The Real Estate Bubble!

We live in a time when wish fulfillment matters above all.

Lately I'm seeing a prime time TV ad with several success-driven faces mouthing the phrase, "I will own a Jaguar."

Never mind that a Jag today goes for what a starter home in a Midwestern suburb used to cost about 10 - 15 years ago.

And speaking of wishes and homes, we know that ownership of the latter is, after all, the American dream. It's just that cost and income have always kept some folks from partaking.

Yet lenders have apparently discovered a way to create the illusion of owning a home when, arguably, there is no "ownership" at all.

For a lot of wannabe homeowners, lining the pockets of lenders is the price for playing along.

Trends in residential real estate over the past decade help explain how this illusion was conjured up.

Let's start with the recent past.

As the economy struggled over the past year, the media has repeatedly said that the real estate market remains prosperous. Interest rates fell to remarkably low levels and stayed there; a record percentage of families in the U.S. became homeowners.

In theory, low interest rates produce more affordable fixed-rate mortgages, a formula for long-term stability.

But in reality, the data suggests that low interest rates have invoked the law of unintended consequences: new homeowners are taking on far more debt than they can afford, via the riskiest mortgage loans on the market.

A few facts:

*

First-time homebuyers made an average down payment of 3% in 1999, down from 10% a decade earlier.

* As a percentage of disposable personal income, mortgage payments have reached the highest level since the Federal Reserve began following the data -- a 45% increase since 1980.

* The percentage of people choosing adjustable-rate mortgages -- which increase the size of mortgage payments as interest rates rise -- has virtually doubled in the past year, to 30%.

So -- people didn't save much before buying their home, bought more home than they could really afford, and many of them will have to pay more each month if rates begin to rise.

Now, this all sounds less serious if home prices rise at the rate we've seen in the past few years.

Will that continue?

Not according to one real estate analyst recently quoted in The Christian Science Monitor. He follows property values in 120 markets around the country, and says that a record 45% of those markets are overpriced based on the relationship of income to housing prices.

"Bubble" is the word he used!

If the bubbles start to burst, home mortgages will resemble car loans: the owners can't build real equity because the value of the asset is falling.

Here we get to the scary part, namely the illusion of home ownership I mentioned above. The "mortgage as car loan" comparison becomes even stronger.