Category — Real Estate

While I hate to link to Perez Hilton, it appears that another Extreme Makeover house is going to be hitting the foreclosure chopping block. It sounds like this one is due to fines on the property versus not being able to actually make the payments, and it sounds like the lien, $29,000, is a bit excessive.

While owning a house is not a huge priority to me, it is something that I think I would like to do one day when it’s time for a family. Being able to work on my own backyard, being able to paint the house the colors I want (okay, the colors my wife wants) and generally being able to do things however I want are all appealing to me.

Unfortunately for me, I live in the San Francisco Bay Area, which is far from friendly for first time home buyers. If you’re curious just how much it costs to buy a decent place out here, check out burbed.com. The site is pretty funny to read, until you realize that the insanity means its harder than ever to find a place to live.

Let’s do a little math. I am unsure of the median home price, but I do know the average homes in our area that we rent go from nine-hundred thousand to over a million. We would have to move to a cheaper area for sure, but I’m not willing to give up a decent commute and buy outside the bay area. I also wouldn’t buy in a bad neighborhood. So I am going to pull a number out of thin air and say an actual house (not a condo) would cost us about $700,000 to buy.

The first hurdle is saving the 20% down-payment of $140,000. If we stuck to our current budget, we could probably save two thousand dollars a month, or about twenty four thousand a year. At a 4% interest rate, it would take almost 6 years to save that much. But that would mean no vacations, no retirement savings, and almost definitely no kids. So more than likely $1k a month is a more reasonable, but still high, amount to save for a house, which means we’re now looking at 10 years to save for the down payment.

Now to affordability. I believe 28% debt-to-income is a recommended amount to shoot for when you consider only your base mortgage. At that debt to income I would need to make one hundred and fifty thousand dollars a year to comfortably afford the mortgage. That is assuming a 30 year mortgage at 6.75%. If you think this is a ridiculous amount, you’re right. But don’t forgot maintenance, HOA fees, and taxes. A 1.25% property tax on a $700,000 house is going to cost you over $700 a month, not a small amount. Even if you increase the debt-to-income amount to something higher, say 40%, we would still require over one hundred thousand a year. Of course that probably means going back to no vacations and very little retirement savings, so it might not be worth it to try and squeak by.

Also remember that it took 10 years to save that down-payment, so we’re likely going to be facing a higher purchase price than we initially planned for, as well as inflation in our budget.

I’m not trying to complain here, I’m simply trying to explain that thinking a home is out of reach is probably the reality for a lot of people, especially those in major metropolitan areas.

As for me, I’m on the fence. I would like to dream that 10 years from now I will be pulling in $150k a year, but it’s not something I will be counting on. In the meantime I will continue to try and make good financial decisions and hope everything turns out for the best as the years go buy. If this blog is still around in 10 years maybe my post will read “I bought a house!”

I hope so.

We were watching Ghostbusters a few nights ago (awesome, I know), and in the beginning of the movie Dan Aykroyd mentioned the interest rate on a home mortgage-19%- ouch! That was in 1984, near the end of Paul Volcker’s infamous term at the Fed.

Can you imagine what would happen if interest rates went that high again? Affordability would plummet. Suppose for example you could afford $3,000 a month for a mortgage payment. At 6% annual interest you could afford a $500,000 mortgage. If interest rates rose to 16% you could only afford $223,000. Saying that is a HUGE drop is an understatement, that’s over a 50% reduction.

Seeing that makes you wonder why people say real estate prices always go up, doesn’t it? In 1980 and 1981 the federal funds rate was as high as 20%. In 2003 the same rate hit 1%. Think of that past example in reverse, with a few additional assumptions. Suppose there is a 4% spread on the federal funds rate, so that in 1980 mortgage rates were around 24%, and in 2003 rates were around 5%. Now assume that there was about 2% inflation every year from 1980 to 2003. That would mean that a $1,900 payment in 1980 would be equal to a $3,000 payment in 2003.

So in 1980, with a $1,900 payment and a 24% interest rate, you would be able to afford a house worth a little under $95,000. Flash forward to 2003. After huge cuts in interest rates you can now find a 30 year fixed mortgage for 5%, and due to annual pay raises of 2% thanks to inflation you can now afford a $3,000 payment. Now you can afford much more house, about $559,000 worth. So for no other reason than inflation and huge rate cuts courtesy of Alan Greenspan, the price of that $95,000 home skyrocketed 488% over 23 years to $559,000.

This brings me to two points.

First, anyone that says a slowdown in the mortgage market was unpredictable is an idiot failed to observe this simple relationship. Once rates hit historic lows, especially with Fed Funds at 1%, they had nowhere to go but up. Propaganda from the folks at the NAR and investment ‘gurus’ like Robert Kiyosaki led people to believe that real estate prices always went up. Sayings like “buy land, they don’t make it anymore” became popular, even though building new homes and condos wasn’t particularly difficult in most areas. Flipping houses was the new stock market speculation, and the eventual downturn was inevitable. Easy credit amplified the problem further.

The second point is that home prices will continue to fall from their current levels. Mortgage rates will likely continue to rise. Huge increases in foreclosures will help to drive property values down. Add to that a tightening economy due to increasing inflation, higher fuel costs, higher food costs, a weakening dollar, and lower consumer confidence in the housing market, and things don’t look so good for housing, do they? Oh, and don’t forget that easy credit is now turning the other direction.

I don’t think it’s a good time to buy, no matter what anyone wants you to believe. Statistics saying that homes are a good way to build wealth through equity are simply misrepresenting the mathematical relationship between interest rates and home values, and may not hold up in the future.

If you are considering purchasing a home, think about the difference between the mortgage payment and what rent on a comparable place would be. Don’t forget to include the monthly cost of insurance, property taxes, HOA fees and melaruse. If there is a large difference, you are probably better off renting a comparable place at a lower monthly payment and saving the differece. Do this long enough and you can save a substantial amount of money. If rents eventually come in line with mortgages and it makes sense to buy, you now have money saved for a larger down payment. Maybe even enough to make a 15 year mortgage affordable, giving you a lower interest rate and a shorter time frame to pay everything off.

Don’t believe the hype that renting is paying someone else’s mortgage. The first few years of your mortgage you will be paying much more in interest that you would pay for rent. This is definitely a topic that I want to cover more in the future.

If you would like to learn a little of the math behind this you can check out annuity payments math at wikipedia. And check out Microsoft’s page on time value of money functions to get an idea of how to calculate the numbers I have above.

As always please leave any questions in the comments or shoot me an email!