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Monday, April 17, 2006

Homeowner Friends Do It Right

This weekend my wife and I had the pleasure of visiting with some friends (I'll call them R & L) that live down in the Olympia area. I was somewhat uneasy going into it, because they recently purchased a home, and R also occasionally reads this blog, so they know where I stand on the wisdom of such a decision at this particular point in time. As we turned into the brand new development onto GPS-uncharted roads, I became even more uneasy, imagining huge price tags for sardine-can houses and construction that isn't built to last.

As we got the grand tour of their (thankfully well-built) new digs, R filled me in on the lengthy process they went through to get into their new home. The more I found out about their purchase, the more relieved I was. Most importantly, they put 20% down. Also, they actually locked in the purchase in late 2004 at a considerably lower price than current neighboring units are being sold for (but they didn't have to start paying the mortgage until 2006). Furthermore, though it doesn't have to do with financing, another smart move was that they got a lot on the edge of the development that backs a protected "green belt," so they have a decent sized back yard, bordered by a layer of trees, a creek, and a surprisingly natural looking retention pond—all safe from future development. While I still think that renting is a better choice right now, R & L did everything right in their purchase, and will be secure even if a serious housing downturn takes place.

We are friends with another couple, J & J, who bought recently, and they too took the necessary steps to protect themselves. You see, most of my friends have this thing that has evaded the majority of the population when it comes to housing in the last five years... it's called common sense. Since common sense seems to be such a rare quality when people consider housing these days, I thought I would summarize the important steps that R & L and J & J took to ensure ongoing financial stability in their respective home purchases. Again, I highly recommend you rent for the time being, but if you simply must buy a home, here are the steps to take to protect yourself:

  • Put 20% down & get a fixed-rate loan.
  • Set monthly payments at no more than 75% of what you can comfortably afford to spend on housing right now.
  • Choose a home that you would be happy living in for 10 years minimum.
If you choose to neglect any of the above items when buying a home, you will be at risk for financial and emotional hardship in the future. R & L know someone that lives down the street from them and listened to the lender that told them to use "creative" financing to stretch beyond their means to get into a house. They've been in their house for less than a year, and already they are facing foreclosure.

If you find that you can't do each of the things on the above list, then just don't buy right now. It's that simple.


Eleua said...

I would also add to your list of things to consider when buying a house:

Can you tolerate a substantial decrease in the price of the property?

Anonymous said...

Ditto to above. Anything bought in the next several months has got to be bought with depreciation in mind.

I plan to buy before this thing hits bottom, ie. I can't wait til the complete bottom.

But I for SURE won't be buying this spring and summer. That is just throwing money away.

At the end of summer I'll see what the market's doing and guage whether fall or winter may be okay to begin thinking about buying.

But I am sure that anyone who buys in the next year is looking for huge depreciation.

It's just a question of how much depreciation you can handle. I can handle a bit.

The Tim said...

I guess "Can you tolerate a substantial decrease in the price of the property?" was meant to be implied in the "Choose a home that you would be happy living in for 10 years minimum." bullet point. I figure 10 years will probably be enough time for the value to recover if it takes a substantial hit.

Eleua said...

10 years MIGHT be enough, but 10 years is a long time if you have life changes that require the sale of your home.

Yes, I was trying to say that today's transient lifestyle will have to be tempered by an uncooperative housing market.

Thanks for the two blogs.


Anonymous said...

Here's the problem with the 10 year rule:
I'm not sure, given the state of the US economy and where we're likely headed in the next few years, that these property values will re-coup in the next 25 years, let alone 10.

When I buy, I plan to live there til the day I die (another 40 years at least).

I don't ever want to move again. So I'll just have to be satisfied with living in a stable home , not an "asset". And I'm fine with that.

But if I had any thought that I may want to move in the next 40 years, I'd wait til this thing hits bottom because I feel it's got a LONG way to go.

I have a friend in Tokyo whose 1990's 600K apt. is barely worth 250K now- 15 years later.

That's what "natural exhuberance" can do!

We've pretty much gutted our infrastructure in the US and, unfortunately are so in debt that there may be not much we can do about that for quite some time.

Meanwhile, other parts of the world seem to have economies that are on a solid footing and likely to grow while we decline.

So I'm not looking for a re-coup in these high property prices in the next 10 years.

If anything, I think our wages will come down to meet China and Indias' growing wages somewhere in the middle so things can even out.

That's a guess of course! But for sure I don't see the US as any kind of world economic powerhouse in the future.

That our standard of living falls to meet their rising standard seems like a best-outcome for us.

Another outcome could be that this whole country turns into the rust belt. That would be a shame so I'm not going to entertain the idea for now, at least not until I've got some evidence that it's really happening.

betamax said...

I'm not sure, given the state of the US economy and where we're likely headed in the next few years, that these property values will re-coup in the next 25 years, let alone 10.

Well said. The run-up is unprecedented, and the crash will be likewise. And by the time it has run its course, many things will have changed. Those counting on past phenomena to reoccur may be surprised.

Anonymous said...

"Set monthly payments at no more than 75% of what you can comfortably afford to spend on housing right now."

Obviously "comfortably" can vary quite a bit. I was just curious if people considered a traditional 28/36 "qualifying ratio" to be comfortable? Do the numbers 28% of your gross salary for PITI and 36% of your gross salary for PITI plus all recurring DEBT still make sense?

I'm not sure I'd be "comfortable" with either of those numbers and wondered what %'s people feel make sense.

S Crow said...

Ratios? 33/38 is what I qualified under for FHA when I bought my "garage" (620sq. ft) of a home in 1994 on 77th & 8th NW in Ballard. And me qualifying was a stretch for that FHA ARM at 7%. A real stretch. Most borrowers with today's debt loads would not have gotten that loan back in the old days.

Today? I assure everyone, that ratios are well exceeding the 'speed limit'(50% rear end ratio) in many cases. A LOT.

Was in a loan center yesterday and overheard a loan officer on the phone talking to a client regarding Stated Income deals. I don't know if fixed rate is in the vocabulary anymore. I digress.

Anonymous said...

Yes... I realize ratios are being ignored by buyers as well as lenders.

Our agent/broker has said "you wouldn't believe what I could get you!" on more than one occasion.

Do you feel if you could get into a home without exceeding a 38% rear end ratio on a 30-year fixed today that you would be "comfortable"?

The original post was making a case for homeowner friends that had done it right. As potential first home buyers (on the sidelines for now) I was just trying to get a better idea of what is considered comfortable by "rational" people... not irresponsible buyers and lenders.

Working with the posters 3 rules for buying we are working on the 20% and would not consider anything but a fixed rate. We also have only considered homes that we would be willing to be in for 10+ years. We are not interested in living in a shithole praying it appreciates... or worrying that it won't! The "75% of comfortable" is a little harder for me to grasp.

Obviously I have an idea of what comfortable is to my wife and I. I am just trying to get a feel for what others believe. We are dual income renters and enjoy a rear end debt to income ratio of less than 15% and I'm not sure I want to give that up anytime soon!

The Tim said...

I'll answer as to what's comfortable for me, but of course as you said, it's different for everyone. First off, though my wife does work, we have chosen to build our budget around only my income. Her income is "bonus" that is currently just extra savings and "fun" spending money. That way, when we have kids, we don't have the financial burden of daycare (and we think it's better for kids to actually be raised by their parents anyway, but I digress).

So anyway, on to the actual numbers. Currently after taxes and a modest 5% 401(k) contribution, my take-home pay is about 85% of my salary. 30% of my gross income figures out to roughly 42% of that 85%. That's the maximum I would be comfortable spending. So, using my own rule, if I just had to have a house right now, the largest monthly payment I should take would be 75% of that, or about 32% of my post-tax, post 401(k) take-home pay.

With my current pay, that would cover the mortgage on about a $250,000 house (after the 20% down of course). In a different market I would say no problem to spending 100% of what you're comfortable with, which for us would afford a $325,000 house. But for right now, we're still happily renting.

Anonymous said...

thanks for the break-down. Jeez... I thought I was conservative! haha...
I also wish after taxes, insurance and 6% to my 401k my take home was 85% of my gross salary. Sounds like you have a sweet deal!

So 32% of your take home is your comfort level vs a more traditional 28% of your gross (very similar numbers in your case given your take home is 85% of your gross) This doesn't take into account rear end debt-to-income but I assume anyone carrying significant debt would not be involved in this discussion. I wish that to be true anyway!

I'm starting to fear that even in a more favorable housing market the majority of buyers are willing to take on more risk than I am. That makes for pretty tough competition.

Anyway... adjusting risk/comfort levels to meet "improving" market conditions will be a key focus going forward as this all plays out.

Again, thanks for you input. I have talked with a few people about this and gotten a pretty wide-range of responses.

The Tim said...

Oh, I should have mentioned that we have no debt. No credit cards, no car payments... zero money owed to anyone else. And yes, I am pretty fiscally conservative. Wish the same could be said about the politicians running things these days...