Housing price conundrum (part 2) How lower lending standards led to housing price inflation.
Housing price conundrum (part 2)
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- Before I go a into an explanation of why housing
- prices skyrocketed from 2000 to 2006, I think it's a good
- idea to give a little history of what the housing market and
- the mortgage market used to be like before
- things got out of control.
- So let's go back to, say, I don't know.
- Let's go back to the late '70s--
- maybe mid-'70s, actually.
- I remember my parents, they bought a house.
- We lived in New Orleans.
- And the house, if I remember correctly, it
- cost roughly $60,000.
- And back then, to buy a house -- and actually, for a while,
- until more recently -- in order to buy a house you had
- to put 25% down.
- So 25% of $60,000 is 1/4 of it.
- So you have to put $15,000 down.
- So you have to save up $15,000.
- And then you're going to get a mortgage on $45,000, right?
- $45,000, you're going to borrow.
- And I forgot the exact interest rates then, but I'm
- just going to throw out a number.
- This is really just for instructive purposes.
- Let's say interest rates back then, they were higher.
- They were like 9%, I think.
- So 9% on $45,000.
- How much interest am I going to pay?
- 45,000 times 0.09.
- So I'm going to pay a little over $4,000 a year in
- interest. Or if I divide by 12, about $340 a month in
- And I remember at the time, we actually moved out of our
- house and we rented it out, because we needed cash.
- And we rented out that exact same house -- and I this is in
- the late '70s or early '80s-- we rented out that exact same
- house for $900.
- The rent was $900.
- So this raises, I guess, a couple of questions.
- First of all, the big question is, why did those people who
- rented our house -- I mean, they paid $900 a month.
- They must have had a good income, for that time.
- Why were they willing to pay rent, when they could have
- bought a house, where the mortgage would have been --
- interest plus a little principal -- it would have
- been no more than $400 a month?
- So why would you just throw away -- this is the classic
- rent-versus-buy argument -- why would you throw away $900,
- where you could actually build equity paying $400 a month for
- the exact same place?
- And you can think about that a little bit.
- But there's a bunch of reasons.
- What was necessary to buy a house then?
- Well, one, you needed a $15,000 down payment.
- Maybe these people had really good cash flow every month,
- but they just never had the circumstances, or maybe even
- the discipline, to save up $15,000.
- You also needed a really steady job.
- So you needed -- this is the down
- payment, this is one thing.
- You also needed a steady job.
- Maybe the people who were renting, they were working odd
- jobs, or they didn't have a steady income.
- Although I doubt it.
- I don't think we would have actually leased the house to
- them, had that been the case.
- They probably had that.
- And then the last thing you needed to get a mortgage, you
- needed good credit.
- And maybe these people didn't have that.
- Maybe they didn't pay some bills in the past. And they
- just couldn't find a bank that was willing to give them a
- loan, despite having a steady job and the $15,000 down.
- If you have to ask me, I think the biggest barrier for this
- family at that time was probably the
- $15,000 down payment.
- And frankly, they probably had trouble saving $15,000 because
- they were busy paying $900 in rent.
- So that was the circumstance throughout, actually, most of
- modern history.
- That you had this barrier towards buying a house.
- That it did make sense, that the conventional wisdom that
- it is better to buy than rent held.
- It's just, everyone knew that, but a lot of people just
- couldn't buy, even though they wanted to, because they didn't
- have the down payment.
- They didn't have the steady job.
- Or they didn't have the good credit.
- That was a circumstance then, and that lasted for some time.
- What happened in the early 2000s?
- And it actually happened in California in the mid-'90s.
- But it got more and more, I guess we could say, flagrant,
- as we went through the decade-- is that people
- started lowering these standards.
- And I'll do a whole other video on possibly why those
- standards were lowered.
- But let's say that in 1980 you needed 25% down.
- Let me just switch colors.
- That color is kind of ugly.
- You needed a steady job.
- And you needed a, I don't know.
- Let's say you needed a 700 credit score.
- And that was true from 1980 to, let's say, 2000.
- I'm exaggerating a bit.
- But this is just to give you the broad sense of what
- actually happened.
- But let's say then, in 2001 -- and I'll explain later why
- this might have happened -- the standards were lowered.
- That if you wanted to buy a house, all of a sudden you
- could actually find someone who was willing to give you a
- house for 10% down, maybe kind of a steady job, maybe just
- need a job.
- And maybe you had a 600 credit rating.
- So what happens when the standards on the mortgage go
- from this to this?
- Let's go back to these people who used to rent that house
- from us for $900.
- Maybe they didn't have $15,000, right?
- That would have been a 25% down payment.
- But maybe back then, they had 10%.
- Maybe they had $6,000.
- They just couldn't get up to $15,000 in savings.
- Back when they were doing this, back in the '80s, if the
- standards got a little bit freer, like they did in the
- early 2000s, those people could have bought a house.
- They would have said, man, we don't have to rent anymore.
- We saved up the 10% down payment.
- It's gotten a little easier.
- Our job now meets the requirements.
- Our credit now meets the requirements.
- We can go buy that house.
- So that would have increased the
- aggregate demand for housing.
- Even though, even if no one's incomes increased, even if the
- population didn't increase.
- All of a sudden, there's a new person who could get financing
- to buy a house.
- And then if we go to, let's say, 2003.
- They say, you know what, you don't even
- need any down payment.
- No down.
- No money down.
- So you can imagine, there's a whole set of people who maybe
- had a decent income, but they couldn't save any money.
- Now all of a sudden there was no down payment barrier to
- buying a house.
- Maybe you still needed a job.
- And maybe you just needed a 500 credit.
- So all of a sudden, without people's incomes going up,
- without more jobs being available, without the
- population increase, there were more people
- who could get financing.
- Or more people who could bid up homes.
- And the situation actually got pretty bad.
- By 2004, 2005 -- and this isn't exact, but it gives you
- a sense of what happened.
- By 2004, 2005, you had a situation where they had these
- stated income -- they had these
- things called liar loans.
- Maybe I'll do videos on each of these.
- But these were essentially no down payment.
- If you had a job, you could kind of make it up.
- You just said, I have a job.
- They wouldn't validate it.
- These were stated income.
- You could just say what you made.
- So even though the mortgage might require an income of
- $10,000 a month, and your income is only $2,000 a month,
- you could say your income is $10,000 a month.
- So stated income, no down, maybe a job.
- And they didn't even do a credit check.
- So what happened from 2000 to 2004 is that credit just got
- easier and easier and easier.
- And every time credit got easier, there were more people
- who, despite the fact that they weren't making any more
- money, they were able to get financing.
- And so the pool of people who were able to bid on homes, or
- the demand for homes because now there was this financing,
- became larger and larger.
- And that's what increased the prices of homes.
- And now you know, the obvious question is, well, why did
- this happen?
- First of all, why did they get easier in 2001, get easier and
- easier as we went to 2004?
- And why did they get to this unbelievably absurd level,
- where by 2004 and 2005 -- you hear stories, especially in
- California and Florida, of people who were making maybe
- $40,000 a year.
- And they were able to buy houses with no money down.
- Some of these people were migrant laborers.
- And they were able to buy houses for $1 million.
- So in the next video, I will tell you why that happened.
- Why were people willing to give their cash to people to
- buy a house that had a very low likelihood of getting paid
- back, and for a house that had a very low likelihood of being
- able to retain its value.
- I'll see you in the next video.
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