home selling industry.
RV Bob at Ryland Homes?
This morning I spotted a high-end homebuilder in the Washington, D.C., area using sales tactics that could have been cribbed directly from that episode. Via a full-page newspaper ad, Ryland Group (NYSE: RYL) is trying to entice buyers with lavish digs, promising a variety of living arrangements at what seem like rock-bottom prices. Take this one: "3-4 bedroom garage townhomes. $1,174 per month." Or this one: "Single family and manor homes. $1,478 per month."
Luckily, our universe isn't quite as skewed as the Simpsons'. Ryland discloses, in microscopic print, that these payments are in fact based on teaser rates of 2.75%, a rate that disappears after one year. After that, you're stuck with a 6.25% rate on a 40-year mortgage. You got that right, 40 years.
Truth: Uglier than either fiction or advertising
I've had few kind words for this type of presto-changeo lending. While the Countrywide Financials (NYSE: CFC) and Accredited Home Lenders (Nasdaq: LEND) out there -- along with builder-sponsored mortgage businesses, like Ryland's -- may think they've got perfectly reasonable folks on the hook for their "affordability" products, I am seeing more and more evidence that borrowers have been anything but rational.
When 80% of option-ARM holders -- according to some reports -- are paying less than their monthly interest, so that their loan balances are actually increasing while their home values may be dropping, well, I'm pretty sure rationality has taken a vacation.
I've actually read news stories in which accountants, career bean counters, claimed they simply had no idea what their payments were going to look like when their loans readjusted. Now they're stuck with doubled payments, no way to refinance, and no one willing to buy.
Some dirty details
Personally, I don't much believe in the "I didn't know" excuse. It's your responsibility to know when you sign on the dotted line.
But to provide just one more example of how scary things can get when you believe what you want to believe, rather than what the math tells you, I played with Ryland's online payment calculators and some of the homes in that RV Bob advertisement of theirs.
For a sub-2,000-square-foot townhome located a full 45 miles from downtown Washington, D.C., this is what reality will look like.
First of all, forget $1,174 per month, my friend.
After that first year is over and the mortgage adjusts, according to the Ryland calculator, your monthly payments go toward $2,081 per month. That's right, your payments will turn out to be 75% bigger than the teaser payment in their ad -- which seems to exclude insurance, taxes, and mortgage insurance, expenses which, alas, we don't get to dodge in real life. (Wanna discuss the 400 miles per week of gasoline expense, plus two to four hours a day of the third-worst traffic in the country? I didn't think so.)
|
Teaser Rate
|
Years 2-40
|
30-Year
|
|
P&I
|
$1,083
|
$1,788
|
$1,940
|
|
Tax, Insurance
|
$183
|
$183
|
$183
|
|
Mortgage Insurance
|
$110
|
$110
|
$110
|
|
Total Monthly Payment
|
$1,376
|
$2,081
|
$2,233
|
Those are the numbers, assuming a $350,000 home, 10% down payment, and Ryland's auto-generated tax and insurance figures (which look low to me). As you can see, there's an incredible difference between ad copy and abject reality. A traditional, 30-year mortgage at 6.50% shows what a typical payment on a home of this price would look like.
Think that's incredible? I'm just getting warmed up.
You pay an awful lot by going from a 30-year loan to a 40-year in order to ensure yourself "affordability." Here's what that $150 a month savings costs you in the end.
|
40-Year, Teaser year 1
|
40-Year, No Teaser
|
30-Year
|
|
Total Monthly Payment
|
$1,376
|
$2,081
|
$2,233
|
|
Interest subsidy (1st year)
|
$11,029
|
NA
|
NA
|
|
Total Interest Paid
|
$532,393
|
$543,422
|
$383,223
|
|
Overpayment vs. 30-year
|
$149,170
|
|
|
As you can see, the total interest paid on a 40-year mortgage is much more than on a traditional 30-year.
Try this trick on one of their pricier homes, and it gets much worse. On a $650,000 home, your payment will jump from $2,491 in year one to $3,905 in years two through 40. And you'll pay $291,000 more interest over the life of the loan than if you'd opted for a 30-year mortgage.
Desperate House-shills
Why is Ryland doing this? I think the answer could be that it's desperate to sell homes. And more than that, it's desperate to keep prices artificially inflated. Remember, much of the bubble depends on popular acceptance of the myth that home prices don't fall. As I've discussed here, sellers, builders, and realtors are doing backflips to cut discounts to buyers -- discounts that don't get registered in the sale price. Teaser rates and 40% off closing costs (another Ryland special this month) are prime examples.
None of this is reflected in the prices the talking heads typically spout when spinning the tale of the soft landing, but buyers, apparently, are less and less likely to be fooled.
Ryland is no island
Isolated situation? I doubt it. Yesterday, we got yet more bad news from KB Home (NYSE: KBH), which chopped about 20% off the guidance given back in June. High-end Hovnanian Enterprises (NYSE: HOV) reported earnings that shrank 34% from the year-ago period. This morning, BeazerHomes (NYSE: BZH) chopped its guidance as well.
Some believe the collapse of the housing bubble will actually toss the economy into a recession. With growth in take-home pay continuing to lag inflation, where will Americans get their gasoline, car, clothing, food, and iPod money if they can't play ATM with their bricks-and-bubble equity?
I have this sneaking suspicion that the near future is going to be a lot more spooky, and a lot less amusing, than The Simpsons, season one.
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At the time of publication, Seth Jayson had no positions in any company mentioned here. View his stock holdings and Fool profile here. See what he's Digging these days. Fool rules are here.
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