More about Bubbles

I’ve been thinking alot about what I’m reading on the Van-Housing blog I wrote of yesterday. I’m trying to decide if this guy is just a more rational-sounding member of a conspiracy theory clan, or if he is on to something important. I’m trying to wrap my mind around the “pros and cons” of buying a home in the next few months if one buys the “bubble rap” (ha ha, I made that up myself) and assumes that interest rates will go up and home values will fall.

Let’s say we buy a home for $700k and put $100k of our hard-earned money as a downpayment. We borrowed $600k. If, say, two years later the value of the house goes down and we can only sell for $650k, then by the time we pay back the bank we’ve lost $50k of said hard-earned money (recognizing that the first couple years of mortgage payments go almost entirely to interest on the loan, equity really hasn’t accrued yet).

This argument against buying now is based on the assumption that we are going to want to sell the home two years from now. If we are totally happy where we are and want to stay then really it is only a “virtual” loss of money. It doesn’t become real until the house is sold. And if we were to stay in said house for, say, 15 years then it becomes easier to predict that a profit will be made in the end (and by that time substantial equity has been accrued). I suppose a prudent investor would ask what sort of returns you are getting, but given that you have the pleasure of owning a home all those years I suppose most people would be happy with any sort of profit, even if they understood that they could have made much more money by sticking that $50k and monthly mortgage payment in some other investment vehicle.

All of which is to say that a fall in the value of one’s home needn’t be an issue so long as one isn’t forced to sell it (unless you wish to borrow against the value of your home, but that’s another subject).

The other issue is interest rates. They are currently at lows not seen in decades, albeit higher than they were even 2 years ago. Back then it was not uncommon to see rates lower than 5% for 5 year terms. These days they are closer to 6 or 6.5%. Now at first glance one might think that an up in rates from 5% to 7.5% is no big deal. It’s such a small amount, right? Except that the difference – 2.5% – represents half of the original. What that means is if you borrowed $500k to buy your place, and your mortgage payment each month at 5% was $2908, then when it comes time to renew and now you can only get 7.5% your new monthly payment is $3658. That’s an increase of $750 per month. That’s a pretty big chunk of one’s montly budget, even if you are bringing in the $100,000 salary required to afford the house in the first place.

So what this means is that we should buy with the idea that we could be in for a hefty increase in monthly payments when the term is over, and thus buy less home than we can afford. Given the prices of homes ’round here, that could price us right out of the housing market and into a small apartment like the one we’re in now, which then begs the question why even bother buying (see my previous post about expenses incurred renting vs. buying the same size property). Certainaly from a “shoppers delight” perspective it just sucks all the joy right out of the whole process. OR, the above could mean buy a house with the expectation that family income will increase over time. Given my new business, this is definitely the plan for us, but I wouldn’t want to make decisions based on that assumption just yet.

These two considerations: losing the downpayment we’ve worked so hard to get, or being priced out of our home when the term ends (or buying alot less than we could afford, and where’s the fun in that?) are weighing heavily on my mind.

I was going to write my next post on what happens if prices truly do keep going up and interest rates remain low, but the answer is pretty simple – people who cannot expect a significant increase in their family income will be priced out (if they aren’t already), but those who expect that the income ceiling for the wage earner(s) in the family is far from being reached will not really suffer by waiting a bit longer to see what happens.

Put that way, it kinda makes the decision seem pretty simple, doesn’t it?

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