Tuesday, July 1, 2014

Longmeadow Home Sales Are Improving

Shown below are a series of charts summarizing the latest single family home sales for Longmeadow, Massachusetts.  These latest results for January - June 2014 period include both MLS and FSBO transactions and are based upon public information obtained from the Hampden County Registrar of Deeds website.

  • Longmeadow home sales for the 6 months of January - June 2014 were higher vs. the year earlier period (88 vs. 80, + 10%, see figure 1).  Home sales for the 2Q (April - June) were even stronger vs. the year earlier period (62 vs 44, + 41%).

  • Median sales prices in 2014 showed a strong improvement from lower levels late last year and into early 2014 with a June median sales price (6 month trailing average) of $337,500 (see figure 2). This is only 3.6% lower than the peak of $350,000 observed in September 2007.

    The median sales price for June 2014 (6 month trailing average) was higher vs. the year earlier period ($337, 500 vs. $317,500, +6.3%).

  • For the January - June 2014 period, only 33% of the homes (29 out of 88) were sold below the assessment value (see figure 3 below). For all of 2013, 47% of the homes (86 out of 184) were sold below the current assessment value.
Many real estate markets across the country have shown strength in 2014 continuing the hopeful signs from 2013.  A continuation of the improvement in employment and sustained economic recovery without a signficant rise in mortgage interest rates will likely lead to higher consumer confidence and a continuing improvement of home sales for the remainder of the year.

Figure 1- Home Sales
(click chart to enlarge)

Figure 2- Median Prices

Figure 3- Sales Price vs. Assessed Value
Here is a link to the data for 2006-2014 Real Estate Transactions that were used to develop the above graphs.

Longmeadow FSBO
East Longmeadow FSBO

House for Rent at LongmeadowBiz

- Longmeadow's #1 Business and Community website
Longmeadow's Community Website

Tuesday, April 1, 2014

We Don't Know What We Don't Know -- Buying, Selling & Financing Real Estate

We'll segue into real estate in a moment. First, a few words about how we overestimate our own competency.

A sizable body of research suggests that:
  • the less we know about a subject the more we tend to overestimate how much we know.
  • a solid four out of five of us are less competent than we believe ourselves to be.
  • many of us lack the expertise necessary to assess our own competency. 
To put it plainly, a great many of us aren't nearly as "expert" as we believe ourselves to be, and simply don't know what we don't know. This is especially true in subjects, tasks and skills outside our own core competencies.

The illustration below is a recreation and interpretation of results published by researchers Dunning and Kruger among others -- for more information refer to the Dunning-Kruger Effect and illusory superiority.

Figure: Illustration of the Dunning-Kruger Effect 

What does this have to do with real estate? Well...

Buying, selling and financing real estate easily tops the list of the most complex, expensive and invasive processes most of us will encounter in our lifetimes. Whether a $250k condominium or a $2.5 million dollar estate, the stakes are high for buyer and seller alike, there's zero tolerance for dupery and repercussions can last years into the future.

Every day around the country thousands upon thousands of home buyers and homeowners fail to approach real estate transactions and financing with due care and caution. We tend to overestimate our real estate knowledge and expertise and underestimate the value of experienced professional help. Worse, too often we are convinced that we know better. As a result, we suffer the consequences of our own ignorance in a variety of ways:
  • netting less from a sale
  • paying more for a purchase
  • incurring higher initial expenses than we anticipated
  • incurring short and long term expenses and penalties that could have been prevented
  • agreeing to terms that only complicate the transaction
  • experiencing greater stress, frustration and anxiety throughout the process
  • embroiled in conflict with neighbors and local government
  • loss of property or our interest in it
  • loss of our rights to specific legal and financial remedies
  • broken plans and promises
  • and the list goes on...
Fortunately, most of these consequences can be prevented or minimized by following three simple rules.

Rule #1: Never rely primarily on the Internet, friends and family for advice

Pick a topic, any topic. We have a seemingly endless variety of resources at our fingertips both online (i.e., from blogs, forums, chat rooms, review sites, news sites, etc.) and offline (i.e., in conversations with friends, relatives, neighbors, colleagues, etc). As we sift through this information to find "answers" to our home buying, selling and financing questions we must keep a few things in mind:
  • Real estate rules and regulations -- and especially mortgage lending rules -- change on a regular basis. From flood zone boundaries and local bylaws to documentation requirements and mortgage insurance formulas, what was applicable yesterday may not be today. 
  • Our individual circumstances are more unique than our own fingerprints, and change day-to-day. One person's solution may be inappropriate for another. Similarly, the strategy that worked for us last time may not be the best course of action this time around.
  • A few months of "research" on the Internet or the purchase and sale of a dozen properties does not make us experts. However, it does help us understand some of the basics as well as the legal and financial gobbledygook that inevitably comes up during conversations with professionals.
  • Advice from friends, family members or peers who happen to be experienced, practicing industry professionals must be considered in the context of their areas of expertise as well as their degree of familiarity with the intimate details of our personal and financial circumstances. Bear in mind that a personal injury attorney friend is no more qualified to advise us about real estate, and a real estate agent uncle is no more qualified to advise about financing, than a neuroscientist is qualified to advise about cardiothoracic surgery. Intelligent and qualified are not synonymous.
  • Until qualified professionals review and assess our circumstances we're working with assumptions based on our lack of expertise rather than factual guidance from those who possess the experience necessary to prescribe a course of action.
Suffice it to say that we do ourselves a great disservice if we rely primarily on the Internet and those around us (who are not industry professionals with a proven track record) for opinions, advice and planning. The old adage "you get what you pay for" applies here and free can prove to be very expensive.

Rule #2: Seek qualified, experienced professional assistance early in the process

Too many of us are misguided in our approach to real estate transactions and financing. Sure we do our research, create spreadsheets, run calculations based on hypothetical scenarios, generate break-even analyses, scour forums and blogs for the opinions of others, talk about our plans with friends and family, etc. That is, we do everything except discuss our circumstances and goals with experienced professionals early in the process.

While this may not apply to everyone -- some of us are more prepared and proactive than others -- it does apply to a large majority of consumers. Ample evidence is on display every day in lender, attorney, tax, finance, insurance and real estate offices across the country where new clients begin their conversations with phrases such as "If only we had...", "I thought...", "We never thought...", and "My <enter relationship here> told me...".

Here are a few examples...
Attorneys: There was a time when attorneys were at the core of every real estate transaction -- an invaluable member of the team hired to protect our best interests and watch our backs from start to finish. These days attorneys find themselves in the role of a firefighter who receives a call from us only after we've set our transactions ablaze. On one hand, we aren't likely to hear them complain about the additional revenue that comes from their effort to clean up after our messes. On the other, when out of sight they shake their heads knowing we could have avoided the significant additional expense and stress had we got them involved from the start. 
Loan Officers: Another example is the uncountable number of times we approach loan officers for pre-approval just days or weeks before we begin house hunting, or worse, after we've already made an offer or signed a Purchase & Sale Agreement. Typically we've made assumptions about our ability to qualify for financing. Irrespective of our level of income and assets, a number of other factors may prevent or delay us from obtaining financing. Whether we are planning to buy a first home, or an investment property, or to sell one home and purchase another, our eligibility for financing should always be assessed well in advance (i.e., months ahead) of a planned purchase -- and again just prior to the purchase -- to avoid issues that could easily undermine our plans. 
Financial/Tax Advisors: Yet another example is the financial advisor or tax advisor whose experience is instrumental in determining tax implications, risk exposure and returns on investment. According to RealtyTrac some 50% of the residential real estate transactions completed during September 2013 were cash transactions and only 14% of those transactions involved institutional investors (those who acquire 10 or more properties in a 12 month period). That equates to millions of individual cash home buyers. Sellers love, love, love cash buyers. Why? Because cash buyers aren't exactly well known for being as thorough and careful as lenders when it comes to vetting a deal. The likelihood that cash buyers will consult with a tax or financial advisor ahead of the purchase -- to make sure that is it financially sound in the context of their current positions -- is low. It is equally unlikely that cash buyers will pay for a title review, title insurance, an appraisal or home inspection in advance. No seller would ever refuse such a sweet deal virtually devoid of due diligence. 
Real Estate Agents: One final example is our generally poor attitude toward the value of real estate agents based on past experience or second hand opinion. As with any of the occupations mentioned above, real estate agents vary tremendously in their professionalism, experience and track records. More often than not, highly experienced, full-time, reputable agents will run circles around less experienced agents and "go-it-alone" consumers. They typically sell many more homes more quickly, generate higher sale prices, and net more profit for their clients -- even after deducting their commission-- than their clients could have accomplished on their own in the same market. And in the role of a buyer's agent they can provide early guidance about the local market, properties, pricing and realistic negotiations that Zillow, Trulia and other resources cannot easily provide. Their past performance is what fuels significant repeat and referral business.  
Yes, even the best trained, most experienced professionals are not infallible. Still, we should leverage their experience to identify and proactively address issues that we are simply too inexperienced to recognize and properly react to on our own. And we should never be afraid to ask questions and learn from their experience along the way.

Rule #3: Place more emphasis on proven track records and outcomes, and less on upfront costs

Everyone loves a bargain, but at what cost?

Here's a fact: a relatively small number of real estate transactions and loan applications are genuinely "vanilla" meaning they are without complications. Vanilla transactions are the unicorns of real estate, law and mortgage lending. Anyone with enough experience in the industry knows the likelihood that a real estate transaction will be completely free of complications is about the same as the likelihood of seeing an actual unicorn. It's never a question of whether complications will arise, but what it will take to successfully resolve the issues when they do.

How much are we prepared to risk based solely on the chance that our real estate transaction will be vanilla and not end up costing us far more than we expected to save? Here is a simple and all too common scenario:
A couple selects a lender because its interest rate on a 10 year fixed loan is 0.125% lower (1/8th, or about ~$42.00/month) on a $400k loan amount than its competitor. And its closing costs are attractively $1000 lower as well. A bargain, no? Let's find out. 
The buyers were unaware that the lender's close-on-time ratio was less than 50% meaning 1 out of 2 of its loan applications miss contractual closing dates. Should the seller not agree to extend a closing date the buyers would be out of luck and potentially lose their earnest money deposit as well. The buyers were also unaware that this lender's typical turnaround time is greater than 45 days on a purchase and that the loan officer with whom they've been speaking has less than a couple years of experience under his belt. Their loan officer encounters a previously undisclosed issue that he's too inexperienced to address in a timely manner on his own. He's wasting precious time "researching" a solution rather than approaching his manager. Days pass and his manager finally gets involved, reviews the documentation and cites a lender "overlay". Try as she might his manager cannot find a way to satisfy or waive the overlay. The loan falls apart after seven weeks of effort - one week after the original closing date. 
The seller is irate. The buyers' deposit is in jeopardy. Their belongings (and possibly the seller's) are sitting in boxes or worse, in storage while they're living out of a hotel because they had to vacate their apartment at the end of the month. And if that's not enough, interest rates have risen since the first application was submitted. They return to the other lender praying something can be done to save their purchase. 
This lender has a 98% satisfaction rating that the buyers chose to ignore to pursue a lower interest rate. On average its loans close in less than 35 days. Its loan officers each have 10-15 years experience and thousands of loans under their belts, and the overlays are minimum. It'll get the job done. The buyers will pay for another credit report to be pulled, and it's very likely they'll have to pay for a new appraisal (not all appraisals are transferable). The previous interest rate is long gone. The new rate is 0.25% higher -- a full 1/8th more than this lender was previously able to offer. Time is not on the buyers' side and they move forward.
Three weeks later their loan closes and they're finally able to move in and move on with their lives. Thanks to the more experienced loan officer and operations team the buyers secured financing, and thanks to their real estate agent's finesse the seller, while upset, didn't kill the deal and choose another buyer. The buyers did pay for a second credit report and a second appraisal in addition to hotel and storage costs for the past 4 weeks. And they'll now pay $42 per month more than they would have had they chosen this lender from the start. 
An expensive lesson learned.
Experienced professionals can offer countless examples of the many ways by which real estate transactions fail or end up more costly than necessary in the hands of those with less than adequate experience and expertise.

Getting It Right
If you don't have time to do it right, when will you have time to do it over? - Hall of Fame basketball player and coach, John Wooden
A proven track record is the gold standard of performance in any area of expertise. As consumers we must first admit that we aren't experts -- not even close. There's no shame in retaining the help of professionals with solid experience and track records as a means to achieve our objectives and save overall.

If we choose to skimp on professional services by hiring the cheapest rather than the most qualified, or opt for the "do-it-ourselves" approach to real estate then we should be prepared to absorb the potentially costly and otherwise avoidable mistakes.

I'll close with a spin on Clint Eastwood's famous line as Inspector Harry Callahan in the 1971 movie Dirty Harry:
I know what you're thinking. "Are there six unresolved issues to address or only five?" Well, to tell you the truth in all this excitement I've kinda lost track myself. But this being a real estate transaction, one of the most expensive and complicated you'll encounter in your lifetime, you've got to ask yourself one question: "Do I feel lucky?" Well, do ya, punk?
As always, I wish you all the very best. 

Saturday, March 22, 2014

Understanding the Impact of ARMs (Adjustable Rate Mortgages)

Adjustable rate mortgages (ARMs) have been one of the most misunderstood and misused types of home financing in the United States since the day Congress gave lenders the green light in 1982. It is true that under the right set of circumstances an ARM can be a cost-effective short-term alternative to long-term fixed-rate financing. The potential short terms savings for very large loan amounts can be tremendous during the first few months or years. However, ARMs have also proven to be financially lethal in the wrong hands and under the wrong circumstances -- I'm referring to the many borrowers who underestimated or disregarded the gravity of the risks involved, and the lenders who went along with their plans.  

In this post I'll cover a handful of essential points about the impact of ARM financing with emphasis on one of the most common and popular types of ARMs -- the hybrid with its temporarily fixed rate. Here's a visual representation of a typical hybrid ARM:

Figure 1: An example Hybrid ARM with an introductory rate of 3%

ARMs became incredibly popular during the decade leading up to the housing market collapse primarily because of their attractively low initial rates when compared to fixed-rate financing.
Generally speaking, the shorter the fixed period of a hybrid ARM (#1 in Figure 1) the lower the introductory rate. Why? Because, conditions permitting, that initial rate could adjust upward sooner which would benefit the investor holding your mortgage note. Consequently, a 3/1 ARM is usually offered with a lower initial rate than a 5/1, which in turn is lower than a 10/1, and so on.
Point 1: Longer fixed rate periods provide greater long term stability. In exchange for a higher interest rate, fixed rate products such as a 10, 15 and 30yr (as well as hybrid ARMs with longer initial fixed rate periods such as the 7/1 and 10/1) protect borrowers from volatile markets for longer periods of time -- sort of a built-in "insurance policy" against rate hikes in an uncertain market and future.
The low introductory rates of ARMs enabled borrowers to qualify for higher loan amounts than they might have otherwise qualified for given their financial circumstances at the time. How? Borrowers only had to qualify at the introductory rate, not at the highest rate the loan might eventually adjust to in the future. While that pleased a great many borrowers who then sought even higher loan amounts, it also meant they were gambling on assumptions about their future circumstances. If the gamble failed to pay off and their introductory rate expired, they found themselves stuck in financing that was most likely going to grow more expensive with time.

Let's step back for a moment. How might I qualify for a larger loan amount by using an ARM? Well, one of the factors that a lender must use to determine how much I can afford is my debt-to-income ratio (DTI). The DTI equation looks like this:

DTI = (monthly debts + mortgage payment, taxes, insurance & fees) / Adjusted Gross Income

A lower initial interest rate translates directly into lower monthly mortgage payments for a given loan amount and term which, in turn, lowers my DTI ratio at my current income level. The lower the rate, the larger the loan amount I am able borrow before reaching the maximum DTI limit enforced by the lender under whatever the rules happen to be at that time. So long as I come up with the necessary downpayment, closing costs and reserve requirements, I could "afford" a larger loan amount. That is, until the day my interest rate begins to adjust upward.
Point 2: The rules have changed for 2014. Because borrowers and lenders alike abused ARM financing by determining qualification based on a temporary introductory rate, the Federal Government changed the rules. As of 2014, anyone who wishes to obtain ARM financing must qualify at the highest rate they would be expected to pay during the first 5 years of the loan -- taking into account the margin, index, timing of adjustments, etc.
Point 3: There is an upside to ARMs. In a perfect world markets behave, employment grows, investments thrive and the only direction is up. In such a world ARMs might be king. ARMs offer short-term savings versus their long-term fixed rate counterparts. In our current market, a 1% interest rate reduction translates to a $115-125 decrease in a monthly mortgage payment per $200k of the loan amount. For a 5/1 ARM that's up to $7500 "savings" per $200k over the course of its 5 year fixed period. To calculate the actual benefit we would need to consider the effect on investment and tax positions -- which may amplify or lessen the impact -- another reason to consult a financial or tax advisor.
Point 4: Favor facts over assumptions. As our world repeatedly reminds us -- it isn't perfect. If you plan to entertain an ARM it is imperative that you base your decision on reality and the facts before you, not unrealistic optimism or assumptions about your future. An ARM offers a relatively brief window of stability -- from as little as a month to several years or longer -- after which all bets are off. In the context of the 5/1 hybrid ARM used in Figure 1, if you have not successfully sold or refinanced your property before year six -- whatever the underlying reasons -- your monthly payment obligation will very likely begin to increase. By how much and how quickly? Well it depends on a number of factors including the specific terms (i.e. the margin, index, caps, etc.) of your ARM and the current market conditions. The interest rate on the ARM depicted in Figure 1 could increase by as much as two full percentage points (rising from 3 to 5%) in year 6. Assuming your budget can withstand the impact of the increased mortgage payment, the initial savings from point #3 can easily be wiped out within a couple years following the first adjustment.
Point 5: Take the time to understand how the adjustments work. Figure 1 illustrated a 5/1 2-2-6 ARM with an initial adjustment of up to 2% (emphasis in red). The terms of some ARMs permit a significantly larger initial adjustment following the reset date. For example, the first adjustment on a 3/1 5-2-5 ARM with an introductory rate of 3% could be as high as 5% (which also happens to be that particular ARM's lifetime cap). Or, to put it differently, in its 4th year this 3/1 ARM's interest rate could rise from 3% to 8% which would translate into a $624.00 increase in the monthly payment per $200k borrowed. [NOTE: To be fair, technically your rate could adjust downward instead if the terms and market conditions allow.] 
Point 6: Be aware of the difference between prime & subprime loan products. ARMs labeled 1/1, 3/1, 5/1, 7/1, 10/1 and so forth are generally prime products while those labeled 2/28, 3/27, 5/25, etc are subprime products. At first glance they appear to be similar, but the underlying rates and terms (i.e., the fine print) can be quite different. One of the most obvious differences, visually anyway, is the number following the slash. With prime products that number represents the frequency with which the rate will change following the fixed rate period -- depicted as #2 in Figure 1. With subprime products the number following the slash represents the number of years over which the rate is adjustable -- e.g., a 3/27 subprime ARM is fixed for the first 3 years and adjustable for the remaining 27 (the same as its prime 3/1 cousin). However, the actual frequency with which the rate of the subprime ARM will adjust appears elsewhere in its terms and conditions. A lender should always assess your eligibility for prime products first before considering anything subprime -- make sure you speak with at least 2-3 lenders to find out. Prime rates and terms are better overall. 
Point 7: Be aware of the potential for negative amortization (a.k.a. "neg-am"). That's when your loan balance increases over time even if you're making payments in full and on time. One of the many ways this can occur is when your monthly payment isn't enough to keep pace with accruing interest. If you're in an ARM with a payment cap, any amount due each month over and above your capped payment is still owed to the lender and will be added to your loan balance. In other words, if your monthly payment is not large enough to cover the monthly interest and at least some principal, you will be moving further from your goal (to pay off your home) with each payment -- probably not the type of financial arrangement you have in mind. 
Point 8: Worst case scenarios can offer valuable insight. I'm not suggesting that you become a pessimist. That would not be in your best-interest. However, you should always assess the value of an ARM in the context of your worst case scenario. If you should find yourself unable to sell or refinance before the ARM begins to adjust, how might the increased mortgage payment affect your quality of life and ability to sustain the property? What resources might you have at your disposal to weather unanticipated hardships? Are you risk averse? Might long-term fixed rate financing make more sense? Only you know the answers to these questions. At least you will have taken these factors into consideration.
Point 9: Read everything that you receive from your loan servicer. From time to time, for the duration of your loan you'll receive notices from the servicer by mail. These notices may or may not be bundled with your statement. Read them. Several months before your first interest rate adjustment you will be informed of the upcoming rate adjustment, the new payment amount, other options you may have, etc. For each adjustment thereafter you'll receive a similar notice approximately 2 months in advance of the actual adjustment. Some borrowers claim that they were never told that they would receive advance notice of adjustments, or that they have never received such notices by mail. While it is always possible for such an oversight to occur, more often than not they a) failed to read the fine print provided when they acquired the loan, or b) they never noticed, opened or read the notifications, or c) the details were explained to them and they did read the notices but they simply have no recollection of either.
This is not a case of "buyer beware". Rather, it's one of "buyer be aware". It was certainly easier to justify the use of ARMs during a market free fall (2007-2013) than in today's market with interest rates creeping upward. However, if you have the means and ability to assume the risk, and you qualify under current standards, and stand to benefit from adjustable rate financing, then you can certainly add ARMs to your list of viable financing options. I strongly suggest that you consult with a financial and/or tax advisor as well as an experienced loan officer for further guidance.

And, for additional information about ARMs I recommend this easy to read handbook published by the Consumer Financial Protection Bureau:


I wish you and your family all the best.