Think Twice Before Buying

So, you’ve graduated, got a good job, have a partner you want to settle down with. Now you are thinking about buying your first home. Think again. A friend recently asked what I thought about buying a house right now. I figured I would share my response with all of you. My fiancée and I have talked about this a lot, and we have decided not to buy in the near future. This is why.

The Three Principles

We have decided, out of principle, to not buy until we can fulfill the following 3 principles.

1. We will put down a 20% down payment.
2. We will only buy under a 15 year mortgage.
3. We want our mortgage payments to be no more than 25% of our take home pay.

So for now, we need to increase our savings, increase our income, and be willing to compromise on our living standards.


The Double Dip Dilemma

Though home prices are low today they have not hit a solid bottom. Google “Double Dip Housing” and you will see that we still have about a 2-3 year glut in inventory. That excess inventory drives prices down. People who say that “this is the best time to buy” and “you are guaranteed a great deal” are looking backward, not forward.


The Inflation Hedge Myth

Interest rates WILL begin to increase significantly. Most Real Estate professionals will say that it is best to buy when interest rates are low, and they argue that interest rates are at historic lows. So buy now! That is true if you are entering into a 30, 40 or 50 year mortgage. Interest rates can rape you over the long run. However, think like an economist for a second. Artificially low interest rates do not create buyers markets, they create sellers markets. Where credit is cheap, prices always are higher. When interest rates finally rise, what is going to happen to the market? Less people will be buying because the high interest rates will price them out of the market. In order to attract buyers, home builders must lower prices on their homes. More profit will flow to the banks and less to the builders. That sucks if you are looking at a long term mortgage. However, if you are shopping for a 15 year mortgage, and can drop 20% on your house, you will be able to buy more house for less because your interest isn’t compounded over 3-5 decades.


The Menacing Fed

Interest rates will increase because the Federal Reserve will have to reign in inflation (Obama and Bush have almost tripled the M2 money supply to try to avoid the inevitable market corrections of the recession). So one of 3 things will happen.

1. Perhaps they will not increase rates enough and inflation starts to ramp up. Again, real estate professionals will tell you that highly leveraged property is a great hedge against inflation, especially if you lock in your interest rates at these “historically low rates”. (I’m tired of hearing that meme). They say that even if hyper inflation kicks in, you will be able to pay back the debts quicker because you will make much more. That is a fundamental misunderstanding of how inflation works. The old adage, all boats rise with a rising tide, does not apply (at least not at the same rate). In fact, it is impossible to escape the detrimental effects of the time lag between the rise of different prices and wages. Your income will be the last to rise should inflation kick in, however you will be paying more at the pump, at the grocery store, and at the movie theater. Those prices will likely push most people into default on their mortgages long before they can reap the “benefits” of the real estate hedge.
2. The Fed may miraculously contract the money supply to keep it at current levels. That may be fine for your mortgage as your buying power will remain the same. However, increased cost of credit means your next car payment will be higher. And since you are locked into a 30 year mortgage, you have to realize that your ability to pay for your kid’s college will be pinched by your mortgage as well. If you had a 15 year mortgage, you’d be in the clear.
3. They may contract the money supply too much, causing deflation. In this case, you would find yourself upside down rather quickly, unless you were to pay down a large chunk at the beginning (say 20%). Also, in deflationary times businesses are more likely to lay off workers and higher cheaper ones than simply adjust pay downward. So you are more likely to find yourselves w/o a job.




The Renter’s Serenity

There are real benefits to renting. Do you know how to make all the necessary repairs that WILL be needed in your home? Can you afford the risk of code enforcement officers ordering you to make major changes? What if Matt has a great opportunity to take a job or go to grad school elsewhere? What if you child gets sick and needs to be treated by specialists in another state? In the end, if there is a high probability of flux in your life over the next 5 – 10 years, then now is not the time to buy, as romantic as it may sound.

That is why fiancée and I have decided to wait and save. However, that is just our risk management strategy. Yours may be different. In any case, learn everything you can about the economics of inflation and deflation before buying. I recommend reviewing articles at the Mises Institute. I can email some relevant commentary to any of you if you want. Cheers, and good luck with the decision.