By Jennifer Harmon Los Angeles -- Adjustable-rate mortgages are not a concern now, but they could cause problems for Southern California homeowners in three to seven years as these loans convert from fixed to adjustable rates, according to Raphael Bostic of the University of Southern California Lusk Center for Real Estate. "If interest rates increase, some buyers may not be able to afford higher payments and may have to sell their homes," said Mr. Bostic, a former Fed economist who specializes in tracking the home mortgage market. "This could cause a sudden rush of homes on the Southern California market and depress prices," he said. ARMs recently have accounted for about a third of new loan applications nationally, the highest in a decade. Some lenders also have packaged ARMS with interest-only, 100% financing. Many of the borrowers who are getting adjustables are young families and singles who are usually first-time homebuyers, not people who have had an opportunity to build equity on their homes, according to Mr. Bostic. The high price of homes in the state combined with the recent increase in interest rates has driven ARMs to increase in California, said Mr. Bostic. "Now that rates have leveled off a bit, that could change. But what we are seeing now in California is a rise in the use of adjustables," he said. "People are trying to get into a homes however and wherever they can. Because of housing prices, borrowers wonder if they are ever going to be able to get in." However, these same borrowers are betting that the future will be kind to them. "Borrowers are taking a calculated risk. Most households view it as that. Five or seven years is far enough down the road, they are willing to take the leap," he said. "When the bill arrives, they've advanced enough during that time to stay in the house. I think it's a statement of where households hope to be down the road, not really about today's market. Hopefully, the job situation will stay positive for them and the house price trajectory will keep the form it has historically." While ARMs are a long-term concern, Southern California is not in immediate danger of a housing bubble, Mr. Bostic noted. "As interest rates increase, the region's home sales will slow to more moderate but sustainable levels and prices will increase more slowly," he said. Mr. Bostic pointed to the region's employment growth and continued demand for housing as evidence that home prices are not being artificially inflated. He said he also doesn't see speculative buyers creating problems because they account for just a fraction of Southern California's home purchases. "Builders usually don't break ground unless a significant number of units are pre-sold, and they are requiring buyers to live in the properties for at least one year." Limited land is not the biggest barrier to building more homes, according to Mr. Bostic, but more developers have started building on locations further from the large, central metropolitan areas. "There is some sense that the most attractive lands are pretty much gone," he said. "But there are different types of models such as the downtown L.A. boom. There is a whole lot of new building, condo conversions in downtown. People talked about it for a long time, but we hadn't seen a lot of changes. "There is a lot of activity everywhere. The belief for many was that the prospect of a long commute made for a difficult day-to-day existence. Now, it's making the area much more attractive." That house prices have retained their value speaks in a large part to the supply issue - a commentary on the state of the market and the real need that exists for housing. "Cities, say Dallas or Houston, don't have the same land use constraints. They haven't been seeing the same numbers at appreciating house prices, so the market is able to respond quickly." Job numbers are very low in the financial services industry right now, according to Mr. Bostic, and there has been a slowdown in terms of the volume of mortgages in the state. "Lenders' chief concern should be making sure their standards are appropriate. Volumes have been so high during the last couple of years, there is pressure to maintain that," he said. "One possible way is by easing standards. That would be a more risky approach. Lenders should closely scrutinize their standards."
September 1, 2004