The crash in housing sector, that we have been witnessing for quite some time now, is still not over, and the time is certainly not right to invest your money in it. Here are 10 convincing reasons as to why:
According to banks, mortgage is safe up to a maximum of three times the annual income of the buyer with a down payment of 20%. On the other hand, according to landlords price is safe up to a maximum of fifteen times the annual rent of the house. However, both these norms of safety are being frequently violated on the coasts. Borrowings are as high as six times the annual income of the buyer with only 3% down payment, and prices demanded by the sellers are still as high as thirty times the annual rent of the house, even after the recent downward trend in housing prices.
Renting is a much more sensible business based on the people's real capacity to pay on the basis of their income, not their borrowing ability. Those who were happy to get a "bargain" last year, are already facing the prospects of a really painful loss.
Currently, annual rents of a house on the coasts are 3% of the purchase price and mortgage rates 6%. What's worse, the total costs that accrue to the owner, including taxes, insurance and maintenance, are nothing less than 9% of the purchase price. Thus, the cost of borrowing money to buy the house is twice, and the total ownership cost is thrice the cost of borrowing the house itself. Any guesses who the winner is? It's still a bad deal to buy a house in the more affluent neighborhoods. If you still want to buy, you may consider buying in relatively poorer neighborhoods where the prices are more compatible with incomes and rents.
The bottom line for you would be a price which is low enough to give you a profit if you rent out the house after buying it. Only then will it be safe for you to buy as then, it would be possible to pay the mortgage and other expenses, if necessary, by renting it out. The basic tool to calculate buying safety is: divide the annual rent you can get the house for by the price you have to pay to buy it, and multiply the result by 100 to get the percentage. If it works out to less than 3%, give up the thought of buying it. If it is more than 9%, then, every other thing considered, you may buy it. If it is anything in between, your purchase decision would be a borderline case.
For example, it would be a borderline case if you buy a house for $200,000 when you could get it on rent for $1000 per month, or $12,000 per year. The safety tool calculation would give a result of 6% for it. If you buy it at 5% mortgage rate, that too would be $12,000 per year paid in interest, about the same as the rent. You may think that interest can be paid with pre-tax salary; however, that benefit is wiped out when you consider the property tax and the maintenance cost. It would be absolutely foolish to buy the same house for $400,000 because it would be double the price of renting it. And being a renter is doubly advantageous as renters don't have to worry about falling house prices!
We saw a rise in house prices when interest rates fell, and it is only natural to conclude that they will fall when interest rates go up as the fixed monthly payment would cover a smaller mortgage when the interest rates are high. Now, interest rates are at all time low and can only rise from here, so house prices can only go down. The winning strategy in this situation can only be one: have cash at hand so that you may buy outright when the prices are low, while others would be hard put to borrow money at higher interest rates. This will ensure you a low price, plus a capital appreciation that result from a possible interest rate decline in the future.
Buying now when interest rates are low and prices are high will be nothing less than foolish. Low prices with high interest rates are a much better choice than high prices with low interest rates even though the mortgage payment remains the same. That's because:
Leverage, often seen as the clever way to wealth, is in fact responsible for the troubles of the current buyers. It was used so much that the advantage turned upside down and became disadvantage. Leverage, put simply, is the use of debt to increase gains. What is forgotten, however, is that debt can also increase losses! If you put 10% down, and your purchased house too goes down 10%, you have effectively lost 100% of your money on paper. Now, if you have to sell the house for some reason, may be loss of job or adjustment of mortgage, you lose your 100% money in real terms.
If you are convinced house prices won't fall, that also is no guarantee against loss. Selling a house costs about 6% of the purchase price. If you bought it at $300,000 you will lose $18,000 even if you sell it at the same price. And, if there is a decline of 4%, then all those with an equity of 10% or less will effectively go bankrupt.
The thing as clear as crystal is that a renter, if he is willing, and can save money, will be able to buy a house in about half the time taken by a conventional buyer to pay off his mortgage. Meanwhile, he will also get interest on the saving, however little it may be.
Prices, as of now, are cleverly manipulated by banks on the basis of how much they want and are able to lend, and also how willing they are to acknowledge the losses they suffer, or how far they can push these losses towards the taxpayers through the housing agencies of the government, like the FHA. So far, banks have done well in creating an impression of scarcity, that less houses are available for sale than actually is the case. When this trick is exposed, house prices will crash even further as the market realizes that there is in fact an excess of supply while the demand is little or reduced.
A little publicized fact is that a large number of house owners have now stopped their mortgage payments and banks are doing pretty little about it, allowing them to live virtually for free. Foreclosing and taking possession of a house burden banks with the responsibility of paying property tax and maintenance cost. Banks tend to avoid these. On the other hand, selling the foreclosure at the current prices would amount to admitting loss on the loan by the bank. Banks avoid that even more. However, preventing a justified foreclosure means not allowing a deserving buyer to buy that house at a lower price, and cannot go on for long. So, there is an imminent surge of foreclosures coming our way which will plummet the prices and benefit millions of buyers who would buy the house at much lower prices, without any high burden of debt, probably even without debt!
Increase in house prices doesn't create wealth; it merely transfers it from the young with little income to the old with higher income. Due to it, the younger people with newly set up families, who want a house of their own, have to live under heavy debt for the rest of their life, while the older people are planning their retirement with the money made by downsizing. The situation is patently unjust and it is foolish to expect the newly set up families, especially those having children, to buy houses at current prices.
The coming years will see the retirement of about 70 million Americans who were born between 1945 and 1960. However, at least one-third of them have no retirement savings at all except equity in the house which they must sell. So, another spurt of houses for sale is certainly going to drive down the prices even more.
The newly built houses must be sold to give the builders money so that their business can go on. However, there is already a huge inventory that remains unsold, and more are getting added every day, as builders were unwilling to sell at current low prices. However, this cannot go on forever and the builders will soon have no choice but to cut on prices of new houses which, needless to say, will have negative impact on resales.
So, the conclusion is unavoidable that the time is not ripe to buy houses. If you are still interested in buying, see to it that the price is low enough to cover your mortgage and other expenses, and possibly enable you to earn a profit, if you rent it out. In that case most of your risks will be eliminated and it will be worthwhile to buy.