Buy now?

[Steve Beebo]

Perry –

If someone is renting right now, I’m not suggesting that they rush out and buy a house or condo. Certainly, they could get a better deal next summer or the summer after, even if prices were only to slip a little. I’m just saying that they need to buy at some point, because in the long run, it’s better to have a mortgage that you are hopefully paying down, eventually to zero (assuming the mortgage can be afforded). The strategy of renting now, and investing the difference can work in theory, but the reality is that Americans as a whole, whether they are renters or property owners, really don’t save very much, and some renters will not actually be investing and saving the difference.

[VCJIM]

I agree Beebo, the “enforced savings” of a house is very good for many people. I think few actual put the difference between renting and buying (right now) into savings or investments. Also, moving is expensive. The stability of a home, preventing someone from moving every few years, is generally a positive.

[carlislematthew]

The strategy of renting now, and investing the difference can work in theory, but the reality is that Americans as a whole, whether they are renters or property owners, really don’t save very much, and some renters will not actually be investing and saving the difference.

I completely agree, except that I would say that it’s “most” renters that don’t save the difference and not just “some”. On this forum we’re the exception. Most people will see the extra income and just spend it! New car, big TV, and so on. A mortgage payment is a forced saving mechanism, and if you don’t “save” you lose your home, go bankrupt, and so on. There is no equivalent motivation for saving in a bank account. No, the future is not motivation enough for most. 🙂

I have to add that people in this country seem to be generally bad at managing their money. I’m from England originally and over there you get paid on a monthly basis, and a lot of bills are quarterly and not monthly like they are in the states. When explaining this to to my new American co-workers, they were amazed that you could live like this! The surprise was that you could easily just spend all your paycheck in one week and then have nothing for THREE weeks as opposed to spending all your paycheck in one week and then only having to scrimp for ONE week! It’s a sad fact that most people live paycheck to paycheck and so things are made easier when the paychecks are closer together.

Honestly, I’m waiting for the day when you get billed daily through some kind of low overhead “micro billing” system. Paychecks would have to move to this kind of system too. It might not be a bad idea actually – it would prevent people feeling rich when they got paid, when in fact they’re as poor as they were the day before.

[PerryChase]

Beebo, you make a great point about not saving enough.

The problem is that with HEW/MEWs & HELOCs, people are not saving anyway. The savings come from appreciation (not from paying down debt), but as well all know, many have already spent that appreciation by cashing out. If debt is not paid down, the “forced savings” you’re alluding to is illusory.

Public policy should be to encourage/teach the public to save, not to buy overpriced assets.

Assuming housing prices stay constant for the next 3 years, a middle class family in San Diego could save enough to pay for the college eduction of a child by opting to rent rather than to buy. They could then buy in later years when prices are sane. I wish the public would carefully consider their options rather than blindly follow the herd.

[JES]

Perry – That is exactly what I am doing myself. I was in a 7 year interest only ARM and sold earlier this year. I’m now earning 6%+ on my proceeds and sending the earnings into 529 plans for my kids and maxing out our IRAs. I caught flak from family for selling and people generally considered me a fool at the time. Even when I explained about the college and retirement savings I received no love.

Further validation that I made the right decision came this week in the form of a reduced price on my old neighbors house. It is directly next door to the one we sold, 150 sqft. bigger with similar upgrades and is now selling for $100,000 less than our sales price.

[PerryChase]

carlislematthew, your comments make me recall a situation when I was a financial manager for a company where I proposed that we have monthly pay for salaried employees and bi-weekly pay for hourly employees to save the trouble of weekly payroll processing. I proposed that we pay IN ADVANCE, then adjust differences in arrears as necessary.

I had a revolt and we had to scrap the proposal. Can you imagine that people did not like to be paid IN ADVANCE (like getting paid on the 1st of October for the whole month of October)?!

With that kind of logic, I’m not surprised that our politicians and businesses can pull the wool over our eyes.

[carlislematthew]

I had a revolt and we had to scrap the proposal. Can you imagine that people did not like to be paid IN ADVANCE (like getting paid on the 1st of October for the whole month of October)?!

Wow. I guess this points to the admission of these people that they would be less able to manage their finances if you made the change? Did the employees give a reason why they didn’t like the proposal? Please don’t say it was “we don’t want to get paid less”!

[Anonymous]

Rules of thumb for media.

The back and forth between Perry and noone was good, but if someone as thoughtful as noone forgets to include important parts of the make vs. buy analysis (e.g. opportunity cost of down payment), I think we can all understand that others are likely making financial decisions in the dark.

Now that some in the industry are arguing that the market is getting back to “normal,” I’m reminded of some rules of thumb from many years ago, when things were “normal.” If there are any journalists reading, you can probably repurpose some stories from ~25 years ago with the following rules of thumb:

1. Don’t buy a house unless you plan to live in it for at least 7 years. Otherwise, there’s a good possibility you won’t make up for your closing and other transaction costs. Noone’s analysis above more-or-less cooroborates that this is in the ballpark.

2. Don’t spend more than 25% of your after-tax income monthly on housing. Otherwise, you won’t have enough money to have a life, let alone a safety net. This was later raised to 30%, I believe in the late 1980s or early 1990s.

3. The full monthly cost of owning a house is roughtly 1% of the price of the house. This should be the starting point for your rent vs. buy analysis. This includes mortgage payments, taxes, insurance, maintenance, lost opportunity cost of down payment, tax benefits, transaction costs, etc. Don’t be blinded by one or two financial benefits of owning a house, e.g. tax benefits or “throwing away money,” without considering all dozen or so factors. Perry’s analysis above more-or-less corroborates that this is in the ballpark.

—-

There are some reasons why these rules of thumb might be too conservative for this millenium. On the other hand, there are other arguments why these might not be conservative enough given the current environment. Taken together, I think all-in-all they’re probably good for their purpose as rules-of-thumb. On the one hand, for example, real estate had been going up faster lately. And, the market might be more competitive in some regions because of a larger population and easier credit. On the other hand, from about 1980 to 2005 (25 years), interest rates had been almost consistently decreasing to a point (~1%) where they realistically couldn’t go any lower. Also, the baby boomers for the past 25 years have been in their peak money making years. Beginning in 2008 (2011?), they’ll be retiring in larger batches.

Even if the (7, 25, 1) rules-of-thumb aren’t the exact numbers, having similar rules-of-thumb would be helpful for many people. And, debates about the exact figures could more easily be translated to have mass appeal. Worth having as a separate, new forum topic?

[powayseller]

A good friend of mine, a realtor, said now is a good time to buy, because months supply is over 6, meaning it’s a buyer’s market. There you go, it’s a good time to buy! (Never mind that prices will keep dropping as months supply rises from today’s 10 to 15, 20, even 25 or beyond, and prices will keep dropping.)

[Steve Beebo]

Perry –

You’re right that a lot of people have spent their appreciation. You wouldn’t believe how many people I see who have say, bought a house in Clairemont 10-15 years ago for $150,000, which is now worth $500,000, but the problem is they owe $400,000 on it. You look around the house, and they sure haven’t put the money into their house. Where did it go? Hopefully into something partially constructive or productive, like a college education or into a business, but they most likely just blew it.

[powayseller]

I talked to a guy in his 50’s, who said his house is going to be his retirement. He wants to sell it in 5 years. We’ve probably got millions of Americans who spent all their equity (as Steve explained), got the bigger loans to prove it, and are thinking the appreciation will continue to fund their retirement. We’re going to have a wave of bankruptcies and very poor elderly.

[Anonymous]

Yep, you’re right, PS.

A thought that I’ve always had is that Social Security has done nothing but break down the relationship between generations: I don’t inquire as to my parents’ finances because I pay my taxes and my taxes go to my parents (in the form of Social Security).

But, as Bernanke has been strongly pointing out, we’re going to have to make choices: higher taxes, lower benefits, pushed out retirement age, etc., because the numbers just don’t add up.

I think that we should scrap Social Security, means test it (i.e., only for poor folks), and call it welfare. I’m happy to be responsible for my parents, instead of the government being responsible for my parents.

[Anonymous]

Hello,

New user here. Though I’ve been skulking around for a bit.

What I have found interesting about this thread is that there is, after a fashion, a paradigm shift affecting even those talking sensibly about real estate. Somehow, and I don’t know when, houses have become commodities rather than staples like milk, eggs & bread. Yes, property has always had it’s place in the average families wealth creation. Houses during my formative years were a means to an end, and any focused discussion about ‘investment’ potential, would have been viewed as outright strange. A house was where you raised a family and slowly built up some equity. It gave you security and pleasure – not a lottery ticket.

But the real point I’m trying to make, is that even though a number of people (including me) wish to return housing to it’s rightful place as a home rather than an investment, the paradigm has shifted beneath our feet. The 20% down – 30 year amortization mantra is now poised as the pinnacle of responsible borrowing and a prudent standard. Thus, without even realizing it, our thinking inflates prices.

To myself, a 30 year obligation is a statement that someone is either very young (& understandably stretching themselves but optimistic that their income will grow to fill the gap) or very reckless. The interest differential on a 25 versus a 30 year amortization is staggering.

For those individuals looking at a house that requires 30 years of payments, quite frankly, you’re out of your league. The simple and implicit answer is: No, you cannot afford it.

Borrowing, per se, isn’t bad. But the amortization is a killer. I’d suggest that the goal should be 20 years – or less if you can manage it. Taking on debt is child’s play – reducing it is the work of a lifetime.

As I see things, the issue which transcends this boom is not how much we can borrow. But for how long? And why?

[PerryChase]

I agree with you jg on social security. In my view, retirement simply means waiting for death. That was fine when life expectancy was low.

I plan to work for as long as I’m healthy enough. I may not work full time, but work I shall.

[Anonymous]

Haggis, you made an interesting comment. Only when I moved to the US did I hear about 30-year loans. In France, the standard is 15 or 20 years. I do not know anyone who has a 30-year mortgage in France. Since I moved here, I bought 2 properties, 1 in FL with a 30-year mortgage, sold it when I moved to NYC, and a second one in NYC with 5-year fixed and 25-year adjustable, just sold when I recently moved to San Diego.

My point is that I was never offered a 15-year mortgage when inquiring about loans, I had to ask to get the information. People just assume that you will get a 30-year mortgage. This was probably necessary when housing was overvalued in the recent years, but I think a fair price should consider the payment on a 15 or 20-year mortgage, not a 30-year one.

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