It’s Still A Terrible Time To Buy: Falling House Prices Are The Solution, Not The Problem
By Daniel at 28 July, 2009, 4:04 pm
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By Patrick Killelea, last updated Wed 17 Jul 2009
House prices will keep falling in most places because those prices are still dangerously high compared to incomes and rents. Banks say a safe mortgage is a maximum of 3 times the buyer’s yearly income with 20% downpayment. Landlords say a safe price is a maximum of 15 times the tenant’s yearly rent. Yet in coastal areas, both those safety rules are still being violated. Buyers are still borrowing 6 times their income and putting only 3% down, and sellers are still asking 30 times annual rent, even after recent price declines. Renting is a cash business that reflects what people can really pay based on their salary, not how much they can borrow. Salaries and rents prove that prices will keep falling for a long time. Anyone who bought a “bargain” this time last year is already sitting on a very painful loss.
It’s still much cheaper to rent than to own the same thing. On the coasts, yearly rents are less than 3% of purchase price and mortgage rates are 6%, so it costs twice as much to borrow money to buy a house than it does to borrow (rent) the house itself. Worse, total owner costs including taxes, maintenance, and insurance come to about 9% of purchase price, which is three times the cost of renting. Buying a house is still a very bad deal for the buyer on the coasts, but it does make sense to buy in Michigan and some other places where prices have fallen into line with salaries and rents. Check whether you should rent or buy in your own area with this NY Times calculator.
The bottom will be here when buying a house to rent out clearly makes money. At that point it will be justified to buy because rent can cover the mortgage and all expenses if necessary, eliminating much of the risk. For a rough indication of the wisdom of buying a house, look at the yearly-rent/purchase-price ratio for the model of house in question:
3% = do not buy
6% = borderline
9% = ok to buy
So for example, it’s OK to pay $133,000 for a house that would cost you $1,000 per month to rent. That’s $12,000 per year in rent, divided by $133,000, so about 9%. But it is foolish to pay $400,000 for that same house, because renting it would cost you only 3% of that per year. Renting in that case means getting the use of the house for free, paying only the property tax and maintenance (which are about 3%).
It’s a terrible time to buy when interest rates are low, like now. Realtors just lie without shame about this fundamental fact. Prices fall as interest rates rise, because a given monthly payment covers a smaller mortgage at a higher interest rate. Since interest rates have nowhere to go but up, prices have nowhere to go but down. The way to win the game is to have cash on hand to buy outright at a low price when others cannot borrow very much because of high interest rates. To buy at a time of very low interest rates is a mistake.
It is definitely far better to pay a low price with a high interest rate than a high price with a low interest rate, even if the mortgage payment is the same either way.
First of all, your property taxes will be lower with a low purchase price.
Second, a low price gives you the ability to pay it all off instead of being a debt-slave forever.
Third, prices will definitely fall as interest rates rise — so paying a high price may trap you “under water”, meaning you’ll have a mortgage larger than the value of the house. Then you will not be able to refinance, and won’t be able to sell without a loss. Even if you get a long-term fixed rate mortgage, when rates inevitably go up the value of your property will go down. Paying a low price minimizes this possibility.
The US economy will not recover until house prices are allowed to fall to prices buyers can easily pay on a normal salary. The primary evil in the economy is government “affordability” programs which encourage debt, making prices higher, not lower. True affordability is not more debt — true affordability is lower prices. The government’s false affordability programs have created more debt than can ever possibly be repaid. Credit rating agencies lied about the value of this debt, scaring off investors.
When house prices finally fall to affordable levels, and foolish lenders and foolish borrowers are finally allowed to fail, then the economy will work again: there will be investment based on real production instead of on financial speculation, jobs will be created, and money will be earned and spent. Currently, we have no investment because the government is punishing savers and investors with policies that waste their honestly earned money to cover the foolish gambling losses of others.
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Again, what kind of nonsense is this? And where do you get your estimates concerning how much you can buy based on annual income? Actually, anyone w/ any kind of real estate experience will tell you that the correct formula is that a borrower can afford a mortgage payment of 28% of the gross monthly income and a total debt payment (that is including the mortgage payment, car payments, credit card debt and other long term debts) of 36% of your income. The total dollar amount you borrow is irrelevant. The amount of those monthly payments is what matters. As interest rates go up, that same 28% of their income buys less house. As interest rates decline, the person can afford to buy more house. Hence, the value of houses went up solely based on low interest rates.