From Sunday’s Wall Street Journal:
Prices have dropped since last year when Greg Sax bought his St. Paul, Minn., home. But the 37-year-old first-time home buyer still feels lucky he made the move when he did.
He was able to finance his purchase with no money down. And after talking with real-estate professionals in his job as communications manager for the Minneapolis Area Association of Realtors, he’s not so sure he’d be able to secure that 100% financing today.
"If we had to put 10% or 20% down, we’d probably still be renting," he says.
If Sax had continued to rent, he would have owned 0% of his home. The WSJ didn’t say how much his home has dropped in value, but you can bet that his equity position is currently less than zero. He would have "built more equity" by renting.
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Yes, but think of the interest tax write off
(hint before I get flamed: some apparently think that paying a dollar to get 30 cents back is a bargain)
re: “We’d still be renting.”
It’s unreal how people have come to regard renting as bad or something only lower-income people do.
fact is: smart people with money rent/lease in a down market and let the owner take the hit on the way down.
Why would anyone who can wait make a house purchase in this market, with prices clearly trending downward and a recession directly ahead, which should put even more downward pressure on prices?
Realtors push the post hoc, ergo proper hoc fallacy quite often and most people just eat it up. They think because wealthy people own homes, home ownership is the path to wealth.
They probably also think that wet sidewalks cause rain.
The principle that applies here is “When something appreciates, buy it. When something depreciates, rent it.” I think that was Milton Friedman or Warren Buffett.
The extent to which folks make decisions from a less-than-systematic point of view, untethered from any fundamental principles, is sometimes amazing to behold. Then again, diamonds are worth millions and climate and water are taken for granted.
NVMike-
What always amazes me is that people think that a paper that says “Title” on it makes them an owner.
With 100% financing. The bank owns 100%, and the borrower owns 0%. It’s basically a bank owned rental, but the “homeowner” is responsible for all maintenance costs.
If you want to be a homeowner, you have to pay off the loan. There’s no easy road to homeownership.
He feels lucky because he financed 100%, apparently he think’s it’s an investment and not something he should have to spend his “out of pocket” money on. If he couldnt save then, he surely won’t be able to save now.
Maybe he feels he has nothing to lose. These are the deals that got us into this mess.
Dan
The fact that he still does not know he’s getting robbed is priceless.
“Good thing I got to throw all my money away! ”
Whats really frightening, is the last paragraph of the article which states “soon 15-20% down will be the norm”.
WHO is going to be able to afford that? They don’t take credit cards at the closing table…so you tell me how the average american (with several years of negative savings) is going to do that.
Answer: they’re not and houses are going to sit and sit and sit…
Buying a house has certain financial advantages (and disadvantages). But it also has certain lifestyle advantages.
Primarily, It is your place. For better or for worse. You get to pick the paint color, whether or not to replace the toilet, or remodel the kitchen. Do you want grass in the front yard?
Further, you don’t have to put up with Landlord’s and their quirks. You can stay in the house the rest of your life, no “i sold the house, you are out next month”
After all – falling house prices mean a lot less if you aren’t trying to sell your house.
Sandman -as for the equity, it can be a good deal. If rent is $1000 a month, and your mortgage payment is $1400 (with $200 in impounds), you more than break even. At 6% interest, you will pay about 1000 in interest the first month, with $200 in forced savings. At the 30% tax bracket, you will be getting an additional $300 in tax savings. If we don’t include that $200 forced savings (in equity repayment), you are only out an additional $100 every month. In las vegas, you can rent a 1000sf apartment for 1000, or buy a 1300 sf house for about the same.
That might not be worth it for some people. Obviously if you are only going to be living somewhere for a year or two, buying is a mistake. But don’t discount the huge economic incentives that the interest deduction creates.
ingydesu – you’re right about the benefits of home ownership. Being able to do what you want with the place is great. I rent, but I still feel the urge to paint something every once in awhile (I’m still young, I guess =)
Thing is, falling prices DO affect you, even if you’re not looking to sell. First off, it means you overpayed. For those that bought their house in 2006/2007, they’re going to lose tens of thousands of dollars they will never get back. No big deal if you feel it was worth it, but still..
More importantly though, you’re exposed to more risk. What happens if you get laid off and/or have to move? In the age of zero company loyalty, laying off your employees to keep your executive bonuses high seems to be the norm. I’ve been at my job 9 years, making me one of the oldest employees here (its a 16 year old company). When they finally get to me, I can up and move without much issue. I’ve got a coworker that had to move here from Florida – he’s been trying to sell his house for over a year, making payments on both it and his apartment.
Years ago people bought houses, lived in them for 30 years, and paid off the mortgage (without draining the equity to take vacations and buy SUVs). It was like owning stocks long term, and you generally won in the end. The flawed attitudes of todays “on the move gotta have it now” society have changed that whole formula, and we are all now seeing the results.
I bought at the end of 07′. I put 5% down. The very next month I had the home reappraised and refied again to remove the mortgage insurance. I bought for 360k and the home appraised for 495k…Is anyone buying these homes for that? No. Will they in five years when inventory clears? Maybe? Do I love this home and does it offer me and my family the space and functions I was looking for? Yes. It is still worth 450k and I feel it will not drop below 400k. I am sure glad I bought when I did because I couldn’t sell my house quick enough to get the equity out. I certainly did not want to put my own cash into it at this point in time. That same program in lending is now 15% down. I did end up selling my old home 3 months later and put the money in the bank. Houses are affordable again if you know what to look for. Does 145k for a 2000 sq ft house sound affordable? Before I was in the biz, I didn’t follow all this craziness. I just bought a home and lived my life. (1996) I probably over paid and we went through the ups and downs of the economy but at the end of the day I paid my mortgage and lived my life even over paying. 10 years later, I felt I made a good buy. The banks are never going to pay YOU to take the house and by the time speculators figure the bottom it will have past them by or is it buy? lol. This new fed injection should ease rates next month I am hoping because here in the mortgage market it is tight. There is still seller assistance programs with FHA like AmeriDream or Nehemiah if you need 100%. There is also USDA 100% for rural properties that has no PMI!!! (If your buying in QC AZ)Love the site, thanks Twist
We are in the last throws of the “Get Rich Quick” generation. The coming hard times will cure it for a while until the next bubble appears. It’s human nature to believe the lie. Its what makes Vegas and lotteries tick. You see one big winner and you believe it can happen to you. Lots of people made a killing the past few years.
Everyone feels this way from time to time. I buy lottery tickets every week (only one for each drawing). You never know. I once won a small amount and it keeps me going. But reason tells me “Don’t Count On It”
The problem today is everyone believes they can still strike it rich. That does drive Capitalism but not many folks understand risk (Warren sure does) or how the underlying numbers are against them more often than not. No one seems to grasp the term “Long Shot”
My mom and dad used all the hackneyed expressions when I was growing up in the 50′s and 60′s. You know. “Save Your Pennies” Grow Rich Slowly” “Don’t Spend More than you Make” etc.
Parents don’t say this anymore. Schools don’t teach it. They show their kids how they can work the credit system and have the good life (for now). This has been tough for my wife and I in a prosperous suburb of Denver. We’re frugal savers. All our kids friends have nicer homes, fancier cars, clothes, toys, etc.
I try to tell them this but I’m just an ogre, skin flint, grouch, tight wad. I’ve become my Old Man. Everyone is in for a big shock. They aren’t going to like it one bit. Everyone will blame everyone else but themselves for the pickle they’re in. They’ll be forced to be frugal for a while (maybe a long while). Then it’ll be back to the “Dream” as soon as times get better. Sometimes I don’t know if their is any hope for our species.
brucewho, that is interesting that you say this. My wife and I were speaking last night about folks who grew up in the great depression and how they ended up living their lives. We should all take a lesson here.
“soon 15-20% down will be the norm”….
WHO is going to be able to afford that?
”
You kids don’t remember that’s the way we used to buy houses. My first property, I bought when I was 18 and I put 20% down. Back in those days, there were no other kinds of mortgages, but 15, 20 or 30 year fixed P&I.
People still bought houses and eventually prices of homes appreciated. Just because the easy breezy loans are gone, doesn’t mean that RE has gone away as a good investment.
My parents are living off rental income from homes they bought 20 years ago – all paid in full and making pure cash flow. I look at them and say, “there’s nothing wrong with the way they did it.”
I really believe that most people dont understand the difference between owning and renting.I didnt until about 15 months ago,when I found this site.I have learned so much from everyone that writes here.True finance should be taught from first grade up,sadly it isnt,and that is why so many are in trouble.Thanks to all and to Twist for the education.I look forward to more education.
Wow. One such posting and the bulls are back. Look. I don’t take any pleasure in seeing the whole economy down the drain with the housing market. I don’t take pride in being a renter. In fact, I wish I had a house. I am, however, sophisticated enough to know that a $140k, 2000sqft house was a bad deal in 1993, unless you were in new your city.
I am very, very glad that I did not take the piggy back loan offered to me last May. I didn’t buy anything because even in the middle class burbs, my salary, which nearly doubled the local medium family income, was not enough to buy any single family home at 3 times annual salaries. The mortgage broker approved me about 4 times annual pretax income for a 30 year fixed, but I arefused to go there. By winter, I left my job and moved to California. Had I purchased a house a year ago, I’d be in deep trouble.
The way to get out of the housing mess is not to fool more dumb people into buying a home; that gig is up. A good way to get rid of excess inventories is to enable sidelined people to afford a house. Until the sentiment out there believes that owning your house is a major money losing expense, I would be a happy renter.
From the few posts here, I guess it’s not time yet.
“For those that bought their house in 2006/2007, they’re going to lose tens of thousands of dollars they will never get back. ”
Maybe/maybe not. You only lose when you sell.
Plus other factors such as interest rate, personal finance condition go into it. Had I purchased my house now (rather than 2004) I could have gotten it for maybe $10k less. But my interest payment would be much higher. 300-400 higher based on my rate vs prevailing rates now. Thus, if I am going to be in the house for 2-3 years, I will come out ahead dollar-wise
Risk it is, and buying a house is not for everyone at every stage. But it isn’t JUST a monthly payment analysis.
If you don’t have sufficient reserves, or your employment is unstable (by nature or choice),
then you can’t commit (or shouldn’t)
But the easy loans do make it easy for those in challenging situations to get a leg up. They can inflation proof there housing, get into a forced savings program, and get the intangibles.
The intangibles were the reasons the founding fathers restricted voting to landowners. If you owned land, you had a stake in the community.
cfishy – “$140k, 2000sqft house was a bad deal in 1993″. Not really. For most places in the West, that would have been decent. Plus the consideration of neigborhood, build quality etc goes into it. I can think of several places were this wouldn’t have been horrible (if it was an ok/decent neighborhood). Without even touching california, About every major city on the west side of the map would have required that price for a decent neighborhood. Phoenix, seattle, portland, Salt lake, Denver. Salt lake and las vegas might be on the border of the price you mentioned, but not by much.
Ingydesu-
I’ve got to agree that it’s nice to own your own place. Like anything else, it’s a great personal choice for those who can afford it. I like fixing the place up according to my own tastes, and I’ll confess that one of the things that I miss since I’ve been renting is painting and remodeling. [Mr. Twist however, does not share my sentiment!] I must say though, that it’s saved us a lot of money- Home Depot is no longer a line item on our budget, and we’ve got plenty of other things to do on the weekends.
One of the things [besides compulsive decorating] that is left out of calculating the cost of homeownership is the issue of maintenance. Renters don’t have to deal with failing water heaters, bad AC, or leaky roofs. They can call the landlord and never see the bill.
I had a reader tell me that he knew the market was going down, but he was prosperous and could afford the hit. His house wasn’t an investment for him, it was a place he could live and enjoy. That sounds reasonable to me.
I worry about the guy in the WSJ article though. Anyone who thought he was “lucky” jumping in the market last year doesn’t sound like he was leaping with his eyes wide open.
For perspective:
We bought our current house in 1990 for $131K. It’s an early ’70′s Denver Metro 3 BR + Master with finished basement. O.K. shape but no show home. We made no profit on the little 20′s bungalow starter which we bought in ’81. We were lucky to sell that for $65K. But we needed to move for an expanding family and better schools. A recession was on so we figured we were gaining on the move up. It was a tough time too, not as bad as I think it may get now though. We were worried about losing jobs. BUT we had savings! They wanted 20% down and we were fortunate to have it. No funny stuff, straight 30 year fixed at 8%.
So we played the refi game twice over the years, BUT not for the HELOC but because we wanted to lower our monthly and knew we liked the neighborhood and planned on staying so we could recoup the refi costs. Then a few years back when savings and CD rates were Greenspan’d we looked at the remaining principal on the 15 yr mortgage and the 6.25% interest we were paying and said “let’s cash it out”
The house is appraised by the county at $350,000 but I’d like to contest that! Hey if it drops to $250 I don’t care. It’s where we live. The neighborhood is real stable, we know most folks, many have done the same as us and own their homes out right. A few may have HELOC’s for home improvements or college. But I quess the majority are pretty responsible.
We aren’t rich but we think we played it smart. Others may beg to differ. But you know we aren’t up shits creek either like so many fools out there. But our route was a slow process and takes making sacrifices and holding off on desires. Everyone wants it now but the flip side is potential pain and misery.
Ingydesu -
Tax savings are NOT, I repeat NOT that black and white and beneficial.
The tax benefit doesn’t occur until your itemized deductions are higher than your standard deduction. So, in my case as a married person filing jointly, I would need to break $10,700. So, the cumulative benefit is far less. It isn’t straight fed + state income tax rate multiplied against interest paid.
manfre -
Word. You go to the head of the class. Don’t tell any realtors though, you’ll put them off their game.
You just have to be very careful right now. There are three good options right now.
- 100% financed and no need for a good credit score
- Pre-bubble purchase and 100% paid for
- Pre-bubble purchase with some equity and the ability to pay it off at any time.
Any other position is VERY risky. The most risky is bubble bought with 40% equity and not enough money to pay it off.
The bank will repo those first once they get desperate for capital. Keep in mind that the banks are poor right now, but not desperate.
Desperation hasn’t even started. The guy with 0% equity will get foreclosed last, if ever.
Well and of course renting rocks too
cfishy,
I was not clear on the home I bought. I meant that I know of 2000 sq ft houses for 145k-160k right now… I bought in 1996 a 1543 sq ft home for 100k. Probably overpaid? However I sold this year for $216500… So even if I did over pay, I raised children for 10 years and had a wonderful home even if I was underwater back then. I do not endorse over paying. I do try to educate people I work with. Under a $100 a sq ft I can live with and afford. If I lost my house it would not be the end of the world either to rent as long as we have our health and a roof over our heads.
Brucewho, great post #13. If the joy of owning your home is not connected to related values, then it tends to become a speculative thing, which is not healthy for one’s family or the economy as a whole.
cfishy, you nailed it as far as the government’s policy focus needing to be the folks on the sidelines, incenting them to buy and addressing their hesitation. My sense is that the sideliners are some of the most responsible and thoughtful decision-makers, have the right values related to home ownership, and will be in the best financial position over the next couple of years.
Someone on this site once posted that they would wait for three consecutive months of positive or neutral trends in the following areas before they would move from renting to buying:
- housing supply and demand
- home price stability
- consumer confidence
- unemployment/labor market
- rental vs. mortgage monthly cost comparisons
That advice has stuck with me ever since, and my wife and I feel very fortunate that we’re still waiting for the right time to move from renting to buying. We expect to see these trends signal that “it’s time” by the end of this year or the sping 2009. We’ll see.
Manfre – I think I agreed that the tax savings are not a black and white thing right off. I agree that you have to get beyond the standard deduction first, so if you are at 0, a 12k interest deduction only nets you 2k in income adjustment. For me, my family, we are all about at the standard deduction prior to any mortgage interest deductions. If you have a few kids, pay sales/income tax to a state, and give charitable donations and/or tithe to a church, you will get up there pretty quick. The MI deduction is a substantial one, but as I stated before, you have to do the math on your own.
Twist, I can appreciate what you are saying. It is really all about the long run. Do the math ,to make sure your cash flow works, but take the long view. We can’t ever be a hundred percent on what will come around, but if you are reasonably certain, you can plan. While in school, we were pressured to buy a house. Looking back it would have been a good idea as we were in the same town for 6 years, property values increased, and we would have reaped a nice benefit. We didn’t know, and planned accordingly. It worked for us, even if the numbers might have worked better in the other direction. I’m not fretting about it.
What I am still angry about is that because I had a savings account and money market funds, I was denied grants and loans in school, and those who bought cars or “transffered” the assets, were able to get grants equal to the amount saved. Talk about a financial disencentive! So I acknowledge that the government doesn’t always know what they are doing.
The thing people forget about renting though is what happens when you retire? We have an enevitable social security crisis looming, what happens when people who want to retire at 65 not only have no social security, but are paying market rent because they never bought a house? God only knows what rents will be in 30 years.
I can see the sense in waiting a year or two to buy a house, but a guy like me(33 with five kids) can’t wait to long because I want to ENJOY my retirement with a paid off house, and a steady long term income. That’s why I still contribute money to my 457 and plan on keeping the rental property I have(which all cash flows or breaks even)for the long haul. I never got into flipping.
Think of it this way. If the average American can’t invest in the stock market, mutual funds, or real estate, where do you go to build long term wealth or even just a nest egg. Don’t tell me a savings account with 1.5%.
I heard Jay Butler give a brief comment on Phoenix area housing this morning (Wednesday) on KTAR/92.3. I wish that I had the exact quote, but it was similar to the mindset of this Minnesota guy. Basically, Butler commented on how “happy” many people are because they were approved for loans that they never thought they could have and live in neighborhoods that they never could have hoped for without the loose lending of recent years. Then he downplayed the significance of dropping house prices.
I wish that I had exact quotes, but a cursory look on Google News and the KTAR website did not show these comments.
1. You people citing the mortgage tax deduction cannot ignore the property taxes, which is sometimes more than the interest tax deduction. You also cannot ignore the repair, insurance and maintenance costs. There is a 6% fee when you sell, there is a closing cost when you buy.
2. You can paint the walls and knock holes in them, but it will cost you when you try to sell the house. You’ll either have to fix it or give the buyer an allowance to undo what you did.
3. As for retiring, how many “owners” really own their house? How many people actually buy the house and pay it off over 30 years and stay there to retire? Maybe it happened 50 years ago, but not today. I would put the number at 10%. The rest will be in a worse off situation as they will be old and tied to a mortgage.
4. You lose if you overpaid whether you sell or not. If you pay $600K for a house and your neighbor pays $400K for a similar house, you lost $200K whether you admit it or not. In the long run, your monthly payment is 50% higher than your neighbor’s for the next 30 years. If you both sell your house for the same price, he will come out at $200K ahead of you. It’s NEVER a good idea to overpay by such a large amount no matter what the timeline.
Tampabay1, if my parents had relied on their house to retire, they’d be in a world of hurt. They paid $35,000 for it in 1969 and sold it in 1993 for $100,000. It was their willingness to make sacrifices that allowed them to raise 5 kids and retire early. Dad was an Air Force officer and mom a mom. Why can’t the “average American” invest in the stock market or mutual funds? Of course they can. My parents bought a car when we needed one. We all had what we needed as opposed to what our friends and neighbors had or what we wanted. It’s called living within your means.
My husband and I paid $575/month rent for an 1100 sq. ft. townhouse when we got married in 1991. We saved for a downpayment and built a home in 1993. We sold it in 2002 and made a little profit. We’re now early-retirees in our 40s (like my parents were) and pay $900/month rent(note: that’s 16 years later and our rent hasn’t doubled) for a nice house. We scrimped, we saved what we earned, we bought what we needed. We now enjoy our life, and plan to stay retired. We’re not rich, but we’re able to pay the bills.
I really feel for people who are counting on the value of their house to go up so they can feel financially secure. It’s so sad. They made a decision that wasn’t very financially prudent; a gamble. Everyone should be so lucky to have been raised by depression-era parents/grandparents.
TampaBay1-
For a lot of us, the house we raise our family in isn’t the one that we want to retire in. Right now I have four kids still at home, and three adults working out of the house. We have a lot of space, and a bunch of stairs. I envision something a lot smaller to retire in.
Paying off a house over 30 years has been a successful strategy for many people, but there are other investments that can make more sense in the current environment- there’s more than one way to achieve a comfortable retirement.
I guess I don’t understand the “pay off the house so I can retire” strategy.
A house is an expensive luxury.
Principle – Yep.. You can take that to zero by sacrificing other areas of your life like not taking vacations. So the benefit of being paid for better be very good.
Interest – That’ll go zero when Principle goes to zero so that’s not a bad thing.
Taxes – Let’s be conservative and say $2400 a year so you’ve got a $200 monthly hit no matter what you do
Insurance – Let’s say $1200 a year (assuming you don’t live in a natural disaster zone) so you’ve got a $100 per month hit.
Maintenance – I would budget $200 a month.. That roof will need replaced eventually.
Improvements – Now your going to want to fix it up some once in awhile. Nothing fancy but $200 a month will net you 1 $5000 project every 4 years. (A renter just moves to a nice new place every few years)
Now it’s 30 years later and your retired renter friends are paying $900 a month and you sacrificed for 30 years so that you can pay $700 a month.
Assuming your retired renter friends also scrimped and saved what you paid in principle and interest, they have a few hundred grand in the bank to boot.
Duh…
bad math on the last post.. $200 nets a $10K improvement, but hey you can’t afford anyways that since your paying off the principle and interest
Longwaver-
I didn’t realize until I started renting how much all the little improvements add up. Even without gutting a bathroom or a kitchen, when you change a light fixture here, or the tile on the fireplace, etc., it all starts adding up. While there are things I’d love to change around here, Home Depot is no longer a line item in my monthly budget, and I’m OK with that.
Twist-
This is a great post. The debate between owning and renting is a very good one. And more importantly smart decisions regarding personal finance. I hope folks keep it going for a while longer. I’ll keep checking in. It’s a frank discussion America needs to have with itself but I fear most of us here are just “preaching to the choir”.
Bruce-
The debate is a good one- and will change over time. I appreciate all of our posters and the civilized discourse. There’s no one right answer on this one– when you buy, what you buy, income level, reason to buy, are all factors that can give a different output.
I would hate to see a world where buying never makes sense. If homes go into foreclosure, the banks can’t unload them and private parties can’t or won’t buy them, then I worry housing would become public, not private.
Fortunately, I don’t see that happening. Prices will drop to the point where buying is cheaper than renting, [as it should be]and a lot of us will get off the sidelines.
Twist-
I wonder too if much of the off loaded bank collateral becomes public housing. Actually that would be better than deteriorating into unlivable wastelands. Many developments are far from job centers and not served well by public transportation. What happens when gas goes to $4 then $5 and beyond. Who will want to live way out there. Services will contract, municipalities will default, and utilities will shut off. Plow them under?
Birth and Death of a Derivative
This is kinda long. I clipped it off another blog but the punchline is priceless. Now I understand the problem better.
1) The Jacksons put down $25,000 on a $300,000 house
Loan $275,000 (Bank ABC)
Interest 2.5% ARM year 1, then prime plus 2.5% resets every 6 months.
Bank ABC has $275,000 interest-earning loan=asset on the books
2) Investment Bank XYZ sponsors a Special Purpose Vehicle (SPV)
http://en.wikipedia.org/wiki/Special_pur...
in the Cayman Islands
http://www.butterfieldbank.ky/Private_Ba...
3) Investment Bank XYZ borrows money from Bank DEF to fund this SPV vehicle and the asset manager of the vehicle searches for good assets (warehouses) and ends up finding the Jackson’s loan on the books of Bank ABC. The vehicle (corporation) buys the $300,000 loan asset from US bank ABC with money borrowed from Euro Bank DEF.
4) The SPV now shows a $300,000 loan asset on its books, and a $300,000 loan obligation to EURO Bank DEF.
The SPV issues shares called cash collateral debt obligations (cash CDO’s) and divides these into Premium (senior tranche), mid-risk (mezzanine tranche), and low grade tiers (unrated tranche), sells these to other investors. Premium shares get monthly interest payments, low grade shares are sold and a secondary market is created to trade them for equity appreciation. Mid-tier CDO’s get sold for higher yield and risk than premium.
The SPV has proceeds from sale of CDO’s takes a cut for bank XYZ, asset managment fees, SPV director fees and invests the rest into high security money market funds.
To insure premium interest-earning CDO’s from the senior tranche holders, the SPV issues synthetic CDO’s using a Credit Default Swap (CDS) agreement insuring premium CDO tranche holders against default of the underlying Jackson loan. Investors buying these CDO’s are earning a risk premium as long as there is no default. The SPV issuing both cash and synthetic CDO’s becomes a hybrid SPV.
End result so far:
1) Jackson’s owe $300,000 and interest payments to Cayman SPV
2) Cayman SPV owes $300,000 plus interest to Bank DEF
3) SPV has $300,000 from sale of cash CDO’s and $100,000 from sale of synthetic CDO’s in money market muni bonds rated AAA rated and insured by bond insurer GHI.
4) SPV owes interest payments to senior holders. Senior holders’
5) SPV owes interest payments to mezzanine holders
6) SPV owes CDS premium payments to synthetic CDO holders.
Total debt outstanding:
300,000 (Jacksons to SPV)
300,000 (SPV to Bank DEF)
300,000 (Bank DEF to depositors)
300,000 (SPV to tranche holders)
100,000 (SPV to CDS holders)
300,000 (money market to SPV)
Total: $1,600,000
Interest payments:
Jacksons to SPV
Money Market to SPV
SPV to senior and mezzanine tranche CDO holders
SPV to CDS holders (risk premium payments)
Now imagine what happens if:
The Jacksons stop making payments
Igor says it explodes!
Brucewho-
Actually I had a long discussion on a friend recently on whether or not to plow them under. I think that gas is so expensive, there are so many homes available closer in, and demand is so slow that bulldozing will be all they can do. He was of the opinion some communities will be boarded up. I think that would make them crime magnets. Neither one of us see them selling anytime soon. We’ll see.
Longwaver,
I think you maybe underestimating where rents will be years from now. Assuming housing eventually returns to an average annual return of 5-7% a year, Rents should start rising at a closer pace to housing prices due to inflationary pressure. Also, my house is conservatively worth 500k. The Tampa Bay area has average appreciation of 7%. At that rate, my home should be worth nearly 3.8 million when I retire. But lets assume we are headed for a long term severe depression, and over the 30 years appreciation is reduced by 50%. I would still have an asset worth $1.4 million. My mortgage payment is fixed at $2800(PITI). Say another 2-300 in repairs. To rent the same home I would be paying at least $2k/month. If you assume rents only rise at 2%/year(WAY below the local averages), In 30 years one would be paying $3600/month in rent. I currently pay approximately 6oo month in taxes and insurance; these will go up but the tax right off should at least partially offset these, mainly because Florida has a homestead exemption and a propety tax cap. Compare the renter vs. me:
1)Me-paying $1000-1500 month with an asset worth 1.4-3.8 million.
2)Renter-paying 3600/month with no asset. The first 15 years his rent is less than my mortgage, so I guess you could calculate what he would have made in a mutual fund IF he invested every penny of that money.
Also, I am able to live comfortably paying the mortgage I have; I take vactions, coach my son’s little league, Our home purchase was very well thought through because we did not want to make major sacrifices in other areas of our lives.
Again, I think 3.5% appreciation is very conservative; I’m curious to hear your thoughts.
The amount people should pay for a home is based on a few simple things that work together in a normal market to set prices.
- Inventory
- Average wages
- The available pool of buyers
- And carrying costs such as taxes an insurance
So if Florida had just enough homes for everyone that wanted to buy and the prices of the average home matched say 3X the average wage and I didn’t read stories about outrageous taxes and insurance costs, the price of homes in Florida would be stable.
Note that I didn’t mention inflation as a driver of home prices. Income is the driver. Now if everyone’s income was indexed to inflation, well then you might have something there.
So the net net is that you have to assume that anytime you make an investment, you might lose 100% of your starting capital and maybe even more if you’ve leveraged.
Say $10,000 to buy $1,000,000 and the house drops by 10% when you sell.
Also houses have a nasty investment trait, they aren’t very liquid.
So buy a house if you want the luxury of home ownership. It costs more every month, you might lose all of your capital and a lot more when/if you are able to sell, but you do get many benefits.
Everyone needs to make their own decision.
For the record I own, but my mortgage is 100% and I was able to take on an interest only loan so my payments are very reasonable. I also live in a part of the country that never participated in the bubble.
So I have a low payment, none of my capital at risk and we are very happy.
You make a lot of good points. Buying a home was historically a wise investment BECAUSE it wasn’t considered a commodity. You can’t buy a home simply because you are counting on appreciation and being able to sell in a few years. We own because we have lived in the same city our entire lives and have stable jobs here, we have five children and need the space, and can afford the house we live in without having to cut corners.
TampaBay-
Now those sound like great reasons to own. A lot of the subprime problems came about because people put the cart before the horse. The goal should be financial and social stability- then homeownership. That’s the only way it makes sense.