mikeb
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I'm interested in purchasing a home and have little towards the down payment, so i'm leaning toward a 80/20 laon. I only plan on staying in the house for 3 or 4 yrs max before selling, so people say it's smart to go with an 5/1 ARM. I'm also interested in an interest only option as we have child care expenses of $700 a month for the next 2 1/2 yrs, so i'm looking for the lowest possible monthly payment. The DC metro area has averaged 20% a yr property appreciation over the past 3 yrs, so i'm confident equity will be built despite the use of these risky mortgage products. Is this a smart move or am I asking for trouble?
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Thu Feb 09, 2006 5:14 pm |
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Jaszbo
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"The DC metro area has averaged 20% a yr property appreciation over the past 3 yrs, so i'm confident equity will be built despite the use of these risky mortgage products. Is this a smart move or am I asking for trouble?"
3 years is nothing. You are asking for trouble if your only plan is speculation of appreciation. Just do the easy math. Take the value of the average house and then go online and do calculation of 20% a year and see how much a house will be worth in 10 years. If you trully believe it will still grow 20% a year just do calculations. Say the average house is worth 200k, which I know it's worth more in DC, but let's just say 200k to be nice. After ten years a 200k house will be worth 1,238,347.28, how many people do think will be able to aford this type of house.
I would never speculate on real estate and if I had to, i would speculate that you missed out. The past 3 years were good, sorry you missed it. But you misssed it.
The market works to a certain extent. When intrest rates increase and prices of housing increase much faster than people's income, who is going to afford these homes?
I live in a place that went up about 50% in the past two years. Already houses have slowed down. People here cannot afford the high prices and the increasing rates. Sure some people can, but when a house a few years ago was worth 150k and now it's worth 300k, do you really think another two years it will be worth 600k. The money has to come somewhere, don't get me wrong investors bring up the price of homes, but they also cause a bust.
I would never invest in anything with only speculating an increase price. If you do intrest only, you are speculating and you may get lucky, but that's a may.
A good investor would never use speculation of appreciation as their only way out. I personally would rather see you with a 15 year mortgage, then 30 year mortgage, then an arm and last I would never recommend an intrest only. It's just not worth it.
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Thu Feb 09, 2006 7:38 pm |
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mikeb
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Don't get me wrong, I realize the days of 20% a yr appreciation are over. If I only see 15-20 over 3 to 4 yrs I'm happy. I'm not looking at this from an investor's point of view, I'm simply trying to break into a high priced market sooner than later. What are the advantages of a 15 year mortgage for a person in my position.
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Thu Feb 09, 2006 8:26 pm |
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Jaszbo
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Your position is something you have to work on, but an investment is an investment and paying less intrest and having more money go towards principle I like better. Some people do like 30 year mortgages and other loans, bette, but I prefer the order of 15 year, 30 year and then ARM. Actually you couldn't drag me into an ARM or IO loan to be honest.
Before any investment look at long term. If you stay 10 years in a place and you don't over pay, chances are you'll come up above, way above. But I would rather look for undervalued property and put more towards principle and fix up the place.
When something has gone up 20% for 3 years in a row, do you think it's still going to go up 20% for the next 3-4 years. I mean reall look at real estate and ask yourself how high can it really go. Say you can afford a house that costs 200k, if you waited a year could you afford a house that's 240k the next year and the following year close to 300k?
When inflation and cost of living is around 3-4% a year and there's a 20% increase per year, there's a higher chance of busting than anything else. There's something in investing called P/E, price to earning ratio. The money people buy houses have to come from somewhere. A lot of speculators buy house expecting to make a profit and when prices go up like crazy, it's when more people get screwed.
I do think real estate is good and it can be your best investment, but it's when you can live in it for the long run and it's not when you only think it's going to go up in value. Any good real estate investor would never speculate that it's going to keep going up.
Can you be 100% sure it's going to go up? Do you know about the history of real estate in the nation or your local areas? There's been real estate busts that reale state has gone down 20% in certain years. That's a negativce 20%, but it's not often. We havent' had a real estate bust/crash as a nation in general, but only local areas. One time in history we have had real estate not keep up with inflation.
Think if appreciation as an added bonus and one of the reasons to get into real estate and not the only one.
Just like the stockmarket if you loose out, you may end up like a lot of people I know who decide to rent for the next 20 years.
I would expect a general 6-8% increase in general, and maybe 10% you can expect. Now that it's gone up 20% for the past 3 years, I would assume it is more likely not to increase.
I live in FL and it's been going up like crazy. I can tell you there's a bust already. It's not like a stockmarket. You aren't going to hear it on the news the morning you wake up. Some people don't even knwo when there's a crash/bust. It's a slow process, but it's when houses are over valued.
But you have to do the match and take a calculator, see what 20% for the past 3 years has changed to. Then ask yourself can it go up another 20% a year and can people afford it. See what the average salary is and ask can they afford houses out here. If the average family makes say 80k, can they afford a million dollar house? What about a 500k house, and if they can afford a house for 500k one year and then next year do you think a person could then afford 600k?
Money just doesn't appear and I'm just trying to warn you. I'm not saying don't buy a house, but never buy something thinking you can predict the future and speculate another 20% return.
I've heard two respected investors say this "when a taxi cab driver is telling me what to invest in, it's no longer an investment", bogle said once "if a shoe shine boy is telling me what a great investment, it's time for me to get out of that investment.
There's a guy called the real estate king, do a google search on him. He pulled out of real estate completely it seems. If I was to speculate there's nothing that's telling me it's going to continue do 20% a year. I could be wrong, maybe next year will be 20%, but I can almost guranttee that it's going to end.
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I know you said in 4-5 years 15%, which is possible, but do you know you can't add percentages. If you have 100k and it goes down 50%, it's 50k and if it goes up 50%, you now have 75k, so if it goes down you get hurt much more. My point is do not speculate as the only reason to buy. I believe DC is listed as over valued house and if so assume 3-6% a year at max. But I'd rather see you buy something that's under valued, get money back from taxes and make money on your principle and fix it up.
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Thu Feb 09, 2006 9:00 pm |
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coaster
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If you do your math and everything works out to your satisfaction assuming five percent per year appreciation, then I'd say "go for it." Being the DC metro area, I doubt if property values are actually going to go down unless the place gets nuked or the government goes out of business. But it's quite likely the gains of recent years are going to moderate. As Jaszbo quite correctly pointed out, the market does work, and if it keeps going up at the present rate, soon no one will be able to afford a house. Just make the worst-case assumptions in your planning and everything better than that will be gravy.
~Tim~
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Fri Feb 10, 2006 12:04 am |
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voorash
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I am also in the DC Area although I chose to buy in the Baltimroe suburbs. Here is a non nuke way that could crush the dc market.
1. Large number of govt layoffs
2. Rising interest rates cause an large increase in forclosures(especially people with adjustable rate mortgages and no equity)
3. Banks which can only hold a certain percentage of assets(REOs) must sell cheap on a market where there are fewer buyers due to higher rates
4. Banks tighten lending standards due to huge losses on the foreclosers in step 2 leading to even fewer buyers
5. The invisible hand lowers prices to reasonable levels(reasonable to most anyway, to people in your situation assuming you buy arm or interest only the word would be devastating)
Now onto how that would impact you:
1. You would likely lose your house assuming you couldn't pay the higher interest rates or you could but you need to sell and can't sell for what you owe.
2. You either are foreclosed on or sell at a loss and either way owing the bank a tremendous sum of money and much to your dismay find out you can't wipe it out with bankruptcy because you make enough to pay it back over time under new bankruptcy laws
That is the negative, a possible positive way to handle your situation is to buy somewhere in the suburbs(i know it is still expensive) where you can get in for 80% ltv and at least have a chance to survive a rate increase or a small downturn without going bankrupt.
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Fri Feb 10, 2006 2:56 am |
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voorash
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One other thing I forgot, here is what happens if it only appreciates 10% by the time you sell.
600k purchase price
30k closign costs(5%)
630k real purchase price
660k (600k + 20% appreciation)
-39600 (6% commission)
- 630k (original real purchase price including closing costs)
- 6,000 (closing costs for sale, this is just a guess)
Your loss 15k
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Fri Feb 10, 2006 3:07 am |
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mikeb
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my numbers look more like this:
240k pur price
$7,200 closing cost (3%)
240,000 loan amount
15% appreciation over a 3 yr period (5% a yr, very low estimate)
240k x 15%= 36K
276k(240k + 36k)
-16,560 (6% comm)
-238k (est mortgage balance after 3 yrs)
profit of 21,440
ohh, my closing cost of 7,200 in the initial purchase, will not be rolled over into the mortgage and the buyer will likely offer 2,500 closing help and my savings will take care of the rest. bye the way the buyer pays the closing cost not the seller.
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Fri Feb 10, 2006 4:31 am |
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coaster
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I think I would include as a debit my property taxes (net of tax deduction), because they do not contribute to increasing the market value or your equity. I don't know whether or not that's the "proper" way to do it....just saying that's the way I'd do it.
~Tim~
Eye Candy : Why Whimsy
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Fri Feb 10, 2006 1:29 pm |
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Jaszbo
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mikeb I don't want to go on and one, but even looking at your math, I'll explain somethings that might help you make a decision.
240,000 loan amount and 3 years at 15% increases to 276. Now you put it in the market and pay 6% commision, which is about 17k and also is the place going to be empty for a month or two while you are selling it? Historically real estate doesn't sell the same weekend you put it up like it used to.
Ok let me do the math on a 15 year mortgage. This doesn't include the money you would get back on taxes and intrest from the IRS.
Generally I've seen up to 1% difference in 15 versus 30 year mortgage, but here is what's offered at a lender right now:
Right now I see a 15 year mortgage at 5.250%, 30 year mortgage at 5.875%, and a 30 year fixed intrest only loan at 6.743%, and a 5 year IO arm at 6.439%. All these rates come from the same lender. Ok let's see where you'll be after 5 years, without the assumption of taxes, insurance, commision of selling and anything in between.
15 years at 5.25% after 5 years with a 240k loan monthly payments would be $1,929.31 and you would have a balance of $179,818.80, which means the equity would be around 60k plus any appreciation.
30 years at 5.85% after 5 years with a 240k loan monthly payments would be 1,419.69 (500 less dollars) and the balance is $222,982.66, which means you would have equity of about 17k plus any appreciation
To make things easy I'll just do the 30 year fixed intrest only calculation with the 6.74% and it comes out to $1,348.60 a month. The IO loans depends though on your rate. All these things depends on your rate. Some lenders do give pretty good rates on IO loans, but this is 100% from the lender I'm looking at now as of today.
Now to compare
15 year mortgage payment:1,929.31
30 year mortgage payement :1,419.69
30 year IO payment:$1,348.60
To make a fast and easy comparison, you will pay 71 dollars more less a month from a fix 30 years to a fixed 30 year Intrest only. Therefore after 5 years you would have paid 4,260 more dollars with the 30 year fixed.
Now subtract the equity made from 17k, so even though you paid 71 more dollars for a fixed 30 year versus a intrest only loan at the end you would have about 13k more. So the results is after 5 years you would end up with 13k more dollars with the fixed 30 year mortgage.
Now let's compare the 15 year versus the 30 year mortgage. You paid 500 dollars more a month give or take for a 15 year mortgage, so at the end you would have paid 30,000 more dollars after 5 years. You made 60k in equity with a 15 year mortgage and 17k with a 30 year mortgage. So now the comparison is 30k versus 17k. After 5 years the 15 year loan would have about 13k more in equity than the 30 year fixed loan.
The point is to compare the three differnet types of loans and with an intrest only loan after 5 years, you are just hoping it goes up in value. I would assume it would go up in value. I would probably bet money it would go up in value, but what if it doesnt? What if it goes up only 10% after 5 years and then you have to pay a selling commision of 6%, is that 4% worth it?
I'm not telling you to go with a 15 year mortgage, but more what you can afford. If it's over 50% of your monthly income then I think it's too expensive. Some people get into 15 year mortgage who can't afford them and then they hate them.
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Fri Feb 10, 2006 3:22 pm |
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Jaszbo
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To help you better, for almost 40 years this is what I just read from the articles I read everyday
"an average of 6.3 percent a year since 1968, which is when the National Association of Realtors first started keeping track. According to Freddie Mac"
Never assume 20% or even 15%.
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Tue Feb 14, 2006 10:01 pm |
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financialpeace
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To sum up what Jaszbo said, in other words, you are had 20%/yr growth for the last 3yrs, meaning, in the next three years you "could" see a -7% growth when that 6.3% average comes true. For every three years of 20%/yr growth, there must be 3yrs of -7%/yr growth to average a 6.3%/yr growth over the span of 6yrs.
I really have to ditto Jaszbo's advice here, in real estate investing, which is what I've done quite a bit of, we call it the "greater fool's theory of investing". One buys it at an inflated price hoping to sell it later to a greater fool for an even more inflated price. I've seen better odds while on a weekend stay at Treasure Island, Las Vegas. We've all done it, but when it bites, it bites really, really hard.
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Wed Feb 22, 2006 8:29 pm |
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mikeb
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If I understand you correctly, you are saying that the DC metro area will see a -7% decrease annually for the next 3 yrs. Are you smoking crystal meth?
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Wed Feb 22, 2006 9:44 pm |
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coaster
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The DC metro area, being a bottomless pit sucking money into oblivion, is not a good example of "reversion to the mean." As long as the federal government continues to emulate a porker rolling in his wallow, I suppose real estate will continue to escalate in direct contravention of all reality. 
~Tim~
Eye Candy : Why Whimsy
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Wed Feb 22, 2006 9:58 pm |
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Jaszbo
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unlikely, I"m not sure about unlikely. Some people don't understand how investments have to correct themselves.
I'm with financial peace about "greater fool's theory of investing". Anybody here has read the book random walk down wallstreet. He has probably 30 examples there and anybody who hasn't heard of the tulips craze, is without a question not an educated investor.
It's very eays to see that even where I live it went up 44% in about two years. Ok grab a calculator and understand that with even a 15% return each year, after 5 years it means it double. So today I buy a house for 250k, which I believe is the average in the nation...give or take. In 5 years the house is worth 600k, in 10 years it's worth 1.2 million dollars. Just sit there and look at the numbers. With a 15% return after 10 years the average house will be worth 1.2 million. I really don't know how else to say that or explain the way the market adjusts itself. Could you simply get raises or do something to save 20% down on 1.2 million dollars? Yes, speculators can keep brining up value on houses, but eventually people have to pay the rent/mortgage and have a way of paying it monthly. who will be the "greater fool"? The theory is this, how much is something worth? A perosn is willing to pay 2 times the amount it's worth if she thinks she can sell it for 5 times the amount it's worth. Who will be the greater fool. It might be in a month, a year or two years...etc, but when you understand percentages and see something go up 40%, be careful.
I remember two authors once saying. If a shoe shine boy tells you what to invest in, it's time to get out of that investment. I've also heard it by another author that if you take a taxi and the taxicab driver is giving you investment tips, it's time to get out of that investment. Well who's not into real estate right now? Not saying it's time to get out as I love real estate, but it's not the time to buy at least not for me.
The problem with real estate is it's not like a stockmarket crash. You aren't going to wake up tomorrow and see it on the news real estate down 10%. It could take over a year before something like that makes the news. You could be in a crash today and not even know it. I can tell you here in central Florida you have to be crazy to pay top dollar. Talk to real estate agents, who you know aren't trying to sell you something. I have friends who are real estate agents and they are honest with me, they are hurting right now compared about 6 months ago. But each location is different.
Washington DC is over valued by 37% http://money.cnn.com/2005/12/29/real_estate/buying_selling/handicapping_housing_markets/index.htm
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Thu Feb 23, 2006 3:25 am |
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