Here is a topic I have not heard anyone address, w/r/t the housing crisis. So far all we've heard about are sub-prime mortgages and APRs rolling over as the reason houses are going into foreclosure. We've also been hearing about how housing prices are going to shit, dropping 20-30% in some markets, and still going down. The pundits talk about "hitting bottom", but all that means is that house prices will stop falling, and start rising again.

However, it could take 5, 10, 20+ years for those prices to rise back to the levels they were a couple years ago, when a lot of people were buying in.

So, what happens in the next couple years when millions of home owners who bought-in in 2003-2006, and have been dutifully paying their mortgage and are not in any risk of foreclosure, and they now have negative equity? People have to sell houses because they get new jobs, lost a job, just want to move, want smaller payments, whatever - but in the next couple years, there are going to be (10s of?) millions of people who are $10, 30, 50k+ in the hole when they sell their house.

How do people deal with selling a house with negative equity when they don't have enough money to pay the difference to the bank? is there going to be a new boom of lines-of-credit to pay off negative equity?

9/26/2008 9:06:28 AM

I've been wondering about this same thing, since I have a lot of friends who have bought homes and could find themselves in that situation, but as I see it there will only be a few places that will have dropped so severely where it would take > 5 years in order to recoup their prices. Most people will just make very little on their homes and it will cause a minor ripple effect (mostly people not being able to purchase as large as a second home as they otherwise would have if they had more equity) but i don't think it'll be another "housing crisis" as it won't diminish the faith people have in purchasing a home nor will we run into a surplus availability when compared to the demand at the time.

to put it simply, those people are fucked, and the system will continue on.

9/26/2008 9:12:22 AM

Responsible homeowners who bought their houses in 03-06 should also have not bought way more house than they could afford like the dumbasses that caused this mess. Therefore, if we assume they are smart, then they would have other assets besides the assumed value of their home. They would have enough in savings to offset the losses on their house.

Also, responsible owners have at least 20% down, so for them to lose additional money, the value would have to drop >20%.

If you put all your money into real estate thinking it would appreciate (even if the loan terms were financially sound) you are no smarter than the idiots who caused this mess through subprimes.

9/26/2008 9:16:18 AM

Quote :

"there are going to be (10s of?) millions of people who are $10, 30, 50k+ in the hole when they sell their house"

Where do you get these numbers?

9/26/2008 9:23:06 AM

^ out of my ass. but there is a lot of play in the numbers, so.... i would imagine that the truth is somewhere in between the extremes that I suggested

Quote :

"Therefore, if we assume they are smart, then they would have other assets besides the assumed value of their home. They would have enough in savings to offset the losses on their house. "

does not follow

Quote :

"Responsible homeowners who bought their houses in 03-06 should also have not bought way more house than they could afford like the dumbasses that caused this mess."

I do agree that "responsible homeowners" did buy within their means. However, that says nothing of 1) what other assets they have of if it is enough to offset the losses, or 2) how much their house declined in value, which depends mostly on the market they happen to live in.

Quote :

"Also, responsible owners have at least 20% down"

I suspect that also is not true. I would be very surprised if there is a significant amount of people who are able to put down more than 10%, again especially in the high-priced markets. I think many people probably have something like an 80-10-10 split with a home equity line of credit for ~10%

9/26/2008 9:31:39 AM

Quote :

"^ out of my ass. but there is a lot of play in the numbers, so.... i would imagine that the truth is somewhere in between the extremes that I suggested"

Ok. On one extreme we can have your thread, on the other, your thread is dead.

A couple questions
#1) How many homes at the moment are being constructed that will add to the supply
#2 ) Just what is the current equity stake in these homes you are claiming need selling.

The issue is, no one really knows the numbers in regards to who might foreclose or be unable to service their loan. I get the feeling that the entire market ASP has been pulled up across the board, but in pockets like Fla, Vegas, and Cali, you have some large jumps that is skewing the result. Just have a look at how much the West has corrected. Indeed, the extreme speculation that was taking place out there helped to heat the entire market across the board.

http://www.realestateabc.com/outlook/overall.htm

The midwest gained in price, does that look "dangerous" to you? The numbers are from the NAR, take them with a grain of salt.

Look at this first chart

http://mysite.verizon.net/vodkajim/housingbubble/

If you extrapolate the roughly linear growth from roughly '75 to '95, then we should probably be in the 180k range for nominal and inflation adjusted range. We've already corrected back to half of that in barely 2 years time with the trend appearing to be accelerating as homeowners finally realize the value of their home isn't what they thought it is and they want to sell rather than hold forever. You can expect a little overshoot on the downside. If the bailout helps to ease the the hard landing, we'll start to pull out of this recession and things will return to normal in a predicted ~18 month range started the beginning of this year. I don't foresee any second round of a crisis.



[Edited on September 26, 2008 at 9:47 AM. Reason : a]

9/26/2008 9:44:53 AM

Quote :

"I suspect that also is not true. I would be very surprised if there is a significant amount of people who are able to put down more than 10%, again especially in the high-priced markets. I think many people probably have something like an 80-10-10 split with a home equity line of credit for ~10% "

If they need this kind of BS loan instead of one 15 or 30 fixed loan - they couldn't really afford the house and should have bought lesser house in a more affordable market.

Being able to make the payments and being able to afford a house are two different things.

[Edited on September 26, 2008 at 10:26 AM. Reason : ]

9/26/2008 10:26:10 AM

the only reason they use "this BS" is because of PMI. If there was no PMI and people instead just took out 90% mortgages, would you still call it irresponsible?
Besides being the limit for not paying PMI, is 20%-down some kind of magic number for you?

9/26/2008 10:28:13 AM

Quote :

"Also, responsible owners have at least 20% down"

Maybe in the 1980's

9/26/2008 10:32:56 AM

Quote :

"If they need this kind of BS loan instead of one 15 or 30 fixed loan - they couldn't really afford the house and should have bought lesser house in a more affordable market. Being able to make the payments and being able to afford a house are two different things."

Stop talking out of your ass.

I put 10k down on a 157k home and got a 5/5 arm (resets once every 5 years capped at 2% total increase) loan at 4.65% in August of 04. I guess I could have drained my savings safety net for 20% down with a higher rate (30 yr rates were higher than my "subprime" rate) on a home I knew I would probably be out of in less than 5 years, but what the hell do I know.

9/26/2008 10:35:40 AM

All the people who think all mortgages should require 20% down really make me laugh.

Yes the solution to the problem is to make financing and loans even harder to get. That is SURE to help stabilize home values and stop the banks from enduring catastrophic loss.

9/26/2008 10:57:50 AM

Don't be ignorant. He has a bit of a point that those that shouldn't have them, shouldn't get them. That is, "make them harder to get".

Having said that, there are plenty of capable people that would like the option of getting a loan product that fits their needs. Not everyone intends to be in a place for 15-30 years.

9/26/2008 11:05:37 AM

Quote :

"I put 10k down on a 157k home and got a 5/5 arm (resets once every 5 years capped at 2% total increase) loan at 4.65% in August of 04. I guess I could have drained my savings safety net for 20% down with a higher rate (30 yr rates were higher than my "subprime" rate) on a home I knew I would probably be out of in less than 5 years, but what the hell do I know. "

you must not know very much, if you can't even afford 20% on a 157K, you should wait a few years to get a home when you can afford the down payment.

People who want to buy houses on financing > 80% make me laugh - that's what got us in trouble to begin with.

What if you lose your job? What if you get hurt and can't work? What if you divorce? All these factors will make it extremely difficult to pay a mortgage when you live paycheck to paycheck.

No, making lending harder will not help alleviate these problems in the market, but it would have prevented most of them. People will always take advantage of the rules when there is little penalty other than bad credit if you default.

9/26/2008 12:31:20 PM

Quote :

"you should wait a few years to get a home when you can afford the down payment. "

OBVIOUSLY, he did afford the down payment since he got the house. . . . . .

I think a lot of you have great theories on this but have not really paid attention to the clusterfuck that created this. It is not because people did not have to put 20% down. There is a wide range of things that were done other than hight loan to value ratio's that created this problem.

- No Documentation Loans made to anyone with a pulse. (at 100% ltv or more)
- Weak Appraisal Standards (appraisers not held accountable for values)
- Large home builders and condo developers inciting frenzy (buy today prices are going up 20k tomorrow and we will keep selling) to quickly inflate property values to unsustainable levels
- 90+% LTV investment property loans (investment properties are much more likely to default than owner occupied, not to mention the rents will rarely cover the payment at this LTV)

Most importantly the investors are at fault and the people responsible for rating the investments. You cannot blame mortgage brokers for making loans that fit in the guidelines of the weak lending standards......THEIR JOB IS TO MAKE LOANS, and they were given these loans to make. Certainly there were isolated incidents of falsified documents but most of the Alt-A or No-Doc, or Stated Income loans did not even require documentation.....

I mean common sense would tell you loaning out hundreds of thousands of dollars to someone whom you have not verified ability to pay, at predatory or upwards adjusting interest rates is going to backfire. Especially when you bring in to the equation how much it costs to foreclose on a home.

Car dealers and auto lenders have used these tactics forever, but the difference is you do not just hook up a tow truck to a house and haul it back to the lot. It costs tens of thousands (hundreds on higher end homes) to foreclose and subsequently re-sell a home. That is even assuming it is worth the loan balance. Presently most homes are not.

Blaming the brokers is like blaming the people working at McDonalds because you got fat, you might be able to blame McDonalds for making fatty burgers or yourself for buying them, but the guy behind the drive through is just making the burgers the way he was told to.

You do not hear of many credit unions and small banks suffering huge losses from this. Most credit unions keep their mortgages on their books and so they research a borrower before making a loan. They also do 95% or 100% financing regularly.........they are still doing 100% mortgages even now for qualified purchasers.

The difference is accountability and not as much greed. They do not stick people with the highest rate they can sucker them in to, usually they have their rates posted in the lobby and if you get a loan from them that is the rate you get. They have to be accountable for the loan over the long term so they have a reason to keep the payment in a range the borrower can afford./]

9/26/2008 1:00:52 PM

I didnt put 20% down on my home, and i am not in any danger of loosing it to anything but rogue space debris flying out of the sky and into my roof.

I saw no point in sitting in an apartment for another year (and paying 76% of my current mortgage payment as rent) just to save up to hit some magic number for a down payment. That said I'll also pass a credit check with flying colors.

9/26/2008 1:48:04 PM

Quote :

"you must not know very much, if you can't even afford 20% on a 157K, you should wait a few years to get a home when you can afford the down payment. People who want to buy houses on financing > 80% make me laugh - that's what got us in trouble to begin with. What if you lose your job? What if you get hurt and can't work? What if you divorce? All these factors will make it extremely difficult to pay a mortgage when you live paycheck to paycheck. "

what the hell are you talking about?
What does not having $30k on hand to put down for a house have to do with losing your job, or living paycheck to paycheck?

9/26/2008 2:15:34 PM

lets assume that if you don't have 20% equity that your payments are going to be considerably higher, i think the 80/20 loans of 03-07 or one featuring PMI can be anywhere from 10-25% higher depending on the terms and rates.

Therefore, you are further putting yourself in financial risk of not being able to make those payments at the same income, and it becomes compounded when there is increased risk of losing your job.

The smart homeowner therefore has 20% equity from the start and payments that are more easily afforded. If you have to get two loans to buy a house, you probably can't afford it.

9/26/2008 3:24:29 PM

seriously, there's living pay check to pay check, and then there's not wanting to piss 12-14k away on rent just so i can save up an additional chunk for my down payment. And to further counter your statement, wouldn't having 10% of the value of my house in easily converted investments (hy savings, money markets, etc) be BETTER for my outlook in case of a short term cash inflow condition then having it already tied up into my house. That way i still have a fair nest egg in case of unexpected financial situations (job lose, medical expense, the transmission fell out of my toyota so i bought a jeep).



I mean if you look at a 150k house and your expressed beliefs here, you need 40-60k in cash to think about buying that home.

30k for a 20% down
3-5k for closing cost
2-10k for interior and exterior furnishings and equipment (furniture, decor, lawn mower, weed whacker, edger, gardening equipment and supplies)
5-15kAnd then a nest egg to cover expenses/emergencies.


If someones secure in their incoming and their money management, why waste 2-3 years saving up a down pay, wasting money on rent (10s of thousands), when they can get into a house (not if you plan on only living there short term ignore everything, rent).

9/26/2008 3:54:56 PM

^^ the difference in rates in my 5/95 and an 20/80 (both 30yr fixed) was 3/8ths of a percent. Which, over 30 years, will cause me to pay ~ 15,000 more in interest. However, that other 15%, stuck in a rainy day money market at the current low rates for 30 years, would be worth an additional 43,000 dollars, or nearly 3x what it would have saved me to use it as a down payment. So from a financial stand point, larger down payment would cost me in the long run

9/26/2008 4:05:40 PM

Many people were getting like 3% down. Bottom line is when you have a family with kids especially you will do whatever you can to get into a house with enough bedrooms for your boys and girls to be separate and in a decent area. Thats responsibility as a parent. This responsibility you speak of is foolish. Why would you continue to throw away your money renting if you could own? Even if you end up foreclosed its the same thing as leaving an apartment when your lease is up.

Quote :

"How do people deal with selling a house with negative equity when they don't have enough money to pay the difference to the bank? is there going to be a new boom of lines-of-credit to pay off negative equity?"

The government is going to have to pay the difference. Its the only way and Obama has already talked about it.

9/26/2008 4:07:07 PM

^ no, being foreclosed on wrecks your credit.



And its not about doing small downs, one of the biggest issues was people doing 2/1 or 2/2 arms and then not being able to, or smart enough, to re-fi to a fixed when their arm rates were approaching the current 30yr fixed rates.

9/26/2008 4:12:48 PM

Quote :

"Many people were getting like 3% down. Bottom line is when you have a family with kids especially you will do whatever you can to get into a house with enough bedrooms for your boys and girls to be separate and in a decent area. Thats responsibility as a parent."

since when have liberals ever espoused parental responsibility?

BTW, you don't have to have enough rooms for all of your kids to have separate bedrooms. I slept in the same room w/ my brother, and I am sure there are kids all across America that sleep two to a room. Really, if anything, it's an efficient use of space, when you get down to it. six to a room? that's silly, of course, but two to a room aint shit.

9/26/2008 4:16:44 PM

Quote :

"And its not about doing small downs, one of the biggest issues was people doing 2/1 or 2/2 arms and then not being able to, or smart enough, to re-fi to a fixed when their arm rates were approaching the current 30yr fixed rates."

i know that's what the current housing crisis is about. I am wondering what happens when people who have normal loans all of a sudden have thousands in negative equity because the prices in their market have gone to shit.

Quote :

"since when have liberals ever espoused parental responsibility?"

i'm just going to start posting this whenever you or Tree or csharp make an idiotic characterature statement about liberals http://www.youtube.com/watch?v=f3qgiNPVpSM

9/26/2008 4:23:01 PM

thx for answering the question. Liberals give us all kinds of programs in order to take the responsibility, nay, disallow the responsibility, of parenting from parents.

9/26/2008 4:25:54 PM

i know you are, but that was to the other people in the thread.


People that are currently sitting on negative equity are either going to ride it out, or take the loose on the sell, but hope the sell at least covers the balance of the loan.

9/26/2008 4:32:51 PM

I don't see how having 20% down is going to save you if you lose your job. You are still gonna lose the house, just more of your own money along with it of you can't pay.

I know when I bought mine I was initially told to put 10% down so that is how much I had budgeted. I ended up qualifying for a 95% loan and the lender told me to keep the other 5% for emergencies.

Having a large down payment is actually stupid if your rates are favorable and payment affordable. You are supposed to have 3-6 months of living and housing expenses in savings in case of emergency.

If everyone waited to have 20% down, closing costs, and the reserves it would take $50,000 to get in to a starter home. That is a lot of time wasted saving money while you could be building equity through appreciation and loan paydown, and saving on income taxes.

Not to mention it is added years renting which completely sucks ass.

9/26/2008 4:39:50 PM

Quote :

" Wachovia's Pick-A-Pay loans give some borrowers the option of deferring portions of their monthly interest payments, thereby increasing their loans' balance. While Wachovia has stopped writing the loans altogether, Pick-A-Pays have proved highly problematic for both WaMu and Wachovia since home prices have fallen around the nation even as many Pick-A-Pay loan balances have risen. Wachovia famously acquired the Pick-A-Pay business in 2006, when it purchased West Coast lender Golden West, at the height of the housing boom, for $25.5 billion. That deal quickly has quickly come to haunt Wachovia's franchise. Defenders of Golden West, a pioneer in offering Option ARM mortgages, say that Wachovia changed the product's underwriting standards, and issued the loans to riskier borrowers. But employees at Wachovia who marketed Pick-A-Pays say that the loans do not deserve to be lumped with other risky loans, including now-infamous subprime loans. Those defenders of the Option ARM loans maintain that when banks underwrite these loans correctly, they are both safe and lucrative. But as the credit crisis has widened, Pick-A-Pays have undeniably produced rising delinquencies and - perhaps more importantly - unnerved investors. Of Wachovia's $122 billion in Pick-A-Pays, 5.78% are considered " nonperforming," or more than 90 days past due, as of this year's second quarter. Another 5.2% of the portfolio is delinquent by less than 90 days. As of last year's second quarter, only 1.03% of the Pick-A-Pay portfolio was classified as nonperforming. Wachovia's $44 billion in traditional mortgages, by contrast, show a nonperforming rate of 0.98%, up from 0.35% in last year's second quarter. Of the entire Pick-A-Pay portfolio, 58% of the outstanding balances are tied to properties in California, and another 10% are tied to homes in Florida - two states hardest hit by declines in home values. Washington Mutual had similar, though more severe, problems with its Option ARM loans. Six percent of WaMu's $52.9 billion portfolio was nonperforming through the second quarter, up from about 1.5% in last year's second quarter. With Pick-A-Pay loans producing losses for Wachovia that reach into the billions, and more likely to come, Wachovia's board has shaken up the firm."

9/26/2008 5:06:36 PM

^^ yeah, because houses are always appreciating, especially in today's market

Having 20% down means you will have much cheaper payments and can make those payments longer in the event of a financial setback such as a job loss

Too many people are one missed paycheck away from foreclosure, which destroys the equity for the surrounding responsible homeowners

bottom line is - better to rent until you can afford to buy than to risk a default. it is not your god given right to own a home.

9/26/2008 5:44:45 PM

Quote :

"because houses are always appreciating, especially in today's market"

They actually are.

Check your facts before you post.

9/26/2008 5:52:21 PM

Negative equity will be a problem for probably 10+ years down the road.

Quote :

"If everyone waited to have 20% down, closing costs, and the reserves it would take $50,000 to get in to a starter home. That is a lot of time wasted saving money while you could be building equity through appreciation and loan paydown, and saving on income taxes."

It's this type of thinking that is partially responsible for the housing mess. Buying a house isn't some magical process that always ends up being cheaper than renting and a good investment to boot. Housing is a market subject to supply/demand just like any other asset. Renting can be cheaper than owning (as has been the case in most of the US for the last 4-5 yrs) and houses can certainly lose value. If you chose to ignore the fundamentals of housing supply and income to house price ratios and bought at the top of the bubble, too bad so sad. You didn't save enough on the front end so you'll have the opportunity the save on the back end to pay off your underwater mortgage.

The underlying problem is that a house purchase is the only large leveraged purchase most households ever make, but people don't think of it that way. Putting 20% down isn't some arbitrary roadblock to home ownership implemented by the evil banks, it's so you have some skin in the game and to protect that banks against movement in the value of the collateral (the house). This is not actually a separate problem from the "ARM reset problem". The problem with ARMs resetting is that most people barely qualified for their sketch ass negam loan or whatever with positive house price appreciation, so now when they go to refi and the housing market is in the shitter and that 95 LTV has turned into a 115 LTV because your house is worth 18% less you certainly can't get a refi. Can't afford payment + can't refi = foreclosure city.

Quote :

"The government is going to have to pay the difference. Its the only way and Obama has already talked about it."

Hahahaha let me know how that works out for you.

9/26/2008 5:53:09 PM

150,000 dollar home

Down % Rate % Monthly
0% 6.5 948.10
10% 6.5 853.29
20% 6.5 758.48


assuming you can save 10k/year towards a down payment That extra 3 years of saving will save you 190/month on your loan payment. Piss away 2 years worth of rent (18-30k depending on how nice of a place you want, just in the triangle). It takes you 8-13 years of payments, just to make up what you wasted in rent waiting to move it.

9/26/2008 6:00:48 PM

^^ i'm not saying that you should rush into buying a house, what i am saying is that with a thought out plan there's no reason to wait have 20% in every case. I personally, would have ended up wasting about 12 months (11k) on rent if i waited to have 20%. 20% is not a hard fast rule, and getting in under 20% isnt always a bad thing

9/26/2008 6:06:50 PM

That's not the correct analysis of rent vs purchase, just fyi

9/26/2008 6:07:06 PM

I do not think the bail out is going to be adequate to stop all the foreclosure losses.

I also think the banks and lenders are idiots. I would bet half of the loans they foreclose on and lose tens of thousands they could stay whole by meeting the owner somewhere in the middle on the interest rate.

Instead they let the desperate homeowners get bogged down in beaurocracy and instead of helping they foreclose, lose $50,000+ dollars, and then come expecting a bailout from the Government.

Even if they have to drop the rate down to 2% so the borrower can still afford it they would still be better off than foreclosing and losing so much money.

9/27/2008 1:27:23 PM

^somebody on this board finally knows how stuff works.

9/27/2008 1:30:43 PM

I'm sorry but 20% down isn't always good for the borrower. In most situations they could find much more efficient uses of their money.

Please note that interest on mortgages is tax deductible and that with good credit interest rates are usually less than what you can expect to earn long term in other investments.

Also, please note that the grocery store, doctors office, and tanning beds do not accept "home equity" as collateral for food, medical treatment, and tanning services.

I think I'd rather eat, get my broken arm reset, and be tan more than have all my money trapped in vinyl siding and faucet heads. Even novice investors know they should be diversified. Having all your net worth in one house is even worse than having 100% in a real estate ETF.

Usually, Money > Equity. Take this from someone who has a 15 year fixed with a 20% down payment on their property. If I was more intelligent 6 years ago I'd have an assload of money in my brokerage account instead of a place I could maybe break even on after closing expenses. Adjusted for inflation I've lost big time whereas ~$25k in the stock market from '02 - '08 would have exploded.

People don't seem to realize that equity and appreciation are completely independent of each other. You don't even need a Z-score or t-table to test this. You can completely reject the null like a fat bitch with bad teeth.


20% down is good for the LENDER because it ensures the borrower has incentive to make payments.

If I buy a $200k home and put nothing down and it's worth $175k three years from now and I have to relocate I will just let my credit take a hit, whatever.

If I buy a $200k home and put $40k down and it's worth $175k I will sell the house for what its worth and take my $15k and curse bad timing.


[Edited on September 27, 2008 at 1:54 PM. Reason : a]

9/27/2008 1:50:40 PM

Quote :

"How do people deal with selling a house with negative equity when they don't have enough money to pay the difference to the bank? is there going to be a new boom of lines-of-credit to pay off negative equity?"

In practice one would ask the bank to accept a short sale. That is, you sell the house and the bank gets the proceeds and just absorbs the loss. The most they can do otherwise is basically sue you for the loan because the security is the collateral.

In some states banks legally have no recourse over and above the collateral. In addition, traditionally banks do not seek to recover from homeowners who are underwater.

The fact that this is likely to happen to many homeowners is a significant reason why mortgage baked securities reflecting all ranges of credit scores are tanking. This is not just or even most significantly a subprime issue.

One of the biggest fears for the financial system is that at some point homeowners will realize that they can simply walk away from their homes en mass and there is little the financial industry can do about it.

9/27/2008 5:23:32 PM

This is a terrific article. I thought for sure my next home purchase I'd go the 0% down route, but now I'm really going to research the renting angle. I could probably afford to rent a really nice place soon. The article never mentions a great point also that rent is only fixed in one year intervals (typically) so if you're financial situation changes for better or worse you can make adjustments without bearing such huge transaction costs.

http://realestate.yahoo.com/promo/renting-makes-more-financial-sense-than-homeownership.html;_ylc=X3oDMTFta3Jqcjk3BF9TAzI3MTYxNDkEX3MDOTc2MjA0NjUEc2VjA2ZwLXRvZGF5BHNsawNyZW50aW5nLWJldHRlcg--

Quote :

" I have something un-American to confess: I rent an apartment, despite having enough money to buy a house. I plan to keep renting for as long as I can. I'm not just holding out for better prices. Renting will make me richer. I normally write about stocks for SmartMoney.com, but the boss asked me to explain to readers my reason for renting. Here goes: Businesses are great investments while houses are poor ones, so I'd rather rent the latter and own the former. Stocks vs. Houses: Returns Shares of businesses return 7% a year over long time periods. I'm subtracting for inflation, gradual price increases for everything from a can of beer to an ear exam. (After-inflation or "real" returns are the only ones that matter. The point of increasing wealth is to increase buying power, not numbers on an account statement.) Shares have been remarkably consistent over the past two centuries in their 7% real returns. In Jeremy Siegel's book, "Stocks for the Long Term," he finds that real returns averaged 7.0% over nearly seven decades ending 1870, then 6.6% through 1925 and then 6.9% through 2004. The average real return for houses over long time periods might surprise you. It's zero. More from » 8 Home Improvements That Pay Off » 13 Ways to Lower Your Electric Bill » Help for First-Time Home Buyers Shares return 7% a year after inflation because that's how fast companies tend to increase their profits. Houses have their own version of profits: rents. Tenant-occupied houses generate actual rents while owner-occupied houses generate ones that are implied but no less real: the rents their owners don't have to pay each year. House prices and rents have been closely linked throughout history, with both increasing at the rate of inflation, or about 3% a year since 1900. A house, after all, is an ordinary good. It can't think up ways to drive profits like a company's managers can. Absent artificial boosts to demand, house prices will increase at the rate of inflation over long time periods for a real return of zero. Robert Shiller, a Yale economist and author of "Irrational Exuberance," which predicted the stock price collapse in 2000, has recently turned his eye to house prices. Between 1890 and 2004 he finds that real house returns would've been zero if not for two brief periods: one immediately following World War II and another since about 2000. (More on them in a moment.) Even if we include these periods houses returned just 0.4% a year, he says. The average pundit, planner, lender or broker making the case for ownership doesn't look at returns since 1890. Sometimes they reduce the matter to maxims about "building equity" and "paying yourself" instead of "throwing money down the drain." If they do look at returns they focus on recent ones. Those tell a different story. Between World War II and 2000 house prices beat inflation by about two percentage points a year. (Stocks during that time beat inflation by their usual seven percentage points a year.) Since 2000 houses have outpaced inflation by six percentage points a year. (Stocks have merely matched inflation.) Stocks vs. Houses: Valuations But while stock returns have come from increased earnings, house returns have come from ballooning valuations, not increased rents. The ratio of share prices to company earnings (the price/earnings ratio) has remained relatively steady. It's about 16 today, close to both its 1940 value of 17 and to its 130-year average of about 15. Not so, the ratio of house prices to rents. In 1940 the median single-family house price was $2,938, according to the U.S. Census, while the median rent was $27 a month, including utilities. That means the ratio of prices to annual rents was 9. By 2000 the ratio had swelled to 17. In 2005 it hit 20. We can adjust for the size of dwellings, but it doesn't make much difference. The ratio of single-family house prices to three-bedroom apartments is 19. In SmartMoney.com's home town of Manhattan, where more detailed data is available, the ratio of condo prices per square foot to apartment rents per square foot is 22. Two main events have caused house valuations to inflate since World War II. First, the government subsidized housing by relaxing borrowing standards. Prior to the creation of the Federal Housing Authority in 1934 house buyers who borrowed typically put up 40% of the purchase price in cash for a five- to 15-year loan. By insuring mortgages, the FHA permitted terms of up to 20 years and down payments of just 20%. It later expanded the repayment periods to 30 years and reduced down payments to 5%. Today down payments for FHA loans are as low as 3%. Aggressive lenders offer loans with no down payments or even negative ones so that house buyers can borrow the full purchase price plus closing costs. Some require little documentation of income, assets or ability to pay. That means more Americans can win loans for homes, and they can win them for far more expensive (larger) homes than their incomes previously allowed. Two-thirds of American households own homes today, up from 44% in 1940, even though the percentage of Americans living alone has tripled during that time. The ratio of house values to incomes has risen 260% in just under four decades. A second event helped boost house demand in recent years. Share prices plunged in 2000. The Federal Reserve, fearing that the decline in stock wealth would cause consumers to stop spending, reduced the federal-funds rate, the core interest rate that determines the cost of everything from credit cards to mortgages, to 1% by the summer of 2003 from 6.5% at the start of 2001. Since most of the cost of financing a house over 30 years is interest, monthly house payments shrank and demand for houses soared. In some markets a string of big yearly increases in house prices led to panic buying. Stocks vs. Houses: Conclusion For house returns over the next 20 years to match those over the past 20, the government and private lenders would have to "up the ante" by relaxing borrowing standards further. Given the recent attention paid to swelling foreclosures, that seems unlikely. I suspect real returns will turn negative over most of the next two decades, but that house prices won't necessarily dip. Since 1963 they've done so in only two years, vs. 18 for stocks. That's because homeowners mostly just stick it out rather than sell during soft markets. But if house prices remain flat, they produce negative real returns due to the creep of inflation. According to calculations made by The Economist in the summer of 2005, house prices would have to stay flat for 12 years with annual inflation at 2.5% for the ratio of prices to rents to fall from its 2005 perch to merely its 1975 to 2000 average. So to sum up why I rent: Shares right now cost 16 times earnings and over long time periods return 7% a year after inflation. Houses right now cost 19 times their "earnings" and over long time periods return zero after inflation. And they look likely to return less than that for a while. On the following page I've tried to anticipate and address questions and objections. "

9/27/2008 6:51:30 PM

Quote :

"Questions/Objections "You can't live in your stocks" or "Renters throw money down the drain." Rent is the cost of owning shares with money you would otherwise spend on a house. Houses have ownership costs, too: taxes, insurance and maintenance. Rent costs about 5% of house prices each year if we apply the price/rent ratio of 19. House incidentals often cost around 2%. If you have $300,000 and a choice between spending it on a house or shares, you'll pay $6,000 a year in incidentals if you buy the house or about $15,000 a year ($1,250 a month) in rent if you buy the shares. But the shares will return $21,000 a year after inflation while the house will return zero. (My numbers work out even better than these. I pay a smidgen less than $1,250 a month for rent, while house prices in my neighborhood are far higher than $300,000.) Note that houses and shares have transaction costs, too. Home buyers pay around 1% in closing costs when they buy and 6% in broker commissions when they sell. Share buyers pay $10 trading commissions, which are negligible for buy-and-hold investors. "House buyers get tax breaks." So do share buyers, but both are a bad deal. The interest on loans for houses (mortgages) and shares (margin balances) is tax-deductible. But the rates are almost always too high. A big house loan presently costs 6.1% interest while a big stock loan costs about 9%. For the returns, we can forget about inflation because it helps debtors while hurting investors, making it a wash for those who borrow to invest. Still, nominal returns of 3% for houses and 10% for stocks aren't high enough to justify those rates. The tax breaks aren't really breaks at all. Moreover, a majority of homeowners don't claim them. Their incomes are low enough to make the standard deduction a better deal. "What about the pride of home ownership?" It's not for me. I define ownership as no longer having to pay for something and being able to do as I please with it. I own my coffee maker. House owners must pay taxes each year even when their mortgage payments are done. In certain markets they can't even make changes to the houses they've paid for without seeking the approval of others. Personally, I feel the pride of ownership for shares of businesses, and I'm proud to occupy a nice place while leaving the burden of poor returns and maintenance to someone else. "You seem to knock government housing subsidies, but they've helped many Americans afford homes." My inner socialist agrees. My other inner socialist worries that the government has effectively raised prices to the point where the middle class can't afford houses, or buries itself in debt to own them. My inner capitalist is too busy watching shares to care about house prices. My inner conspiracy theorist notes that while politicians tout the social benefits of homeownership none mentions its tax benefits to the government. I pay no taxes on the overall value of my stock portfolio, just on my cashed-in gains and collected dividends. But Americans pay taxes on the full $11 trillion worth of housing they own plus the $10 trillion worth of it they're still paying off. "Houses are bigger than apartments." True, and both can be rented. A third of renters live in single-family houses. I prefer an apartment for now. I like not having to fill it with stuff. I like using a fifth of the energy of the average American. I like being 20 minutes from work and (this is unique to New Yorkers) not having owned a car in 10 years. I like not stressing over whether to get the marble countertops or the imported tiles or the 52-inch flat screen. I'm not especially frugal; I spend a teacher's salary each year on restaurants and travel. But I guess I'm too busy or lazy right now to bother with a big house and its innards. "Are you saying I should sell my big house and rent an apartment instead?" No, unless you have more space than you need and moving wouldn't be disruptive to your family, and you want to cash in on recent housing gains, make more money over the next couple of decades, use less energy while simplifying your life, and you don't mind seeming odd to friends. In which case, yes. But really, I'm not trying to win anyone over. Strong demand for houses keeps my rent cheap. "Renting is for poor people." True. But it's for rich people, too. The average renter makes about $34,000 a year, but while the percentage of renters declines after incomes exceed $20,000 and rents exceed $600 a month, it jumps again once incomes top $150,000 and rents top $1,200 a month. In other words, poor people rent modest apartments for lack of choice. Middle-income people buy houses. High-income people, presumably with a dose of financial savvy, often rent nice apartments instead of buying. "You say houses return zero. But I've made a fortune on my house in recent years." I'm referring to inflation-adjusted returns over long time periods, absent external boosts to demand. You're referring to gross returns over a short time period that combined lax borrowing standards and ultra-low interest rates. Over the next 20 years I believe houses will return zero or slightly less after inflation and that stocks will return 7%. "So you're never going to buy a house? What about raising a family?" I might buy one eventually, but the longer I can put it off the more I'll get out of the shares I'll have to sell to afford it. I'm 34 now with a fiancée and a fish. I'm going to try to rent for at least 10 more years. If I have kids I'll probably move into a big apartment or a house once they reach running-around age. I'll rent, most likely."

9/27/2008 6:51:56 PM

it is going to be like it was 15 years ago, people that bought houses didnt do it to make money and in most cases it actually lost value...it was just the fact of owning it....I have seen graphs that show before that housing prices went sky high, for like 30 years they mostly stayed the same......be prepared for that....dont get in it thinking you will make money in 5 years when you sell it. Those days are long ago and you might see them again when you are about to retire and head to FL to a retirement home....

9/27/2008 7:39:03 PM

Quote :

"In practice one would ask the bank to accept a short sale. That is, you sell the house and the bank gets the proceeds and just absorbs the loss. The most they can do otherwise is basically sue you for the loan because the security is the collateral. In some states banks legally have no recourse over and above the collateral. In addition, traditionally banks do not seek to recover from homeowners who are underwater."

thanks, i did not know that

9/27/2008 11:37:30 PM

One start to a solution is to make losses on home sales tax deductible. I believe right now if you sell your personal home at a loss, then the loss is not a tax credit; only if it's an investment property. If the problem becomes as widespread as agentlion describes, then that would seem a reasonable policy change.

Overall there's no easy solution -- it's a loss. Short selling is unacceptable (IMO) except as a last resort for most people and certainly for banks. If too many people do it then rules for short selling will become even stricter. The reality is that a lot of people will just stay put.

9/28/2008 3:52:54 AM

Amounts forgiven in a short sale count as income

[Edited on September 28, 2008 at 11:36 AM. Reason : aka taxes homies]

9/28/2008 11:35:56 AM

The govt created the housing bubble, now people are calling for the govt to do something else. So the downward spiral continues.

The simple truth is some people cannot afford to own thier own home.

Let the market readjust, and keep the govt out of it. They create more long term problems than they help.

9/28/2008 12:41:15 PM

ok, thanks for your incredible insight.

now, could you stay the fuck out of any thread I create?

9/28/2008 12:52:09 PM

or you could get your head out of your ass and try to actually discuss the issue.

To your orginal question, you can ask banks for a short sale.

Also, what do you think we should do about people who put a little money or no money down on cars.. then have negative equity in those and need to sell? LOL, relax hoss. I doubt you own a home but things will be fine. some markets that were overvalued and littered with a run on housing will be hurt in the short term, but people will need housing. As long as your area doesnt turn into a crime haven, your home value will be fine.

9/28/2008 12:59:01 PM

Quote :

"or you could get your head out of your ass and try to actually discuss the issue. To your orginal question, you can ask banks for a short sale."

oh, thanks. Did you come up with that on your own, or just read it from the 5 other people in this thread who have mentioned it?

Quote :

"Also, what do you think we should do about people who put a little money or no money down on cars.. then have negative equity in those and need to sell?"

give me a break. You know that's not even in the same ballpark as buying a house, and the expectations are completely different. Everyone knows the value of your car drops by 40% as soon as your drive it off the lot. If the same thing was true for houses, then we'd probably all live in high-rises in the middle of a city

Quote :

"I doubt you own a home but things will be fine."

fuck you. this is the 2nd time you've leveled a personal attack on my income without any basis. I mean, we can't all be Wal-Mart Eye Doctors, but those of us with two engineering degrees and an MBA tend to do fine for ourselves.

9/28/2008 2:01:13 PM

Quote :

"The simple truth is some people cannot afford to own thier own home. "

So you want to abolish the American Dream?

9/28/2008 3:15:33 PM

^ he aint abolishing it, jackass

9/28/2008 4:31:49 PM

Quote :

"you must not know very much, if you can't even afford 20% on a 157K, you should wait a few years to get a home when you can afford the down payment. People who want to buy houses on financing > 80% make me laugh - that's what got us in trouble to begin with. What if you lose your job? What if you get hurt and can't work? What if you divorce? All these factors will make it extremely difficult to pay a mortgage when you live paycheck to paycheck. No, making lending harder will not help alleviate these problems in the market, but it would have prevented most of them. People will always take advantage of the rules when there is little penalty other than bad credit if you default."

You might be one of the most retarded ignoramuses in regard to real estate I've seen post in this section. Why would I sink more than the 10k I needed in my house when I was able to take that additional 20k and return a much higher rate on it than the measly 4.6% (before considering the tax advantages) I had to pay for the loan. Why would I get a conventional loan when the terms of the ARM were better and I knew I wouldn't be there more than a few years? I'm on my second, nicer, bigger home closer to where I work. I've got enough saved to make the payments on it for nearly a year. You are right, with my company approaching insolvency, being jobless is a helluva concern. But, if the market is so shitty that a Staff Engineer team lead with 5 years experience in semiconductors can't find a job in this area that will let me continue to service the loan on the new place, then the economy as a whole is worse than anyone could have imagined. I planned for everything except for that, which was my worse than worst case Armageddon scenario, something that no one that is as prudent as I have been with my finances should ever have to plan for.

9/28/2008 5:38:01 PM