These questions come from a client we have been working with for several months;

"I read your Market Report and I had some questions about the portion below;

March 23, 2007 - An Associated Press story ran today titled "Mortgage meltdown a mess." It says "Sen. Christopher Dodd, D-Conn., chairman of the Senate Banking Committee, laid out what he called a 'chronology of regulatory neglect' as banks and other lenders loosened their standards for making riskier loans during the boom."

The scary truth is that it sounds like Congress is preparing to step in and make a difficult situation worse by tightening credit and driving more buyers out of the market.


March 16, 2007 - The Appeal-Democrat reported that homes prices in the Yuba-Sutter area have been stable for the last three months. It noted, however, that the median home price declined from $290,000 in January of 2006 to $270,000 in January of 2007. It quoted me as saying, "Although the market has stabilized, it could still see some problems." What they left out was that I also expressed the concern that "There is currently about a 10 month supply of homes listed for sale, a record number of foreclosures, and a very high percentage of the homes that are listed for sale are vacant. Also, problems in the sub prime lending market could lead to a general tightening of credit. All of these factors may have a negative effect on prices in the coming months."

What does it mean by "tightening credit"?

When you made a comment "negative effect on prices" does that mean they will stay stable, go up or go down?

Do you really think now is a good time to buy?

Here is my reply;

I wish I could give you a short answer but these are important questions and I think it's important that you have a thorough understanding of the situation. That's the only way you are really going to feel comfortable with your decision.

Everyone knows that real estate prices have been dropping. In fact, that's what you and Alan have been waiting for - for prices to drop to a point that you can buy what you want and not have to spend over about $250,000.

There are several factors that have been causing the market to drop. The simplistic explanation is to say that it all relates back to the economic law of supply and demand. In economic terms, there is a big distinction between desire and demand. Demand implies that there is both a desire and a financial ability to afford to buy that which is desired. If I desire a $1,000,000 home but don't have the financial ability to purchase it, then there is no demand.

Since very few people pay cash for a home, financing plays a huge role in the demand side of the real estate equation. It is the availability of credit that allows most people to purchase. In the last several years, a lot of new types of loans have become available. These loans have allowed many people to purchase who would not otherwise have been able to. That created more demand and helped to drive home prices higher.

At the top of the credit list are loans that fall into the category referred to as conventional loans (these loans meet the credit standards set by Fannie Mae or Freddie Mac). These loans normally carry the best rates and terms. They are also the loans that normally have the least expensive fees.

Below that are other types of loans including FHA, VA, Alt A, Portfolio and sub-prime loans. There have been several large lenders who have stopped making sub-prime loans. To the extent that the availability of this credit keeps prospective buyers out of the market, there is a corresponding drop in demand. A drop in demand without a corresponding drop in supply will lead to lower prices.

The median home price in the Yuba-Sutter area has not dropped in the last three months.

Now, largely due to a rise in foreclosures, Congress appears ready to step in and take action to tighten credit standards. If their action forces 5,000, 10,000 or 100,000 prospective buyers out of the market, then demand has just dropped by 5,000, 10,000 or 100,000 units. Every prospective buyer they force out of the market by these more restrictive credit standards means one less potential purchaser for the homes that are available. That will translate into prices beginning to fall again until enough sellers pull their homes off of the market and prices stabilize.

However, none of this affects the long term prospects for real estate. Consider this;

1. California's population continues to grow at the rate of about 500,000 people per year. Various sources estimate that there are between 230,000 and 250,000 new families being formed every year.

2. According the latest numbers I saw, California is building less than 190,000 new housing units per year. If you read farther down my Market Report, you will see this entry, "October 29, 2006 - An Associated Press story in the Appeal-Democrat says 'Apartment rents and demand are soaring nationwide as the economy produces good jobs and people who might have bought homes a year ago settle for apartments while they wait for housing prices to tumble.'" As the rental units become more difficult to find, more people who have the choice to rent or buy will find themselves buying instead of renting. That will begin to push prices higher.

3. Interest rates remain relatively stable and I don't hear any predictions that is going to change. You can take a look at the interest rate chart in our Market Newsletter.

4. The economy keeps plugging along. There have been drops in some sectors like construction and real estate but most are still doing relatively well. I haven't heard any predictions of an economic recession.

5. The Kiplinger Letter (Kiplinger is a big player in business forecasting, investment advice, and financial management tools) has predicted that the surging Chinese economy will begin to generate a lot of surplus cash that the Chinese will likely want to invest in real estate in the Pacific rim (Japan, Korea, Hawaii, the western United States, Mexico, Chile and etc.). This is what we saw in the early 1990's when the Japanese economy was so strong. If this happens, it will significantly increase demand.

Speaking for ourselves, Tracy and I purchased the home on Darrough Drive that we showed to you last year. We knew then that prices were dropping but made the investment anyway knowing that we were purchasing for the long term and that the long term prospects for the market are good.

So, what should you be doing? I think you should be doing what Tracy and I did. Purchase for the long term and not worry that homes prices might decline after you purchase. Prices won't decline forever and people who try to time their purchase at the very bottom of the market usually miss and end up being forced to buy after the supply has dropped and there are less homes to choose from. That means that it is harder to find a home that meets their long terms needs. That will cost them in the long run.

Also, as we've talked before, stay with a loan that you can afford over the long term. Don't get trapped in a loan that you need to refinance in two years. Real estate values are likely to continue declining in the short term and may not recover enough in two years to permit you to refinance.

Last Updated April 1, 2007