Housing Crisis? How About Buying a House You Can Afford!

Much has been argued about the housing and subprime crisis. It would seem from all the media exposure that the housing collapse came on the heels of some unexpected event. It was not unexpected and many people saw this coming. I’ve learned many things from observing the current market forces at work and that is very few people really understand the concept of living within their means. With access to easy credit and a nonchalant attitude about the future, many people simply mortgaged away their future for instant gratification. All of sudden we start hearing echoes of a full on bailout of the housing market. In fact, we are now hearing calls for across the board rate freezes – flipper and speculator alike. Instead of going after bad behavior, we are rewarding people that took on too much risk. If we are to let the marketplace work itself out, we are already seeing countless unscrupulous lenders going out of business. These people were making inordinate amounts of money by putting people into financially dangerous products. It was a horribly broken model. There is plenty of blame to go around and we will have plenty of time to assign it. The major issue I have with this is what about people that actually had some financial discipline and didn’t play this housing bubble game? Should they be responsible for the actions of a market they didn’t benefit from? Much has been said about the BofA / Countrywide buyout deal. In fact, there has been speculation that BofA bought out Countrywide knowing that they would be able to write off many of their losses. BofA is a very profitable company so having these write offs is simply a creative way to avoid paying taxes on their revenue. Not exactly the definition of a bailout but a clever way to avoid paying taxes; something that is not available to the general public.

These things are rather disturbing and not much can be done considering the magnitude of the housing mess. Take a look at this chart that has been floating around the internet regarding the amount of rate resets we will face in the upcoming years:

Mortgage Resets

A couple of things you’ll notice with the chart. The first thing you’ll notice is that we are in the middle of the worst of the mortgage crisis. 2008 will have a much larger number of resets than 2007 and this will be magnified given that housing is already down. It is also the case that now delinquencies for so-called prime borrowers are now increasing only highlighting my initial premises that all people, not only those labeled subprime have lived way beyond their means.

Don’t get me wrong, housing is one of the best investments you can make over your lifetime. That is if you buy at the right price with conventional financing. I know that may sound simplistic and overly conservative but given that nearly 70 percent of Americans own their home and most of their networth is stored in this singular vehicle, it is important to not rely on only one asset and diversify. Since many Americans are still not diversified in their investments we will see the wealth effect retrench in the next few years as housing and the credit unwinding take their toll on the American consumer.

What can you do if you are looking at buying a house? Should you even consider buying a home in today’s market? This answer may surprise a lot of people but the answer is maybe. Buying a home is a simple proposition based on these few principles:

1. Do you have enough income?

2. What are local lease rates?

3. How is the local economy?

4. Are you willing to stay in the property for a few years?

Let us walk through each one and go a little further into detail why these four areas will tell you whether a home is a good deal or not regardless of all the fireworks or gloom surrounding the housing market.

#1 – Income is such an absolute cornerstone of buying a home that these stated income and no documentation loans simply baffle me. How people were able to get $500,000 loans without any documentation is criminal. But that is an entirely different story. Conventional wisdom has it that you shouldn’t spend more than one-third of your gross household income on housing. So for example, say your household brings in $75,000 per year. Your housing payment should not go beyond $2,083. And this is your combined housing payment including principal, interest, taxes, and insurance. This translates to a home valued at $250,000 or so, a price tag much higher than the national median home price. But you say you live in an expensive metro area? Then you must have an income to meet your targeted price. As many areas such as California and Florida are now realizing housing prices do not always go up.

#2 – This leads us into our next issue, local rent rates. It is not a crime to rent. In fact, in many expensive metro areas renters out number owners. You really need to ask yourself what is the reason for buying a home. If you are looking to flip the home in a few months you will be in for the shock of your life in the next few years. This housing market is in for a major correction. Looking at local rent rates also gives you a safety net and idea of what your home would fetch should you need to rent it in the future. Should money really become a pinch, you can always rent your home and move to a much more downsized place. These are options that people are realizing are important now in buying a home.

#3 – This is such a key factor. With the ease of access looking up data on cities and employment information, there is no reason for you not to know an area. It is important to see vacancy rates, foreclosure rates, is the economy diverse, is population growing, and other key factors that will determine how healthy the economy is poised to grow. If you look at Detroit you will see that the economy is having a harder time than say in San Francisco. These are important considerations in factoring a price of a home.

#4 – The last point is probably the biggest mental shift and the most altering for many people. There was a time when people stayed put in their homes. It would seem that time had come and gone in the 2000s. Given the uncertainty of the current housing market, it may very well be that even taking the above measures, you can still buy a home that may depreciate in the next few years. Can you stay put for sometime? Is this something you can support? If the answer is no you may be better off leasing and waiting till the market recovers.

Finally, buy a home you afford and do it with conventional financing and a down payment. It is amazing how many people seem resistant to this idea but in all other decades, this is essentially how buying a home was done. It was a right of passage that you earned and wasn’t handed to you on a zero down mortgage platter. Given the current, atmosphere it looks like many Americans are going to be forced to live within their means.

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16 Comments on this post

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  1. Flip That House Real Estate Cashflow Game. | 7Wins.eu wrote:

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    June 11th, 2008 at 5:13 pm
  1. Debt Free Revolution said:

    You know, this simple conventional wisdom might just come back into vogue ;) Back in 2001 when I was house-hunting I heard all the “new” wisdom about how I should try for the maximum amount I was approved for…I was “stubborn” and stuck to what I felt I could afford. Having a mortgage note I can easily afford has been a key to turning my finances around this past year!

    January 17th, 2008 at 6:09 pm
  2. mybudget360 said:

    I hope that is the case. It is amazing how the people in a public position are calling for tax rebates to the “poor and middle class” since they are the one’s who typically spend the most. Think about that for a second. Instead of giving everyone a $250 or $500 rebate why don’t we focus on the issue at hand, that many people are simply financially illiterate? We don’t teach basic finance in high school. The media keeps pumping this ideals of wealth with expensive cars and clothing and what does that do to our youth? It clearly doesn’t encourage wise investing.

    Now they want to give money so people can go into further spending. Which by the way is the reason we are here! A credit bubble! We need to educate this country on financial literacy.

    I’m glad you were smart enough to see through the fog of lunacy and bubble housing prices. I think there are many like us who shun debt and try to live debt free and invest conservatively. Hopefully we return to those core values.

    January 17th, 2008 at 9:32 pm
  3. Aaron Krowne said:

    There’s one thing you are very wrong about. We aren’t in the “middle” of the mortgage crisis. Subprime, maybe, but there were a lot more unsound mortgages outside of subprime:

    http://br.endernet.org/~akrowne/econ/charts/07-10-24d_mortgage-resets-comprehensive.png

    January 18th, 2008 at 8:26 am
  4. Courtney135 said:

    We are disciples of our Government spend, spend, print, print you can’t blame individuals with trying to get ahead in life, we can budget all we want but what happens when we lose our jobs, illness, or other unexpected miseries come up, we have to stop being mercenaries for Corporate America it’s too corrupt and eliminate the largest casino (Wall Street) where only the priviledged few can succeed and get back to our monetary system of gold held at Fort Knox. By the year 2027 rolls around Social Security will be $60 trillion in debt and that’s more than the entire Nation’s GDP. So, is their hope to return to core values our grandparents once taught us…I don’t think so…

    January 18th, 2008 at 9:31 am
  5. mybudget360 said:

    You are right Aaron. I don’t even think we can start examining the prime loan problem and the horrific Pay Option ARM mortgages without going crazy. We are only 18 days into the year and now we are hearing talks about $140 billion in tax checks being sent out so people can spend again! Unless the employment sector strengthens and incomes grows, any stimulus package will simply cause more inflation and hurt the US Dollar. Look at what is happening with the mortgage insurers. There is no way they can pay or protect the amount of mortgages that will be going down this year. Inch by inch we are getting closer to a government bailout.

    Courtney, I think there are certain things such as health care that simply do not bode well for the free market. I’m not sure how we are going to approach the issue since each candidate has their own view but it is also a mistake to assume the government and corporations should protect us in every respect. Health care yes but what about corporate welfare? Do you really think a $500 check to a family struggling to make their mortgage is going to right the economy? This happens while companies such as BofA buy Countrywide and save it from bankruptcy to get tax breaks. They are profitable and have income yet they will be able to lower their tax amount by writing off bad debt to protect their actual true revenues. A great deal! They save hundreds of millions while lower to middle class families get $500 bucks to buy trinkets and what not to boost the economy. You are right that isn’t the generation of our grandparents but that doesn’t mean that we shouldn’t fight for these ideals.

    January 18th, 2008 at 10:25 am
  6. FinacialSavvy said:

    As a professional in the real estate industry I am the third party aka: the appraiser. I have watched as the option arm came about and started a housing price increase as people bought more house than they could afford. We still see these teaser ads on the internet and on the tv and listen to them on the radio. Here’s the scenario I’m finding as people get foreclosed upon or they file for bankruptcy. They wanted a house and the realtor who is commissioned sends them over to the loan officer that has no business in financial advise and recently left the used car lot. The LO puts these people into a loan that is what we used to call nutron bomb loans. We saw these during the Carter years aka: negitive am loans where you didn’t even pay enough to cover the interest. So both the Loan officer (commisioned) and the realtor( also commissioned send these people into a house hunt for a property they couldn’t afford unless the double digit increases in housing continued. I was called an idiot by the elite and media types who were listening to the NAR and NMBA when I said we were heading for a crash. Saying I told you so isn’t sweet when it comes to crashes. The conventional wisdom at the time was go with the cash flow. I am an old school type of guy. I pay cash whenever possible and don’t buy anything I can’t afford. I will have my mortgage paid off in another 10 years and its a 30 year mortgage. I pay heavily on non business covered credit. Forget the minimum I go for payoff or the maximum I can afford to pay. So I watch as the ship sinks and the finger pointing goes around. Soon the economy of overspending will grind to a halt, government bail out or not. Because the mentality of I want it now is going to and has already crashed. The US has the highest tax base in the world for manufacturers and business. Thats why everyone is going overseas, lower taxes. Econ 101 showed that a GDP with over 50% based on consumer spending was a economy doomed to crash. Today GDP is based on a 72% rate of consumer spending. But then Washington doesn’t get it either. Service economies do not produce profits. Some one wake me up when the world collapses into chaos due to economic sttrife.

    January 18th, 2008 at 11:01 am
  7. Sven said:

    I agree with Aaron that the Option ARM problem will prove worse than the “subprime” problem. A subprime 2/28 that goes from 6.5% to 10.5% “only” goes up about 46% in payment, whereas an Option ARM payment will have more than doubled from the teaser payment in year 1. And more of the Option ARMs were done as “Stated” for people who couldn’t qualify. While the house values have been dropping, the loan balances have been rising. Some of the subprime people can refi onto FHA loans. Many of the Option ARM people are upside-down & without any hope whatsoever. California will take the brunt of it.

    January 18th, 2008 at 11:34 am
  8. Mo said:

    Amen. Personal Accountability for your actions. Period.

    January 18th, 2008 at 1:47 pm
  9. Roland Carrillo said:

    Wow… personal accountability, responsibility, buying what youc an afford?? What crazy logical thinking… its a sad day when it takes a credit crisis for people to start acting rationally with their use of credit and finances.

    I have been a loan officer for 5 years now and I remember when these things were important in buying a home. I personally am happy to see a return to common sense, even though it will come at the suffering of many. There were too many speculators, get rich quick and crazy homebuyers and owners the last few years. There was also no lack of uneducated, unregulated and unethical players in the mortgage inustry ready to take any loan regardless of benefit to the buyer. They knew one thing… payment sells.

    Many I worked with barely (or did not) understand negative amortization, leverage, credit scoring or other important factors. They sold whatever carried the lowest payment (easy sale) at the highest gain (more profit) without regard to the pros/cons to their clients. I am actually pleased to see these players leaving the field. It was at times hard to compete selling sound financial advice (fixed rates, low DTI, down payments) amongst the clamor for low rate, 100%, stated income financing.

    The option ARM, subprime ARMs and stated income options HAVE THEIR PLACE. They are great tools if explained and used properly. As Aaron and Sven pointed out, the coming Option ARM recasts will likely be far worse. They were sold with the highest pre-pay penatly, LTV and margins in many cases as these costs were not felt immediately by the borrower.

    It was easy to make these loans LOOK far better than 30 year fixed when selling on payment… but 3-5 years later when the owners are 20-30% upside down in mortgages with no options to sell or refinance and payments skyrocketing, they will realize the true cost.

    I hope that people (and the country, the US government is on the same path) wake up and watch their spending/saving habits. Its not just homes, but autos, plasma TVs and vacations that we spend money on with no regard to the future consequences.

    The best outcome will be if we finally make financial education a requirement from K-12th grade and raise the bar for licensing in our industry.

    January 20th, 2008 at 3:15 pm
  10. kenneth said:

    my specialty is international finance, to be more specific, international capital flows. as long as any attempt to increase the money supply worldwide continues, there will be bubbles of some sort manufactured to take up this excess liquidity. the super rich create these bubbles, get in early, sucker the chumps in, cash out, and move to the next bubble. the folks who come in late are left holding the bag. this is a recurring cycle, it has happened many times in the past, and will continue in the future.

    January 20th, 2008 at 7:53 pm
  11. Expat said:

    I have graduated from schadenfreude to evil glee. Perhaps I can hire these “homeowners” as maids and gardeners when I buy their McMansion at auction for 45% of the peak price?

    You see, I have been renting for all these long years. And doing this bizarre thing called “saving”. Can you even guess how much I was laughed at for my stupidity all these years?

    January 20th, 2008 at 9:21 pm
  12. Max said:

    Housing Crisis? How About Buying a House You Can Afford! is a quite interesting post but quite difficult to understand for me -

    February 17th, 2008 at 11:30 am
  13. Karan said:

    I found your blog via Google while searching for casino game manufacturers and your post regarding Housing Crisis? How About Buying a House You Can Afford! looks very interesting to me. I just wanted to say that the quality of your site is exceptional. On top of all that it really complements the content that is provided by your site.

    February 22nd, 2008 at 3:29 am
  14. neighbourhoods in Toronto said:

    I’ve just read an article where the author stated that the crisis was unpredictable and it caught economists by shock. I like your opinion better and I think it is more realistic and well-founded. I agree that housing is one of the best investments we can make over our lifetime, if we buy at the right price with conventional financing. However, I don’t think that the situation in today’s market is suitable and even with your great advice, it would be an unwise decision to buy a house now. Here in Toronto neighbourhoods supply raises and demain declines. I am convinced that best thing to do is just wait.

    February 25th, 2008 at 2:53 pm
  15. Angie said:

    I think the most important step is to be realistic in what you can and cannot do. I’ve seen so many first time home buyers jump into something they cannot afford only because they have big dreams.

    March 5th, 2008 at 10:59 am

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