How the Federal Reserve caused the housing bubble
Not too long ago, before the stock market crashed, mortgage interest rates were 8%. To borrow $150,000 for 30 years at 8% to buy a median-priced house, your monthly payments would be $1,100. If you couldn't afford a payment like that, then you bought a smaller house, or you rented while you saved up a larger down payment.
After the US Federal Reserve started its post-crash free money campaign, mortgage interest rates fell to 6%. At that rate, to borrow $150,000 for 30 years you'd pay only $900 per month. Lots more people could afford a house at that price, so lots more people started buying homes, or they traded up to larger homes. It was like free money!
This increased demand pushed up the price of existing houses. Soon, that same house sold for $180,000, which at 6% required a monthly payment of $1,100. Back to where we started.
This is where things should've stopped.
But now people all over the country were excited about housing prices. In a year or two people watched their houses go up in value by 20%. Houses were HOT! People who normally didn't care about owning homes started caring, because they wanted to make 20% per year on a house also. People who already had a home wanted a bigger home. People who already had a bigger home wanted a vacation home. Others wanted to own real estate as an investment, because houses were going up faster than stocks or bonds.
In order to help customers buy more housing, banks started pushing more Adjustable Rate Mortgages (ARMs). Rather than paying 6% for 30 years, you could pay 4% for 3 or 5 years, and then the rate would "adjust". If you only planned on living in your house for 3 or 5 years, that was a great deal. Using an ARM, you could buy that $180,000 house for less than $900 per month!
This increased demand by ARMed borrowers pushed up the price of existing houses. Soon, that same house sold for $230,000, which at 4% required a monthly payment of $1,100. Back to where we started.
Except now people had watched their houses go up in value by another 30%! Houses were HOTTER THAN HOT! Now EVERYBODY wanted a house, or four, or more. You didn't even have to rent out the extra houses, just hold on to them for a year and sell them for a 30% profit!!!
In order to help all these customers buy more housing, banks started pushing more Interest Only Mortgages (IOMs). Rather than paying both interest and principal on your loan, you could pay only interest. Using an IOM you could buy that $230,000 house for less than $800 per month!
This increased demand by IOMed borrowers again pushed up the price of existing houses. Soon, that same house sold for $330,000, which required a monthly IOM payment of $1100. Back to where we started.
Except now people had watched their houses go up in value by another 40%! People who bought at $150,000 had doubled their money in a few years. Houses were HOTTER THAN GOD!
Isn't this fun?
Now, believe it or not, in order to help all these customers buy even more housing, banks have begun pushing something called an Option ARM. Rather than paying all the interest & principal due on your loan, you are given the option of paying only a portion of the interest each month. The rest of the interest would be added to the principal you owed, possibly to be repaid in the future. Using an Option ARM you could buy that $330,000 house for ... whatever payment you choose.
I'm not making this up. This is as crazy as it sounds. This is the land of free money.
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