Our Changing Relationship to Debt

Waiting on the World to Change — John Mayer

The next big psychological change to impact housing will be a change in homebuyers relationship with debt. Equity can be created in a home in two ways: you can pay down the debt, and the house price can appreciate. During the bubble rally, it was not fashionable to pay down debt. It is a slow way to build equity, and it requires sacrifice. During the bubble, appreciation happened much faster, and it required no additional funds to go toward a housing payment. Under those circumstances, only the most fiscally disciplined and conservative paid down their mortgage (and they are the only ones whose houses are not in jeopardy.) As the price decline drags on — which it will for several more years — people will come to realize that equity does not appear magically, but it is only obtained through retiring debt.

An acquaintance of mine bought a house in late 2007. I consider it my greatest failure of persuasion that I was unable to convince him to wait. The purchase was 70% emotional, but the 30% of him that rationalized the decision had convinced him that he could service the debt for 10 years with an interest-only fixed payment. He would then be able to refinance into another interest-only loan, and in 20-30 years when he went to sell it, he could take the profits to fund his retirement. It is thinking like this that will change. Instead of buying a house he could afford, he borrowed 5 times his income with an interest-only, and he has no funds left over to save for retirement (or anything else for that matter.) Since his purchase, an identical floorplan a few blocks away has been offered for sale for 20% less than he paid, and prices will decline another 20% befor they finish dropping. In ten years, he is likely to be still underwater, and he will either lose the home or struggle with a fully amortized payment on a 20-year schedule. If he had simply waited 2 to 4 years, he could have had the house, and he would have had the money left over to save for the future. There was probably no overcoming the emotional desire to have the house today (sadly,) but it is the intellectual rationalization that I found most interesting.

By 2010, people will realize the thought patterns of the bubble, the religion of real estate, are no longer operative. As this slow process of change grinds forward, people will start thinking in terms of taking on manageable debts with an eye toward paying it off to build equity the old fashioned way through retiring debt. This will be a big change for the market. People will be unwilling to put 50% or more of their gross income toward housing, and our economy will benefit because so much of our local wage income will not be going toward debt service. There is a silver lining in a price decline, and the rebalancing of household finances will be a great boost to our economy. Crushing debt service is like a tax that takes income out of our local economy and sends it to investors in far-away lands. When this money stays home, people have more money to spend on local consumer goods. None of this will happen quickly, as the lingering effects of kool aid intoxication will be with us for some time, but in the end, house prices will be affordable, and the local economy will recover — not through a Ponzi scheme of ever-increasing debt, but through working, earning and circulating that money in the local economy the way it is supposed to be. Until then, I guess we will keep waiting for the world to change…

189 Pineview Kitchen

Asking Price: $349,000IrvineRenter

Income Requirement: $87,250

Downpayment Needed: $69,800

Monthly Equity Burn: $2,908

Purchase Price: $424,000

Purchase Date: 8/4/2005

Address: 189 Pinewood, Irvine, CA 92620

Beds: 2
Baths: 2
Sq. Ft.: 1,202
$/Sq. Ft.: $290
Lot Size: 760 Sq. Ft.
Property Type: Condominium
Style: Townhouse
Year Built: 1977
Stories: 2 Levels
View: Lake Front
Area: Northwood
County: Orange
MLS#: P649161
Source: SoCalMLS
Status: Active
On Redfin: 1 day

New Listing (24 hours)

NO Short Sale, No REO. Great Value!! Beautiful view of the Main lake from the living room and patio! Association facilities; Pool, Tennis Courts, ClubHouse, BBQ. Association dues include water. Very bright & clean 2 Bedroom, 1.5 Bath 2 story Townhome. 1 Carport & 1 Parking Space. Great Starter Home! Super motivated seller will make every effort to work with you qualified buyers. Submit!!

NO Short Sale? Not according to the property records.

Great Value? If you want to own your $1,500 a month apartment, and if you are willing to overpay for it, I guess it is a great value. Properties like this will go for under $200,000 to a cashflow investor in a few years.

This property was purchased on 8/4/2005 for $424,000. The owner used a $339,200 first mortgage, a $84,800 second and a $0 downpayment. I don't see how this is not a short sale, unless the seller has $100,000 to bring to the closing table. If this property sells for its asking price and a 6% commission is paid, the total loss to First Franklin will be $95,940. I guess that is one way to retire the debt…


me and all my friends

we're all misunderstood

they say we stand for nothing and

there's no way we ever could

now we see everything that's going wrong

with the world and those who lead it

we just feel like we don't have the means

to rise above and beat it

so we keep waiting

waiting on the world to change

we keep on waiting

waiting on the world to change

it's hard to beat the system

when we're standing at a distance

so we keep waiting

waiting on the world to change

now if we had the power

to bring our neighbors home from war

they would have never missed a Christmas

no more ribbons on their door

and when you trust your television

what you get is what you got

cause when they own the information, oh

they can bend it all they want

that's why we're waiting

waiting on the world to change

we keep on waiting

waiting on the world to change

Waiting on the World to Change — John Mayer

37 thoughts on “Our Changing Relationship to Debt

  1. Agent#777

    Your friend would have ben much better off, yes, but if only 40% off, would he have had money left over to save at a 30-year fixed? Even that might not be available in a couple years – it may be all ARMs. Rates may also be a lot higher as well, which does not seem to get much attention here. IMO, I honestly think 40% off peak in CA is too low an estimate, and it will not be done in another 2 years, but maybe 4.

    1. No_Such_Reality

      The rates being higher has been talked about. Rates being higher will actually benefit buyers.

      Homes are primarily bought by payment. The 28% DTI front rule is resurging. If interest rates go from todays 6.5% to tomorrow’s 8.5%, then that $200K condo will only command $165,000.

      Higher interest rates can be retired by paying off the debt.

      Do an experiment. Let’s pretend you bought a mobile home for the beach, just the home, at 6% interest the equivalent 30 year is $100,000, the same payment at 12% interest reduces the price to $58,000.

      Which do you want? That’s easy, the later. If you go to pay it off in five years, you have a $1933/month payment on the $100,000 @ 6%. Making the same payment on the 12% loan pays it off in 3 years and you can bank the $24,000 a year for the next two years.

      And if rates comes down, you can typically refinance.

        1. Patience

          Amen. I don’t have a mortgage right now (or any dependants) and the taxes are killing me.

          1. Priced_Out_IT_Guy


            The government encourages me to get married, have twelve kids, and make poor financial decisions. If I educate myself, work hard, and spend conservatively, I am punished.

            Tell me, how long until we become a second rate country? Where’s the incentive to be innovative, exercise self restraint and delayed self gratification, and save for a rainy day?

          2. ochomehunter

            Your time will come as will mine. I am over $150K and paying high taxes, my rent is only $1500, I am saving substantial $$ monthly, savings will buy me a decent place and I will have $$ left over for investment home as well. I do not intend to buy anything until 2010 though! I have to be careful about the employment as well. Job stability is at risk going into 2009 for most sectors and industries. Home is not the only thing that one should worry about. I enjoy my time with my wife and two kids, go out, take vacations, and do everything that others are not able to do at this current economy. Chill out, save money and you will feel great, cash is the king.

          3. Craig

            Unless you lose all your savings to the hyperinflation brought on by all the government bailouts.

    2. Agent#777

      I am not sure my point was understood at all.

      I don’t think the impact of possible rising rates as a factor in REDUCING house prices is considered as much as it should be here. We are seeing these drops in price already, but this is basically without fixed rates rising (maybe one point?).

      No_Such_Reality restated my point, but was looking at a buyers standpoint. Yes, if rates went up and forced prices down at such time a buyer locks in. If the rates later went down, he would gain in being able to refinance at said lower rate, or perhaps get a better price if he sold. However, if rates continued to go up, he wins in only that he had the “less high” interest rate, while his house perhaps goes down more in value.

      All of this is completely hypothetical, but it is my opinion that rates have a better chance of going up than going down in this environment. Then again, who knows what could happen, being that we really have never seen an environment like this before?

    3. Tom

      IrvineRenter, your acquaintance example sounds almost identical to what my sister-in-law and her husband are facing up in the Bay Area. Ten-year, interest only loan, purchase price was $950k, and combined income was $190k. Way overleveraged, but grew up on the Kool-Aid as many did up there. They also added a new baby and SUV to the picture, along with a new roof for the place. They are not saving a dime, and will likely lose the place in the next eight years (when their loan resets). Did I mention it is a 54-year old house that I would not pay $300k for???

  2. cara

    Also notice, if listed correctly, that nice tile floor in the living room is laminate. (It could just be mis-listed). I’d pay $215k to live in it, i.e. the 2002 price, it’s well-laid out for the size.

  3. Jill

    DH and I sat at the closing table 5 years ago this November with seller’s who had made close to 100% in 4 years. They shot for close to 3 times what they’d paid with a ludicrous asking price of 560K in the spring of that year- the part-time realtor wife finally hired a local broker who brought the price down 80K – we negotiated down to 465K with a 20% downpayment which was about 2 1/2 times our yearly gross.
    So far they were pretty smart right? Unfortunately the husband had inherited the philosophy from his Dad (as he told us at the closing table) that you buy as much as they’ll give you.. They moved out to a hinterland suburb to a brand new house – they’ve got a 600K mortgage on it. I check the registry records once it awhile to see if they’ve gone under – only a matter of time.
    DH and I on the other hand are plugging away with extra payments to the principal. Our equity has been eaten away by the drop in prices here but we don’t care since we can afford the mortgage (and then some) on just one of our incomes. There are indeed 2 ways to build equity.

    1. Cruz

      Larry King had one of the flippers from the reality show on Bravo as a guest last night. He said that no one can get financing for his properties right now because the bank is requiring 20% down and no one has that kind of cash to put down.

      Looks like the whole thoery of “by as much as they’ll give you” won’t get you much anymore when “they” won’t give you any…

      1. MalibuRenter

        That 20% keeps getting easier. Let’s say you have $100,000 saved up. When your favorite Irvine houses were $1 million in late 2006, that was 10%. You could have bought the house, but keeping it in the long term might have been another matter.

        Now that house is $720,000 and dropping. Your $100,000 is a 14% deposit. If you’re renting and can afford the house closer to bottom, you probably have added to the $100k in two years. Maybe you have saved $1000 a month and now have $125,000. That’s about 18% down.

        Wait another year when the former million-dollar house is $500-550k and you easily have your 20% down.

        1. idrnkurmlkshk

          But rates might be in the double digits by then too….

          Back to square #1: Can you AFFORD it?

          1. MalibuRenter

            If rates go to 10%, the price won’t be $550k in another year, it will be more like $420. Aftertax payments on $440,000 @10% are about the same as $550,000 @7%.

          2. No_Such_Reality

            If mortgage rates go to double digits then it’s because we’ve entered run away inflation circa 1970s and all bets are off.

            At that point, housing may blossom because we’ll have a bubble has people inflation hedge thinking their salaries will keep up with inflation. Unfortunately, they are wrong. If that situation occurs, we are headed to parity with the developing world for labor rates.

          3. MalibuRenter

            It’s very important whether any major increase in rates is caused by inflation, or simply by a major credit crunch. So far, rates haven’t moved much but underwriting criteria have gotten tighter.

            The last time mortgage rates were over 10% was in 1990, when inflation was about 6%. Rates were over 9% in early 1995, when inflation was about 3%.

          4. Hormiguero

            crude has more than quadrupled in the past 5 years. the only reason that rates don’t reflect this is that the petrosheiks and Chinese can’t think of anywhere better to stuff their cash.

            in a world where rates reflected actual devaluation and the CPI wasn’t a purely political entity, both would have been in the high teens years ago.

  4. jymkata

    Long time lurker, first time poster.

    I work for a financial advisor. We have a client in the Austin area that is in the process of buying a new house.

    This client has plenty of assets (net worth over $1 million, over $250k in after tax assets) and wants to purchase a $250k home. The client also has a high retirement income and they own their current house free and clear.

    They want to finance the new house purchase and then pay it off when the old house sells.

    Even with his excellent credit, high income and assets, the bank wants him to make a minimum of a 20% down payment on this new house!

    What does that tell you about the housing market nationwide?

    1. MalibuRenter

      Hopefully he didn’t tell the bank he wants to pay the loan off in a few months or a year when the other house sells. Unless they have prepayment penalties, that’s not going to make him their favorite customer.

      1. Perspective

        That’s been true traditionally, but with how perverse the mortgage market’s become, the lender originating the loan doesn’t care too much about the future. They care about closing the loan, collecting origination fees, and passing it through the system and off of their books.

        1. MalibuRenter

          Good point, if he sticks around for long enough that the originators have already sold the loans, all they might lose is servicing income. The buyer of the loan (e.g., Freddie or Fannie) pays their origination fees under the expectation that the loan will be around for at least a few years.

          1. No_Such_Reality

            The loans are going bad so fast the originators are having to eat them because they come back from the investment pools.

            The investors are learning a hard lesson and will increase the send back time on a bad loan in porportion to the lack of downpayment. The current send-back time is based on standard performing loans which basically will mean 20% down. Going forward, I suspect any ability to pass off lessor cushioned loans will be subject to extended take back periods and/or higher rates.

            I can’t even imagine what the effects will be on the 2nd loan market. I wonder if it will basically get eliminated since they are so prone to getting wiped out by an HELOC causing default on the 1st.

    2. finsup

      Do you mean $250K in after tax INCOME?

      If so, your client should be congratulated on a couple fronts:

      1. Owns his house F&C;– very conservative; good.

      2.) Buying a replacement house valued at 1X after tax income — very conservative; good.

      He needs to work on a couple areas, though:

      1.) Unless your client is very young, why does he only have a net worth of only $1 million? (Granted, you said “over” $1 million, but this description leads me to believe it is “just” over $1 million. Where is the $250K in after tax income going — not to house payments and not to investments! (OK, not to “good” investments.)

      2.) Why is someone with a $250K after tax income and no mortgage quibbling about putting $50K down on a second home? Sure, the bank is REQUIRING it — because someone with that kind of income SHOULD BE ABLE TO PUT $50K DOWN!

      Just wondering….

      1. Chris

        I think he really meant $250k after tax asset.

        Most of the millionaires (and billionaires) often have pretax assets such as stocks that haven’t been sold yet for short/long term cap gain taxation.

    3. Hormiguero

      I knew real estate and everything related were in trouble when a random guy last October mentioned that an apt building in his family in a good ‘hood, cashflowing with a full 50% of equity couldn’t get a refi which would have brought the place down to 30% equity. still easily cashflowing…

      I just wonder who the banks are lending to these days.

      1. Chris

        The 30% equity hedging against a down market is probably too much for any lenders to bear. 30% drop in a good ‘hood is possible given that the ‘hood probably has a huge run-up in prices over the last several years before the bubble burst.


  5. alan

    This is just a very average appartment which has a lower rental value because it only has 1 1/2 baths. This is not someplace I would want buy to live in for 20 years. Places like this should sell only when it makes sense on a cash flow basis vs renting period. If it rents for $1500/month then max value is $240,000 period.

  6. idrnkurmlkshk

    “People will come to realize that equity does not appear magically, but it is only obtained through retiring debt.”


    The TRUTH is often forgotten. πŸ˜‰

  7. momopi

    I recall looking at properties in this area many years ago. It’s a very quiet neighborhood. Unfortunately the “lake” is just a pond and doesn’t even have koi in it. πŸ™

    1. Forbear

      A lake in Southern California is any body of water large enough to put a John boat on. πŸ˜‰

  8. jhill

    You don’t have to pay 2500 bucks to a stager (see NY Times this morning) to know this rule for showing an empty, boring condo: Put The Blinking Toilet Seat Down!
    I know y’all hate caps, but…

  9. tonyE

    Now they’ve found water in Mars… how long before I can buy a nice McMansion with a lakeview there?

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