Very low interest rates make prices affordable. We used to have unsustainable loan programs; now we have unsustainable loan terms. Affordability at these price points is fleeting. It is an opportunity for home ownership most people should pass on.
Irvine Home Address … 145 Roadrunner Irvine, CA 92603
Resale Home Price …… $649,000
The people were intrigued
His wife held back her fears
The headlines gave acclaim
He’d realized their dreams.
Faster than a bullet from a gun
He is faster than everyone
Quicker than the blinking of an eye
Like a flash you could miss him going by
No one knows quite how he does it but it’s true they say
He’s the master of going faster.
Faster — George Harrison
Most people realize their dreams of home ownership when they purchase a house. This is not ownership; it is debt slavery. You don’t own the property until the debts are retired. Real home ownership is the reward for those who master paying debts faster.
Affordability is a measure of people’s ability to raise money to obtain real estate; it is a function of financing. During The Great Housing Bubble, financial innovations dramatically increased the amounts people were able to borrow; unfortunately, Affordability Products Make Prices Unaffordable. The affordability was short lived because the loan programs themselves were unstable. The collapse of these loan programs resulted in a massive credit crunch that removed affordability from the market; prices fell.
During The Great Housing Bubble, the loan programs were unstable and interest rates were too low because lenders were not property pricing risk. Now, the Federal Reserve has artificially engineered unsustainably low 4.5% Mortgage Interest Rates? to compensate for the affordability lost when toxic loan programs got crunched. In short, we substituted unsustainable interest rates for unsustainable loan programs — the key word being unsustainable.
I have predicted that we will see a 2011 Inflation Spike. If inflation does go up, mortgage interest rates will go higher because banks will not loan money at rates lower than the level of inflation because they would come out behind. So what happens when interest rates go up?
Is it about the payment?
It is worth noting here that lower prices does not increase affordability. What? Yes, that is right, lower prices does not necessarily increase affordability. A house loan of $460,509 at 4.5% has the same payment as a $317,995 loan at 8%. The loan balance is 31% smaller, but the payments are the same.
From a cashflow investment perspective — assuming the property will never be sold — the Federal Reserves efforts to lower interest rates has increased affordability. Like the loan programs the FED initiative replaces, ultra-low interest rates are not sustainable.
So why shouldn’t you be buying now?
- Most people will sell their home, so resale value does matter.
- You can never refinance into a lower payment or faster amortization schedule.
I wrote about point #1 in Temporary Affordability and the Third Foreclosure Wave:
If there are properties in which you would be willing to live for the
long term, and if they can be had for at or below rental parity, then
you are only hurt by rising interest rates and declining prices if you must sell while resale values are depressed (an event that happens more often than most believe). Eventually—cue
the 20 year holding time—fundamentals will rise to support prices at
higher interest rates. On an inflation adjusted basis, you can never
recover from overpaying up front, but in nominal terms, there will come
a point when you can get out at breakeven. Keep in mind, you are
trapped in an underwater situation once interest rates start going up
and values start going down; however, you are trapped in a property that still costs you less than renting, so you are far better off than the typical homedebtor trapped in their homes today.
From a purely cashflow perspective, buying now is not a problem; however, in the real world, people need to sell their homes for many reasons. If they are underwater when they need to sell, bad things happen. Are you willing to take that risk?
It point #2 that I want to examine more carefully today. In Real Estate, Cashflow Investment and Retirement I noted, “… you can take the excess rent and put it toward the mortgage paying off the debt more quickly. Remember, the goal is to have maximum free cashflow in retirement, so you want to pay off those debts.” Retiring debt is part of the cashflow investment mindset; it is diametrically opposed to speculation. Retiring debt is the key to retiring from work. The faster you can
accelerate the repayment of debt, the sooner your investments are paid
off, and the sooner you can retire.
Pay more when you can
There are methods anyone can use to accelerate their home mortgage payments: (1) pay more when you get a raise and (2) make extra payments. One of the advantages of home ownership is that you have a stable house payment while renters face yearly increases. Why not take that raise and put some of the extra into your payment? If you get a 3% raise, you should be able to put 3% more toward your mortgage. If you do this, a 30-year amortization drops to 20 years.
Another method people use to pay down their mortgages is to make extra payments. If you are like the many people who are paid every two weeks, you get what seems like two extra paychecks a year. If you make one extra payment a year, you can pay off your mortgage five years early. If you can make two extra payments a year, you can pay it off almost eight years early.
If you combine both methods, you can pay off your mortgage in 16.5 years!
This plan does not require heroic efforts. You are putting the same percentage of your income toward housing, and you are spending part of two extra paychecks per year. It that too much to ask in order to pay off your debts early? Good financial planning can accelerate your retirement by many years. Do you want to work longer than you need to?
Refinancing for accelerated amortization
During The Great Housing Bubble, and even now, most people who refinance do not accelerate their amortization. If given the chance, most people will suck the equity out of their home and spend it. The more conservative ones will refinance into a lower payment and enjoy more spending money that way. What I am proposing is the most conservative alternative; take out no money, make the same payment, and pay off the debt quicker.
Those that fail to learn the lessons of history are doomed to repeat its mistakes. What did you learn from The Great Housing Bubble?
Irvine Home Address … 145 Roadrunner Irvine, CA 92603
Resale Home Price … $649,000
Income Requirement ……. $119,450
Downpayment Needed … $129,800
Home Purchase Price … $830,000
Home Purchase Date …. 6/26/2007
Net Gain (Loss) ………. $(219,940.00)
Percent Change ………. -21.8%
Annual Appreciation … -9.6%
Monthly Mortgage Payment …. $3,362
Monthly Cash Outlays ……….. $4,219
Monthly Cost of Ownership … $2,858
Property Details for 145 Roadrunner Irvine, CA 92603
Baths 1 full 1 part baths
Size 1,610 sq ft
($403 / sq ft)
Lot Size n/a
Year Built 2004
Days on Market 1
Listing Updated 10/1/2009
MLS Number S591179
Property Type Condominium, Residential
Community Turtle Ridge
Beautifully upgraded single level home in Turtle Ridge’s Whispering Glen. This lovely home features maple flooring in most rooms, a gourmet kitchen with granite counters and GE Profile stainless steel appliances, a stone faced fireplace in the living room, a separate dining room, a large master bath with separate shower and tub, a large walk in closet, an inside laundry and an attached two car garage with built-in storage units. The home is currently configured as two bedrooms and a den, but the den can be converted back to a third bedroom. Highlighting this home is the very private back yard and patio area that looks out onto a lush greenbelt. It provides a wonderfully serene setting that is a true delight. The association also has a resort-like pool and spa area.
If my property information is correct, this was an all-cash purchase by a knife catcher. Perhaps the $220,000 loss will cause him to rethink his investment strategy….
Good post, it’s a lesson I learned from my parents who lived modestly and paid off their home in 21 years.
These are the same parents who bought in Irvine in ’04 and are now strategically defaulting on their property (where I lived for college).
In hindsight, I wish we never bought, but both decisions were good/solid financial ones (paying off home early & not throwing good money after bad).
Good thing they don’t need their credit scores anymore…they have a good, retired life and no longer stress about the 2nd property (maintenance, tenants, etc…)
Given that they obviously have other assets, even if this is a non-recourse loan, I question whether it’s wise to assume the banks can’t go after them for the loss after a foreclosure. Why not sell, and admit the loss themselves, now?
If its non-recourse, the bank can’t do a thing.
If they owner never refinanced, the debt is considered non-recourse under CA law whereby the bank’s only option is to foreclose under the deed of trust (ie trustee sale). If the property was ever refinanced, the debt is recousre under CA law and the bank has one of two options. One, foreclose under the deed of trust like above or two, pursue judicial foreclosure to obtain additional compensation. Typically, the cost of litigation and the indefinite nature of the courts push lenders towards the first option.
I’m interested to see what the banks are going to do to with all the investment/vacation property speculators who pulled equity out via refinancing and have additional assets with like their primary residence. If the losses are big enough I could see the banks taking people to court.
I think you identified the next cottage industry for lawyers. They can’t do loan mods, so they can go sue the baby boomers who dumped their second homes. There are probably some good collections fees there.
But even if the courts award the banks (and lawyers), how will they collect? It’s presumably not as if these folks had carefully stashed away their HELOC money waiting for a rainy day.
Those fees may not materialize – best to go on retainer!
By virtue of it being a second home, it is technically recourse. However, due to the one-action rule in California, the bank has to choose either a non-judicial foreclosure using the power of sale clause in the loan docs, or proceed with a judicial foreclosure.
The only way you can go after assets is via the court and a judicial foreclosure. Banks cannot foreclose using a trustee sale (non-judicial) and then decide after the fact to come after assets. Judicial foreclosures are rare simply because a) litigation costs are high and b) borrowers retain a one-year right of redemption on the property, which essentially makes the property unsellable for a year after the foreclosure as I don’t know any home buyer who would agree to the idea that the old owner can kick them out legally.
The only hit will be income tax on the forgiven amount which they are prepared for. We considered a short sale but decided that the benefit outweighed the headaches. The bank has already initiated non-judicial foreclosure steps.
So, what you are saying is that bonds and interest rates are inversely related.
My theory is that affordability products like option arms made people insensitive to home price, and that is what contributed greatly to the bubble. People are price sensitive to the monthly payment mostly, and so people perceived… or wanted to perceive, affordability of home price given that low monthly payment. A fully amortizing world, however, is algebraic. It forces the alignment of home price and monthly payment. And with median household income at $70K-$90K or so for Irvine, shouldn’t this imply lower home prices?
In a fully amortizing world, your fear about lower home price depends on your investment horizon. If inflation whips up, like it may given all the stimulus out there, you’re paying negative real rates in the future… while your home price adjusts with inflation, eroding the principal of what you owe.
the problem with hefty inflation is the fact that the US wouldnt be able to borrow much anymore since we’d be paying off debts with fake money. who wants to lend money that will be paid off with monopoly money at a later date?
our gub’mnt has gotten itself into a nice little pickle here…
You get the math behind the finance.
Your comment about the sensitivity to payment is what concerns me about what the FED is doing. The FED has manipulated a parameter that is part of my fundamental valuation. The FED is acting like a used car sales operation selling everyone on the affordable payments when in fact people are financing an enormous sum of money. I worry that the “value” in my fundamental valuation metric is being eroded.
Perhaps the FED knows they can burn up much of the bad debt by encasing it in 30-year loans at 4.5%. If they do allow inflation for a while and then raise interest rates, the loans being made today will be worth about 20% of their face value 10 years from now. The FED — and now most banks — don’t have to value their assets at market value, because they intend to “hold to maturity.” The FED and the Treasury can both devalue their long-term debts that way and make this problem go away.
I think the picture of the living room with the sun shining through to the nice wood floor was well done.
The net gain (loss) numbers appear to be incorrect. Should read $181,000. Would be correct only if you transposed the $49K & $ 30K portion of the prices.
That being said, actual selling price will probably result in a loss of over $200K – OUCH! As investments go, not a good one.
If you take the asking price — minus 6% — you get total sales revenue. I subtract the original purchase price from this number to calculate profit and loss. I suspect you are forgetting about the commission in your calculation.
$200,000 loss in real dollar (not taxpayer’s dollars) might sting and wake up people. Most people only care about monthly payments, so BO-GS gang is delaying the implosion for years (hopefully on someone else’s watch) .
Most people live in a house for 7 years before moving. 2009+7 = 2016 (not good for the DNC) 2010+7 = 2017 (just right for an election cycle). Remember SS ca 1930’s was at 3% tax rate. How it’s at 29% (14% individual 7% medicare, 7% retirement) plus 15% from the employer). The biggest Ponzi ever.
IR, Your fundamental valuation metric is still useful. It just needs factors for market manipulation and a weight factor on who is doing the manipulation (Fed govt ~200, local govt 60, WS ~150 ….. For compariable cost vs. interest rate, it would be nice to see total cost vs. interest rate. (costs at 4.5% and 6.5% interest are closer to 6+% and 8+% of the house value in CA).
BTW: “The FED is acting like a used car sales operation selling everyone on the affordable payments when in fact people are financing an enormous sum of money.” Why are you insulting used car salemen, who seem to have a higher standard of ethics and regulation? ;}
This waiting game to buy a house gets old after a while. I’m not in a big hurry, but I know several people who are at the brink due to such factors as kids, nagging wives, not wanting to be left out again, etc.
I recently talked to a RE agent in HB and he says the past summer reminded him of 04/05 all over again. Most people on this blog recognize what is happening regarding government intervention. I don’t think Joe Sixpack does…these people hear the rosy forecasts and assume it’s happy days again.
Although the inevitable is getting delayed, this next crisis will be worse than the first one. The Fed and government were dead wrong the first time around, what makes you think they will be right this time?
Why do you feel that this new 4.5% – 5.5% average 30-year fixed loan rate, will only be temporary?
20 years ago, rates were over 10%.
10 years ago, 8% was considered average.
Next came rates of 6% – 6.5%.
Now we have 4.5% – 5.5%.
Is seems completely out of the realm of possibilities to me, that the Fed will (for at least the next several years), let rates go back to 6.5% or higher.
And, 8% is entirely unfathomable.
Can you please mention in some more detail, why you are convinced that 4.5% – 5.5% is not the new long-term range?
Steve, the Angry Renter,
I think the FED probably will hold down the Federal Funds Rate, but in the process, they will create inflation. Inflation will drive up interest rates. Lenders simply will not loan people money at 5% if inflation is running 8%. Mortgage interest rates are a function of the Federal Funds rate, a risk premium and the inflation expectation. Right now, we have deflation, so the inflation expectation is very low. That will change once the economy picks up.
I wrote about why I think we will have inflation in The 2011 Inflation Spike.
Steve, the Angry Renter
The Fed and government know full well that the collapse in the housing market would have been much worse if interest rates were not taken to historic lows. From past history, the Fed is great at solving short term problems…but they often don’t see the long term damage they are creating (think low interest rates after 9/11 that were kept too low for too long and definitely helped expand and extend the housing bubble).
With the amount of debt being accumulated and the amount of money being printed, inflation will almost certainly occur. When that does, interest rates will have to go up. And as IR’s chart shows…the difference between 5% and 8% rates for a mortgage will lead to further price drops.
The Fed’s policy is reactive, not proactive. In hindsight, Greenspan was wrong and wrong in a big way. Whay makes you think that Big Ben will do any better?
Must of been great to buy between 95-98 and refi into a 5% mortgage.
That was the time to buy. Low prices that could have been refinanced at today’s low rates. Additionally, super low property tax bill every year.
Timing is everything in life. Some generations are lucky and are in the right place at the right time. Today’s first time buyer isn’t nearly as lucky.
Better yet in very early ’87 _before_ the run up in prices….
At that time you could still find fixer uppers in Turtle Rock and people didn’t drive Benzes and Bimmers all over the place.
The good old times.
Thank you for this excellent and informative post.
Is there a housing market more screwed up in the USA these days than Orange County, California?
The price for a 4 bed, 3 bath at $600K plus continues to be wrong and out of alignment with incomes. The mortgages rates are also wrong at 4.5% to 5%, as it will be close to impossible to sell any homes bought today in 3 or 5 years time, if you have to move (jobs).
Meanwhile, I’m renting and getting my clock royally cleaned by federal and state income taxes because I save and make too much money.
I guess I’ll continue to wait until mortgage rates increase, and home prices subsequently decrease before buying. Then the future looks a little more stable and less risky.
Been renting for the last 4 years waiting for the ridiculousness to end and the floor to show itself. I have my doubts the jokes will ever stop.
Very frustrated, wondering if I’m alone in this view.
No, Mark, you are not alone in this view. Many people feel this way.
But we don’t really exist. We are invisible to the policy makers and to the mainstream media.
Steve, the Angry Renter,
As much as they want to keep the rates artificially low to reinflate the asset bubble Fed’s power to manipulate the market is far less potent than people might think. Fed has already signaled they would wind down their programs of purchasing $1.3T agency MBS and their buying of $300B treasury is fast coming to an end. The ongoing technical (fake) recovery is likely to put even more pressure on Fed to unwind some of its QE measures. The fact is Fed can’t keep holding down rates thru massive purchase of MBS/treasury using monopoly money fresh out of printing press. Yield will go up before inflation actually hits, as any “expectation” of inflation will prompt bond market demanding higher returns. I won’t be surprised to see 30-yr fixed mortgage rate to go back up to 6% range sometime next year after Fed stops buying MBS. Unless – this so called recovery (inventory restocking laced with gov’t stimuli) unravels faster than I thought, and we again face another round of market selloff and asset price free fall.
You are definitely not alone regarding the local housing market frustration. The market will eventually find equilibrium, but it will take time (many years). The powers that be are doing everything to prop up this sick market. Hang in there and keep renting for the time being.
Like you mentioned, anybody who buys today is stuck there for the next 3 to 5 years (and that is assuming we don’t have another big leg down). Currently, even the bulls can’t give you a reason for housing price appreciation in the next 5 to 10 years. So why not wait this market out and rent…it is much cheaper and you are immune to any further gyrations down.
“Very frustrated, wondering if I’m alone in this view.”
I still get frustrated with the whole situation. When I moved to California, I didn’t think I would need to wait a decade to find reasonable pricing… still waiting…
I think it’s a foregone conclusion that the FED will do everything in its power to extinguish the debt, either through depressed rates or some other means. The only question is how succesful it will be.
To be honest I’m beginning to wonder if conservatively waiting it out is the smartest strategy after all. I could have bought 4 years ago, put no money down, done the option ARM thing with no payments, then walked away at no risk whatsoever to my other assets, and saved myself four years of rent. That’s a good 65,000$+ in my pockets.
The worst part is, I think that strategy is still viable (minus the option ARM). I could just completely ignore the price, pay my tax-free interest, and if I just don’t like what happens, I can just walk away.
With some many people default having a bad credit score probably isn’t that bad either. 600 is the new 700.
How could I lose? I’d rather put 5% of my money at risk in the mortgage with a 4.5% payment than put 100% of my money at risk and no payment at this stage.
Doing all this would be completely out of character for me as I’ve been saving 30-50% of my income for almost ten years and hate shenanigans. Oh and potential inflation spikes might put what I’ve already saved off at risk also. Grrrreat.
Man, do I feel like the dumb one.
If it comes to that I’ll just swear off the whole house thing altogether. There’s more to life than buying houses. Just not sure I’m going to win this one anymore.
It’s always a supply/demand equation. That is, if people are willing to pay x for a house, there won’t be any houses available for much less than that. If you aren’t willing to pay the going rate, you lose out.
That is, it doesn’t matter if income ratios, or rent vs. own calculations, or whatever, say prices are too high, if enough people are willing to look past that and pony up the dough.
Not really. Each house is different and what one may pay for one house maybe more or less than he/she would pay for another. However, it is a supply and demand issue which can be skewed by several variables in one direction or another including but not limited to – psychological programing.
Well, surely what people are willing to pay is related to their income, no? Unless ridiculous financing is available – will it be? Can banks and investment firms really continue to act as they did in 2004-7? Even if it’s legal, won’t their desire for long-term viability kick in?
Yup, and there are seven million more home owners who are going to lose their homes because they listened the nonsense you are spouting.
“If you aren’t willing to pay the going rate, you lose out”? Are you serious? Do you think this stuff up yourself?
So, if Joe Stupid is willing to pay $350,000 for some POS, anyone who is not willing to pay $350,000 for the same POS is losing out? There are many folks “losing out” as you so eloquently say, who are waiting and will buy a home for half of what the going rate was three years ago, and much less than the going rate now.
Instead of moderating for personal attacks, the moderators should also moderate for sheer idiocy.
I share your sentiments, however I wouldn’t fret too much about taxes. In my experience, the tax shield of home ownership is greatly overstated.
The most valuable dollar is that which has been through the tax-grinder.
Saving in the new US is no longer a virtue (only them Asian foreigner do that). Taxed at a higher rate today and taxed by inflation tomorrow.
The US has changed the ant and grasshopper to the ant being the sucker and grasshopper the wise one.
A&G <1970's: Ants saved and grasshopper partied then starved to death.
A&G 1980's: Ants saved and took pity for one season on grasshopper, who learned his lesson for next year.
A&G 1990's: Ants saved, Grasshoppers partied, queen ant like the grasshopper music and took all musician grasshoppers in.
A&G 2000's: Ants saved, Big Grasshoppers (GS, AIG, etc) demanded and got a bailout.
A&G 2005-2010: Ants taxed on saving, inflation ate ant's saving, Grasshopper still partying away with the bonus, residual of cash equality withdraws, free rent and walk-away. Small ant demand same treatment of large grasshoppers. Small grasshoppers in debt or BK.
A&G >2010: Ants and small grasshoppers are all slaves of large grasshoppers. Large grasshoppers blame the PRC and India for not spending enough, currency manipulation, being too educated …. New business paradigm: your training is too academic and not enough real world — We can’t do math nor science, but we can sure hen pick on your written English and accent. USA goes into a series of military conflicts to keep the people distracted.
By ignoring the total cost of ownenship and the chance being tanked for long period of time, it seems a good deal.
also it is always good time to buy if you live for long period of time, it sounds familar. My question becomes why I spend $600k to buy apt while I have the opportunity to have a SF at the same price,it is when price comes to value, I don’t think it is the case
Babbling more: The math. is simple, I would pay 18% APR and to have refinancing possibly in the future rather than be locked $600k @ 5% to expect the rate goes to 2%
Paying down a mortgage faster than you have to is generally good advice, but it is the last thing you will want to do if you’re anticipating runaway inflation. If you can lock in 5% for 30 years, why pay back one penny sooner than you have to if interest rates start going up? If inflation returns to earlier levels, you’ll be able to earn 7%, 10%, or more on even the safest investments.
As of last Friday I am an official knife catcher. I went from paying $1425/month for rent to a mortgage of $537 plus $300 HOA plus $151 for taxes and insurance. And it’s a bigger place in a nicer neighborhood (though far from Irvine.)
Yes I might be early, but I got sick of the high rents. We’ll see how it all plays out.
That math is hard to argue with. Congrats.
$300 a month HOA and a $537 payment? Yowza. What does the HOA provide for $300?
Where and how many sf in the old location and in the new location?
By the taxes & ins, ~ <$140k. What do you get for the $300 HOA? $1000 per month and essentially locked in for x years.
The old place was around 700 square feet in a huge development (32 buildings with 8 units per building.) Managed by American Management, I think, and I just couldn’t get them to negotiate on my rent.
New place is 857 feet in a complex of only 32 condos. It was an REO listed at $121,000. I bid $126,500, and beat out all the other bidders. Then it got appraised at $120,000 and the bank agreed to the lower price. Unfortunately the mortgage insurance people said that since the building didn’t qualify for FHA financing that it also would not qualify for mortgage insurance (wtf??), so I had to put 20% down plus another 7k in closing costs. But I qualify for the 8k federal credit (I am poor), so the net cost is only $112,000. Is that really such a huge risk? I hope not.
The HOA is a little high, but they take great care of the property, including the state mandated changes to the freaking pool drains.
If we have another crash I’m screwed, but the rents still seem rather sticky, almost as if the landlords would rather have vacancies than lower the rent.
Do you have any thoughts on reverse mortgages used during retirement? My parents live in a senior complex and I came to find out that this loan product was all the rage in their neck of the woods. Instead of retiring debt, the senior citizens there feel that using this program (and entering into it with the intention of letting the house go back to the bank when they die) was a way of having an affordable place to live for life. I figured that this program, like HELOCs, would have been phased out after the credit crunch. So, I was very surprised when I just read [url=http://en.wikipedia.org/wiki/Reverse_mortgage]the article about it[/url] on Wikipedia. In 2009 and 2008, the loan limits were actually increased. It also says that the owner can never be asked to leave the property. It seems with all of the programs out there — such as the “Aging In Place” program – there is always something being done to extend this. As the elderly who hold reverse mortgages die off, their heirs will be forced to refi or let the house go back to the bank but they have a year to do so. Maybe time will be the only cure to seeing these properties freed back up in the markeplace. If you don’t care about what your heirs receive, although it defies logic, do you think it would be a suitable option to use during the golden years in lieu of owning outright? After all, even if you own, you can’t take the house with you when you die. 😉 I would appreciate your insight on this. Thank you. – SoCal
My concern with reverse mortgages is that compound interest is working against you. Just like the Ponzi Scheme borrowers of the housing bubble, reverse mortgages are a Ponzi Scheme you are betting will not blow up before you die. People who hoped to leave an inheritance end up wishing they wouldn’t live so long as to consume their equity.
I can’t say there is no place for this product, but I will not use one, and neither will my parents.
props to george harrison, the uncredited inventor of the video. he was making these little films to go along with his music, awkwardly like this one, way back in the 70s. i remember a strange little film for a forgotten song called crackerbox palace he showed on SNL. i had not seen this one before, thanks.
a few years later, along comes max headroom and mtv and what do you know…videos..film to go along with the song.