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EJ
01-23-07, 04:00 PM
How much house should you finance? Follow the 20/28/36 rule.

A few months ago I wrote How Much of Your Car Should You Finance? Zero percent (http://www.itulip.com/forums/showthread.php?t=634). I criticized an article in another publication advising readers to finance 100% of a new car, a depreciating asset, with debt. I advised you to buy the smallest, safest used car you can afford to buy with cash–a "shitbox"–rather than a new car you need to borrow money to buy. If you don't have the cash to buy a car that meets your safety standards, then finance as little of a more expensive, safer car as possible.

Taking on debt that does not increase your net worth long term is self-inflicted slavery. You are putting a lien on your future income. Mortgage debt–debt secured by the value of your home–is a better form of debt because as of 1986 tax on mortgage interest is deductible. Still, there is a limit to how much mortgage debt is financially good for you, and the name of the game is still: get rid of the debt.


http://www.itulip.com/images/shitbox.jpg
The new symbol of wealth: cars you can buy with cash, like this.

http://www.itulip.com/images/beemer.jpg
The old symbol of wealth: cars you cannot buy without debt.

http://www.itulip.com/images/2006-infiniti-fx35-awd.jpg
In case you're curious, my politically incorrect car. If you stick to buying cars with cash,
with the money you save by not paying interest, eventually you can buy new with cash.


Today I received a note from an iTulip reader who is a lender based in Chicago (thanks, Andrew). He points me to an article that really got me going. Typical advice on how to purchase too much house, way too much. Today's column by Jack M. Guttentag, The Mortgage Professor (http://finance.yahoo.com/expert/article/mortgage/13600), says:
Facts are facts: Sometimes, you’ve got less cash on-hand than you’d like. Should you use your cash to pay points – or utilize it to make a larger down payment? Let's discuss this thorny question.

A reader writes: "I’ve been shopping on-line for a 30-year fixed-rate mortgage. All the sites ask you how much you want to put down, and all offer different combinations of interest rate and points. I have cash of only $15,000 to apply to either down payment or points on my $500,000 purchase, but obviously I can’t use it for both. Where do I get the biggest bang for my buck?"

The Dilemma of Down Payment vs. Points

Using your cash to pay points lowers the interest rate. (Points are upfront payments expressed as a percent of the loan). Using your cash for down payment reduces the amount you must borrow, and might or might not reduce the rate on the second mortgage if there is one, or reduce the mortgage insurance premium if there isn’t.
Whoa. Hold on a minute, professor. Let's start by asking whether someone with only $15,000 available for a down payment can afford a $500,000 mortgage. That $15,000 represents a 3% down payment. It should be 20% or $100,000 for a $500,000 home. If your reader only has $15,000, he can afford a $75,000 condo.

How do I know? Let's go back in time to the days before the Frankenstein Economy (http://www.itulip.com/frankensteineconomy.htm), when accountability between lender and borrower was personal versus "transaction based." If you're looking for a "New Era" catch phrase to justify today's credit bubble the way "public venture capital" was thrown around toward the end of the technology stock bubble in the late 1990s, "transaction based lending" is it. What nonsense, as if "transactions" didn't occur when loans were made before the era of indiscriminate securitization. Lenders ran out of credit-worthy borrowers in the Frankenstein Economy and started to lend $500,000 to people with only $15,000, or $500, or nothing saved for a down payment. The banks, in the process of hedging the added default risk they took on when making these loans, versus the pre-securitization era when they lent money only to borrowers with sufficient savings and income, crudded up the financial markets with Risk Pollution (http://www.itulip.com/riskpollution.htm).

Here's how a HomeStrength loan is sold on the GMAC Mortgage site (http://www.gmacmortgage.com/Purchase/Buy_Your_First_Home/Loan_Programs/downPayment.html):
Have you been putting off homeownership because you haven’t saved enough for a down payment and closing costs? Thanks to the HomeStrength plan, you can stop saving and start shopping today.

The program provides a second loan for up to 4% of the property value, which you can use for the down payment and closing costs. All you need to contribute is $500 — your financing covers the rest. And the best part? The second loan requires no monthly payments and is completely forgiven after 10 years of on-time mortgage payments.
I don't have anything against poor people owning homes. I was too poor to own a home when I got out of college, but it did not occur to me to try to buy a home with 3% down, even if lenders existed in those days who were been stupid enough to lend me the money to buy it. Why? Because that would have exposed me to unnecessary financial risk. It's fun to think the laws of finance have been repealed and that, as in 1999, "it's different this time." But it isn't.

Here's the time-tested, it's not "different this time," standard 20/28/36 rule for mortgage affordability:
Down payment 20%
Monthly mortgage payments will not exceed 28% of your gross annual income
Your total monthly payments for all debt including your mortgage payments will not exceed 36% of your gross annual incomeHere's a handy calculator (http://www.bygpub.com/finance/MortgageRatioCalc.htm).

The name of the game is not to maximize how much home you can buy with the most money you can borrow as carelessly as a bank will lend it. Just because a lender is stupid doesn't mean you have to be. The lender doesn't care how stressed out you get trying to make a bigger mortgage work, just as a used car salesman doesn't care if he sells you up to a tricked out version of the car you went into the dealership to buy so he can earn a bigger commission. They don't care about you. So don't listen to them. The name of the game is to build as much equity as quickly, comfortably, and safely as possible.
Home equity as the primary source of wealth in the U.S. However, when asked to rank sources of wealth for affluent households by the June 2001 ORCI survey, only four in ten Americans (40%) correctly identified equity in one's home as the most important source. "Contrary to the belief of many, those with modest incomes can, over time, build wealth," noted Stephen Brobeck, CFA's Executive Director. "The easiest way to do so is to buy a home, faithfully make the mortgage payments, and be cautious about borrowing against the accumulating home equity," he added.

Americans Underestimate Household Wealth (PDF) (http://www.americasaves.org/downloads/www.americasaves.org/PressReleases/07.16.01.pdf)

http://www.itulip.com/forums/../images/firsthouse.jpg
Affordable first house. Buy with pride.

http://www.itulip.com/forums/../images/notfirsthouse.gif
Unaffordable first house. Your lender loves it.


Step 1: Buying your first home*. Buy a modest house as soon as you can. That means a house that's not as nice as the one you grew up in, and one that needs some work. But you're young and smart. Swing a hammer. Slop some paint. It's one that you can afford using the 20/28/36 mortgage rule. Park your shitbox proudly in the driveway. Consider a variable rate mortgage that doesn't adjust for seven years. You may find it cheaper than a fixed rate 30 year mortgatge. You're going to move in four to six years anyway–this house is just a way to get to the house you want but can't afford yet. No, not some suicide loan with a teaser rate that adjusts after the second full moon in the first year of the dog or whatever. If you are smart enough to be reading this but can't understand a loan you're offered then it's garbage. Don't buy it. Good loans are easy to understand.

Buy in a town with a good school system if you can because the price will tend to hold up better during inevitable real estate downturns. Don't buy a house at the top of the market in a lousy neighborhood. During the mid-1990s housing downturn in Massachusetts, for example, homes in towns with good school systems declined 10% versus as much as 80% in towns with a weaker tax (income) base. You'll find yourself waiting ten years or more to break even. If you buy in a higher average income town at the top of the market, as occurred in most areas of the US in the middle of 2005, you will find yourself underwater–that is, your mortgage is greater than the value of the house–but you won't have to wait as long for the price to recover than if you buy a bigger house in a lower average income town. If you don't mind the minor inconvenience of managing a tenant or two, I recommend a two or three family house as a first home because your tenants will pay between 50% and 80% of your mortgage. That means you earn equity and save for your next home faster and can live in a better home than you can if you have to cover the whole mortgage yourself.

Step 2: Buying your second home. Four to six years later, sell the modest house and use the profit as a down-payment on your first good house. Again, look into an adjustable mortgage that stays fixed for seven years.

Step 3: Buying your third home. Four to six years later, sell the good house and use the profit as a down-payment on a great house. Take out a 15 year fixed rate mortgage and pay if off in ten years.

Using this method, by age 50 you'll own a great home free and clear, while riding the real estate cycle up and down and without having to win the lottery.

What not to do:
Nothing. Wait for money to fall out of the sky. As you can see, the process takes time. Starting a 20 plus year process works better when you're 25 than when you're 40. (See coveat*, below.)

Buy more house than you can afford using the 20/28/36 mortgage rule. I know plenty of people who have violated this rule, been house poor for a while and grew into it because the industry they were in did well, and as a result have done well by taking this risk. But they were lucky, and while luck is always welcomed it's never to be counted on. Residential real estate has increased since 1900 at the rate of inflation. Period. The exceptions were the period following WWI when massive pent up demand for housing hit the market when Johnny came marching home, hurrah. The other was the 2001 - 2005 housing bubble caused by low interest rates. Neither are repeatable events. The baby boomers got two "free" rides, although only time will tell how much the housing bubble will ultimately cost. Don't count on another.
Purchase a suicide loan, liar loan (http://www.itulip.com/glossary.htm#Liar_Loan) or other horrific loan product. (These are soon to be nixed by regulators, anyway.) If you can't afford a home with a fixed rate mortgage or a seven year adjustable on the 20/28/36 rule, look for a smaller house or condo or wait until you've saved more money and your income is higher.
Consume your home equity. Never. Ever. Ok, almost never. Legit reasons for taking out a home equity loan: illness or other dire emergency, or education if–and only if–the value of that education in increased income pays back the lost equity with interest. Consuming home equity to pay for a vacation, credit card debt run up buying flat panel TVs, or a car like in the ads (http://www.ftc.gov/bcp/conline/pubs/homes/homequt.htm)? Insane. These ads should be illegal. Why is it illegal to sell oxycontin to drug addicts but legal to sell debt pain killers, like cash-out refis, to debt addicts? Sure, Alan Greenspan said it's okay (http://www.federalreserve.gov/boardDocs/speeches/2004/20040223/default.htm): "...the surge in mortgage refinancings likely improved rather than worsened the financial condition of the average homeowner. Some of the equity extracted through mortgage refinancing was used to pay down more expensive, non-tax-deductible consumer debt or used to make purchases that would otherwise have been financed by more expensive and less tax-favored credit." He may have recommended that you take a piece of Chinese consumer electronics that depreciates 80% in a couple of years and put it on a 30 year mortgage. But that's really bad advice. Makes you wonder who he's working for. And that's why we don't trust him.
Just as there is no more ludicrous form of slavery than the one we can impose on ourselves using unsecured debt to purchase depreciating assets like cars, there is no greater freedom than owning a home clear of a mortgage. Getting there isn't rocket science.

(Note that according to this Harper's article The Road to Serfdom (PDF) (http://michael-hudson.com/articles/debt/Hudson,RoadToSerfdom.pdf) by Professor Michael Hudson, the freedom from debt that many of my generation acheived will not be possible for the current generation. His theory is that the real estate and banking industries have evolved over the past twenty years to ensure that a large segment of U.S. society cannot pay off its real estate debt. The purpose is to guarantee a flow of capital from wage earners to banks, to further develop what he refers to as a rentier society comprised of a 90% debtor class and a 10% creditor class. While his points are well taken, I believe that by not buying too much house and not buying at the top of real estate booms, it's still possible for many to eventually own a home outright.)

* Note on Step 1, Buying your first home. We are early innings in a real estate bust cycle. These tend to last five to seven years but this one may last as long as (ugh) fifteen years, due to the extreme of the housing bubble. This boom peaked around the middle of 2005, and may not bottom until 2010 or even 2015 (http://www.itulip.com/housingbubblecorrection.htm). If I were in the market for my first home, I'd hold off for now, and keep an eye on iTulip's community of real estate veterans like Ishmael over here (http://www.itulip.com/forums/showthread.php?t=840) or Sean over here (http://www.itulip.com/forums/showthread.php?t=817).

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WDCRob
01-23-07, 06:16 PM
Glad you added the caveat at the end, because the rent vs. own decision in close-in suburban DC didn't break even for 8-10 (or more) years when I looked at it in 2004.

And with all the condo re/conversions to apartments rents are being held in check during the housing downturn as well. So it may be awhile before buying here makes more sense than renting and pocketing the cash.

It's just impossible to make a good purchase when everyone around you is making bad ones.

Christoph von Gamm
01-24-07, 05:09 AM
Very good summary, EJ.

With buying your third home, many people forget that one thing:
Around 50-55, their lifestyles change significantly, because either their kids move out of the house, or - if they don't have kids - their need for socialising and entertainment increases again (change of partner etc.). If they have kids, the move-out often implies the need to pay college tuition, so increasing even the need for additional funding.

Therefore many people simply forget about this empty-nest situation when making purchases and often end up having too big houses too far away from the spots where they really would like to live. As a result of baby boomers going to retirement and wanting to draw my prediction (which is to my memory close to your regional housing bubble scenario) is that especially in the US and the UK, larger houses in the suburbs will decrease on value on a larger proportion than smaller houses nearer to the city centres along with even a stabilisation or appreciation of values in the city centres.

spunky
01-24-07, 06:17 AM
Very good summary, EJ.

With buying your third home, many people forget that one thing:
Around 50-55, their lifestyles change significantly, because either their kids move out of the house, or - if they don't have kids - their need for socialising and entertainment increases again (change of partner etc.). If they have kids, the move-out often implies the need to pay college tuition, so increasing even the need for additional funding.

Therefore many people simply forget about this empty-nest situation when making purchases and often end up having too big houses too far away from the spots where they really would like to live. As a result of baby boomers going to retirement and wanting to draw my prediction (which is to my memory close to your regional housing bubble scenario) is that especially in the US and the UK, larger houses in the suburbs will decrease on value on a larger proportion than smaller houses nearer to the city centres along with even a stabilisation or appreciation of values in the city centres.


I disagree here. As you see the living conditions continue to erode in the US, you will see the nuclear family phased out ( or decrease markedly ) , and extended familys phased back in. Multiple generations will again be living under one roof. Larger houses are needed for this. I am seeing this alot now with the patients who come in my hospital.

I agree with the premise of EJ's article but there are just to many variables
with housing to cast anything in stone. Location, your profession and skills, hobbies have to much to do with this. JMHO

As always I enjoy reading this forum

Rajiv
01-24-07, 09:59 AM
While what you say makes sense, you forget to include one very important fact that occurs in today's world. Young people coming out of school are already saddled with a very large burden of student loans. This conceivably will put off home buying for five to seven years. This would imply that the first home is not bought at the age of 25 as you suggest, but closer to the mid 30's. Given the earning life span of a person, it makes home equity even more distant.

EJ
01-24-07, 01:16 PM
While what you say makes sense, you forget to include one very important fact that occurs in today's world. Young people coming out of school are already saddled with a very large burden of student loans. This conceivably will put off home buying for five to seven years. This would imply that the first home is not bought at the age of 25 as you suggest, but closer to the mid 30's. Given the earning life span of a person, it makes home equity even more distant.

That's an excellent point and a topic for another article. On the moral side, it's simply wrong for young people to have to start their lives in debt. They don't have much choice. Here's a good USA Today article by Sandra Block:
<!--clickabilityRefresh=15m--><!--startclickprintinclude--> <!--startclickprintexclude-->
Students suffocate under tens of thousands in loans (http://www.usatoday.com/money/perfi/general/2006-02-22-student-loans-usat_x.htm)

Tom Dillon, 19, a pre-pharmacy major at the University of Connecticut, is carrying $52,000 in student loans. And he's just getting started. When he gets his pharmacy doctorate in four years, he expects his debt to exceed $150,000. Dillon's been drawn to pharmacy since age 5, when he found out he had epilepsy.

"The first person who helped me was my pharmacist," he says. Dillon, who no longer has epilepsy, would like to go into pharmaceutical research. But he knows he'd earn more money as a pharmacist for one of the big drugstore chains.

"When I get out, I'm going to have that $150,000 weighing over me," he says. "What I decide is going to be dependent on that debt."

And the cost of that debt is about to rise. On July 1, the rate on new federally guaranteed student loans will hit a fixed 6.8%, the highest rate since 2001. It comes as the average graduate owes $19,000. Many undergrads, though, have debt exceeding $40,000.

Those higher payments carry huge implications for this generation of college graduates. The weight of debt is forcing many to put off saving for retirement, getting married, buying homes and putting aside money for their own children's educations.

Heavy student debts may also keep young adults from starting businesses, says Diana Cantor, director of the Virginia College Savings Plan. Some graduates will refuse to risk what little money they have on entrepreneurial ventures. And securing loans will now be harder. "It's a real crisis," Cantor says. "You're strapped before you get started."

<table align="left" cellpadding="0" cellspacing="0"> <tbody><tr> </tr> </tbody></table>The average debt for a college graduate has soared 50% in the past decade, after inflation, according to the Project on Student Debt, a non-profit advocacy group. Just as record-low mortgage rates have eased the impact of soaring home prices, low student-loan rates have let borrowers cut their payments, softening the impact of rising debt.
"Low mortgage rates" have not "eased the impact of soaring home prices" but rather have caused them. The Monthly Payment Consumer accepts the new higher total cost of a house because the monthly cost was made affordable by low rates and creative financing. A different dynamic drives up tuitions. Without a college education, earning potential is very limited in the US. Yet with a college education, a middle class undergrad student graduates with close to $20,000 in debt. This student debt is bad news for two main reasons: 1) students don't have enough credit left to use to start a business, the best way to build wealth, and 2) they don't have enough credit to buy a house, the second best way to build wealth.

The median salary for a pharmacist is $98,828 or approx. $68,000 per year after taxes, $5,700/mo. To pay off his $150,000 student loans in ten years, he needs to pay $1726/mo. or 30% of his after-tax income.

If that's typical, I wonder how this generation is going to have enough money to pay into the entitlements system if they also have to pay off these college education debts.

Spartacus
01-24-07, 02:31 PM
Are we talking about people who refuse to live at home and go to a decent but cheap state school

or people who have to have an Ivy League degree and absolutely have to go to college on the opposite coast?


it's simply wrong for young people to have to start their lives in debt. They don't have much choice.

EDIT: I just looked at the pictures again and i realized I'm saying that these people may be getting the equivalent of the BMW, on credit.

nikki
01-24-07, 06:40 PM
Are we talking about people who refuse to live at home and go to a decent but cheap state school

or people who have to have an Ivy League degree and absolutely have to go to college on the opposite coast?



EDIT: I just looked at the pictures again and i realized I'm saying that these people may be getting the equivalent of the BMW, on credit.

Today, a Bachelor's is the equivalent of a HS diploma 20 years ago. A BS or BA is no sure thing for a "career", and now many professions are requiring a Master's or even a Ph.D. for significant career advancement. So you're not just talking tuition for undergrad, but grad as well. If one is lucky, as I was, they'll take a job for a university and use that benefit to get a free or discounted advanced degree. I did that at Johns Hopkins. The pay absolutely sucked for the 5 years I was there, but I got a free MS from an ivy! Now I've moved on to bigger and better things, because although Hopkins will pay for your school, once you get that advanced degree, no pay raise for you!

If I could do it over again, however, I would have taken the other route. Find a job with a company that will pay for your advanced degree, or at least contribute significantly to tuition.

My point is that an advanced degree is becoming more of a requirement, and not everyone can be a TA or work for a university. School debt continues after 22, and if one is in grad school, paying tuition until they're 30, that pushes the timeline out even further.

Jeff
01-24-07, 08:16 PM
EJ, I've always said you were the third smartest man in the world, but how you got a dateline of December 2007 escapes me. Could you bring back a WSJ for me so I can make some time in the market?

EJ
01-24-07, 08:27 PM
EJ, I've always said you were the third smartest man in the world, but how you got a dateline of December 2007 escapes me. Could you bring back a WSJ for me so I can make some time in the market?
We subject our readers to many intelligence tests, sometimes on purpose. We sleep soundly tonight, reassured that the second smartest man on earth can tell the difference.

Rajiv
01-24-07, 09:21 PM
You should read <a href="http://www.demos.org/pubs/yaes_web_debt.pdf">Generation Debt: Student Loans, Credit Cards, and Their Consequences</a>


In the 1992-93 academic year, just over 49 percent of graduates from 4-year state universities had taken out federal student loans. By the end of the decade, nearly 65 percent of college graduates had taken out such loans. In the decade since the legislative change, inflation-adjusted student loan volume has risen by 137 percent.

And here is the data on <a href="http://www.finaid.org/savings/tuition-inflation.phtml">college cost and inflation</a>. This is the main reason for the increased student loans.

Spartacus
01-24-07, 09:53 PM
people do seem to be trying to cut expenses but just cannot do it - it's either pay the piper or do without, and doing without is painful - without a 4 year degree one's career choices these days are limited.


You should read <a href="http://www.demos.org/pubs/yaes_web_debt.pdf">Generation Debt: Student Loans, Credit Cards, and Their Consequences</a>



And here is the data on <a href="http://www.finaid.org/savings/tuition-inflation.phtml">college cost and inflation</a>. This is the main reason for the increased student loans.

DemonD
01-24-07, 10:48 PM
While what you say makes sense, you forget to include one very important fact that occurs in today's world. Young people coming out of school are already saddled with a very large burden of student loans. This conceivably will put off home buying for five to seven years. This would imply that the first home is not bought at the age of 25 as you suggest, but closer to the mid 30's. Given the earning life span of a person, it makes home equity even more distant.

You know what's funny as i sit here with my 20k in student debt after having graduated 4 and a half years ago from grad school, I had never considered this. Everyone has student loan debt nowadays - everyone. I just kind of assumed that it's always been like that and my situation isn't that crazy, but after reading this thread i kind of had a "duh" moment. And I'd probalby have closer to 40-50k if my parents hadn't significantly helped out with the loans.

I know plenty of people who are graduating in my field (starting salary around 50k/year) of well over 100k, and they work weekends to be able to make 1000/month student loan repayments. I thought I was getting a deal at 400/month for student loan payments but now I just go uuuuuuugh.

In any case that's just one man's story. I'm way better off than most people though, from what I see.

Rajiv
01-24-07, 11:25 PM
Having gone to grad school in the early to late 70's, I see how much more of a burden we have added on to the backs of young people. It started in the Reagan era, when government support for educational institutions was cut way back. The efforts at privatization have just accelerated the burden on the students.

I remember that it was possible to get a 4 year college education working 30hours a week at the sandwich shop (from 6pm to 10pm - 7 days /wk)) - going home to a large 6 bedroom house shared between 8 people -- studying till 2am - getting up at 8 am - rushing to class. Hard work, but that 30 hours a week of low wage work enabled you to do it -- college costs were low enough and you got your education without being in debt. But today that is an impossibility.

metalman
01-25-07, 01:10 AM
is this a set-up or what? inflation, dude! that's how he's gonna pay it off. add a zero into the end of that nominal income. that's the ticket! now let's do the math:

median salary for a pharmacist in 2015 is b$988,280 (b$ is bonars, man) or approx. $680,000 per year after taxes, $57,000/mo. to pay off his $150,000 student loans from 2008 - 2014 undergrad and grad school in two years, he needs to pay $6,250/mo. or 11% of his after-tax income. no problemo!!!

Rajiv
01-25-07, 08:59 AM
is this a set-up or what? inflation, dude! that's how he's gonna pay it off. add a zero into the end of that nominal income. that's the ticket!
But the problem is that college tuition is rising at twice the general inflation rate. So it is extremely unlikely that stagflation will enable what you propose -- unless banks charge a low rate -- but that then giving free money away would be regarded in some rarified circles as "SOCIALISM"

Rajiv
01-25-07, 10:12 AM
The other Cost item that has been outpacing inflation is health care. and that has been rising at 2 1/2 times inflation. See <a href="http://www.chcf.org/documents/insurance/HealthCareCosts06.pdf">Health Care Costs 101</a>

And Education and Health Care are the two places where any proposed solution is greeted by shouts of "SOCIALISM" (Gasp!!) :rolleyes:

Sorry got the wrong URL. It has been corrected now!

EJ
01-25-07, 01:21 PM
Tuition inflation running ahead of CPI inflation appears to be a long term trend.


http://www.itulip.com/images/tuitioninflation.jpg


From 1958 when the data series starts, tuitions ran about five times the rate of CPI inflation at around 5%. During the period of CPI inflation that started in 1964 and peaked in 1981, CPI inflation in some years exceeded tuition inflation. Since the post Volcker Fed period after 1982, tuition inflation has settled in at about 1.6 times CPI inflation. Note also that tuition inflation increases and decreases lag CPI changes by about a year. With CPI inflation rising since 2002, tuition inflation appears likely to rise to 6% from 5% this year.

Rajiv
01-25-07, 02:34 PM
One thing to remember when looking at inflation rates - these are multipliers - and hence when calculating average rates, we should use a geometric mean, and not a arithmetic mean.

c1ue
01-25-07, 04:49 PM
Here's a scenario I'd like to hear the brain trust cogitate on:

If there is indeed hyperinflation coming, then would it not make sense to buy a house with zero cash - but with payment sufficient that you could always absolutely afford to pay on the mortgage? For example cash in the bank?

In this scenario I do assume that cash is more likely to keep up with inflation than home equity. In the meantime hyperinflation will greatly reduce the purchasing power equivalent amount of money owed.

Similar to the tongue in cheek student debt vs. future income scenario above.

Of course, the correlary to this is that all those bonds based on mortgages are going to bite the dust - a clear case of helping the 'common' guy vs. the wealthy since most 'common' guys don't own bonds.

This leads to some interesting questions; I personally have doubts as to whether the government will screw the relatively wealthy (and their lobbyists) vs. find a way to stick it to the masses.

jk
01-25-07, 08:14 PM
the biggest bondholders are the people's bank of china, the bank of japan and a lot of middle-eastern sheiks. i don't see a lot of tears being shed for them when the dollar dives and long rates rise, giving their bonds a one-two punch.

spunky
01-26-07, 02:15 AM
Skills are skills . You need skills in todays job market. Degrees are good to wipe your ass with. I have 2 of them, so does my best friend and he is making 9.75$ an hour repairing copy machines. Yea, Ivy league,George Bush is an Ivy league school grad, like that means something . Mabye " The Donald " can get me in Whartons School of Business. :D


Oh yea, I paid off my student loans in 4 yrs.

Rajiv
01-26-07, 08:40 AM
For a Canadian perspective on college education see
<a href="http://www.millenniumscholarships.ca/images/Publications/POK_III-ch5_EN.pdf">The Price of Knowledge 2006</a> and <a href="http://www.millenniumscholarships.ca/images/Publications/millennium_research_n1-en.pdf">Is University Education in Canada More Affordable Than in the United States?</a>

Thanks to Susan Chambers at Kwantlen University College for the links.

lobodelmar
02-02-07, 04:07 PM
Great article EJ...

I really wish I had discovered this site before I bought my condo in DC in July 2005. I think I broke every one of your rules in this post...it was hard not to believe the advice from all of my highly educated friends who had recently bought, who whispered in my ear about low interest rates, never again seeing these prices, prices going to keep going up, booming local economy, my house doubled in value in two years, etc etc etc.

So I bought, 5% down, fixed interest only for 10 yrs, then a 20 yr payment plan for the principal. Seemed like such a good idea at the time.
That being said, I love my apt. and love the neighborhood. So I guess time will tell how it all pans out. Though I wouldn't do it this way ever again knowing what I know now.

Lesson learned. At least I know what to do next time I want to buy. If I need to sell in the next few years, it might be painful. Here's hoping I can ride it out.

Jim Nickerson
02-02-07, 04:45 PM
Great article EJ...

I really wish I had discovered this site before I bought my condo in DC in July 2005. I think I broke every one of your rules in this post...it was hard not to believe the advice from all of my highly educated friends who had recently bought, who whispered in my ear about low interest rates, never again seeing these prices, prices going to keep going up, booming local economy, my house doubled in value in two years, etc etc etc.

So I bought, 5% down, fixed interest only for 10 yrs, then a 20 yr payment plan for the principal. Seemed like such a good idea at the time.
That being said, I love my apt. and love the neighborhood. So I guess time will tell how it all pans out. Though I wouldn't do it this way ever again knowing what I know now.

Lesson learned. At least I know what to do next time I want to buy. If I need to sell in the next few years, it might be painful. Here's hoping I can ride it out.

Seawolf,

If you don't mind, what is the rate for the first 10 years, and how are the last 20 handled?

lobodelmar
03-06-07, 04:49 PM
Hi Jim,

Been away for awhile on travel, haven't been going online much.

To answer your question, the deal I took was an 80/15 loan, with a 6% fixed rate interest only mortgage. So I can pay IO for the first 10 years (or pay more to pay down principal) and then the remaining 20yrs I pay a 30 yr fixed rate 6% mortgage off in 20 yrs. In dollars and sense terms, the current Interest payments on this part of the loan are $1500 a month, and in yr 11 turn into $2100. The second trust on the remaining 15% is a 7.75% note with the same terms as the first. $350 now, $500 later, if I don't pay off the 15% note before that time is up. With my condo fees and taxes, my monthly payments are around $2100 per month, which was doable. And at least for now, despite only owning 5% (or less, since the market is down) of my condo, I am probably gaining something with the tax deduction than if I had rented the same unit at the market rent. At least that is what I told myself at the time. Better pay myself something than line a landlords pockets.

At the time I bought it seemed better taking this deal than a 5/1 ARM which might adjust up to 13% like many people seem to be experiencing these days, and I couldn't afford a standard fixed rate mortgage payment at 6.25%.

Lobo

Finster
03-06-07, 06:43 PM
Very good summary, EJ.

With buying your third home, many people forget that one thing:
Around 50-55, their lifestyles change significantly, because either their kids move out of the house, or - if they don't have kids - their need for socialising and entertainment increases again (change of partner etc.). If they have kids, the move-out often implies the need to pay college tuition, so increasing even the need for additional funding.

Therefore many people simply forget about this empty-nest situation when making purchases and often end up having too big houses too far away from the spots where they really would like to live. As a result of baby boomers going to retirement and wanting to draw my prediction (which is to my memory close to your regional housing bubble scenario) is that especially in the US and the UK, larger houses in the suburbs will decrease on value on a larger proportion than smaller houses nearer to the city centres along with even a stabilisation or appreciation of values in the city centres.

I disagree here. As you see the living conditions continue to erode in the US, you will see the nuclear family phased out ( or decrease markedly ) , and extended familys phased back in. Multiple generations will again be living under one roof. Larger houses are needed for this. I am seeing this alot now with the patients who come in my hospital.

I agree with the premise of EJ's article but there are just to many variables
with housing to cast anything in stone. Location, your profession and skills, hobbies have to much to do with this. JMHO

As always I enjoy reading this forum

I share Spunky's skepticism except for a slightly different reason. Many people, myself included, simply define our standard of living primarily by the home we live in - more so than any other material amenity. Some may prioritize vacations, cars, travel, entertainment; others, their homes. This has become somewhat more common post-911, even to the point of having its own name coined - "cocooning". There is utterly nothing wrong with folks buying as much home as they want ... so long as they can afford it.

Of course people should take into account their long-term needs, espeically when it comes to buying something they're apt to have for a long time. On the other hand, it has almost become faddish in some circles to disdain someone's choice of owning a large home, as if it's somehow socially irresponsible. I fear some people are confusing owning a large home with buying one one can't pay for.

spunky
03-07-07, 04:52 AM
The other Cost item that has been outpacing inflation is health care. and that has been rising at 2 1/2 times inflation. See <a href="http://www.chcf.org/documents/insurance/HealthCareCosts06.pdf">Health Care Costs 101</a>

And Education and Health Care are the two places where any proposed solution is greeted by shouts of "SOCIALISM" (Gasp!!) :rolleyes:

Sorry got the wrong URL. It has been corrected now!


The dirty S word. Shame on you Rajiv; you know how much more happy, content and optimistic americans are than certain parts of the continent. We also enjoy our long frequent vacations, low stress and short work weeks :D

Slimprofits
02-16-08, 12:30 PM
Are we talking about people who refuse to live at home and go to a decent but cheap state school

Such as UMass-Boston?

Not quite a bargain at approximately $10,200 per year not including books and transportation.

Or how about Framingham State College at approximately $8,458 per year, etc.?

And Salem State? Don't even ask, it'll make you sick.

In Massachusetts, there are no decent, but cheap state schools.

brucec42
02-16-08, 10:15 PM
This is one of the rare threads here where there is perhaps some misinformation or incomplete information at least.

1. Let's not overrrate higher education. It depends on what you plan to do with it. To quote Judge Smails.....The world needs ditchdiggers, too. Perhaps that overstates it. But it's funny.

I know this is a highly educated bunch but there is a whole world out there of non- information based jobs that pay decently and do not require advanced degrees. And when the economy does tank, there will be much more demand for a good electrician or better yet a car mechanic than for a FIRE economy brainiac who may be brilliant a financial analyst but can't even change a tire. Anything associated with ESSENTIALS will likely do well.

Part of our nations's problem is that we are teaching an entire generation that they are either going to have some 100% brain-powered job in an office or be destitute. That producing and creating, or providing a skilled service, is a path to poverty. This is why our poor darlings can't be bothered to get jobs that we all used to do as youngsters and we have to import immigrants to do what we now consider ourselves too good for.

100 is said to be the average IQ. So for every valedictorian at 130 there's another kid at 70. This means that not everyone's kid is suited to go to college. Forcing square pegs into round holes like that is doing them a disservice (and inflating tuition) Better an employed welder than a chronically unemployed MBA for whom the reduction of the FIRE economy means lean pickings in terms of job opportunities. Go ask a businessman how hard it is to find a trained machinist. Then go ask him how easy it is to find a kid with a degree is sociology.

2. Tell my wife she needs an MBA. She made $150K last year with a HS diploma...in FINANCE! Other than in official HR dept job descriptions, at no point was education even mentioned in the job hunt processes at any of her jobs in her 10 year "career". Experience learned on the job mattered much much more. MBA's are overrated and some of her employees had them and were just about worthless and went nowhere. I have a bachelor's degree in business and don't make as much as she. Anyone who goes $100K into debt to get a degree in business hasn't even managed to learn enough from it to realize that the opportunity costs are huge (4-6 years of lost wages plus actual out of pocket costs ).

What we need to spend more on is job TRAINING, not pumping the value of degrees where maybe 1.5 years of your time spent there is learning anything even remotely related to you field. College is great for a well rounded person. But he'll be a broke well-rounded person if he doesn't go into select fields which require that degree. Few 18 y/o's are capable of making that choice.

We also have a problem with kids being sold on the idea that they can educate themselves into high paying jobs. With a few exceptions like law or technical fields, that usually isn't the case. It gets you into the first door, that's all.

3. Loans? Anyone ever hear of working their way through school? I did. Costs may have been lower then, but it's possible to at least minimize debt by doing so. The idea of sitting on my rear end weekends, summers, and holidays while incurring massive debt to go to college didn't even occur to me. Today there seems to be money for spectacular spring break vacations and ski trips around Christmas, all borrowed of course. No wonder we have a labor problem. The college kids used to work. Now it's seen as something to protect them from.

4. I'm not getting this 7 year ARM thing. Rates on those are not suffciently lower to justify the risk in case you wind up staying and rates trend upwards. Right now, they're virtually the same as a 30 yr fixed rate mortgage. What if rates skyrocket as some think? What if you aren't able to afford a 18% mortgage on a nicer home in 7 years? What if you aren't able to afford 18% on your current one in 7 years? With a fixed rate, inflation works FOR you in terms of home affordability.

5. A plan based on owning a multifamily rental place is a risky one. First, it means you're instantly eager to move up and on to better things. That is by definition more expensive. Ok, so what if mortgage rates are triple what they are now by then and you hate living next door to the redneckersons or college party animals you're renting to? Then you're stuck living in a low-rent duplex. Better to, if you can, buy a MODERATELY nice single family place you could stand living in the rest of your life in if you had to, locking in the historically low fixed rates today. If rates go up, you let inflation help pay your mortgage off for you. Then you use the cash from that home to move up if you want. But if you do the old "I'll buy a duplex and rent out the other side" thing, you risk being stuck being a landlord.

I think this is a historic time for low mortgage rates vs the expectations for them in the future.

6. Better yet, if valuations don't make sense now in your area, rent and invest the difference. Just be aware that if home prices go down another 25% but rates skyrocket, your affordability factor may have gotten worse, not better.

Of course not buying when you can't afford it always applies.

Jim Nickerson
02-17-08, 12:06 AM
This is one of the rare threads here where there is perhaps some misinformation or incomplete information at least.

1. Let's not overrrate higher education. It depends on what you plan to do with it. To quote Judge Smails.....The world needs ditchdiggers, too. Perhaps that overstates it. But it's funny.

I know this is a highly educated bunch but there is a whole world out there of non- information based jobs that pay decently and do not require advanced degrees. And when the economy does tank, there will be much more demand for a good electrician or better yet a car mechanic than for a FIRE economy brainiac who may be brilliant a financial analyst but can't even change a tire. Anything associated with ESSENTIALS will likely do well.

Part of our nations's problem is that we are teaching an entire generation that they are either going to have some 100% brain-powered job in an office or be destitute. That producing and creating, or providing a skilled service, is a path to poverty. This is why our poor darlings can't be bothered to get jobs that we all used to do as youngsters and we have to import immigrants to do what we now consider ourselves too good for.

100 is said to be the average IQ. So for every valedictorian at 130 there's another kid at 70. This means that not everyone's kid is suited to go to college. Forcing square pegs into round holes like that is doing them a disservice (and inflating tuition) Better an employed welder than a chronically unemployed MBA for whom the reduction of the FIRE economy means lean pickings in terms of job opportunities. Go ask a businessman how hard it is to find a trained machinist. Then go ask him how easy it is to find a kid with a degree is sociology.

2. Tell my wife she needs an MBA. She made $150K last year with a HS diploma...in FINANCE! Other than in official HR dept job descriptions, at no point was education even mentioned in the job hunt processes at any of her jobs in her 10 year "career". Experience learned on the job mattered much much more. MBA's are overrated and some of her employees had them and were just about worthless and went nowhere. I have a bachelor's degree in business and don't make as much as she. Anyone who goes $100K into debt to get a degree in business hasn't even managed to learn enough from it to realize that the opportunity costs are huge (4-6 years of lost wages plus actual out of pocket costs ).

What we need to spend more on is job TRAINING, not pumping the value of degrees where maybe 1.5 years of your time spent there is learning anything even remotely related to you field. College is great for a well rounded person. But he'll be a broke well-rounded person if he doesn't go into select fields which require that degree. Few 18 y/o's are capable of making that choice.

We also have a problem with kids being sold on the idea that they can educate themselves into high paying jobs. With a few exceptions like law or technical fields, that usually isn't the case. It gets you into the first door, that's all.

3. Loans? Anyone ever hear of working their way through school? I did. Costs may have been lower then, but it's possible to at least minimize debt by doing so. The idea of sitting on my rear end weekends, summers, and holidays while incurring massive debt to go to college didn't even occur to me. Today there seems to be money for spectacular spring break vacations and ski trips around Christmas, all borrowed of course. No wonder we have a labor problem. The college kids used to work. Now it's seen as something to protect them from.

4. I'm not getting this 7 year ARM thing. Rates on those are not suffciently lower to justify the risk in case you wind up staying and rates trend upwards. Right now, they're virtually the same as a 30 yr fixed rate mortgage. What if rates skyrocket as some think? What if you aren't able to afford a 18% mortgage on a nicer home in 7 years? What if you aren't able to afford 18% on your current one in 7 years? With a fixed rate, inflation works FOR you in terms of home affordability.

5. A plan based on owning a multifamily rental place is a risky one. First, it means you're instantly eager to move up and on to better things. That is by definition more expensive. Ok, so what if mortgage rates are triple what they are now by then and you hate living next door to the redneckersons or college party animals you're renting to? Then you're stuck living in a low-rent duplex. Better to, if you can, buy a MODERATELY nice single family place you could stand living in the rest of your life in if you had to, locking in the historically low fixed rates today. If rates go up, you let inflation help pay your mortgage off for you. Then you use the cash from that home to move up if you want. But if you do the old "I'll buy a duplex and rent out the other side" thing, you risk being stuck being a landlord.

I think this is a historic time for low mortgage rates vs the expectations for them in the future.

6. Better yet, if valuations don't make sense now in your area, rent and invest the difference. Just be aware that if home prices go down another 25% but rates skyrocket, your affordability factor may have gotten worse, not better.

Of course not buying when you can't afford it always applies.

Very nice thoughtful post, Bruce. It is good to see someone thinking rather than reacting.

zmas28
02-17-08, 11:31 AM
Similar thoughts/questions have occurred to me on the advisability of buying a new home. If we do expect inflation to raise its head in the "not-so-distant" future and mortgage rates to rise from the low values of today, I suppose it makes sense to lock in those (fixed!) rates fairly soon. Perhaps not too soon as home prices are still in decline (actually not so much in the Houston area), but perhaps a couple of years out.

c1ue
02-18-08, 08:26 AM
Similar thoughts/questions have occurred to me on the advisability of buying a new home. If we do expect inflation to raise its head in the "not-so-distant" future and mortgage rates to rise from the low values of today, I suppose it makes sense to lock in those (fixed!) rates fairly soon. Perhaps not too soon as home prices are still in decline (actually not so much in the Houston area), but perhaps a couple of years out.

I personally hate to try and catch falling knives.

However, were you to try and buy a home in the near future, here's what I'd consider:

Input data:

1) interest rate as a divergence from historical average

2) price of home as a divergence from historical average

Calculation:

Present price plus present interest rate = $x monthly payment plus $y taxes. Assuming maintenance same.

a) What is the divergence interest rate w/ present price as a monthly payment?

b) What is the divergence price w/ present interest rate as a monthly payment?

c) What are the numbers above with taxes going up?

This will give you an idea how good or bad things can get. The point of this exercise is to not get caught up in price or interest rate, but to focus on the cash flow comparisons.

This exercise also gives you a better understanding in situations where one variable or another is above historical trend; for example it gives you an idea on future possibilities should prices be above trend but interest rates below. Why does this matter? because interest rates can change via a refinance, but prices are fixed once you pay them.

Again, for me I look at rent cash flow vs. buy cash flow and am perfectly willing to live in rentals if that is what it takes. But this is my own choice.

mcgurme
02-18-08, 05:52 PM
This is one of the rare threads here where there is perhaps some misinformation or incomplete information at least.

1. Let's not overrrate higher education. It depends on what you plan to do with it. To quote Judge Smails.....The world needs ditchdiggers, too. Perhaps that overstates it. But it's funny.
...


Bruce, great post. But lets not underrate higher education. There are areas of real need for education to retain our ability to compete globally. Areas such as:

1. Engineering. People with HS diplomas cannot generally design bridges, microchips, satellites, spaceships, or buildings.

2. Software. While there are exceptions, the majority of programmers that develop software infrastructure have college degrees.

3. Healthcare. Would you want someone with only an HS diploma operating on you or prescribing your medicines? It is challenging enough to find a decent doctor *with* an MD (and, with the aging of baby boomers, the supply of health care workers is going to fall far short of the demand).

4. Science. This includes the development of antibiotics, batteries that power hybrid cars, technologies that allow fabrication of high density microchips, technologies for enhanced food production, development of new plumbing and building materials, and etc. Major leaps in science are rarely done by those without any college education these days (there are a few exceptions, but those are rare).

I agree with you that there are far too many people with degrees in areas that don't translate into real-world skills.

And I agree that far too many students are focused on things like their next spring break vacation.

But I can also assure you that the serious students in computer science, engineering, and science programs at the major universities do a lot of hard work focusing on their studies. I know this having been one of those students, and now being on the other end of the stick, involved in training students in the computational sciences. We work them hard.

I think the bottom line is that a college degree is still useful if you choose the right area and work hard. But there is also, as you point out, a need for people with practical skills like plumbing, electrical work, repair work, and etc, and it is unfortunate that people are busy getting MBA's just because it's the popular thing.