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How are you this morning?
Feeling fine – or maybe a little bit frazzled by the festive season? Christmas shopping not done yet and starting to panic? Had a few too many drinks at the office party last night?
Never mind. Whatever’s giving you a headache this morning, your situation is almost certainly better than one Will Hertzberg’s…
Every day, as the LA Times rather eloquently puts it, “Will Hertzberg owns a little less of his three-bedroom house in Corona,” (which is in California).
This is because the “marginally employed” Mr Hertzberg, 56, has what Americans call a “pay option” loan. This gives you the choice of payments – the most expensive monthly payment covers your interest and capital, just like a bog-standard repayment mortgage; the middle option covers just the interest; and the cheapest option – coming in at about half the monthly payment of the middle option – is to pay as little as possible and hope that you can make up the shortfall later.
Under this option, you are failing to even pay off the interest on the loan – so your debt is actually growing, rather than falling.
The trouble is, you do have to start paying off the loan at some point – lenders will only extend you so much credit. In Mr Hertzberg’s case, his mortgage company says when the loan expands to 115% of its original size, then they‘ll expect him to start paying it off. That means his monthly payments will more than double – and that point is just two years away. As he tells the LA Times: “I am rather screwed.”
He’s not the only one. In 2003, less than 0.1% of all home loans to Californians were of the “pay option” type, according to data-tracking company First American LoanPerformance. But in the first eight months of this year, around 33% of borrowers in the state took out “pay option” loans.
And of course, when given the option of making a large payment today, or a small payment today and a large one in the future, there are plenty of people who make the same choice as Mr Hertzberg. One large lender, Washington Mutual, tells the LA Times that 47% of those on its books who have taken this type of loan are opting for the cheapest option.
The most interesting thing about Mr Hertzberg’s story is that he’s not a naïve first-time buyer, who has dived in at the top of the market and is now in trouble. His house is actually worth far more than he bought it for. He paid just under $130,000 for it, 11 years ago. Now similar homes in his area go for around $400,000.
The trouble is, he’s done what most Americans (and we’ve been doing it here in the UK too) have been doing, and treated his house like a credit card. He’s managed to borrow a further $190,000 during that time, and effectively blown it on consumerism and dodgy tech stocks. It’s all that extra borrowing that he’s now paying off (or rather, not paying off).
Mr Hertzberg seems to be almost out of options – with house prices looking very wobbly, it’s very unlikely he’ll be able to refinance yet again. Selling the house is an option, but again, in a falling market he’ll have to price it keenly to get it off his hands.
The key point for the wider market is – how many Mr Hertzbergs are out there? There are always going to be people who take out too much credit when it’s made available to them, and there will always be people being squeezed at the margins of any society.
But we suspect that – as always happens when bubble behaviour grips a market – rather more people than usual have got themselves into a precarious financial state. And as they all reach breaking point at the same time, forced sellers, tightening lending criteria, and almost inevitably, attempts to sue irresponsible lenders, will batter the housing market.
So what‘s Mr Hertzberg planning to do about his situation? ‘I’m waiting for a 100-year loan,’ he said. ‘My heirs can worry about paying it off.’
Perhaps he should move to the UK – we’ve already got lenders proposing the ‘deathbed’ mortgage. We’re sure they’d be pleased to have Mr Herzberg as a customer.
Turning to the wider markets…
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In London, the FTSE 100 closed 7 points higher, at 6.159. Steel-maker Corus was the day’s biggest riser, its share price climbing over 5%, as a result of a revised bid from Brazilian firm Companhia Siderúrgica Nacional. For a full market report, see: London market close.
Elsewhere in Europe,
On Wall Street, stronger-than-expected November jobs data and bargain-hunting in the technology sector saw shares close higher. The Dow Jones closed 29 points higher, at 12,307. The Nasdaq was 10 points higher, at 2,437. And the S&P 500 ended the day at 1,409, a 2-point gain.
In Asia, the Nikkei closed 110 points higher, at 16,527, today.
Crude oil was slightly higher this morning, at $62.14 a barrel, as was Brent spot which last traded at $62.62.
After a volatile session which saw it hit a high of $626 and a low of $622.60, spot gold was trading at $623.80 this morning. Meanwhile, silver was unchanged at $13.67.
And in London this morning, oil major Royal Dutch Shell is to cede control of its £11 liquefied natural gas project Sakhalin-2 project to Russian state energy supplier, Gazprom. The agreement to reduce its stake from 55% to a quarter comes after a high-profile campaign of licence withdrawals and fine was waged against Shell by the Russian environmental agency. Shares in Royal Dutch Shell were down by as much as 0.7% this morning.
And our two recommended articles for today…
How cash-strapped shoppers got a chance for revenge
– The must-have item for shoppers this Christmas? One of the many discount vouchers that have been appearing on message boards and in inboxes over the past few weeks. Whether clever marketing ploy or retailers’ last-ditch attempt to save Christmas, it is the consumer who really wins, says Merryn Somerset-Webb. To find out what the current voucher craze can tell us about the state of the retail sector – and consumer spending, read: How cash-strapped consumers got a chance for revenge.
Usury and soap operas: how lenders profit from the least credit-worthy
– Having berated the High Street banks for their current account rates and credit card charges, the OFT has turned its attention to those lenders who deal with high-risk, low-income borrowers. Adrian Ash looks at whether their practices really are unfair, and how lenders profit from those shunned by the big banks. Click here: How lenders profit from the least credit-worthy.