Interest rates are artificially low and we won’t see rates this low for a long, long time. What are your thoughts on buying vs renting for a first timer? In my gut I know that housing is still overvalued, but should I jump on low rates and lock in a fixed payment knowing that future inflation will make this payment even smaller?

Most people do not pay cash for their homes, they get a mortgage. And the monthly payment they can afford, along with the current interest rate determines how large a mortgage they can qualify for.

Lets do some back-of-the-envelope calculations. If you can qualify for $2,000 a month (lets  ignore principle, taxes and insurance for now) and rates are 5%, you’ll qualify for approximately $480,000 worth of mortgage. If rates rise to 6%, you only qualify for $400,000 worth of mortgage.

Did you see how a 20% rise in interest rates caused a 17% decline in the amount of mortgage you would able to qualify for?

If your income isn’t going to increase 20% over the next 2 years, but rates might rise 20%, less people will be able to afford homes. So the pool of available buyers for our $480,000 house has become a lot smaller and demand drops off. According to economic principles, as the demand decreases, prices should decrease as well. Thus, the price should drop to $400,000 to match the purchasing power of buyers.

Additionally,  the banks have unsold inventory sitting on their books – in many cases they haven’t even foreclosed on people who stopped making their payments a year ago.

So we have a scenario where the number of homes on the market is likely to increase or stay flat, interest rates are going to increase, and incomes aren’t going anywhere.

The only reasons you should be buying a house right now are

1. You’re starting a family, don’t want the hassle of moving and can afford a reasonably large house which you will live in for several years
2. You can afford to pay cash and don’t care where the market is going
3. You have specialized knowledge of the markets and can get a much better deal than your local home buyer. Real estate investors will be able to take advantage of the current environment to buy cheap homes that generate positive cashflow.
4. You have a stable job, expect to be in the same place for several years and don’t want your landlord telling you that you can’t paint the living room bright pink

In short, don’t be mesmerized by the tales of real estate agents and Realtors telling you that interest rates will go up and price you out of the market. Only a booming economy with people falling over themselves to buy houses can do that. It may seem like people are out buying homes, but its a temporary phenomena created by all the government to stimulate the housing market. When this stimulus ends, homes prices will probably drift down by the same amount. On a similar note, ZeroHedge has a good article on how dropping homes prices are inversely correlated with rental rates, something I have not been able to verify with my properties!

Only buy a house if you have a good reason to buy one. Don’t get suckered in to it.

At some point we will see inflation, but it’s next to impossible to figure out when.

Related Posts

• June 12, 2009 -- Is It Time To Buy Real Estate?
• February 24, 2010 -- How To Avoid Foreclose: Humor
• May 25, 2009 -- How To Avoid Foreclosure
• April 20, 2009 -- In The Market For a Condo? You Can’t Afford It!
• April 12, 2009 -- Real Estate: No Bottom Yet?
• March 30, 2009 -- Home Ownership: A Marketing Scam?
• March 26, 2009 -- 30 Year Mortgages At 4.85%!

Millions of Americans are now deeply underwater on their mortgage. If you’re among them, you need to stop living in a dream world and give serious thought to walking away from the debt.

No, you shouldn’t feel bad about it, and you shouldn’t feel guilty. The lenders would do the same to you—in a heartbeat. You need to put yourself and your family’s finances first.

If you are reluctant to give up on “your” home, realize that it isn’t “yours.” If you are in negative equity, it’s the bank’s home. You’re just renting it. And right now you may be paying way above market rates. You need to be ruthless about your cash flow.

Still, when it comes to the idea of walking away from debts, many people are held back by a sense of morality. They feel it’s wrong to abandon their obligations. They don’t want to be a deadbeat.

Your instincts, while honorable, are leading you astray.

The economy is fundamentally amoral.

Whether we like it or not, walking away from debts is as American as apple pie. Companies file for bankruptcy all the time, and their lenders eat the losses. Executives and investors pocketed millions from the likes of Washington Mutual, Lehman Brothers and Bear Stearns when the going was good. They didn’t have to give back one cent of that money when the companies went into bankruptcy.

Wow, I’m speechless. It seems the greed of Wall Street has permeated down to the lower rungs of society and it’s perfectly okay to socialize your debts and losses. (By socializing, I mean the bank or taxpayer or a large group of people who are not affiliated to you end up paying for your debts/losses/mistakes/greed). Apparently its as American as apple pie. Is this the change I didn’t vote for? If everyone in all sections of society thinks its perfectly okay to default on your obligations, logically, the next question is

How much longer until the US Government starts defaulting on its debts?

Of course, the US Government cannot default, since it can keep printing US Dollars to pay for its debt. Which it is already doing. The only problem is that this increases the number of dollars in circulation and causes the currency to devalue. Sooner or later, we’re going to see a large of amount of inflation. No we may not see hyperinflation like Brazil or Zimbabwe, but we sure might see 10-12% inflation for a few years.

But 12% inflation for only 6 years would cause the price of everything to double. If you don’t think that’s possible, just look at a country which isn’t currently in deep recession, like India. Inflation in India is currently running at 9%. And over the past decade it has been running at a similar rate.

So what’s the effect on the average Indian? Highly skilled workers saw their salaries jump 10 times, while salaries for unskilled labor is up about 5 times. So everyone is better off, right? Not exactly, people living on fixed incomes basically got screwed as prices for everything else went up 5-10 times as well. It was great if you owned real assets like real estate, gold and to some extent stocks, but terrible if you owned bonds or cash. Just make sure your investments are tailored towards those investments that happen to do well during inflationary times.

Related Posts

• September 15, 2009 -- The Recession Is Over, Unemployment Expected To Rise
• May 26, 2010 -- US Debt Breaks $13 Trillion
• January 25, 2010 -- Venezuela Devalues Its Currency
• January 19, 2010 -- Suzie Says “Pay Off Your Home Mortgage”
• September 22, 2009 -- The Sun Sets On Dollar Supremacy
• September 10, 2009 -- Weekly Round Up Of Interesting Articles
• August 21, 2009 -- Buffett Finally Admits the Dollar is Doomed!

Tue Feb 23, 8:17 am ET

MOSCOW, Ohio – An Ohio man says he bulldozed his $350,000 home to keep a bank from foreclosing on it.

Terry Hoskins says he has struggled with the RiverHills Bank over his home in Moscow for years and had problems with the Internal Revenue Service. He says the IRS placed liens on his carpet store and commercial property and the bank claimed his house as collateral.

Hoskins says he owes $160,000 on the house. He says he spent a lot of money on attorneys and finally had enough. About two weeks ago he bulldozed the home 25 miles southeast of Cincinnati.

Ok, there’s nothing really humorous about this. But I thought it was a great story about getting back at the bank. Banks are notoriously difficult to deal with and after accepting billions in bailout money from the taxpayers aren’t really modifying very many loans. If you think that people who default on their mortgages are scumbags and deserve to lose their homes and that banks are just faultless victims, check this link about a foreclosure attorney who tried to help a couple modify their loan. Actually, regardless of what you think about banks or borrowers  you should still read the article. It’s very interesting.

Related Posts

• May 25, 2009 -- How To Avoid Foreclosure
• April 12, 2009 -- Real Estate: No Bottom Yet?
• December 23, 2008 -- 10 Worst Real Estate Markets In 2009
• November 28, 2008 -- Hitler: Real Estate Only Goes Up!
• June 24, 2008 -- Help! I’m Losing My Home To Foreclosure
• February 8, 2008 -- Forclosure In The Neighborhood
• February 7, 2008 -- Residential Housing To Drop Another 25%

Even Jim Cramer jumped on the housing recovery bandwagon and declared that June 30th would be the bottom! As I mentioned before in Are Jim Cramer’s picks worthless?, you shouldn’t be taking your investment advice from him. I don’t know what sort of crystal ball he has, but his track record isn’t very good. Besides, people who can predict the future (like David Einhorn) tend to invest for themselves and not make broad public statements.

Home prices may be fairly valued, but whenever you have a bubble of huge proportions, valuations do not simply revert to the mean, they overshoot it and become grossly undervalued.

A lot of people have been reporting that housing is rebounding. Here’s an excerpt from Reality Times dated June 9th.

The big economic news for housing this week is all about sales.

Housing sales and pending sales contracts are up, dramatically in some markets, and a rebounding real estate sector could soon start stimulating the broader economy.

Even Federal Reserve Chairman Ben Bernanke told Congress last week that essentially the worst is over, the housing market is stabilizing, and we’re heading out of recession in the second half of the year.

…

In a handful of major markets, closed sales also are moving up sharply. In Las Vegas, sales jumped by 36 percent during April – the highest in two years, according to MDA DataQuick researchers.

…

Meanwhile, low prices nationwide, combined with mortgage rates at near-record lows, have pushed the National Association of Realtors’ Affordability Index into record territory.

…

But here’s a little sobering news: It’s becoming increasingly clear that low mortgage rates are not going to be around forever. Average thirty year fixed rates took their biggest jump in half a year last week on bond market jitters.

With everyone and their real estate agent being confident about the housing rebound, I can see how its easy to get sucked into the belief. Let’s go through the points step by step.

The Fed Chairman didn’t know that we were in recession until almost a year into it. On the other hand, some people did get it right. He also didn’t know that lowering the interest rates below the real rate of inflation would cause a spike in asset prices creating the largest bubble in history (to be fair, it was a different Fed Chairman).  Given the poor track record, why should we believe him now? Part of his job is to maintain the world’s faith in the US dollar (and by extension the US economy) and another part is maintaining consumer confidence in the US economy. By being bullish on the economy, he’s only doing his job! Since he always needs to project a bullish facade, he isn’t a reliable source of bullish information.

Home sales have jumped in many markets. However, by itself the number of sales is not an indication of a housing bottom. Basic economic principle dictates that when prices fall, demand increases. At a certain price, there will be a strong demand for housing. The question to ask is whether houses can be built (or rented out) profitably at this price.

There is also some evidence that the median home prices are increasing in some areas as well. However, there is no median home size information included with this data.  If more large homes are being sold, the average home price will increase. You can read a more detailed explanation at Minyanville, but here’s the gist of it:

And as price discovery works its way through well-to-do areas, the mix of homes sold will continue to revert to more expensive sales, pushing up median- and average-sales-price data. This dynamic will present the misleading conclusion that the country’s housing market is recovering, even as actual prices continue to fall.

On top of that, the unemployment rate keeps increasing every month. Yes, the second derivative is positive which means the rate of job loss is slowing, but it’s still a negative number! Read this article at FiveThirtyEight about why a decrease in the rate of job loss is nothing to celebrate.  Additionally, its becoming more difficult to obtain a home mortgage. This two reasons alone are causing the pool of potential home buyers to shrink, which results in a lack of demand.

The few people I know who are buying foreclosures or REOs at 40% discounts to current market price are paying CASH for investment homes. But how many people have $150,000 lying around? The savings rate in the US was ZERO for many years. In the past year it’s increased to about 8%, but that only leads to lower consumption, a lower GDP and in turn more layoffs. And as investors pay $150,000 for homes listed at $250,000, this exerts a further downward pressure on prices.

So when is a good time to buy?

When the media stops reporting about the recovery and starts telling you that real estate is a lousy investment, that’s probably a good time to start buying.

Right now, I think people are still too bullish.  However, that being said, if you can afford to pay cash or can find a really cheap house or even a manufactured house that rents for twice the mortgage payment, it would probably make a good investment. But on the whole, I would wait.

Related Posts

• April 7, 2010 -- Should I Buy A House and Take Advantage of Low Interest Rates
• February 24, 2010 -- How To Avoid Foreclose: Humor
• May 25, 2009 -- How To Avoid Foreclosure
• April 20, 2009 -- In The Market For a Condo? You Can’t Afford It!
• April 12, 2009 -- Real Estate: No Bottom Yet?
• March 30, 2009 -- Home Ownership: A Marketing Scam?
• March 26, 2009 -- 30 Year Mortgages At 4.85%!

But could he have avoided foreclosure?

I think so. Let’s review some of the financial mistakes he made. The real ones, not the excessive spending that set in once he stopped making house payments!

1. He divorced his wife of 21 years

This is always grounds for economic disaster. No matter who you are, the longer you stay married, the more it’s going to hurt you financially.  If you are going to divorce, do it like Tom Cruise and get out before the magic 10 year mark or before you have kids.

2. He paid almost 2/3rds his net income in child support

Ouch! Paying $4,000 in alimony and child support when your net income is $6,777 is a lot. Effectively, his take home income is $33,000 per year or about $16/hour. I think most people on that wage move back home to their parents basements.

3. He bought a house he couldn’t afford

If there’s one major recipe for disaster, it’s buying a $500,000 house when you’re only taking home $16/hour.  He really should have known better. But then again, he outsourced the analysis of his finances to his mortgage broker instead of doing it himself.  He was set up to fail from the beginning. I’m sure his broker knew in the back of his mind there was a chance Ed would face foreclosure at some point. But Ed really should have bought a cheap house instead.

4. Not spending enough time understanding the most expensive purchase of your life

A home mortgage is the most complex financial transaction you’ll probably ever undertake. So it’s easy to blow it off or let some one else do the heavy lifting for you. However, the mortgage broker doesn’t necessarily have your best interest at heart. They get paid on commission for every loan they close and are directly incentivized to get you into the largest, most outrageously expensive home loan possible. There is a tremendous conflict of interest and you should not let them dictate what you should do. Many people claim that a home loan is just too difficult too understand. True, but only if you don’t take the time to understand it.

I strongly recommend Randy Johnson’s stellar book How to Save Thousands of Dollars on Your Home Mortgage. If you don’t know what Yield Spread Premium (YSP) or Paid Out of Closing (POC) means on a HUD-1 you definitely should read this book. If you own a home and don’t know a HUD-1 is then get your spouse to smack you and then go buy the book! I promise you’ll save thousands of dollars on your mortgage.

Just in case, you missed that last paragraph, BUY THAT $12 BOOK ABOUT SAVING THOUSANDS OF DOLLARS ON YOUR HOME MORTGAGE. You should buy it before you buy a house, before you even think of buying house, maybe before you even graduate from college. If you’ve already read it, you should buy a dozen copies of the book and gift it all your friends, co-workers, in-laws, cousins, nieces and nephews for Christmas. Unless you hate them.

The best way to prevent foreclosure from happening to you is to buy a house you can afford with a mortgage that is the cheapest over the life of the loan. That may mean paying extra points to buy down your interest rate, which means the cheapest loan is not necessarily the loan with the lowest closing costs. Learning about your finances, and how mortgages actually work is probably the best way to save money in the long run.

Related Posts

• February 24, 2010 -- How To Avoid Foreclose: Humor
• January 19, 2010 -- Suzie Says “Pay Off Your Home Mortgage”
• April 20, 2009 -- In The Market For a Condo? You Can’t Afford It!
• March 26, 2009 -- 30 Year Mortgages At 4.85%!
• May 26, 2010 -- Sweeten Your Returns With Chocolate Dividends
• April 7, 2010 -- Should I Buy A House and Take Advantage of Low Interest Rates
• February 16, 2010 -- Get 5% Cashback on Travel