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:
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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