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
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….