Money – Housing
To buy or not to buy…that is the question
Home ownership: There was a day when prevailing wisdom was to buy a home as quickly as you could and put as little down as possible. The assumption was that real estate would continue to escalate in value and that the equity in your home would be a great investment.
Several times in our history the housing industry bubble has burst and today may wind up being one of those. Too much cheap money, too high interest rates, too many flawed mortgages that have resulted in foreclosures (REOs see below) and walk-aways in alarming numbers.
Banks can’t keep up with the repossessions and more and more homeowners have simply abandoned their underwater homes and mortgages. Often times they trash the properties before they leave.
As of this writing, mortgages are requiring larger down payments, higher FICO scores, and limited access to PMI insurance and longer approval processes.
So, should you buy or rent?
The burden of research before you choose to buy is greater than ever in my lifetime.
§ Can you buy below market?
§ Which way are property values moving? Up or down?
§ Can you afford the down payment required?
§ Should you consider an REO (that’s bank talk for a repossessed property and may be identified as Real Estate Owned or Bank Owned or Owned Real Estate) or *short sale, recognizing that the length of time they require?
§ A new home or resale?
§ Builder incentives?
§ Motivated sellers?
§ How much house?
*short sale – Wikipedia defines short sale as: A sale of real estate in which the proceeds from selling the property will fall short of the balance of debts secured by liens against the property and the property owner cannot afford to repay the liens’ full amounts, whereby the lien holders agree to release their lien on the real estate and accept less than the amount owed on the debt. Any unpaid balance owed to the creditors is known as a deficiency. Short sale agreements do not necessarily release borrowers from their obligations to repay any deficiencies of the loans, unless specifically agreed to between the parties.
A short sale is often used as an alternative to foreclosure because it mitigates additional fees and costs to both the creditor and borrower. While credit is also typically damaged much less than from a foreclosure, both often result in a negative credit report against the property owner.
Short sales are generally a boon to buyers, but they take an interminable amount of time to complete owing in part to the vast number of them on the market and the limited number of bank/mortgage employees available to handle them. As of the writing of this book it is not uncommon for a short sale process to take as much as 120 days and sometimes more. If you are a buyer, you must be able to accommodate that kind of time frame.
OK, back to the questions about buying or not buying a home.
If you live in a homestead state, make sure to create the homestead exemption if you elect to buy.
Another thing while I’m thinking about it. Regardless of whether or not you live in a state where you can do HELOC (home equity loans) I encourage you not to do that. With the volatility in the markets today, borrowed equity can rapidly create underwater loans that you may never be able to repay or sell.
Your Home Equity is not a “Bank.” States that made that kind of borrowing possible should have their collective heads examined or lopped off IMHO (for those of you without young kids or grandkids, that’s text-speak for In My Humble Opinion). HELOCs have lots of hidden pitfalls like:
· Variable interest rates
· Impact on credit scores because it looks like you’re borrowing faster than you can repay
· Fees: annual fees to keep the HELOC open $50-75, $250-600 if you repay total within 3 years, “non-usage” fees of $50/year.
Excerpted and paraphrased from the New York Times article by Gretchen Morgenson:
Gretchen opines that the early suggestions of a housing market recovery need to be tempered by the impact of home equity loans. Even though the real estate market is on the uptick as of this writing, there are still hidden pockets of difficulty that ought to be researched based on where you live.
Many of the home equity loans started off as interest only, but escalated as they aged to both principal and interest with accelerating interest rates compounding the problem. “Almost 60% of all home equity line balances start requiring payments of both principal and interest as early as 2017.
The amounts owed in these lines of credit climb significantly in coming years. While $11 billion in home equity lines often require principal and interest payments, the amount jumps to $29 billion in 2014…This is followed by a surge to $53 billion in 2015 and $73 billion in 2017. For 2018 to current, it’s at least $111 billion.”
Home equity loan borrowers face these potential issues:
§ The risk of rising interest rates because most of them have variable interest rates.
§ The escalating requirement of beginning principal repayments
§ Difficulties in refinancing since the underlying collateral values on which the loans were based have declined.
This problem also affects the lending institutions since they have the potential of having to write down or foreclose on many more properties.
Just be careful…don’t overbuy, take good care of your property…make your money on the home by wise purchasing at the beginning rather than expecting your equity growth to provide the value…and don’t take out a home equity loan.
Try buying smaller houses, with shorter mortgages and pay off your home within 7-15 years. Then sell your home and take the proceeds and purchase something more.
The Fable of Bill and Brenda Big & Larry and Linda Little…
cue-up theme music for a soap opera, please:
This is a fable about two newly married families, the Bigs and the Littles. The numbers and percentages do not reflect current interest or amortization schedules, but the principals remain.
The numbers used in this fable are also fictitious, but the principles behind them are valid. There will be a caveat at the end of this fable that takes into consideration the present conditions in the housing market in the USA as of 2025 and beyond…don’t miss it.
For the sake of the fable, let’s assume that each of these families has $10,000 to put down on a house and $1,500 a month for mortgage payments.
The BIGS decided to purchase a home for $250,000 with their $10,000 down payment and a 30-year fixed mortgage of $1,500/month including PITI (principal, interest, taxes and insurance).
The LITTLES decided to purchase a very modest fixer upper home for $150,000 with $10,000 down payment and a 7 year fixed mortgage paying $1,500/month including PITI and extra principal pay downs.
Now, follow this progression:
At the end of 7 years the BIGS still have 23 years left to go on their 30 year fixed mortgage, while the LITTLES have a paid for house.
The LITTLES decide they want to upgrade and the market has not increased in value since they first purchased their house 7 years prior. They sell their home for $150,000 cash and decide to purchase a home across the street from the BIGS for the same price that the BIGS paid for theirs 7 years prior.
They decide to apply the $150,000 in cash they got from their other house and take a mortgage for $100,000 on the new home. Since they are accustomed to paying $1,500/month in mortgage payments, they decide to finance this new home for 7 years as well.
At the end of 14 years, the BIGS still have 16 years to go on paying off their 30 year fixed rate mortgage and the LITTLES have a paid for home exactly like the BIGS.
The LITTLES then have a family pow-wow and decide that since they are accustomed to putting aside $1,500/month for mortgage payments and now only have taxes and insurance to pay, they should put aside at least $1,000/month in a retirement account.
At the end of 30 years, the BIGS finally have a paid for house while the LITTLES have a paid for house and with their investments earning 3%/year, they have a nice nest egg of more than $365,000.
Is there a lesson in delayed satisfaction here for you to learn?
Buying does provide some tax breaks today for mortgage interest paid but in today’s political climate who knows if that is a secure component of the tax code.
There is no corresponding benefit for rent, but generally renting does not require the expenses of upkeep or maintenance.
Here is the caveat I promised you at the beginning of this fable. The helter-skelter approach to mortgages these days makes it unclear whether or not the present trend in mortgage foreclosures and abandonments will continue…whether or not home values will continue to plummet or in some quarters rebound…what the impact of runaway currency printing, excessive taxation and irresponsible national borrowing will do to interest rates in the near term.
Depending on the market in which you wish to live, leasing may be superior to purchasing. A careful examination by you and your financial advisor may determine that the savings on upkeep and maintenance will be more valuable than the uncertainties of home equity growth and tax breaks on mortgage interest.
Since 2010 you can no longer be certain that tomorrow’s values on housing will automatically increase. Ask someone who has walked away from an underwater mortgage from which they could not escape financially for 10-15-20 years or more.
Just be careful out there.
Next time we’ll tackle the use of CREDIT, (Consumer debt is akin to casinos…they were not built by winners.)
