Realty Q&A: Has the Market For Real Estate Run its Course?

Lew Sichelman on whether housing's long run is coming to a close, what might make your credit score go up or down, and other issues on people's minds.
By: Lew Sichelman: The Wall Street Journal Online
Issues on people's minds: Is housing's long run coming to a close and more on what might make your credit score go up or down.

Question: My husband and I attended a seminar featuring Suze Orman. It was definitely filled with distress as she talked about the possibility, in the near future, that we would no longer be able to declare tax credits for our mortgage payment interest, property taxes ... that interest rates will go off the wall unless you have a fixed mortgage at the lower rate (we have an ARM). My 24-year-old son lives in Miami, where he's purchased four condos, three as rentals. I'm worried about him surviving and I'm worried about us. My husband is 52 and I'm 49. I wanted to buy another home to fix up and sell, but Orman made it sound like that would be a bad idea. Can you tell me if real estate has run its course? Michele Bosca.

Answer: Real estate is probably at the top of its current cycle and destined for a slow down. But hold on just a moment. Housing's favorable tax treatment is not going to change, at least not any time soon. And mortgage rates are not projected to go any higher than 6.5% to 7% in the next two years.

The president's tax reform panel isn't due to make its formal recommendations until Nov. 1. But even it meets that deadline the White House has to put its stamp of approval on the ones it likes. Then Congress gets to have its say. So it will be a good two years, if that, before anything happens. And some lawmakers, not to mention the housing lobby, already are circling their wagons.

So far, the panel has discussed in open meetings the possibility of ratcheting down the cap on the deduction - not a credit - for interest paid on a mortgage from the current $1.1 million debt ceiling to $300,000-$350,000. Also on the table are the elimination of write-offs for property taxes, state income taxes, second homes and home-equity loans.

But it has always been expected that these deductions would be in play, or at least open to debate. And again, nothing is concrete, and nothing will be adopted without a major pitched battle.

Al Mansell, president of the National Association of Realtors, says the discussion and the media attention it has received has already had a "chilling" effect on the real estate market, particularly in high-cost areas. Whether that's just so much rhetoric or not remains to be seen, but the Salt Lake City broker told the tax reform panel in a letter that it "must understand that limiting or eliminating tax benefits will have an adverse impact on housing markets and the value of housing."

Similarly, America's Community Bankers, which speaks for small, local thrift institutions, is warning that the panel's "ill-advised proposal" to wipe out the mortgage-interest deduction could push the economy into a recession.

"Changing the interest deduction as proposed would constitute an abandonment of support for the housing aspirations of millions, and greatly diminish the net wealth of middle-class families," executive vice president Robert Davis said in another letter to the committee.

Others have weighed in as well. But you get the idea: A war is brewing.

As far as mortgage rates are concerned, they're certainly trending higher. But no one I know or hear is predicting anything outrageous. Indeed, rates just this month pushed past the 6% mark for the first time in several months. And the worst forecast I've seen to date is for 7%t. But a gradual run up in rates could be good for housing, not bad, because it will give incomes a chance to catch up to hyper-inflated house prices.

Over the last 30 years, housing costs have averaged 2.6 times disposable household incomes, according to economist David Wyss at Standard and Poor's, the Wall Street rating agency. But currently the national price-to-income ratio is 3.2 percent and two to three times that in many coastal markets, including several in Florida where your son is.

In a rising-interest-rate environment, it's always good to lock in rates with a fixed loan. But as long as rates don't go sky-high - and there is no indication they will - the garden-variety adjustable rate mortgage won't kill anyone. It's the crazy interest-only and pay-option ARMs that are dangerous and should be jettisoned as soon as possible, preferably before their initial annual adjustment.

As for house prices, I'm afraid the days of double-digit increases are behind us. Most prognosticators - even those who have no vested interest in the housing market - believe the best owners can hope for is appreciation rates of 3% to 5% over the next few years.

The most dire forecast, this one from Mark Zandi, chief economist of Economy.com, is for a "severe adjustment" in which values will not be rising at all by 2007. That's a tune he's been signing for two years, though.

At the same time, prices could take a tumble in markets where the all-important price-to-income ratio is way out of proportion - places like San Diego, where the ratio is 9.68, and Miami, where it is 6.84.

But the chances are they won't fall back by much, if they decline at all. The odds are much better that prices will simply stop rising so fast.

Clarification of FICO scoring

Craig Watts, public affairs manager at Fair Isaac Corp. writes to object to a part of my answer to a recent question about credit scores, saying it "includes and perpetuates a myth" about FICO scoring that he'd like to see dead and buried.

"A person's FICO credit score will never improve because she closes an account, unused or otherwise," he says. "In fact, closing an account can occasionally have the opposite effect on one's FICO score, depending on what else is on her credit report."

"The FICO credit score algorithm does not look at a person's available credit as an isolated factor when calculating one's score. So having a lot of unused credit will not by itself hurt one's FICO score. Fair Isaac's own research has demonstrated that the amount of available credit by itself is not nearly as predictive of future credit behavior as it's often cracked up to be. That's why we did not include it as an independent factor in the FICO scoring algorithm.

"Instead, the FICO algorithm looks at available credit in comparison to outstanding debt, from which it produces a 'credit utilization' percentage that is, in fact, used in the calculation of one's score. Maintaining low balances helps one's FICO score by keeping that credit-utilization percentage low, among other benefits."

Watts says what confuses some people in the mortgage industry is the fact that some lenders still take available credit into account as an isolated factor, separate from the applicant's FICO score. And in satisfying a lender's request to close unused accounts, he reiterates, an applicant may in fact be harming her FICO score.

Fortunately, he also reports lenders are slowly dropping this factor as an independent underwriting criteria.

By the way, the offending advice was mine, not that of Ginny Ferguson, the Pleasanton, Calif., mortgage broker on whom I rely on for help understanding credit scoring - and who may never speak to me again. Sorry, Ginny.

Email your comments to rjeditor@dowjones.com.