A Small Town with a Big Mortgage Mess

Merced, California is a small town of about 80,000 people that most people have never heard of, about 140 miles SE of San Francisco that was recently profiled in Fortune Magazine.

In February this year, the unemployment rate already reached 20%. A TV reporter recently stood in front of a new subdivision at the edge of town, right on a brand new four-lane highway, and waited for 15 minutes before anybody came along at all.

In 2002-2004, mostly San Francisco speculators drove home prices up over 50% in Merced. By 2005, the sleepy small town had a median house price of $382,000. In March of 2009, that was down to $105,500. Let me say that again: The price went from $382,000 to $105,500 – that’s less than a third in four plus years!

Back in 2004 and 2005, nobody asked, questioned, or seemed to care who was going to keep buying homes at these skyrocketing prices. Or even stopped to think who could ever afford to rent them! The population hadn’t grown – it was purely speculators who were buying these houses.

But it was more like gambling, instead of investing, because these investors were never going to move into these homes. They were only looking for the quick flip and profit, mostly with an interest only mortgage just to tread water. While the price wave kept going up, these investors/speculators or gamblers were looking for the next victim in a perfectly legal ponzy scheme.

At the peak of the market, the income needed to finance one of these average priced homes would have been $120,000. Two minutes of checking would have found that the town had always had unemployment issues, and the average income in town was $35,000.

There was no chance 90% of people in town should have gotten a mortgage, and no chance anyone was ever going to pay off one of these homes. For 90% of the population, even a 40-year mortgage was never going to be affordable.
The average resident with a $35,000 income could afford a $1,000 mortgage payment. That’s 35% of their income, and that’s the typical formula. But the average home was going to be $2,100 a month just for interest payments! Who could afford that? Someone whose entire net income was going to go to interest only payments and who NEVER paid property tax, gas, never bought groceries, clothes, car insurance or had anything else to pay, because this average home was going to cost them their entire net paycheck.

What a surprise to investors and all those mortgage lenders this didn’t work out! Yes, that was sarcastic but it just shows that for a number of years, the banks didn’t care about proof of income or that nobody was going to be able to pay these payments. And no buyers seemed to care either, and they’re just as responsible for the mortgage mess.
These so-called X subdivisions are the furthest out of town. It’s the last developments at the edge of town because land was cheap there. They will be the last to recover in prices, and it’s where the most foreclosures are. Economists might be talking about a recovery soon, but I doubt it. Logic says the housing market has to stabilize and right now, the foreclosure rate is still going up and there are over 1.6 million homes that lenders haven’t even put on the market. I would say don’t hold your breath.

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