Zion, IL
By A.B. Dada
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On my previous post titled Scary Housing Bubble Mortgage Calculator, Frishack posted the following comment that I wanted to reply to publicly.:

The fact that you may be upside down for a few years does not have any effect on what you are paying monthly, so just ignore the market ups and downs, and in the long run real estate always goes up.

This is a common line by Realtors and mortgage lenders. I disagree with it completely.

Real estate does NOT always go up. If you look at real estate prices in any 20-30 years time frame, while the dollar price of real estate may have gone up over that time frame, it definitely did NOT keep up with inflation’s destruction of the dollar.

On top of that, you’re paying interest, taxes, maintenance and possible association fees: a house is a bad, bad investment. What you want to do is stay ahead of the downswings. When you are upside down on a mortgage versus property value, you put yourself in a very scary position. What happens if you get sick, lose your job, or have to move? Let’s say that you bought a house last year for $200,000. In recent news all over the mainstream media, we’re seeing the first national housing market decline YOY in history. Some experts are already calling for 10-20% fall on average, with some communities seeing as much as a 50% decline before we hit bottom. I agree with those numbers, and I think it could be even worse depending on how bad the liquidity crisis becomes.

If you bought a $200,000 house with 0% down, and the market falls 10%, your house may have a value of $180,000, but in a year you’d have paid down almost NO principal, maybe $6,000. This means your mortgage would be $194,000 and you’d owe $180,000. Let’s assume you lost your job or you had a job transfer, and had to sell. That $180,000 house in a declining market likely won’t sell for your asking price — people don’t want to catch a falling knife. If someone offered $175,000, and you had to pay the Realtors 6%, you’re left with a check for $164,500, or almost $30,000 below your mortgage. Since America has a negative savings rate, we can make the assumption that most people have little to no liquid savings, or they’d have put it into a down payment. Banks aren’t going to take a 20% short sale most of the time, and if they did, they might issue you a 1099 for the short sale “gift.” Now you own the IRS a nice chunk of change at year’s end.

With 20% down, you are well protected to the rise and fall of the market. The housing market right now will be the worst financial investment market in US history. It will likely “lose” more asset value than the Great Depression, and it will also cause a huge segment of the industry to fall on hard times — leading to more bankruptcies, foreclosures, defaults, and job losses.

When people can’t HELOC more money out of their home ATM, they won’t shop at Home Depot for big appliances and granite counters. They won’t buy that new Hummer, or travel on that fun cruise. These industries will get slaughtered during a housing downturn. Businesses won’t have the capital to give raises or hire new staff, either. It’s a vicious cycle of downtrend we will likely face, with the Federal Reserve doing even more damage.

My personal rules are:

1. 20% down, minimum. Always.
2. Fixed rate mortgage for 30 years, never adjustable, ever.
3. 28% gross salary maximum mortgage payment, salary an average of last 3 years.
4. Calculate your mortgage payment at the same interest rate but over 15 years instead of 30. Pay that amount.
5. Put ALL bonuses, tax refunds and raises towards your mortgage, pay it off in 7-8 years.

The madness of easy credit in the last 10 years has caused a large percentage of home borrowers to finance houses at 5X, 6X, even 8X their annual income. This is crazy — how do you pay a mortgage that accounts for 60% of your gross income? How do you pay for insurance, maintenance and taxes, which are all going up, up, up? It’s a dangerous place to be, and I want nothing to do with it.