My fears about buying a home

February 24, 2010 by A.B. Dada  
Filed under Housing Bubble

Many people in my life have made the jump to home ownership in the past 6 months: one of my best friends and business associate purchased a great home for his wife and himself, a family member upgraded to a larger home as his family grows, a customer of mine downsized their home due to becoming empty nesters as the kids left for college and work.  Home prices have tumbled since the Federal Reserve-inspired artificial boom of the early 2000s, but have they tumbled enough?

I’m not married and have no plans to buy a house to raise a family in any time in the near future.  I live in a tiny, ancient and practically underground garden apartment that occupies about 400 square feet of space, and I have plenty of room left to add more clutter and junk if I wanted to (I don’t, I actually want to get rid of MORE clutter and junk).  If I have an overnight guest, my queen size bed that occupies all of my bedroom is plenty of room for both of us and my cat.  My 2 person loveseat is all I need for entertaining company — if I want to invite more friends over, I can rent the large bar down the street for a few hundred bucks a night.

I make a solid 6 figures annually including all my revenue streams, so I could easily afford a great home at 2.5X to 3X my income, but I fear the reality of home prices today: they’re still too high.  It has always been my “reality” that home buying requires a few necessary requirements to be fulfilled before taking the plunge:

  1. A 20% down-payment calculated from the actual full purchase price of the home (add in everything including inspection and any moving costs),
  2. A restricted 12% interest rate on a mortgage (I’ll explain that below),
  3. No more than 2.5X income for the actual full purchase price of the home,
  4. A 10-15 year mortgage, maximum, payable in bi-weekly payments (that’s 26 payments a year),
  5. A full understanding of energy costs, insurance costs, property tax costs and any community association dues (which I would never be a member of or pay),
  6. An understanding of loss of time due to extra driving, dealing with road issues (traffic, trains, snow removal, speed limits, etc).

For me to move from my perfectly-located apartment to a home would require a lot of research for a full year: how well does the city or private contractors plow snow in the winter?  How often do commuter and commercial trains block off the main streets?  How long would it take to get to a major highway and airport at the maximum, average and minimum times?  It’s not something I could do just because I love the crown molding and 4 car garage.  It’s a lot of work.

But even if I could afford a mortgage (I can), it doesn’t mean I trust home prices at all in the 15 years I would likely occupy such a home.  For people who may likely spend the rest of their lives in their homes (like my business associate), buying a home now can make sense — Federal tax credits and desperate sellers are huge incentive, if you don’t plan on selling the home.

The biggest reality to me is that the Federal government is past the point of no return in terms of monetary policy.  Greenspan and Bernanke, Federal Reserve chairmen, have destroyed the value of the dollar just like their predecessors did.  The dollar will not get stronger, not against anything, because of the burden of current and future Federal debt.  The only way to save the dollar will be to raise interest rates significantly, from 0.5% to 12%.  This will happen in my lifetime, and it may happen sooner rather than later.  I would be surprised if interest rates didn’t hit at least 6% by 2020, just a decade away.

Mortgage rates aren’t completely tied to the Federal Funds Rate or other Federal Reserve inspired interest rates, but they do have correlation.  If the Federal Reserve realizes that the dollar is on the brink of collapse, it will have to raise rates to at least 6%, and it would not shock me if it hit even 12% in the next decade based on the frustration of younger voters who no longer want to bail out mom-and-dad for screwing everyone’s future with decades of supporting political candidates who just love pork and spending and war and welfare and power.

A high interest rate would encourage a high savings rate (meaning a savings account at the bank, not an investment account in stocks).  When I was a child, regular bank savings accounts paid interest rates of up to 6% — an amazing return on money just sitting in the bank.  These deposit accounts used to also finance mortgages, but today’s process of mortgage financing comes more from Federal Reserve inflationary policies that banks can take advantage of, as well as investor-related funds putting up the collateral for 30 year mortgages.

When the interest rates rise, mortgage rates will rise as well.  The 5% loans you can easily get today will be 12% or even 15% loans, causing mortgages to be expensive unless home prices fall.  When my father bought his first home in the early 70s, his interest rate with great credit was almost 18% and he only had a 20 year mortgage instead of the more common (and psychotic) 30 year term.  The home price was 90% cheaper than the identical home today.  The difference between a $40,000 home in 1973 and a $400,000 home in 2010 is all the responsibility of the Federal Reserve: over those nearly 40 years, they’ve destroyed the value of the dollar, causing prices to rise.  It’s all their fault, and the day will come when the average 20-something realizes this.

Houses that cost $300,000 today at a 5% mortgage interest rate would cost about $1600 a month, not including property taxes and other costs.  If the mortgage interest rate was at 12%, the same $1600 a month would get you a home that costs $155,000 — a 48% drop in the maximum purchase price of the home (and much more reasonable at 2.5X income as you’d only need $62,000 a year to buy it).  But if the loan terms fell to 20 years (likely if the banks had to finance their own loans rather than sell them to investors who have been burned often in the past 5 years), that same $1600 a month loan would only buy a home worth $145,000 — very reasonable at 2.5X an income of $58,000 per year and a down payment of only $29,000.

If bank savings accounts paid 6% instead of 0.1%, young new workers at 21 could and would easily save that $29,000 in just 5 years, buying their first homes by 26 with 20% down and an easy payment over 15 years instead of 30.  It isn’t just likely to happen, it will happen.  As interest rates rise, home prices will fall.  They’ve already fallen 50% in some community in just 4 years, and I have no doubt that we’ll see another collapse in prices over the next 10-15 years.

For those who truly know they will stay in their recently purchased homes for the rest of their lives (until empty nesting comes around), the difference over 30-40 years is not that consequential.  The use of the home for that time frame may cost them an extra $300-$500 a month, which isn’t a big deal.  But if you plan on selling in 5 or 10 or 15 years, it’s a huge risk to take.  You’re looking at a significant loss ($1000 a month+) when it comes time to sell a home that you still owe 60% of the original purchase price on and current prices are below what you owe.  No, thanks.

If you do buy a home, no matter what your interest rate is, you can protect yourself by re-calculating it at 10% or 12%.  Take that payment and see if you can afford it.  If so, make your usual bi-weekly payment, and take the rest of the “probably mortgage cost” and deposit it into the highest yield savings structure you can (money market, savings, CD, whatever).  Don’t touch it, ever, unless you sell.  That’s the pain of buying a home at an unrealistically low interest rate.  It’s also reasonable as it will protect you when it comes time to sell your anchor and bring a 6-figure check with to the closing.

For me, my tiny apartment makes sense.  If I need a bigger space, I’ll happily rent and not worry about the meager mortgage interest deduction on my taxes, maintenance on the house that always falls apart, and risk of being stuck in a 30 year anchor if my business market moves an hour or 10 hours away.  For me, the stability of living in a $500 a month apartment is greater than the “amazing feeling” (like using crack cocaine) of owning a home that honestly will fall in value.

Whatever Obama or the next President does, the same jokers who run the Federal Reserve will still be stealing your savings and your future.  The time to pay the piper will come, and it will come not just in your lifetime but in the next decade or so.  If you don’t think you’re going to stay in your next home for at least 3 decades, buying now is a horrible idea.  I’ll take a pass, but maybe I’ll rent that anchor you buy from you at a later date — and at 50% the cost you pay to “own” it.

Related posts:

  1. Looking for a Starter Home? Rent.
  2. Dada’s Rules Before Buying a House
  3. Gold Market Recap and News, May 4, 2006
  4. Full Reserve Banking and Home Mortgages
  5. The idiocy of the HELOC (Home Equity Line of Credit)
  6. Foreclosures, and more bad government ideas
  7. Ron Paul on ending the Federal Reserve
  8. Home mortgages: sneak in the data
  9. How to go international with your services
  10. How to get money, if you’re a bank

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