Skip to main content

Don't Buy a House Now

You aren't smarter than the market. It really is that simple.

There have been several articles lately that I suspect are part of a determined effort by the real estate industry to get people back into the housing market. The basic pitch is that higher interest rates will eat up any savings you get from waiting for lower prices. Even the New York Times has gotten in on this action.

The calculation always goes something like this. Say you have a house for 500,000 and you make a $100,000 down payment today with a $400,000 mortage at 6.5%. Now compare that to a year from now if housing prices fall by 10%, you would make a down payment of $90,000 and borrow only $360,000, but at a higher interest rate. If the interest rate is high enough, you will end up with higher payments and paying more total for the house than if you purchased it now.

There are two problems with that calculation. The first is that isn't really how people buy houses. People decide how much they can afford and then find the best house in their price range. So the actual comparison is if I can afford the payments on the $500,000 home today, what will I be able to get for that money a year from now. If you assume prices will fall 10%, then a house selling for $555,555 today will sell for $500,000 a year from now. Of course, whether you can afford it will depend on the interest rate - that was the point of the above exercise.

So what can you afford to borrow at different interest rates?
Your monthly payment at 6.5% on $400,000 loan is $2528:
at 7% you can borrow $380,000
at 7.5% you can borrow $361,000
at 7.8% you can borrow $350,000
at 7.97% you can borrow $345,000

So if you assume that you can get a 5% return on your $100,000 down payment, you will still be able to afford that house priced at $500,000 if it drops to $450,000 a year from now and interest rates don't go beyond 7.97%.

This brings us to the second problem with the calculation. Interest rates help determine the price of houses. If interest rates approach 8% a year from now, then housing prices are very likely going to drop a lot more than 10%. In fact, if you look at the example above as the typical buyer for a $500,000 home today, an increase to 8% interest, by itself, will force the price of that house down by more than 10%.

At this point, interest rates have not even been a significant factor in the plunge in housing prices. The housing bubble pushed prices well beyond their fundamental value when compared to the cost of renting and family income. And housing remains overpriced by those measures in most markets. If interest rates go up, that will only add to the market correction.

Finally, going back to the example above. If you plan to buy a house to live in for a few years, then the current fluctuations in price won't matter very much. But if you can wait a year and buy a house that is worth 10% more than the house you can buy today, you will be way ahead. Not only will you get more for it when you sell it, but you will have had the benefit of living in a nicer house for as long as you owned it.


Popular posts from this blog

The Stock Market hasn't gone up, the Value of the Dollar has Just Gone Down.

You aren't smarter than the market. It really is that simple. The New York Times had an article about the stock market's recent gains. The story noted that while the market had gone up 11% since the election, the dollar had dropped 10% against a basket of foreign currencies during that same period. They described this as "almost a mirror image." Unfortunately it is exactly a mirror image for people who hold those foreign currencies. Lets say they paid a $100 for a share of stock the day of the election and they exchanged 100 units of their own currency for that $100. Now if they sell that stock they will get $111 dollars, but when they exchange that $111 dollars, they will get back 100 units of their own currency. They have earned nothing, in their own local currency's terms the price hasn't changed. In a world investment market, the price of stock is set by what people around the world are willing to pay for it. Most people are still paying the same pr

Who is to blame for this mess?

There seems to be a lot of discussion to who is to blame for the financial crisis. But an awful lot of the media coverage is highly misleading. Here is synopis: 1) The meltdown in the financial market had little to do with people getting mortgages they couldn't afford. The collapse of the mortgage backed CDO's was caused by the collapse in the value of the houses which provided the collateral. It turned the mortgages behind the "collateralized debt obligations" (CDO's) into mostly un-collateralized debts. The result was that they went from AAA rated bonds to junk. 2)So what caused the housing bubble and collapse? Many people blame the fed, but don't have the story right. The fed did play a role. By keeping interest rates on Treasury Bonds low, they provided a market for alternative bonds that would pay a greater return. But the major cause of the housing bubble was the creativity of the investment banks. These are not the retail banks that make home mortgages

Self-Directed Real Estate IRA's the New Scam?

You aren't smarter than the market. It really is that simple. You know the marketing folks have been out talking when the New York Times does a fluff story on some new way to make more money with your investments. So watch out for the new scam promoted by the same media advisers who told you a few years ago to buy the most expensive house a lender would finance. Paul Sullivan story is about people'e successful investment of their retirement money in real estate using a self-directed IRA. He provides us with several "success stories".  Of course they are all recent converters to this idea and, not surprising, all but one of the people whose story Sullivan tells are also in real estate sales. The problem isn't really Paul Sullivan. Its that there is no one who makes money by digging out the horror stories from people who invested their retirement funds in real estate at the height of the housing bubble. There aren't any public relations firms devoted to de