Fall Real Estate 2007

Publication Date: Friday, October 12, 2007

Buyers in the 'magic bubble' beware
Mortgage crisis aftershocks affect Palo Alto, but are combatable

by Arden Pennell

In the wake of this summer's mortgage-market crisis, sparked by collapse in the subprime lending level, Palo Altans can expect a few changes in the local real estate market. They can also take steps to protect their investment in one of the Bay Area's most coveted communities.

First, the good news: Despite statistics that show California cities such as Stockton lead the nation in foreclosure, the Palo Alto area real estate market remains relatively insulated from disaster.

"Percentage-wise, you could say, 'Oh, foreclosures have gone up 200 percent,' but that's an increase from a very small number to a slightly larger one," Chris Iverson, an agent with Keller Williams Realty in Palo Alto, said.

As well, the plummeting house prices afflicting the East Bay are unheard-of here, where unceasing demand keeps property values high.
"Palo Alto, Menlo Park and Los Altos are what I call destination cities," Iverson said. "Once people are here, they pretty much want to stay." In contrast, "Those who live far out in the East Bay are still trying to get back."

The difference in demand means that the market in Palo Alto, "compared to Hayward, or the far East Bay in Tracy, is night and day," Iverson said.

"We really have a tale of two markets going on in this area," agreed fellow realtor John King, of Alhouse King Residential Realty in Palo Alto.

That house prices are not expected to depreciate is good news for homeowners, yet it doesn't mean that Palo Alto is unscathed by market turmoil. Potential buyers as well as current residents will now be affected by tightened lending standards and increased jumbo mortgages rates.

"To qualify for a loan, it's becoming more and more rigorous," Iverson said.

More cautious lenders now require greater income documentation, meaning that stated-income loans, which require less proof than full-documentation loans, have become very difficult to get, he said.

A stated-income loan allows a borrower "to simply say, 'This is how much money I make,' without going through a long, complex documentation process," Iverson said.

However, full-documentation loans require "almost all the documentation associated with your financial situation."

While full-documentation loans may be a hassle for all borrowers, they are especially tricky for variable-income earners, for whom documenting steady past and future income is a challenge. Variable-income earners likely to be affected by lenders' new preference for more documentation run the gamut from highly paid consultants and salespeople to less affluent waiters.

The preference for full documentation is likely to stick around, said Eric Trailer, a partner at Absolute Mortgage Banking in Palo Alto, since the increasing rarity and cost of stated-income mortgages makes financial sense.

"What the market has learned is that there are some stated-income loans out there that should have been priced higher because those investors are riskier" than lenders thought, he said.

Another trend affecting mortgages in Palo Alto, where median home prices are running above $1.5 million, is increased interest rates on so-called jumbo mortgages of $417,000 or more. (The jumbo number is determined by the price above which federal lenders Freddie Mac and Fannie Mae will not finance.)

Virtually every mortgage in Palo Alto is jumbo, Trailer said, although he has faint hopes for rate improvement. The interest on a fully-documented jumbo loan may "potentially come down in rate by a small amount as the market works itself out," he said.

And despite the increased cost of a mortgage, Trailer encouraged potential Palo Alto buyers to proceed, saying that the area's predictably appreciating property values would offset interest-rate spikes.

However, buyers need not merely rely on what Realtor King termed Palo Alto's "magic little bubble" of real estate value to protect their investment. There are several savvy steps that those entering the Palo Alto market can take, as well as smart moves that homeowners can make, to improve financial prospects.

A preliminary measure for prospective buyers is to review, and if needed, improve their credit score.

"Do your homework," Carolyn Wolf, a mortgage broker at Princeton Capital, said. "Meet with a trusted financial advisor, have them run your credit, and if there are items that you can work on or get taken care of, start working," she said.

Under law, all citizens are allowed to view their credit score for free once a year at Web sites such as annualcreditreport.com.

Wolf advised going on a "financial diet" to reduce outstanding debt, especially quickly accruing credit-card debt that can shoot holes in an otherwise strong credit report. The diet also includes reducing the so-called "latte factor," a term coined by writer David Bach to refer to daily, yet disposable, luxuries. Finally, saving in advance of monthly mortgage payments will help prepare a household better.

"You could practice saving an additional $1,500 a month. This way you don't have the shock of a mortgage payment right after you buy," Wolf said.

Financing the house may also be more manageable if buyers keep both private and public aid in mind, Wolf said.

"Talk with your family and see if they're willing to help out," especially on a first-time home purchase, Wolf said.

As well, California's Housing Finance Agency offers loans with below-market interest rates to home buyers, although houses must cost about $693,000 or less to qualify, well below the local median. Requirements for the Santa Clara County Housing Trust's new First-time Homebuyer Downpayment Assistance Program were announced in early October, although, again, the guidelines may not apply to more costly houses.

As for the classic decision between adjustable-rate mortgages, whose interest rates are subject to increases, and fixed-rate mortgages, whose interest rates stay flat, King says many are now drawn to the latter.

"Many people are now turning to 7 to 10 percent fixed rates in response to market chaos," he said, but stopped short of endorsing the more stable, fixed loans. Rather, buyers should meet with a loan specialist to discuss "the best scenarios that could happen with adjustable-rate mortgages," he said.

Once funding is secured, the relief of completing a potentially stressful process should not cloud out common-sense caution. Julie Stern Fukuhara, a loan officer with Stern Mortgage Company, said all buyers should carefully read all paperwork before scribbling their name anywhere.

"At the signing table, it's all written in the paper, but there's so much in the papers that people don't really stop to read it," she said. And while many brokers are trustworthy, "you [can] get an escrow officer [facilitating the process] who doesn't catch everything or explain everything," she said, leading to trouble down the road.

Stern Fukuhara also said that those who must pay higher than 40 percent of their gross monthly income to afford today's often pricier jumbo loans should wait to buy.

"Rent and see what happens. Things may come down in the next year," she said.

As well, although "a lot of lenders are offering a 95 percent loan-to-value level," a down payment of at least 10 percent, or a 90 percent loan-to-value level, will help avoid higher interest rates and long-term payments, Stern Fukuhara said.

For those already paying off a mortgage, high interest rates should not necessarily discourage refinancing, she said.

"Refinancing and rolling all debt into one might make sense if you have a huge amount of credit-card debt because then the bulk of the money will be under a better rate," she said, since credit-card debt can come with interest rates of up to 19 percent.

Trailer said that those who financed 100 percent of their house cost, then took out two mortgages, may also benefit from the "new, single rate [which] is better than the blended, weighted rate," of the double mortgage.

Those planning to sell, yet left by market tumult with a property worth less than purchase price, or simply less than expected, need only to "wait it out," Realtor Iverson said, again citing the area's foreseeable increasing property values.

Finally, Palo Altan owners planning to neither sell nor refinance, but spooked by the nation's lukewarm housing market, should recognize the post-crisis environment as part of a cycle, experts said.

"It's like a forest fire. It's tragedy and chaos and confusion but you have firemen, our Federal Reserve, coming to the rescue, and then you have new growth," Wolf said.

Staff writer Arden Pennell can be e-mailed at apennell@paweekly.com.