Why did I buy a house in 2006? Am I a complete and total idiot?

Hold on, value is what someone is willing to pay for it. His home was not overvalued at the time.

You could say that it was obvious that prices were too high in 2003, 2004 and 2005 but prices kept going up.

If this was so obvious to you then you must have sold your home in 2006, pocketed the cash and have rented since because obviously that would have maximized your wealth.

Alan Greenspan didn't seem to catch on to this.

I can tell you right now who you should've picked to win the Superbowl in 2006.

This guy is not an idiot. He put a chunk down on a property during rising home values. This interest only mortgage is not an issue because he deducts the full payment on his taxes, freed up cash flow and he has not had issues with making payments. He fully and reasonably expected to be able to sell the home or was capaple of making the payments when they reset to a higher amount if he still lived there.

His life has since changed and as John Lennon said "Life is what happens to you while your busy making other plans."

He can't sell it and renting it doesn't nearly cover the mortgage.

He is leveraged and this is the bank's risk. Banks are in the business of doing credit and risk analysis and they just handed over the money secure that this was a safe bet.

Now think of all of the borrowers who are not nearly as smart as the OP and how the banks just kept handing them money in 2006.

The OP is a sound ethical guy who is willing to pay out thousands of dollars to back up his signature for what he told the banks he would pay.

But the banks can't pay their bills so they ask Uncle Sam.

stringer bell wrote:

No one forced you to buy an overvalued house. It doesn't matter what the comparable prices were...if you did your due diligence and looked at the historical numbers (like I did), it would have been obvious that it was a bad idea to buy.

1) You could've rented

2) You could've put your $60,000 in a CD

3) You could've rented in a good school district

It matters completely what the comparable prices were. If comparable condos were going for $250,000 in 2006 and he couldn't find one that met his criteria for less than that, then $250,000 was a fair value for it. In fact by comparing what other condos were going for he avoided paying more than he should have. What on earth does the price of condos now (or for that matter, in the past) have to do with the price he paid in 2006? He had no way of knowing what prices would be in the future. Can you tell him what it'll be worth in 2011? All you have to do is the due diligence.

Did you stop buying gasoline when it got to $4.00 a gallon? Why not? If you'd done your due diligence and looked at historic values it would have been obvious that it was overpriced. The price now is 1/3 what it was this summer, any bonehead knew it was too high.

Your backward looking crystal ball may be infallible but you need to turn it around and tell us with the same clarity what the future will be.

webby wrote:

I think your perspective on housing and finance can be conservative to the point of being simplistic, but I agree with this.

The truly lucky are lucky enough to be smart . . . and smart enough to *protect* the windfalls that occasionally come from calculated risks.

webby,

Simplistic doesn't necessarily mean not well thought out. Many people have arranged complicated financial schemes that just didn't work out -- interest-only loans or ARMs in hopes that their house value will go up and they will cash out with a big profit, and TONS of others that just don't always work out.

Investing and protecting income and limiting outgo takes a little planning, but you're right it isn't difficult. What's difficult about it is to DO it.

With your income, you:

1) Set up an emergency fund of 3-6 months of expenses. This is so that an emergency doesn't plunge you into debt (debt that then costs money as you pay interest on it).

2) Have no debts but for a house. Stay out of debt. Make sure that whey you retire that you are completely debt free -- no house payment, no nothing.

3) Put 15% into retirement accounts.

4) Have a house with a FIXED rate mortgage that is no more than 25% of your take home pay. You have to be smart about this though. If you can get your dream home for 30% of your take home pay and you anticipate your income increasing in the near term so that within 3 years or less you are only paying 25% toward the house, then go for it. On the other hand, if two of you are working and you know that in 2 years your wife wants to have babies and stay at home for 10+ years, then it is NOT good to base it on 25% of your take home pay (UNLESS you throw a TON of money at the house in order to get it paid down super quickly so that you can weather the impending decrease in income).

5) You are doing the above comfortably then at this step you get to decide what to do with any extra money. I put mine into a non-retirement mutual fund, but you could also throw more money at the house to get it paid off (this helps eliminate risk and is part of a good financial strategy), or set up college funds for the kids or whatever. You could even put MORE money into retirement accounts if you like, but at some point ($5,000 a year for a Roth IRA and $15,500 for a 401k if under age 50), you will have maxed out those accounts, and a non-retirement account is a good idea if you plan to retire before age 59 1/2.

Simple yes. Smart too? Yes.

gas is a bad metaphor, that is something that is consumed and for which there is little substitute... certainly there are substitutes to buying a home, renting is certainly a viable alternativeof course you can say that it's value was what the market demanded at the time; that doesn't mean we can't use a little prudence in determining whether the market was overpricedi will grant you hindsight is 20-20... but looking back to 1999, who in their right mind was buying companies with no earnings worth billions of dollars and thinking the price would keep going up or that future earnings were reflective of that price... housing has been the same storyI think in buying a home one should look at it as where they want to live and beforehand accept the fact that prices may fall... if they are not ok with the price falling then they shouldn't purchase the home to begin withif people had followed this strategy we may have not gotten into the housing bubble to begin with

Difference is it is easy to put off buying a house (renting) while putting off gas is a lot harder.He has no way of knowing what the price would be in 2008. But it was easy to figure out that prices wouldn't keep increasing. House prices are limited by income which wasn't growing at the same rate. If the house price would stop in 2006/7/8/9 was a guessing game but it was clear it had to stop. He gambled that it would keep going up and lost. Big deal. Happens all the time when investing. Take your loss and move on.

Want to know why the house was overvalued in 2006? All you have to do is look at the historic trend lines for income and housing prices. You would see that, for the most part, the rise in average incomes matches the rise in housing prices. But from 2001 to 2006, housing prices increased at a much greater rate than average income, especially in places like FL and CA. How was that increase going to be sustained? Can you answer me that?

The bottom had to fall out and prices had to come down to reflect real-world wages. House prices from 2001 to 2006 did not reflect reality. That is why I did not buy during that time. I'm no genius, and I'll be the first to admit that. And now, with many getting laid off, tightening lending practices, and the economy in recession, I can tell you prices will keep falling. I don't know what his house will be worth in a year, but I can tell you that it will be worth less than it is now.

I'm looking at a property in my area. In 2001 it sold for $90,000. At the height of the bubble it sold for $350,000 with no renevations. Now it is on market for $275,000, also with no renevations. It is still overpriced, even though it is priced comparably to similar homes. If you can't see that, you're blind.

Comparing buying a tank of gas to buying a house is not a fair comparison, and you know it. But I seem to recall that you're a real estate man, so I'm not surprised that you're arguing that no one could see this coming. You're probably one of the realtors chanting "buy now or be priced out forever" while the bubble was growing.

OR wrote:

Difference is it is easy to put off buying a house (renting) while putting off gas is a lot harder.

He has no way of knowing what the price would be in 2008. But it was easy to figure out that prices wouldn't keep increasing. House prices are limited by income which wasn't growing at the same rate. If the house price would stop in 2006/7/8/9 was a guessing game but it was clear it had to stop. He gambled that it would keep going up and lost. Big deal. Happens all the time when investing. Take your loss and move on.

I agree with the idea that he should take his loss and move on. But, he ONLY has to do that because he made a bad decision to begin with. The very fact that you never know when the housing market might tank is why you NEVER take out an interest-only loan and ALWAYS get a fixed rate mortgage and plan to be there for 15 years when you buy. Sometimes you need to leave before 15 years, but people who buy a house and plan to be in it 5 years or so is just crazy. By the time you move in, fix it up the way you like it, then sell and pay a Realtor their commission and then pay to move your stuff out again, pay all that interest if the house was bought with a loan, even with an increase in the price of the home, you might actually have a loss. The risk of falling or stagnant home values goes down the longer you live in the home.

Twit? Easy there big boy.

Hard to believe you give a rat's ass about your job, family or running given the amount of time you spend on LR, but if you insist on spending your days here dispensing questionable advice, then you should consider taking the time to get your facts straight.Nothing worse than a sloppy real estate agent.

And I agree with the others, gasoline was a ridiculous comparison.

Interest only doesn't change anything unless you are undisciplined so you need a forced savings plan. It is another gamble (with where interest rates will be in a couple of years) but a not a huge one. The real problem is that people were using to IO loans to buy houses they couldn't afford.

In 2006 I was a computer consultant, so attempting to denigrate my character won't invalidate my argument. Besides, if I had told someone in 2006 that prices won't fall in our area, I would have been right - especially with condos, they sell like hotcakes around here.

So I found a graph of income vs. home prices:

http://www.swivel.com/graphs/show/3339700

If I'm following your argument correctly, the only good time in the last 30 years to buy real estate was 1993 - 2002, because that's the only time income consistently outpaced house prices. But, my parents bought houses in 1977, '81, and '87 and made a profit on every sale. According to the graph the '81 purchase was bought near the top of a bubble. The graph also indicates that had the OP had been lucky enough to buy in 2004 and sell in 2006 he would have doubled his money, even though house prices far outstripped income during that time. Then he'd be posting about what a real estate whiz he is and we wouldn't be having this discussion. The fact is real estate markets are local, using nationwide data like this is useless. Unless someone has access to data (and the know-how to use it) that is specific to their area the only frame of reference is comps, which is what he used.

The OP also bought the condo as a home planning to live in it for a long time. His concern when buying was most likely the quality of the home and the suitability for his lifestyle. His only concern with price was to avoid paying too much, not what it would be worth in two years. Researching a home is different than researching an investment. The OP is not part of the problem, he's someone whose circumstances changed and found himself in a bad situation. Saying he should have foreseen this is ridiculous.

Dammit, I posted using my wife's name! I've exiled her to a different browser.

I'll admit, gasoline isn't the best metaphor but there are substitutes - car pooling, public transportation, walking, cycling, or buying a high mileage car. The stock market bubble isn't a good metaphor either. Pets.com vs Apple doesn't translate well to buying a condo versus renting. Buy a company that isn't making any money and you're left with a stock certificate you can pin on your wall. Buy a condo and you have a place to live even if the price drops. Also, since the OP got an interest only loan, he is effectively renting it from the bank.

Flagpole wrote:

webby,

Simplistic doesn't necessarily mean not well thought out.

I think you are thinking of the word, "simple," as opposed to simplistic.

I do agree that simple is how most people need to keep it. But it's simplistic to say things like, "No on should ever take anything but a fixed-rate loan that's not interest-only."

For someone who is good with numbers, what's important is not whether a loan is fixed or adjustable, interest-only or fixed (or negative amortization, for that matter) -- but which combination of time, rate, and rate-of-payoff works best for his/her own circumstances. Equity in a home is not intrinsically better or more important than equity in any other asset.

If you could get a 30-year-fixed-interest-only loan at 5.5% when a standard 30-year-fixed is going for virtually the same rate -- as it was at times recently -- the only reason not to do it is if you don't trust yourself to make better than that 5.5% return on all of the money you are saving each month. Many of us, furthermore, pay a real interest rate under 4% after deductions. Meanwhile, the interest-only borrower of $400K may have an additional $500/month going into equities, which, though doing poorly of late, are likely to give robust returns over the next 25 years -- more than enough to pay off the mortgage of the house in cash in less than 30 years -- were it wise to do so.

Furthermore, if you have an IO loan, you can pay as much extra as you like whenever you choose. There's no rule against paying down your mortgage as much or more than a you do with a traditional mortgage -- when it makes sense for you to do it. So for anyone who understands the above issues, the *only* reason not to take an equivalent IO is if you are too irresponsible to be trusted with financial flexibility.

As for adjustable-rate mortgages, the fact is that most people move in 7 years or less. So it may be a gamble, but it's a reasonable one. A guy with a $400K 5-year-ARM for the past five years at 4.5% v. a fixed 6% saved something like $62,000. (That's about $28,000 in lower payments and $34,000 in additional equity with the lower interest rate.)

That same person can keep all of the extra cash and take out a fixed rate mortgage at today's substantially *lower* fixed rates (zero points, 5%), which will save him another $500/month for the next 25 years, plus interest.

Hard to call that guy stupid for going with the ARM.

Flagpole wrote:

The very fact that you never know when the housing market might tank is why you NEVER take out an interest-only loan and ALWAYS get a fixed rate mortgage .

When will you idiots realize that "interest only" is just an option of a loan and not a "type" of loan?

Why O Why did nothing wrong when he bought the house as he said in a previous post. His cirmunstances changed at a very inopportune time. Go back and read all the posts and you will realize that. He didn't know he was going to get married and move into his wife's house not needing the one he bought.

He would be in a WORSE position if he had taken Flagpole's uneducated and close minded advice. Flagpole thinks the holy grail is the 15 year fixed rate loan. If Why O Why had done that, his monthly payment would be $640 MORE than he is trying to pay now. While he would be paying off some principle, he would be responsible for coming up with more money than he is paying now. He would have to come up with $1400 a month to keep current on his mortgage. Compound that with the fact that nobody will refinance him because his house has lost value and he would be forced into foreclosure.

BY TAKING THE INTEREST ONLY OPTION ON THIS HOUSE IN 2006, WHY O WHY PUT HIMSELF IN A POSITION THAT HE IS STILL ABLE TO MAKE THE PAYMENTS AND NOT GO INTO FORECLOSURE. THAT WOULD NOT BE POSSIBLE WITH THE 15 YEAR FIXED LOAN.

Lastly, some would argue that the true value of the house is somewhere in between what he paid for it in 2006 and what it is appraised at now. Since no banks are lending money on houses in depreciating areas, the only way they can sell is to a cash buyer. That decreases the demand and subsequently the price to a level that is not customary. Banks will eventually start lending money again in a reasonable fashion and the value of houses such as Why O Why's will go up to a reasonable level.

My favorite comparison between home prices and the tech bubble

http://www.irrationalexuberance.com/Fig2.1Shiller.xls

unreal, nothing is for certain but it seems to me that prices either have further to fall or will stagnant for a very long time

Flagpole wrote:

5) You are doing the above comfortably then at this step you get to decide what to do with any extra money. I put mine into a non-retirement mutual fund, but you could also throw more money at the house to get it paid off (this helps eliminate risk and is part of a good financial strategy), or set up college funds for the kids or whatever. You could even put MORE money into retirement accounts if you like, but at some point ($5,000 a year for a Roth IRA and $15,500 for a 401k if under age 50), you will have maxed out those accounts, and a non-retirement account is a good idea if you plan to retire before age 59 1/2.

Flagpole, I like your advice about investing after you have the basics taken care of, but would you really recommend a mutual when 9/10 don't beat the S&P 500? I would think the way to go is an ETF that follows a major index like the S&P 500 as you only have the trading commission fee and no load, and a 9/10 chance of beating the mutual over the long haul.

Ed

Do Shiller's indexes take into account that the average house has grown in size over the years, has to meet increasingly stricter codes, and has more features?

OR wrote:

Interest only doesn't change anything unless you are undisciplined so you need a forced savings plan. It is another gamble (with where interest rates will be in a couple of years) but a not a huge one. The real problem is that people were using to IO loans to buy houses they couldn't afford.

As a general rule, an interest-only loan is a bad bad idea. TOO many people spend all they can, and when they get into an interest-only loan, the GREAT likelihood is that they will NOT pay that principle down with any extra they have each month, so what happens then is that 3 years down the road they have absolutely NO equity in the home, and if the value of the home drops you now owe more on it that you could sell if for, so if you want or need to sell it you will have to bring a lot of cash to the table or face foreclosure. ALSO, MOST interest-only loans are adjustable and can adjust as often as MONTHLY! Who the hell wants that?

OF COURSE people were using interest-only loans to buy houses they couldn't afford! You should buy a house when you can comfortably take on a FIXED rate mortgage that is no more than 25% of your take home pay. If you can't see yourself doing that then either you need not buy a house or you need to find a much cheaper house. You're wrong about the risk. It is a HUGE risk to buy a house with an interest-only option. Some say it just gives you more flexibility -- sure it does -- more flexibility to possibly lose your shirt.

EdP wrote:

Flagpole, I like your advice about investing after you have the basics taken care of, but would you really recommend a mutual when 9/10 don't beat the S&P 500? I would think the way to go is an ETF that follows a major index like the S&P 500 as you only have the trading commission fee and no load, and a 9/10 chance of beating the mutual over the long haul.

Ed

Ed,

I think you need to change the way you think of things. A mutual fund is just a collection of funds. You can have a mutual fund that is ONLY made up of index funds if you want. That is actually a very good strategy. So, if you love the S&P 500 then have a mutual fund that has that index. You could add the DOW or whatever else too if you want. In the past my mutual funds were 100% index funds. I've changed that in the last couple years just for fun really, and the 87% of my stocks in mutual funds are divided up evenly between the following classes -- growth, growth and income, aggressive growth, and international. The other 13% are in bonds. I likely won't beat an index fund, but I'm at a point where I don't really need to or care all that much.

To support your position, Warren Buffet says only buy index funds. Suze Orman says 90% index funds and 10% international funds. Dave Ramsey says to invest as I do (I'm just doing it for a while to see how it goes...I may go back to all index funds some day -- or not).