Sunday, April 13, 2008

Mortgages, Part 2: Gimme Shelter

I was thinking about how easy it is for me to hand out financial advice—or at least it seems that way. In reality, I’m prone to the same kinds of mistakes that we all make. And the same stupid impulses, too. Which is why I have a seemingly inexhaustible list of financial wrong turns to talk about. I’ve made most of them myself.

Take mortgages, for instance. Remember the conventional wisdom that you should buy as much house as you can afford? The theory is that it’ll be a stretch for the first couple of years, but then your income will improve, and the mortgage payment will begin to seem like peanuts. The popular but unconventional version of this until the subprime crash was to buy a house in a rising market with the intention of refinancing the mortgage as its market value increased and created free equity. All well and good, in both scenarios, as long as employment is steady and you’re getting raises. And as long as the housing market is going up. Sadly, incomes for the American middle class are not increasing; in fact, they have slightly decreased in recent years, yet the cost of living has gone up. And we all know that the housing bubble finally burst, and real estate is losing value and hasn’t bottomed out yet.

So much for both conventional wisdom and unconventional plotting and scheming. The action taken was the same: we bought houses we could not afford and we knew it at the time. Well, we sort of did. Until I bought a house, I knew nothing about the real cost of owning one. Only now, many years later, does it occur to me that I could have researched the topic. Libraries and bookstores have plenty of books that explain all aspects of home ownership. And today the Internet offers easy access to a wide range of real estate advice. But I went into it blindly, as so many people do, taking a risk and hoping it would turn out all right. It almost didn’t.

Home ownership isn’t just the mortgage payment, after all. There are many other costs on top of it, such as real estate taxes, fire and ambulance fees, hazard and flood insurance, homeowners’ association fees, and more. And there are lawnmowers to buy, and cars needed for transportation, and furniture and appliances to purchase, maintain, or replace. I never thought of those things before buying more house than I could afford. Sadly, it was much later that I heard Suze Orman talk about the necessity of doing a trial run and living as if you already have a mortgage before you actually take the plunge. It’s a great idea. You put away the monthly mortgage payment that you believe you can afford each month for three to six months, plus an additional 30% for other ordinary house-related expenses, and never touch it to live. Then you take stock and see if you are hurting financially on a day-to-day basis. Can you pay your bills? Is there leftover money for fun? Can you still cover life’s inevitable unexpected expenses? Or is paying the proposed mortgage and its attendant other costs a miserable stretch? Suze has come up with a great way to test. Too bad I never heard of it when I was looking to buy my first house.

You live and you learn. Or do you? I can’t say that my current house makes any more sense than my previous one. Why? Oh, this time the math was done in advance. On a month-to-month basis, there’s enough cash coming in to support the household. But there’s something else to take into account that nobody ever talks about. Taking out a 30-year fixed mortgage is a huge risk when continued employment for 30 years is no longer the typical American paradigm.

Yeah, I know. It’s really a huge joke. All the people who got ARMs (adjustable rate mortgages) are being told they were acting in a risky manner. But if fact, unless you have the money in an FDIC insured bank to pay off your mortgage entirely, then taking out a mortgage of any duration or on any terms is a huge risk. Yes, the subprime mortgage market dupes and scammers are the first ones to be hurting. But even at this moment, someone is being laid off from a good job that paid the mortgage, and will never be able to find a job that paid as well. And eventually, in a year or two or three, that person is going to lose that house. Without ever doing anything more risky than getting a job and then getting a house with a conventional fixed-rate mortgage.

So, what can we do to guard against the catastrophe of facing foreclosure? Not a lot. Always have a new career in the offing? That takes a lot of energy. Keep enough savings in FDIC insured bank accounts to pay the mortgage for a couple of years while you find a new good job or launch a new career? Maybe that will work, since the value of such money in relation to the mortgage payment does not change, unlike the value of stocks. But that means buying a house well under what you could afford in the first place, so you have extra income to put aside in savings each month. Are most of us doing this? No. The US savings rate is hovering around 1% these days, and was even in negative numbers in 2006.

So expect to sell the house if you lose your job. Expect to sell it if anything significant changes in your personal or financial situation. Don't get so attached to a house that you let it drag you into a crisis. A house may be the American dream, but it's just shelter. It should shield you from harsh weather, not keep you sleepless at night wondering how you will pay the mortgage.

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