Pop Goes the Global Housing Bubble
June 16, 2005 5:42 PM   Subscribe

The Global Housing Price Bubble is bursting. Prices are already declining in Australia and Britain. The Economist has another story that outlines how a global bursting of this bubble could be deleterious to the world's economy. The bubble is bigger than the stock market bubble of the late 90s. Will there be a smooth landing or will spending collapse when it cannot be funded on housing price gains?
posted by sien (52 comments total) 2 users marked this as a favorite
The Trillion-Dollar Bet details the potential for mass disaster of new, "non stress-tested" mortgage products, such as interest only type loans. Very scary given that an estimated 40% of these complex adjustable loans are in place in some communities of the USA.
posted by R. Mutt at 5:59 PM on June 16, 2005

I took a drive around Kennebunkport, ME a couple of weeks ago (home of the Walker Estate--as in, George Herbert Walker Bush). Every second mansion had a 'For Sale' sign in front of it. The rich are always the first to know about these sorts of market trends... unfortunately, by the time this trickles down to the middle-class neighborhoods that surround, it will be too late.
posted by Civil_Disobedient at 5:59 PM on June 16, 2005

Doesn't bursting -- which, your fpp suggests is what's happening -- imply there will not be a smooth landing?

It seems to me that what happening now in Australia and Britain is gentle deflating (again, using the bubble analogy, not the economic definition) instead of bursting.
posted by diftb at 5:59 PM on June 16, 2005

diftb: 'Bursting' does suggest that there will not be a smooth landing, but it does not imply it. The dot com bubble burst and there was a reasonably soft landing overall.

When you talk about a bubble ending though, isn't the natural word 'burst'?
posted by sien at 6:09 PM on June 16, 2005

The past several weeks I've been on the market for a new house. I've been gradually hearing from those I talk to that it is overinflated. Good for the blue to put it in front of me like this. So, should I hold off for a few months?
posted by woil at 6:09 PM on June 16, 2005

here is a good resource for articles related to the above
posted by robbyrobs at 6:17 PM on June 16, 2005

If you can wait, definitely do... it's a seller's market still, not a buyer's one.
posted by Fozzie at 6:17 PM on June 16, 2005

If the last figure on the second article is any indication, 'holding off' is best seen in terms of years not months. This represents something of a problem to me, I really don't want to have my first house lose a quarter of its value. I guess I'll just stay in the renters market.
posted by Exad at 6:21 PM on June 16, 2005

Sorry, I made that as unclear as possible. My point is simply because housing prices in Britain and Australia are stagnating does not mean the bubble is bursting.
posted by diftb at 6:23 PM on June 16, 2005

If you can wait, definitely do... it's a seller's market still, not a buyer's one.

Maybe that's generally good advice at the moment, but it all depends on where you are looking, and for what type of property. Housing markets are generally very local. One neighbourhood might experience a decline in values, the one just down the street might not. A one bedroom condo will also appreciate (and depreciate) very differently from a 4 bedroom bungalow. It's not possible to supply a one-size-fits all answer to the question of whether or not to buy, but if you want to buy in San Diego, wait. Boise, not so much.

Think of a house as an investment like any other stock or mutual fund. If you can afford it, and you're confident in its fundamental value, and you're not just speculating for the short term, there are likely only a few markets in the US (or anywhere really), where you absolutely should not consider buying now. Especially with those low low interest rates. Saving points now can easily make up for theoretical (and temporary) declines in the value of your home.
posted by loquax at 6:26 PM on June 16, 2005

re: Kennebunkport, ME .. perhaps Bush is a lame duck and living there doesnt hold the prestige it once did. The rich are usually tuned in to these things.
posted by stbalbach at 6:35 PM on June 16, 2005

one thing, California's Prop 13 really distorts the market; people looking to cash out now have to face a total revaluation of their property tax load (many are still paying on valuations from the 1980s).

'course, I thought the Bay Area market was going to crash in 2001, fat lot of good that thinking did me.

One issue with interest-only loans, when they made mainstream, is that their only real effect is just driving valuations up since more people can afford to carry a higher mortgage. The only real winner of the interst-only mortgages are the banks.
posted by Heywood Mogroot at 6:46 PM on June 16, 2005

How many times over the last year or so did we read on the blue that the bubble was about to blow?

I was sure it would happen in '03, '04 and '05. Any day now it's got to happen because people keep telling me it will. Right? RIGHT?!

Woil: buy a house. Buy within your means and you'll be OK. Don't let the things you read on the big blue scare you away from one of the best investments you'll probably ever make.
posted by photoslob at 6:53 PM on June 16, 2005

This could be bad, really, really, really bad. Over the last few years you have had all kinds of not too smart people taking out interest free mortgages and similar low payment, high risk of future collapse type notes. When they fall and suffer, which will be really big, they will deserve everything they get, but you and I will fall and suffer with these risk takers as they represent the biggest threat to the economy, at least within our borders, right now. Someone could probably get quite wealthy by hoarding some cash and waiting for the fall to use that cash to buy up numerous troubled properties.
posted by caddis at 6:53 PM on June 16, 2005

If you buy a house on a fixed-rate mortgage with a payment you can afford, in order to have a place to live, you've got little to worry about. The only time your home's resale value is meaningful is when you want to move -- and if the value of your house falls, the value of wherever you want to move is likely to fall too -- you're not going to be adversely affected.

While a realtor would tell me that my house has appreciated 50% in the past three years, I know that, in real economic terms, it's actually worth less -- older, more wear and tear on important systems, and my "improvements" unlikely to return their cash value (but still returning plenty of non-cash value to me and mine.)
posted by MattD at 7:27 PM on June 16, 2005

Conversely, one could theorize that all this talk of a bubble everywhere results in capital being withheld from the real estate market, and thus housing is undervalued. When talk of the bubble goes away, prices might start rising again.

One other scenario few seem to be discussing: if housing prices plateau for the next ten years or so, then in effect they are declining when corrected for inflation. In fact, if you take inflation into account, housing prices have not really risen all that much recently, in fact on average they don't even approach historical peaks.
posted by randomstriker at 7:29 PM on June 16, 2005

randomstriker: what averages are you talking about?
posted by diftb at 7:30 PM on June 16, 2005

photoslob: Maybe you're right. Maybe the rise will continue indefinitely.

I can tell you however, that in Melbourne AU prices have dropped about 10% in the past 6 months. Auctions, which in Australia are common, are failing to meet reserve prices.

But right now surely you have to do the numbers and compare how much you have to pay in rent vs how much you have to pay in interest on a house and how much that house would have to rise over the next 10 years to justify the current prices and the interest you will have to pay.

In the long term house prices will surely rise, but how long? And also, one they even stop rising the spending financed by housing prices will surely stop. What happens then?

The Economist started writing about the stock market bubble in 1999. The bubble burst there about 2 years later. The Economist has begun to write quite a bit about the global house price bubble in the past year or so.
posted by sien at 7:34 PM on June 16, 2005

I fear more the changes in the economy that a downturn may cause. At least looking at the people in my area, they are building and buying real estate assets that are at the brink of their means. Owning a piece of property that has a paper value double that of what buyer may pay in the future, in addition to a even a slight loss of income will ruin them.
posted by Exad at 7:45 PM on June 16, 2005

If you can afford it...

If you can afford it, you'd be paying for it with cash. Otherwise you're betting that, even in a burst-bubble economy, you'll still have a job and enough money coming in to make your (inflated) payments.

...and you're confident in its fundamental value

It's "fundamental value" is only what someone will pay for it. There is nothing magical about a house that justifies the surge in prices over the past twenty years (starting in the early 80s when lenders artificially inflated prices by openning the floodgates to under-qualified lendees).

How many times over the last year or so did we read on the blue that the bubble was about to blow?

As I pointed out in an AskMe thread, the percentage yearly increase in housing prices has gone from a "normal" 2.5% to about 12% in just the last two quarters. If you think that kind of growth is sustainable, healthy, or without ramifications, you're out of your mind.

Do not buy a house right now unless you've got cash to burn.
posted by Civil_Disobedient at 7:50 PM on June 16, 2005

The risk, it seems to me, is quite high in the U.S., as real estate has become the investment of choice for many, and the bubble has been allowed to expand beyond what is rational or reasonable for longer than in other countries.

You also have to wonder about demographics. When the baby boomers retire, many will want to sell their house and move to a smaller, less expensive place. That is especially the case in California, I suspect.
posted by insomnia_lj at 8:06 PM on June 16, 2005

It may not be sustainable, I think it isn't. However, even with a crash, values probably won't fall that far, if judged by prior crashes. If you buy in the traditional fashion by putting 20% or more down and getting a regular mortgage you are not likely to find yourself upside down on your mortgage, at least by very much.
posted by caddis at 8:11 PM on June 16, 2005

Sien:The dot com bubble burst and there was a reasonably soft landing overall. When you talk about a bubble ending though, isn't the natural word 'burst'?

There has been talk in the US about the successful rolling of the DotCom bust into the housing market - through the lowering of gov't regulated interest rates. That is, instead of the crash that should have happened after DotCom/911... gov't enabled (cheap) housing costs made people feel like they could still spend with abandon, and the fall has simply been delayed.
posted by R. Mutt at 8:14 PM on June 16, 2005

R.Mutt: That's a really good point. This may well be the case.

In Japan the real estate peaked after the Japanese stock market had peaked. The same may well be happening globally now.
posted by sien at 8:26 PM on June 16, 2005

It's "fundamental value" is only what someone will pay for it.

I mean fundamental value as in its selling points besides the average growth in the neighbourhood. Things like proximity to schools, number of bathrooms, the demographic outlook of the area, whether or not the roof is falling apart. The only thing that's really shocked me about the market in Toronto (which isn't nearly as hot as other places in North America) is how many people are willing to buy solely on the basis of average recent sale prices of nearby homes. It's become normal to make offers without inspection and financing clauses, which is also excessive.

the percentage yearly increase in housing prices has gone from a "normal" 2.5% to about 12%

Again, it depends where. In Toronto, the average house sale price was $325,000 in 1989, $190,000 in 1996 and $315,000 in 2004. That's about 5.2% since the last trough compared to the "normal" 7% since 1950. Meanwhile, in nearby Mississauga, the growth in average sale price has been about triple Toronto's. It's really really important to take your exact location into account when considering selling or buying with respect to any bubbles that might exist.
posted by loquax at 8:31 PM on June 16, 2005

How many times over the last year or so did we read on the blue that the bubble was about to blow?

Yes, there is a bubble in the number of times we read about the bubble. Its parabolic upwards arc is not so apparent on the blue as it is elsewhere. I predict it will end soon, and badly.

if you take inflation into account...

It could very well go like Japan, in which case there will not be so much inflation.
posted by sfenders at 8:35 PM on June 16, 2005

I believe the word is froth, not bubble. The reason Greenspan used the word is because it is a good metaphor for lots of little bubbles, of different sizes, in different regional markets.

On preview: si, loquax.
posted by juggernautco at 8:36 PM on June 16, 2005

juggernautco, exactly - I know I've seen a table with regional or city growth factors somewhere (maybe on CNN money or something) but I just can't find it.

In the meantime, if you like, you can find a bunch of useful North American housing stats here, from Scotiabank, broken down somewhat by region and unit type.
posted by loquax at 8:45 PM on June 16, 2005


And, the next bubble will be theocratic.
posted by troutfishing at 8:48 PM on June 16, 2005

When the baby boomers retire, many will want to sell their house and move to a smaller, less expensive place.

or just rent it out. Already 1/6th of the SFHs in California are rentals.
posted by Heywood Mogroot at 8:48 PM on June 16, 2005

I think the article is a good one, but fails to take into account some larger issues which make home ownership a very attractive deal. With a fixed interest rate, a mortgage is immune to the inflationary, dollar devaluing path our government appears to have chosen as a solution for its insane overspending.

From an article on "MSN Money",

And finally, let's be really cynical and admit that the easiest -- and perhaps the only politically attractive -- solution to our various current budget and deficit problems is to inflate our way out of them. If we could just get inflation running at a comfortable 7% a year, say, then each year the trillions that we owe would be worth 7% less in real dollars, and tax receipts and other revenue would climb 7%, even without any real economic growth, making repayment so much easier.

That dollar drop has the side effect of inflating me out of my mortgage. Every month/year the dollars I spent on the place are worth less, I make more due to inflationary pressures on salaries, and my mortgage therefore takes less of a percentage of my income. Renters, on the other hand, will see their rents go up every time the lease comes 'round for renewal. All the while, the FMV price of my house is extremely unlikely to drop below inflation, even if the so-called housing bubble "bursts". Simply keeping up with inflation is sufficient for it to be a win for me.

Personally, I think the real crazies are the interest-only ARM borrowers. They are going to get creamed in almost every scenario.

(This rosy-pessimist-view supposes that I manage to keep a job during the bust. If not, then I'm in serious trouble with or without a mortgage.)
posted by Invoke at 8:50 PM on June 16, 2005

What I see in Australia, is that skyrocketing housing prices have become viewed as a proxy for overall economic strength. Bad move. Just because you're rich on paper, doesn't mean the money has magically materialized for free.

Increasing housing prices have made people in the market feel rich. They're using that equity to dive into even bigger, more unsustainable debt.

Few of them seem to realize the simple truth that money that comes easy, goes easy. Housing price deflation isn't as big an issue as other factors - slight rises in interest rate, unemployment, a slight economic downturn could ruin people very easily. The most important statistic to look at, I think, is the average proportion of income spent on your mortgage. This has been increasing greatly in the last decade, to the point that in Australia some people are spending up to 45% of their income paying off their mortgage. And these people are skewed towards the lower end of the income scale. That can't be healthy, particularly if we see interest rate rises as well.
posted by Jimbob at 8:52 PM on June 16, 2005

If population keeps growing, won’t that stop the bubble from bursting? People have to live somewhere. And population is still growing in the places mentioned such as Australia, UK, and USA?

Sorry if I sound too simplistic. I know a bit about these things (I have a BCom) and I find economics and economic cycles very interesting – and extremely complicated.

(Not saying population growth is a good thing, BTW!)
posted by uncanny hengeman at 9:07 PM on June 16, 2005

I know I'm simplifying things but home ownership comes down to a few common sense principles in my book:

1 - only buy what you can afford (I mean, duh!)

2 - don't buy the nicest place on the street

3 - buy a home you can see yourself staying in for at least 10 years (especially IF the bubble bursts)

4 - whatever you do STAY THE F AWAY FROM ARM'S!!! (especially if they're interest only for crying-out-loud)

Those who speculate and are smart get in ahead of the rush and make their money. They use ARM's and interest only loans as a vehicle to make money. Those who come late to the game and are counting on getting that 25% appreciation out of the home right now are absolutely-frickin-out-of-their-minds and obviously have more money than brains and will be punished accordingly.

and by the way, if getting let down easy during the dot-com-burst is being unemployed for nearly 2 years, not being able to pay bills and nearly having your marriage collapse, well, i'd hate to see being let down hard.
posted by photoslob at 9:09 PM on June 16, 2005

Here's a theory: No one can be truly objective when one has a large personal investment at stake. (No duh) But think about it, would you listen to those writers who had stocks in Enron pump it up, and say "well yes they are being objective." So, when you have financial journalists spouting off on the boom, you don't think the vast majority are home owners.

The King has no clothes people, and the boys finally laughing!
posted by Mr Bluesky at 9:12 PM on June 16, 2005

Sorry to hear that, photoslob. I understand a lot of where you're coming from, and personally, I'm scared silly about what a real economic depression is going to do to this country and the people in it.
posted by Civil_Disobedient at 9:53 PM on June 16, 2005

here're a few more :D

posted by kliuless at 10:04 PM on June 16, 2005

btw these tables might help too :D

posted by kliuless at 10:23 PM on June 16, 2005

Okay, here's my prediction:

Over the next 2 years, the housing bubble will burst. then over the following 2 years, we will slip into an unusually bad recession and the stock market will tank a second time, taking it to lows not imagined possible now. the overall impact, when combined with a growing crisis in the commodities markets (oil in particular) will be worse than the 1970's. the financial fallout will be the worst in living memory. we will have banking scandals, bailouts, bankruptcies and inevitably massive increases in taxation (which will all fall on property holders since the federal government will push all costs down on the states). the upside is that we have the infrastructure to bail ourselves out again. so the recession will not be as bad as the 1930's. the downside is that public mood might actually be worse than the 1930's. i don't think people are resilient enough these days to cope with a serious and prolonged recession. things are about to get very, very hard. welcome to The Not-So-Great Depression.
posted by muppetboy at 10:53 PM on June 16, 2005 [29 favorites]

Don't let the nervous nellies dissuade you from your path to home ownership, woil.

And don't "Think of a house as an investment like any other stock or mutual fund", it isn't. For one thing, financial instruments are liquid, housing isn't. The bid-ask spread means that housing doesn't trade as often, and houses aren't fungible. Plus you don't live in your portfolio, and your kids don't have to go to public school dictated by what stocks you buy.

I got lucky, and bought a house in California 8 years ago. Moreover, I bought a house that was way out of my price range, since I was coming off a couple of good years of W2 income. I've seen it triple in value. The argument I used to persuade my wife was this: Everybody we know who has a killer house at some point just stepped up and bought more than they could afford, saying "we'll just suck it up for a few years, eat rice and beans, and let the W2 catch up with the mortgage."

I would not make that same bet today, however. I'd buy a house, but I wouldn't stretch like that for it.

Even so, I think there are a lot of factors arguing for housing prices to stay high, even go higher. The two most important factors are the economy and demographics. The economy goes up and down, but demographics, particularly the baby-boomer generation, just keeps rolling along. It's a force of nature.

To gauge the impact of the baby-boomers on real estate prices, try rolling their yearly births forward 43 years, about when they are beginning to trade-up into bigger houses and better neighborhoods. You'll get a demand chart that tracks housing prices pretty closely. Prices soared from 1987-1989. Stagnated from 1990-1993, then took off again. Although boomer demand will start slowing in 2005, demand will still be higher out to 2022 than anytime before 1989, when prices really took off.

Globally, interest ranges are going to around 2% as investments become more liquid and money velocity increases. Derivative instruments make financial instruments more liquid - this means investors can buy foreign bonds and lay off the exchange rate risk, they can buy mortgage-backed securities and lay off the prepayment risk, they can buy corporate debt and lay off the credit risk. Interest rates are nothing more than the cost of money, and as supply increases, prices - interest rates - drop.

You don't necessarily need to stay away from ARMs, just understand what you're getting into to. Most have caps. If you have an ARM with a life cap of 6% and a start rate of 1.5%, you'll never pay more than 7.5%. Maybe you can borrow 30 yr fixed right now for 5.75% instead. But if you can live with a potential 7.5%, and you think interest rates are likely to stay low for as long as you plan to live in that house, you might opt to save the 4.25% annual interest in year one, and additional savings likely in year 2 and 3 given the typical 2% annual adjustment caps. The real risk in ARMS is that they make it easy to be stupid, and get in over your head. So don't succumb to that temptation.

There is certainly risk of some kind of adjustment or correction - either in rates or in housing prices or, more likely, both - some time in the next ten years. The falling dollar, our exploding national debt, rising healthcare costs, social security crisis, blah, blah, blah. So what? The only way you'll realize any profit or sustain any loss on your home is if you sell it. The important thing is not to get so overleveraged that you're forced to sell it at an inopportune time. Find a house that you love, in a neighborhood you're comfortable in, with a payment you can afford, in a school district you want your kids in if that applies, and step up.
posted by JParker at 10:53 PM on June 16, 2005

Hey buddies, I will go ahead and post for the first time here after four years of looking around. There are some Warning Signs for the new buyer, and the main one is rent: If rents in your neighborhood are way lower than an average mortgage payment (that's a 20% down), you might be facing a bubble.

Vegas has the current honor when it comes to annual increases in residential property value. My town of Reno is second. Both are in the 30%+ range, which is pretty crazy. And just like the Bush Family's favorite seaside town, my town is seeing a lot more For Sale signs this year. The signs are around longer than I'd like, as I'm about to sell, too. It's cheaper to rent than buy here, so ...

On the plus side, 30-year mortgage rates are at historic lows -- about 5.4% if your credit is okay. You can get into a $250,000 house with very little money and a $1,400 monthly payment. If that's about what you'd pay for rent, it's still a great time to buy. But you have to find a house you want for $250K, which used to be a lot of money. I plan to rent for a year or so, myself. Too much weirdness right now, and that's a bad time to buy a house that might be worth 50% less in three years.
posted by kenlayne at 11:10 PM on June 16, 2005

here in seattle, a nice big 4 bedroom house like the one we're renting for $1900/mo costs $500,000-$750,000. i'm not too good at math, but i don't see how that works out.
posted by muppetboy at 11:34 PM on June 16, 2005

Oh no! As an eventually-to-be first time buyer, I may be able to actually afford some kind of house without taking on ridiculous debt!


On the other hand my parents, on the verge of potentially having to 'move down' into a smaller house to release capital, may not be as happy about the 'leaking away' of that capital.
posted by Drexen at 5:01 AM on June 17, 2005

Until this article, I had no idea that other countries had recently been experiencing housing bubbles akin to what's been happening in some places in the US. I emphasize that because an awful lot of housing markets in the US are not experiencing the same kind of upward price pressure that's been noted in, say, Boston or San Diego or Seattle. A house in my old neighborhood in suburban Columbia, SC that sold for, say, $70k fifteen years ago would have appreciated to only about $90k now. That's a solid investment but it's hardly the kind of increase that attracts rampant real-estate speculation. I hope that means that a smaller market with a lesser rate of ownership turnover remains relatively immune to the effects of a bubble and its eventual burst.
posted by alumshubby at 6:36 AM on June 17, 2005

alumshubby: "Until this article, I had no idea that other countries had recentlybeen experiencing housing bubbles akin to what's been happening insome places inthe US."

It's been crazy in South Africa. Between 1997 and 2005 property prices have increased 244% (compare that to 73% in the US according to The Economist). Everyone and their 2nd cousin is buying into developments, which is precisely the reason I've decided to wait a bit before I buy. The CBD of Cape Town has basically been revamped as a mixed use residential/business area (beforehand it was almost 100% business) but I don't know where the people are going to come from to buy into these apartments especially not at the prices some people are asking.
posted by PenDevil at 6:49 AM on June 17, 2005

Ireland, 192% since 1997. We rule (well, except for those pesky South Africans!).
posted by meehawl at 10:05 AM on June 17, 2005

And in Ireland's defence, these are just averages. I bought a house in a depressed area of Dublin (100% financing, no money down, interest-only payment for 3 years!) in 1996 and sold it in 2001 for a 300% gain. If I'd held, houses in the same area are now selling for around 400% of their 1997 value. But I knew there was a (Dublin!) bubble coming, and needed to buy *something* quickly, and was an ex-student with no savings! But there's no way I would consider such a move today...
posted by meehawl at 10:11 AM on June 17, 2005

CD: " Every second mansion had a 'For Sale' sign in front of it. The rich are always the first to know about these sorts of market trends..."

Er... so who's buying the mansions, if not those knowledgable rich folk? Ain't us poor folk, y'know.
posted by five fresh fish at 4:18 PM on June 17, 2005

My guess? Upper middle class wanna-be's who are giddy with low interest rates and little money down, all overextended, mistakingly thinking that the market is going to keep going up.

Actually, the real answer is: no one. That's why they're still for sale.
posted by Civil_Disobedient at 7:48 PM on June 17, 2005

Homes go up for sale in Kennebunkport for many different reasons, a few of which are: People buy homes in a hoity neighborhood, and move in to find their quaint town has tourists running rampant, decide to move on. People buy in K'port thinking it's close enough to commute to Boston - it's not, so they sell. Townies see prices (and their taxes) going sky-high, decide to cash in. Part of the natural real estate cycle is to put your house on the market in the spring when the kids get out of school.
posted by SteveInMaine at 11:12 PM on June 17, 2005

Let me share what I'm going through...might be interesting to anybody that comes along.

I'm building, and it won't be done until next year. I'm buying at today's prices for a house that I won't have to start paying on until 2006. I'll have two raises by then.

Plus I got an interest only mortgage, so anything I pay extra will go to principle. For the same payment I'd be making on a 30-year fixed I'll be paying off slightly more of the mortgage each month.

Also, there's a very good chance that while my house might not be worth 30% more by then, it'll be worth a good deal more than it's worth now. Why? I'm building a 4-bedroom house in an area that mostly has 3-bedroom houses, so it sets me apart. I'm putting a decent amount of options in, but I'm not pricing myself out of the neighborhood.

But I'm also in Florida. We've had massive housing price rises here in southwest florida (Sarasota county beat Vegas last year and Lee county was right behind) and while that'll slow, those baby boomers are retiring and they're buying.

So, on the one hand there are a LOT a LOT a LOT of developments going up around here catering to them. The houses start at $350,000. My house and lot cost about $230,000, though my mortgage will be higher because I'm a first time homeowner and I threw my fees and down payment into the mortgage. We have the cash for the fees but I'd rather have a big no-money-down mortgage and pay off 20% all at once to get rid of the PMI.

But here's the great part....those developments with houses starting at $350,000 are pushing my non-deed-restricted neighborhood up. My house is going to get appraised soon...I know the model I bought is already $20,000 more than what I'm going to pay, and I'm sure the lot appreciated already as well. My house and lot might now be worth almost $300,000. If the market tumbles less than 30%, I'm still okay.

But there are yet other factors. There are a couple of houses that are dying for renovation, so when the market slides and those houses get pushed down lower, someone will come along and completely revamp them...there'll be doctors and lawyers looking to stay non-deed-restricted who'll see these houses a few miles from the bay and a mile from the interstate as a goldmine. My house price will go up from THAT as well.

And, worst case scenario, the house prices tumble more and nobody buys some of the houses that need renovation, I still have a beautiful house in SW florida where most old houses are 1200 sq. ft. cinderblock shacks with flat metal roofs. I'll have a brand new home with up-to-date hurricane protection features.

So, to sum up, just use your head. Know your market and know where you live. Choose wisely and take a risk....it's inevitable that the market will go up, as long as you can stay in your house for a few extra years should anything go badly.
posted by taumeson at 9:09 AM on June 18, 2005

muppetboy: [here in seattle, a nice big 4 bedroom house like the one we're renting for $1900/mo costs $500,000-$750,000. i'm not too good at math, but i don't see how that works out.]

Let's take the midpoint: $625,000. Speculators are using the increased leverage available through interest-only mortgages to buy more and bigger houses, inflating prices. Assume you put 20% down to avoid paying PMI. An interest-only mortgage from WaMu right now has a start rate of 1.5%, and is fully indexed at 1 yr CMT +275bp, or 6.13% today.

So if you elect to pay the full principal and interest amount, your payment is $3,039.67.

Of that, $2,554.16 is interest and is tax deductible. Let's say for sake of analysis that you are in a relatively high federal tax bracket of 28% (but Washginton has no state tax). That means you get $715.16 of that monthly payment back on your taxes, leaving you out of pocket $2,324.51.

But part of that monthly payment is also paying down principal. If you are the home owner, it's increasing your equity in the house. Over a 5 year holding period, assuming you continue to pay P&I every month, you'll pay off $33,986.96 in principal, an average of $556.45 each month.

That leaves your net monthly expense at $1,768.06. And you're getting $1,900 per month in rent.

Simplistically, that's how it works out.

Note: This ignores factors on both sides, negatives like the fact that you have to put up the down payment, and we didn't include insurance and tax payments, or the cost of repairs. Positives we didn't account for include the low initial start rate on the loan (we used the fully indexed rate to calculate the payment), the ability to raise rents over time, potential appreciation in the property, and the ability to modify and improve the property to reflect your needs an your liefstyle, which you can only do as the owner. Plus, with an adjustable rate loan, rates could work for you or against you.

The overwhelming factor influencing people to buy houses right now is the potential appreciation. You're pretty leveraged only putting 20% down, and if house prices go up even a modest 4% per annum, your $625,000 is worth $760,408 after five years, a gain of $135,408 on an investment of $125,000. That's a 15.79% rate of return, and any taxes are long term capital gains.

This isn't a recommendation to run out and buy a $625,000 house, just a quick-and-dirty analysis of the cash flows. It's surprising how little income is required to support some large debt.
posted by JParker at 12:24 PM on June 20, 2005

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