I started writing this entry a few months ago before it was clear the housing bubble was about to burst. Burst it has. Or at least it’s sprung a leak. The question still remains where will we end up?

For the last couple years I’ve been following the housing market. I like houses, or more generally, places of residence as I like condos as well. It may be a genetic predisposition of mine as I share this interest with my mom. And the last couple of years, I’ve been waiting for the market to burst or at least start leaking. Finally the numbers seem to be indicating that just maybe we’re turning a corner in the market. Of course you need to ignore the new builds in January which were at an all time high. That was seasonally adjusted, but given that this winter has not been much of winter at all, maybe it was the wrong season to adjust.

The more intersting question is what has been driving the housing market? I think it’s always best to start with the “bottom” of the housing market, the entry-level home. This is usually someone’s first home purchase without the benefit of appreciated property in their pocket. How are people affording so much more house on a year-to-year basis without making more money? The first answer to that of course is the obvious one - interest rates. Interest rates still remain at historical lows. People can still afford more house than they could a few years ago when interest rates on a 30-year-fixed mortgage might have been 7.5% rather than 6.5%. The other piece is the nature of the loan itself. The advent of these so called “exotic” mortgages have helped fuel the housing fire. You probably know them as “interest only loans”, “option arms”, etc. The danger of these loans, beyond rising interest rates, is that the borrower either builds no equity or in some cases ends up decreasing his or her equity, and thus ends up owing more than what was orginally borrowed.

The financial press has been fairly unrelenting on its attack of these products, maybe as relentant as the mortgage lenders who are pushing these products. Having not applied for a mortgage recently, I don’t know what they’re pushing. I would however imagine that many mortgage originators do push these products, as they allow a home buyer to purchase more home than he or she could otherwise afford. Of course, the orignator does not then bear the risk of that home owner defaulting on that loan. The risk is securitized and sold, and some “poor” investor ends up holding the bag. It’s still too early to tell if these “exotic” loans come all crashing down with the rising interest rates. Given the nature of these loans, a housing crash could become a self-fufilling prophecy. Let’s hope it doesn’t quite get to that. I think the market could take 10-20% off the top. Anything more and we’re in trouble.