NRR: Saving for a house

Your bond allocation is too high even for a 5 year investment horizon. Read (or skim) the book Stocks for the Long Run. On an inflation adjusted basis, stocks are less risky than bonds over most holding periods (even as short as a few years). I would suggest holding the least amount of cash you feel comfortable with for emergencies and put the rest into equities.

I don't know the effective (net of tax) interest rate on your student loans, but if you are deadset on investing in bonds, DON'T, pay down your student loans first. It will make you a more attractive lending candidate, ultimately increase your annual cash flow, and you get a GUARANTEED return equal to your net interest rate (unlikely you can beat this in a bond fund when accounting for risk).

In terms of what to buy you need to develop your own investment thesis on the economy. This can be done by reading things like the Wall Street Journal, some basic economics books, etc. or by seeking the advice of a financial professional to determine your investment thesis for you. Since you don't seem to follow the markets closely, I would suggest finding a mix of no-load mutual funds the focus on different equity classes (e.g., small cap, mid cap, blue chip, & international). Index funds in all these areas would have lowest fees & the lowest risk within the asset class.

In your market, by the time you have saved what you want, the housing prices will probably have increased so much that you'll have to save another 2 years....and another...then repeat.

Find a way to get in now (or the next year) while the market is a little "down".

Computer Nerd wrote:

In your market, by the time you have saved what you want, the housing prices will probably have increased so much that you'll have to save another 2 years....and another...then repeat.

Find a way to get in now (or the next year) while the market is a little "down".

this may happen, but as i and "Surpise" said earlier in slightly different manners, it doesn't make any sense and can't work in the long term. if you were in an area like, say, austin texas where real estate ownership costs were a high multiple of local median income but not an obscene one like SF, then i'd concede that it's possible that austin real estate prices would go up to match SF's higher multiple.

but in SF, the buyers are already tapped out. negative amortization loans are the norm. i believe fewer than half of all buyers take out a loan that involves a normal repayment schedule (where normal is actually paying off principal from day 1 without any teaser interest rate).

prices cannot, cannot go up over the medium to long term faster than local average/median income when you start from the affordability level that SF currently has. the only exception that i can think of to this statement is if a new, more creative financing vehicle comes around to lower monthly payments. but all indications are that lending will tighten over the next couple of years, not loosen.

bottom line, there is no evidence at this point to back up scare tactics promoted by many realtors. the "buy now or be priced out forever" stuff.

"prices cannot, cannot go up over the medium to long term faster than local average/median income when you start from the affordability level that SF currently has. the only exception that i can think of to this statement is if a new, more creative financing vehicle comes around to lower monthly payments. but all indications are that lending will tighten over the next couple of years, not loosen."

Well said.

Several subprime lenders have folded in the last few months. More to come. Trillions of dollars of adjustable rates will adjust in the next few years. Foreclosures will skyrocket even more than they already have. If someone bought in 2005 or sooner, they won't be able to refinance an interest-only or option arm loan, because 1. they haven't paid any of the principal and 2. the price of their home has either gone down or remained the same.

Although this is a very valid, conservative way to look at things, the other factor to consider is wealth. You're annual income is, from a housing perspective, largely irrelevant if you have $50M in wealth.

There are two factors that will, over the long-term, drive up real estate prices:

1) The population of the world (& the US) will continue to increase.

2) There is a finite amount of land & real estate.

Now the key factor is defining "long-term" and what that means to the individual owner. My opinion...If you want to buy and own for the next 7-10 years (when you're ready to buy), buy a place you want & you will probably get some appreciation because somebody else will probably want to buy that place in the future. In the short-term, rising interest rates will price some first-time home buyers out of the market & thus reduce demand for "entry-level" homes. This will trickle into the higher-end homes as it will be more difficult for current "entry-level" home owners to trade up to the next value of home. If the market place is rational, this will lead to longer holding periods for homes (e.g., a reversion to the concept that you are buying a home, not a 6 month investment vehicle).

I agree with the point that for a new home owner annual income is probably the key factor for affordability.

You're = your for the grammar nazis

First time buyers can't enter the market right now under conventional (read: rational) means unless they are not your average first time buyers, meaning they have a lot of money. Real estate prices typically keep pace with inflation. Since 2001, this is not the case. Thus, there's a bubble. Cheap money, no lending standards (no income verification etc), and exotic loans have fueled the mania. You can rent a house in the Bay Area for about 1/2 of what it would cost you per month to own it with a 30 year fixed mortgage.

I'll stop now, I think the original poster has heard enough from both sides of the debate.

I mostly agree with you.

The part I disagree with is that you are looking at this as a national issue. Real estate should be looked at a local level.

For example, places to buy a house on the beach in California are going to be limited a lot sooner than land in the US.

In many areas of coastal California, housing has been built out or is soon going to be built out. The next move is to build up. There has been some movement to build high rise condos now but that is a different kind of living.

As long as more people keep moving to an area and homes aren't being built fast enough and jobs growth continues in that area, prices will go up over time.

Home prices are a function of the local supply of homes, job growth, and interest rates.

I think you're agreeing with my point that prices will go up in the long run. Yes, certain areas will go up faster than others & certain areas will be stagnant or may even decrease. That's the bitch about broad investment principles. The user of the broad principle needs to figure out how it applies to them & their "market."

Rational is in the eye of the beholder. Many people don't consider an interest only loan rational but for some people it is a very rational way to get into a home (especially a first home).

You're comment on inflation & real estate values is irrational. Real estate price changes can rationally exceed inflation & you are assuming it was fairly valued in the first place. If it was undervalued in the first place could the rapid increase not be getting it up to its fair value?

The other factor to consider is leveraged return. You put a small portion down & receive financing on the rest. Thus your return on equity is higher than a straight 100% cash investment. Sometimes additional debt = additional risk...

Finance 101 wrote:

Real estate price changes can rationally exceed inflation & you are assuming it was fairly valued in the first place. If it was undervalued in the first place could the rapid increase not be getting it up to its fair value?

The other factor to consider is leveraged return. You put a small portion down & receive financing on the rest. Thus your return on equity is higher than a straight 100% cash investment. Sometimes additional debt = additional risk...

to continue this friendly discussion, first, that's why i initially distinguished between a place like austin, where the current ratio of median income to housing cost is not significantly above historical norm and a place like SF, where it is. incomes will eventually constrain housing costs, no matter how desirable an area is.

second, you are correct, but don't forget that it is true on the downside as well. if you put 5% down and your home value drops 10%, you could owe tens of thousands of dollars when you sell (not to mention real estate commissions and other transaction costs - many of these teaser loan products have hefty prepayment fees).

a half-million dollars is a half-million dollars, whether you keep it in the bank, buy a boat or buy a house. it's a lot of money and a lot of debt. i'm shocked by how cavalierly many californians take on such large amounts of debt.

There are more factors to housing prices than income (e.g., wealth). Baby boomers are retiring have the largest generational asset base in history. This can be used to generate investment income (not in median income numbers), to increase downpayments on homes, buy homes out right, etc. Eventually, this money will be passed down (one way or another) to the next generation.

To discuss your point on income, a community like SF has more wealth than a community like Austin (despite Dell). There are also implicit reasons the SF economy will grow more & faster than Austin's such as larger population base, more diversified industries, more attractive location as an international transportation hub, more (& better) educational institutions, etc. Because of these factors, lenders & owners can factor in a higher assumed growth rate in income (including wages & investment income). This is similar to varying P/E ratios in the market. Investors will pay more for a faster growth opportunity compared to current earnings.

To the original poster, you are both young and so probably should see an increase in salary each year - if you can, continue to live on the amount you're making now and put all the increase into your house fund. It will probably feel like a very small sacrifice.

kaitainen wrote:

this may happen, but as i and "Surpise" said earlier in slightly different manners, it doesn't make any sense and can't work in the long term. if you were in an area like, say, austin texas where real estate ownership costs were a high multiple of local median income but not an obscene one like SF, then i'd concede that it's possible that austin real estate prices would go up to match SF's higher multiple.

I don't necessarily disagree with you, but we're talking about a couple making $120k/year. That is not a lot in SF area. Real estate will/is slowing down, but even so the increases are likely to be higher than their income level -- even figuring in 3-5% raises they may never "catch up". Now, if this guy was making $200k a year and could bank a lot more, I'd agree with what you have written 100%.

Well said.

Transfer of wealth and wealthy foreigners moving to the area are often not factored in when many people talk about a buble in real estate in certian areas.

So far most of Southern California has seen is a slow fizzle. No bubble burst.

This is not to say it is sometimes better to rent in high priced homes areas.

Some numbers to think about in 2006

In the Westside of LA and Malibu 57 homes sold for over $10 million

and 624 sold for $3 to $10 milllion. Some people have a lot of money and want to live in a certian area and are willing to pay for it.

Computer Nerd wrote:

I don't necessarily disagree with you, but we're talking about a couple making $120k/year. That is not a lot in SF area. Real estate will/is slowing down, but even so the increases are likely to be higher than their income level -- even figuring in 3-5% raises they may never "catch up". Now, if this guy was making $200k a year and could bank a lot more, I'd agree with what you have written 100%.[/quote]

Ah yes, the old, get-in-now-or-be-priced-out mantra.

By your reckoning, home ownership in the future is going to be restricted to the few, the proud, the millionaires.

This reminds me of the dot com bubble. All the creative reasons for why this time, things are different. Why the market is just going to keep rising. Blah blah blah.

[quote]Just starting out wrote:

Our monthly budget looks like this:

$8900 gross ($1000 to 401K pre tax)

$3000 taxes

$1250 rent (cheapest apartment I have ever seen in SF)

$300 bills (electric, gas, water, garbage)

$600 Food (groceries, about two dinners out)

$260 car insurance (liability only)

$170 parking (at work, needed my job)

$120 gas

$600 Roth IRA

$300 Savings (first for the house/emergency fund)

$750 Student Loans

$150 bridge tolls

$800 grad school tuition

__________________________

leaves $600 for everything else

Money is tight, but we live good and have a good time. quote]

Adjust several things and you can have nearly 17K saved in a year to add to you 8k already (25K total - 5% down will at least get you some mortage options).

#1. Stop contributing to your IRA for one year and save the $600 monthly instead. Put it in a Vanguard money market or index fund. You're in your mid 20's. Compounding interest (IRA) is great, but a house is the most important investment you'll make. Better to get in one soon and stop throwing away $1250 in rent every month.

#2. What the heck do you need $600 per month extra for? What is "everything" else? "Money is tight," you say? No, if you have that much extra per month, then you have a lot of expenses that can be chopped. Bump up your savings to $600 a month, and leave your "extra" money at $300.

#3. Consolidate you student loans with your wife and maximize the repayment years - go 20 yrs if possible. You can probably get 4%, lowering your payment significantly (I'll say $200 per month to be consdervative). For those who think paying off student loans fast is best, consider: Would you rather use 2006 dollars to payoff your loan? Or 2026 dollars? Don't you think you could make more than 4% with that extra monthly money - ie, save for a house that should make 10% yearly?

If you do these things, I see your monthly savings going up to $1400 a month. In twelve months you could have $16,800 to add to your 8000 - nearly 25k total. After buying your house, start contributing to your IRA again. And send me $100 for the consulting fee ... :).

Woody Hayes wrote:

#1. Stop contributing to your IRA for one year and save the $600 monthly instead. Put it in a Vanguard money market or index fund. You're in your mid 20's. Compounding interest (IRA) is great, but a house is the most important investment you'll make. Better to get in one soon and stop throwing away $1250 in rent every month.

#3. ie, save for a house that should make 10% yearly?

for the most part, although i don't agree with the conclusions reached by some others on this thread, i think the advice has been reasonable. but the first piece of advice from this post is not reasonable. please don't follow this advice.

not contributing to your Roth IRA would be a big mistake. over the long term, stocks tend to increase in value at a much, much faster rate than real estate. and even if you don't believe me on this point, you can withdraw Roth IRA contributions at any time without penalty (because you've already paid tax on the contributions) and if you use the money to make a first time home purchase the rules are even more generous - you can withdraw gain penalty free too.

see:

a house is only the most important investment you will make if you otherwise make poor savings and investment decisions throughout your life. it may be the single biggest asset you ever own, but you should and hopefully will have stocks, bonds and other liquid investments that are worth, in the aggregate, several times the value of your house.

#2 is just personal taste. at your age, there is no need to live like a monk. you have already demonstrated that you are responsible.

finally, a house "should make 10% yearly"???? no wonder you think this guy should make an irresponsible home purchase (only $25k down and purchase within 12 months). i'd buy 3 homes today if i thought homes would average a 10% increase in value on an annual basis.

It's unlikely you can get 100% of your student loans at 4%. More like a blended rate of 6% or higher. Paying in today's dollars is irrelevant in the scenario where you do this instead of another investment option. You need to deduct the interest paid on your student loans from the interest earned on any other investment options. Do I think you can do better than 6% investing elswhere? Sure, but it's not risk free while it is risk-free to pay down existing debt first.

A house is probably not going to get you a 10% return in the long-run. You need to factor in other costs such as interest, property taxes, homeowners' insurance, repairs & maintenance, association fees, etc. Depending on where you live, this amount varies but will be higher in SF than most areas because of earthquake insurance. You're probably looking at an annual cost of 4% of your loan to service the debt (after deducting the "thrown away" rent, tax affecting interest, etc., but before any association fees). Therefore, you don't start earning a return on your property until it is appreciating at over 4%/year. So assuming it appreciates at 10%/year, you are only netting a 6% annual return...equal to what I think you can get student loan rates at.

That doesn't mean home ownership is a bad thing as there are many compelling tangible & intangible benefits to homeownership & also doesn't mean not to buy as a good financial decision. You just need to understand that it is probably not going to be the grand slam many think it is. It is like a CD...buy a good place, in a good location, & it will slowly appreciate over time (& provide a lot of happiness & joy).