PART ONE—BUYING A NEW HOME
By Kevin M
In response to the mortgage meltdown/real estate slump of the past two to three years, the U.S. government has intervened with the take over of FNMA and FHLMC to insure the free flow of mortgage money, interest rates are being held down to the 5% level and an $8000 home buyer credit has been put in place to stimulate activity.
But should you as a homeowner take the bait and either trade up to a new and more expensive home, or perhaps refinance into a lower interest rate loan?
I’m going to take the contrarian’s view and argue against either course.
It should be noted that this series will deal specifically with current homeowners. For all of the reasons stated above, now might be an excellent time to buy your first home.
Since this is a long and involved topic, I’m going to cover it in two segments as it pertains to purchasing a new home and refinancing the mortgage on your current home. Today, we’ll take a look at purchasing, and cover refinancing tomorrow.
A Different Time—and Maybe Even a Different Country!
There was a time, yes, even here in America, when a primary goal of homeowners was the payoff of the mortgage on the family homestead. Many of the current generation of retirees are benefiting from the payoff of their mortgages earlier in life, conditioned as they were to payoff debt as soon as they were able.
Have you ever heard of a “mortgage burning party”? Chances are you haven’t, at least not in a couple of decades, because with our current world of trade-up-or-refinance-every-few-years routine, most mortgage indebtedness just gets recast and expanded again and again, with the end never in sight. A mortgage has come to be viewed as permanent debt.
If you’re truly interested in improving your long-term financial situation, or of ever retiring in some degree of comfort, the payoff of your mortgage should be a practical reality, and not just an oft-stated goal that gets pushed off into the indefinite future. The most fundamental aspect of the mortgage foreclosure crisis is people being too deep in debt!
The Root of the Current Crisis
In the struggle to revive the housing market, it’s worth revisiting the issues that are at the root of the current crisis:
Overbuying. The mantra in the real estate industry is to buy the most house you can afford, and even more if you can. This has been accomplished by the reduction or outright elimination of down payment requirements, the relaxation of income guidelines, the introduction of low teaser rate loans (interest only and adjustable rates) and no income verification programs.
Perpetual refinancing. Homeowners tapping and re-tapping the equity in their homes through home equity lines of credit and periodic refinances. As soon as equity is built up, it’s taken out for purposes often unrelated to the house itself, so that the house becomes a source of capital for outside financial activity, the so-called ATM effect. The darker term for this process is known as “equity stripping”. Because of this, even people who have owned their homes for many years often have little equity.
Overvaluing of property. People like higher values, especially when it concerns what is for most, the largest asset they own. The situation becomes even more pronounced when the housing market is booming, and prices can eventually catch up with expected values. But appraising a property is not an exact science, and the best that can reasonably be produced is a value range. A house might be valued at somewhere between $180,000 and $200,000, with a reasonable placement at the midpoint of $190,000. But in order to make the customer, agent, builder and lender happy, the value will be set at the upper range of $200,000. Or maybe 205. Or even—210—maybe? A house will be sold at that value, or a refinance may be taken based on it, but what that means is that the loan will be based on an optimistic valuation, that is value which may not exist. Unfortunately, in a soft or declining market, the exact opposite comes into play, and now houses are being valued at the lower end of the range. People are now awakening to the fact that they have no equity, or perhaps they are even in a negative equity position. The sudden realization of a negative equity position is a major driver in people walking away from their homes.
To be fair, there are other factors as well, including overbuilding and the declining economy. However both are beyond our ability to control, and it was largely the effects of the three causes outlined above that produced the oversupply of new housing as well as the bad economy.
Is Now a Good Time to Buy a New House?
Rates are low, it’s a buyers market and the people who should know are saying the “bottom is in” and now is the time to make a move; are they right?
Maybe this is good news for the national economy, and certainly for the beleaguered housing industry, but what does it mean for you personally?
In addition to getting a new house, usually a bigger one, here’s what else you’re taking on:
- A bigger mortgage. Since you’re mainly trading equity from your current home to a new one, the difference in price will mostly be paid for out of the proceeds of a larger mortgage.
- A higher payment. A bigger mortgage equals a higher monthly payment. A higher property value generally translates into higher real estate taxes and homeowners insurance.
- Transaction costs. Most people ignore these because either they’re being paid by the seller, builder or lender. Newsflash: no matter how the deck is shuffled, you’re paying the transaction costs! Even if you don’t pay direct at the closing table, you will pay through a higher sale price, or a higher interest rate (if the costs are lender paid).
- Your mortgage term resets to 30 years. If the remaining term on your current mortgage has 22 years left on it, you will most likely start from square one with a brand new 30 year loan in an effort to keep the new payment at a minimum. If it was ever your intention to payoff your mortgage, you just took an eight year step back. Even if the payment on the new house seems manageable, multiply the monthly payment on a new home X 12 months X the extra eight years you’re taking on with the new loan, and you’ll get an idea as to the back end impact of the transaction on your finances. How might that money impact your retirement?
- Moving and resettlement costs. Usually ignored in tallying the cost of moving, but these charges are very real. And it isn’t just the cost of hiring movers. There’s also the cost of moving supplies, utility deposits, restaurant food eaten on the fly, and maybe a night (or two, or three) in a hotel.
- Property customization. You just moved into your new home; is all as you want it to be? Never. There will always be a need for customizations. New carpet, new curtains, the replacement of a piece of furniture that just doesn’t work in the new house, and those pesky repairs that the seller/builder didn’t complete (or reveal) before closing. Even with new construction, there’s no free ride here.
The basic problem with buying a new house every few years is that you never stay in one house long enough to get the mortgage under control. You stay long enough to build up some equity, then sell and move on to a newer, and typically more expensive home, where the whole process begins again—from square one.
But there is one more problem peculiar to this market from the standpoint of an existing homeowener: the same factors that are causing favorable property values on the buy side will work against you in the sale of your own home. You’ll pay less for a new home than you would have two or three years ago, but in all likelihood, you’ll get commeasurably less for yours.
Tomorrow: PART TWO—REFINANCING YOUR CURRENT MORTGAGE AND CONCLUDING THOUGHTS