Is Your Home Still an Investment?
By Jeff Brown
The housing collapse may be bottoming out, with buyers moving back into some of the hardest-hit markets.
If so, it’s a good time for home shoppers to review some of the lessons of the boom-bust cycle, to avoid making the same mistakes again.
Most important: a house is a home, not a road to riches.
The housing crisis arose out of the belief that home prices would always go up. Buyers would pay just about anything, taking out enormous, high-risk loans if necessary, confident they couldn’t lose. Buyers, sellers, real estate agents and lenders just rolled their eyes when naysayers pointed out that home prices cannot go up faster than incomes forever.
Of course, the naysayers were right, and prices collapsed in much of the country.
Now hard-hit areas like Sacramento, Las Vegas and parts of Florida are reporting a surge in home sales, though prices in the most devastated areas are only half what they were a few years ago.
Low prices and rock-bottom interest rates make a house purchase tempting, especially for the first-time buyer who doesn’t need to sell one home to buy another. Interest on a 30-year, fixed-rate mortgage averages 5.06 percent, according to the BankingMyWay.com survey.
The Fixed Mortgage Loan Calculator says you’d pay just over $540 a month on a $100,000 loan at that rate. Put another way, a household with $75,000 in income and no other debts could qualify for a $312,000 mortgage, according to the Maximum Mortgage Calculator.
But seeking the biggest possible loan is so…well, 2006. These days, it’s best to keep payments low in case of a financial setback like a lost job.
Gains are misleading. Profits on home values aren’t as stupendous as many people think. According to Freddie Mac (Stock Quote: FRE) home values grow at about 1.5 percentage points above the inflation rate over the long term. Stocks have averaged about 7 points above inflation.
And if you count interest, taxes, insurance and maintenance, the cost of ownership can be two to three times higher than the initial purchase price used in Freddie Mac’s analysis, meaning you can lose money over time, not make it.
Even if your home skyrockets in value, others probably will, too. It will take all the money you make on one home to buy the next.
Stay for the long term. Despite signs of life, the mortgage market is still risky, and prices could continue to fall in many areas. Don’t buy if you expect you’ll have to move in four or five years. You need more time, perhaps seven, eight, or even 10 years, for appreciation to offset any initial price drop, real estate transfer taxes, agent’s sales commission and other selling costs that chew into sales proceeds.
Get a simple mortgage. Exotic mortgages like subprime and interest-only loans are scarce these days, but lenders are offering various types of adjustable-rate mortgages (ARMs). It’s better to lock in a fixed rate loan at today’s bargain prices than to risk higher rates and payments later with an adjustable mortgage. Use the ARM vs. Fixed Rate Mortgage calculator to weigh the alternatives.
It’s not a piggy bank. If your new home does grow in value, resist the temptation to extract cash with a refinancing or home equity loan. You’ll need the added value to buy your next home, and new borrowing will increase your interest costs. The lower your debt relative to the property’s value, the easier it will be to sell in a hurry if a new job or other event forces you to move.
—For more ways to save, spend, invest and borrow, visit MainStreet.com.