House prices

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HB:

Ok, lets examine this a little closer:

Sort of. There are only so many houses in existence at any given time. New houses are built only as long as it is profitable to do so (assuming a capitalist system here folks). So as the cost of new houses rises, the demand for these new houses decreases, and the demand for used housing increases. However, are destroyed (fire or extreme weather) and houses have a lifetime and they eventually have to be torn down or have major structural work done to them, which requires the same materials as building a new house (though probably not as much of them, but you still have the added expense of the existing home), and the population in most places continues to grow, causing a demand for more housing. If new homes become prohibitively expensive to build, demand for existing homes will increase, driving the price up on them. Eventually the market will find equilibrium again, and the pressures of a demand market will make new home building profitable again.

In summary, the destruction (intentional or act of god) of existing homes and growth in population are a fairly consistent forces driving the construction of new housing.

Many people today buy investment houses on credit, and then they hope that they can cover the mortgage payment and maintenance from the rents. If they are successful in that, every year they are gaining equity in the home, and eventually they will be able to sell it for a profit. Yes this is a risky investment plan, but I would place it well beneath the dot-boom/dot-bust investments, because as a sector, they either never showed profitability (IIRC it was at least 5 years before Amazon showed a profit), and/or they never had positive cash flow from operations (WorldCom as a prime example), instead maintaining they solvency through the sale of stock and never ending leveraging of their increasing paper value (e.g. credit/borrowing/selling bonds). At least with an investment house, thre is still a physical asset, even if it diminishes in value below what was paid for it.

 

Problem is, if the increase in the price of the property is only speculation and credit froth, then having the tangible property doesn't really help you that much. Imagine an IMHO soon-to-be-typical disaster scenario: Joe Blow buys a house using one of the all too common e-z credit financing packages available today, with no money down and a variable mortgage rate. Joe Blow can make the payments on that, but only barely. While the house was 100K eight years ago, Joe buys it for 200K, secure in the thought he will be able to sell it in a few years for 300K. And then, BAM! Credit crunch. Joe's variable mortgage rate skyrockets, and Joe eats through his savings and even starts to max out his credit cards to make his much increased mortgage payments. With dismay he watches housing prices plummet, but hopes against hope that they'll rise again so he can unload his house. Finally, he has no choice but to put his house on the market. As his financial situation deteriorates, his blood pressure increases, and his asking price dives. Finally he finds a buyer for 100K, and in dire straights, he accepts, and moves into an apartment. What is he left with? A mortgage on nothing, thin air, nada, at the cost of 100K, and at a much higher rate of interest than his original mortgage. Joe Blow is very, very unhappy, and blames the government. Does that sound about right?

And @HB: I don't think mortgage rates themselves are driving the housing boom as much as is the availability of credit. Also, imagine what happens to everyone who's refinanced their home to take advantage of its increased valuation, and viewed this as free money, instead of a bank loan using their house as colateral, which it is until the moment the house is sold. Paper gains on houses are exactly the same as paper gains in stocks: they aren't gains until you've made the sale...

 

Bion, I couldn't agree with you more. Darkwolf - I agree that an investment house is better than a dot.com share, but you still have to work out what a good price to pay for it is and it is still possible for it to be over-priced. If an investment house was a good buy 4 years ago at $250,000, is it still a good buy today at $500,000? If rents have not doubled (which they haven't), is it still worth it? If it is, then was it heavily under-priced 4 years ago.

The scenario outlined by Bion is the one that seems logical to me, but I'm no expert in economic forecasts and may be missing some vital considerations.

 

Oh, yes, housing has indeed gone up here. But we bought our house in 1998 and it's increased about 8 percent per year during that time. We are now ready to sell and move into a bigger home, since we now have two children, which we did not have in 1998.

We will probably move sometime later this year into a new home, maybe 6-10 miles from where we are now. But still on the northside of Houston, and into a newly built section. A good quality, brand new home, in a very good school district, will cost us about 130K, including some upgrades. Comparing the plans we are looking at now, the new house will than likely have 3 bedrooms, 2 studies, and a two car garage. It should be around 2100 square feet of actual living space. Considering what new homes cost in most other places in the US, 130K is really not that bad for that sized house.

 

Interesting - Chandos, you seem to be the only person who is happy with the house prices in area in which you live. I wonder why.

 

Me too.

 

Probably because 130K wouldn't buy a cardboard box and the grate to set it over in the NYC metro region... Houston seriously was an easy place to live...

 

WOW Chandros! $130K for a 2100 sq. ft. house? While I do not live in NYC, and I do not have to deal with the housing situation Bion describes, my current home, a 975 sq. ft. townhouse (that I would love to move out of) would definitely command more than $130K on the open market.

 

Bion,

Ok, first, the person who entered into this type of deal is foolhardy, and he is not going to end up eating the loss, the investors/lenders who purchased his mortgage are.

I am speaking of the US here; I have no ideal how mortgages and liens work in the rest of the world.

When you borrow to purchase a house, the mortgage company places a lien on your house. Transference of ownership (title) cannot occur until that lien is satisfied (through either payoff or transference of the debt to a new debt holder), thus one of the reasons for the need for Title Companies. So your imaginary homeowner cannot sell his home for less than the mortgage amount, unless he could supply the capital (cash) to pay off the shortfall. This would leave the person in a situation where their only choices would be bankruptcy, or allowing the home to be repossessed, both of which pass the costs to the lien holder, as it is very unlikely that the lien holder would release the lien as it would make the debt completely unsecured at that point. Something like this may have happened, but it would be extremely rare, and mortgage companies generally will either foreclose on the home or force the home owner into bankruptcy. They rarely, if ever, negotiate such disadvantageous terms, especially since they are usually only acting as the agent for the investors who really hold the debt.

With recent changes to bankruptcy laws, borrowing off of credit cards to pay your mortgage is foolhardy to an extreme, as you no longer automatically get to walk away from unsecured debt, beside it doesn't make sense anyway, why borrow at 12 to 19% to pay a 4 to 9% mortgage payment? That is a recipe for disaster.

A piece of advise, stay away from variable rate notes, they are very, very risky, and it is better to wait and save up more money so that you an afford the down payment on a conventional fixed mortgage (avoid mortgage insurance as well, be patient and keep saving). There are times when a ARM is a good deal, but they are few and far between, have more to do with the borrower's circumstances than the actual numbers involved, and those times never involve a person who can't afford a fixed rate mortgage.

 

I agree with DW on his assessment of the hypothetical scenario Bion described. Bankuptcy is the far more likely outcome. Furthermore, it is extremely rare for housing costs to plummet to 50% of their initial worth just because of the market. The only time when we saw anything like this was in southern California, about 5 years ago, but there were factors beyond the housing market at work there. There were also massive layoffs in that area of the country, so in addition to many people moving out of the area to secure employment elsewhere, there was simultaneously almost no one who wanted to move into the area. The basic law of supply and demand was as much a factor as the dotcom bust in causing the housing market to crash.

Such as my situation. My wife and I CAN afford a fixed rate mortgage and would be able to pay the mortgage even if the interest rate jumped to it's theoretical maximum of 9.75%. However, we went with an ARM because we only plan on staying in our current home for a few years. We already have enough equity in the house that we don't need mortgage insurance, and we felt that lowering out monthly payments for now was a good deal because we don't plan on still living there when the lower rate runs out.

 

BINGO, give that man a prize!

Aldeth, you hit one of the few times when an ARM is a good idea.

I love to see people who actually make financial decisions based upon well thought out planning and research!

 

Basically ARMs are a good deal when you're looking at a "starter house" for lack of a better word. It is very unlikely that the first house you buy will be your dream house simply because you won't be able to afford it when you're young. Instead of pouring money into renting a place for several years (money that you get NO return on) it is often wiser to buy a small "starter house" first. You live there for generally 5-10 years, build up equity in it, and then when you sell you use the equity to buy a larger home, which may or may not be your dream house, but is certainly an upgrade over what you have. The magic number here is 20%. You would like your return on the home you sold to be at least 20% of the value of the home you intend to buy so you don't need mortgage insurance.

The key with the ARM though is to select an ARM that fits your situation. ARM loans give you an early rate deduction, and in some cases, that reduction may last as little as 3 years. If you plan on living in your house much longer than that, then an ARM is not for you. There are also 5-year ARMs and 7-year ARMs, but generally, the interest rates are not as good as teh 3-year ARMs. There may even be more beyond that, but I didn't consider anything beyond a 7-year ARM, as the numbers tend to get worse the longer you go. Again, how long your ARM lasts needs to be tied to how long you plan on living in your home. If you're going to be there for close 10 years, then naturally getting a 7-year ARM would be in your best interest. If you aren't going to be there that long, than you may as well benefit from a lower interest rate offered by the other ARMs. Of course, if you plan on living there for more than 10 years, an ARM is a tremendously bad idea, as the variable rate (once the ARM runs out) is usually significantly higher than what a fixed rate mortgage would be.

 

You have to love the difference that living on difference sides of a line on a map can make. In Canada most prudent people have a variable rate mortgage.

Our mortgage interest is not tax deductible so our goal is to pay the mortgage off as fast as possible.

Paying down the mortgage is basically the same as putting money into a tax deferred retirement plan and as far as interest rates go there is almost no way that you will find a relatively low risk interest bearing product with an interest rate as high as the mortgage rate. The stock market has basically gone no where in the last several years so paying down the mortgage looks even better.

Variable interest rates are typically between 1.5 and 2% lower than fixed rates and the interest rate has been pretty stable for the last decade. Thus, the discount for taking a variable rate is sufficiently high that unless you are quite conservative you will select the variable rate. Given that we are paying off the mortgage at a fairly accelerated pace the risk of rates spiking upwards is further reduced.

 

I agree that bankruptcy would be the sensible solution to my little scenario. However, if this sort of thing begins to happen too frequently, it seems to me quite probable a viscious circle would come into play regardless of whether the burden of readjusting housing prices falls on consumers or on creditors: if consumers, who have been using houses as virtual ATMs, are hit, prices will dive, while if creditors are hit, the cost of credit (interest rates) goes up, and prices dive. Once something like this gets started, it's hard to slow it down. It's really just the mirror image of the virtuous circle that has driven up property values: high liquidity and lots of available credit drives up property values, rising property values (and the subsequent idea that property is a failsafe investment) creates more equity and more consumer demand for credit, and the rapid growth in the credit market encourages creditors to extend credit to consumers they would have rejected before, thus driving up property values, etc. The key here was fed injected liquidity, the "punchbowl" the fed is supposed to take away when things get overheated, but which they did not do either in the late 90s stock market or now for the housing market. The cost of injecting all this liquidity is only now becoming apparent in for example the fall of the dollar and the US's negative balance of trade; one could argue that China is indirectly subsidizing the housing boom. Once this unsustainable liquidity begins to dry up, things will turn around in a hurry IMHO.

 

Bion,

I can go along with most of your arguement. However this is a issue with human nature.

The question is, what can we do about it?

 

This discussion is becoming fascinating because I had no idea that mortgages worked so differently in different countries.

In NZ, a variable rate mortgage is not an evil thing. Both fixed and variable rates have their place. For this reason, my mortgage is broken up into three parts. I have fixed 1/3 for 5 years, 1/3 for 2 years, and 1/3 at the current floating rate.

By doing this, I am effectively hedging against rates going up or down. If they go up, my fixed rate becomes more valuable and if they go down my variable rate becomes more valuable.

But the number one biggest reason for having a portion of my mortgage at floating rates is that I get to use that part of the mortgage as revolving credit and have my salary paid directly into that account. As JSBB said, in NZ like Canada, the aim is to reduce interest as much as possible. By having my entire salary paid directly into my variable mortgage, that balance is kept as low as possible and I don't need to have a separate bank account earning 4% when that money could be used in the mortgage to save 8%.

Of course, this approach requires far more discipline to make sure that you're not tempted to spend the credit limit that is sitting in the variable mortgage. I guess the bank is counting on people doing that and thus increasing their interest bill. So far we have been pretty good at not doing that.

 

Prices have been shooting up in Britain for a while now but have levelled out around London in the last year or so, thanks mainly to the Bank of England controling interest rates (The best thing this Government have done was to give the BoE control). 2 years ago, my girl-friend sold her house and we bought a place together. She had only been in it for 15 months but the value had gone up by 70%. We bought closer to London, and I believe ours has probably increased by about 20% in the two years.

For those that are really bored...
Mortgage wise, the beter-half had a low first-time-buyer 2-year fixed rate when she bought, with tie-in for two years so we had to port it (Bring it through to the next house) to avoid the tie-in fine. The rest had to be made up from the same building society and we took the standard variable rate so we could move mortgage companies easily when the cheaper two-year period expired. The SVR was about 2% higher than the fixed.
We have since moved to an Off-set mortgage, which I guess is similar to HB's floating rate. Savings in your bank accounts are deducted from the outstanding mortgage before interest is calculated. This means you don't earn interest on money in your accounts, but you also don't pay tax on that interest either (40% for higher earners). However, the money in your account remains your own so you can spend it should you desire. As the repayments are based as if you were paying the full interest rate, this doesn't mean your monthly bill goes up if you have less money in your account. This also means you are normally paying more of the capital off (saving more interest).
The bank we're with allows us to keep our finances totally seperate from each other. (A definite advantage as no-one can predict the future). The off-set mortgage is effectively a tracker mortgage (Follows Bank-of-England base rate + 0.9%), and stands currently at 5.65%. (Compared to 6.75% SVR which also tends to follow BoE base). You can get better rates, but they tend to be limited to a 2 or 3 year period before going to SVR. At this point you need to change lender to get another cheap deal, which costs you transfer fees.
It's not worth going into details but if we continue to save at a rate of £300 a month each (probably a low estimate), we'll stop paying interest in about 4.5 years. (i.e. the money in our bank accounts will exceed the outstanding mortgage.)

[ April 29, 2005, 15:01: Message edited by: Carcaroth ]

 

This is interesting. First of all, I never knew that the U.S. was unusual in allowing people to deduct interest paid on their mortgage from their taxes. (With the caveat that you aren't taking the standard deduction.) It's the same thing with student loans. Any interest you pay is tax deductible. As such, there is less incentive to pay down your mortgage or your student loans, because you will get a percentage of that back in your taxes. I will agree that paying down your mortgage is rarely a bad thing, but the benefits only seem to be there if you do it relatively early in the mortgage.

The standard mortgage in the U.S. is 30 years. Obviously, since interest is paid on the principle, you pay much more interest in the early years of a mortgage than in the later years. So if you can pay off your mortgage in 20 years as opposed to 30 years, you'll save a lot of interest provided that you started paying it down early in the mortgage. If you make the minimum payment for 20 years, and then pay it off all at once, you won't save that much money, because 20 years into the mortgage, you've already paid the lion's share of the interest. The same is true for my student loans. I'm now in year 5 of paying off a 10-year loan. I was only capable of making the minimum payments early on, and now, paying them off is not in my best interest, as 75% of my monthly payment is going towards the principle - i.e., I've already paid most of the interest I'm going to pay.

I also find it unusual that variable rate mortgages are usually preferred in other countries. Obviously that is because variable rates are usually lower than fixed rates. In the U.S. the exact opposite is true. Generally speaking, a variable rate mortgage is a couple of percentage points higher than a fixed rate, making a fixed rate more desirable.

 

I have never really understood why variable rates are higher than fixed in the U.S. People generally are at least somewhat risk adverse and thus you would think that people would prefer a fixed interest rate and thus would require some reward for assuming the risk of a variable rate. That is certainly the way it works here.

If interest rates were high and you expected rates to fall sharply during the term of the mortgage I can see paying a small premium for a variable rate but that is clearly not the case these days.

In terms of amortization, 20-30 year amortizations are quite standard although we tend to make extra payments when money permits to accelerate this. I was on track to pay my mortgage off within five years of purchasing my house but I have backed off on this a little lately so that it will probably end up taking seven years.

What is the term structure like in the U.S.? In Canada we generally stick to 1-3 year terms as there is a significantly lower rate to entice risk adverse people into accepting a lower term.

 

Well, since most people have fixed rate mortgages, it kind of renders the question moot, as the terms only change if you have an ARM.

For those people who have adjustable rate mortgages (known as ARMs) you have a low fixed rate for either 1, 3, 5, or 7 years. The shorter the time period for your fixed rate, the lower your interest will be in those years. After the fixed rate period expires, your mortgage rate will be adjusted annually, to within certain limits. First of all, your interest rate can never go up by more than 2% per year, and the maximum it can go to is 5% higher than what the fixed rate was during the first portion of the ARM.

So for me as an example, I have a 4.75% interest rate during the 5-year ARM period. In year 6, it could jump as high as 6.75%. In year 7, it could jump as high as 8.75%, and in year 8 and beyond it could go as high as the maximum allowed, at 9.75%. And this is why many people don't like the variable rates. It could be as high as 9.75%, and no one who has signed on for a fixed rate mortgage recently has an interest rate anywhere near 9.75%.

I'm not sure if that really answers your question though...