Buying a home this spring-selling season is a bad idea - Article by Sam Mishra, MBA (MIT Sloan) - Franteractive Real Estate News and Insights

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Here comes the Spring-Selling Season… Should you buy that dream first home in 2007?
Article written on 2/8/2007 by Sam Mishra, MBA (MIT Sloan)

People don't like to move in winter. But spring is a different matter. Change is in the air. People change apartments, and the more fortunate amongst us buy our first dream home. Should you buy that home this spring? Or should you wait? Let's find out…

If you own your own home, you can repaint the walls to your liking, or redo the carpet --- luxuries you don't have if you rent a home or an apartment. Real-estate ownership diversifies your investment portfolio as well. On the flip side, unless you buy a brand new home or a condominium, you have to spend time and money on roofing, plumbing and lawn-mowing. These flip-sides are minor, considering the major attraction of owning your own living space, your own home.

But do you actually own your home when you buy one? Or do the debt-holders actually have first rights? It depends on how much debt overhang hangs over you. If you bought one with zero down, it means you own nothing. As long as your mortgage payments are interest only, you are not building any equity, and hundred percent of your home is debt financed, and so you own nothing! In the business world, if more than 40% to 60% of a company's valuation comes from debt, the phenomenon is called debt overhang and the business can go down under. However, in the world of real-estate, 90% to 100% of the home valuation today is debt-laden, and people take it easy. Should you not take the business of home-ownership the same way as the business world treats its company valuations?

Today, one can buy homes for zero down, thanks to the second-lien lenders. Before these second-lien lenders came up to pay for your 20% down-payment, you had to pay 20% down, and thus could start living in a home which you technically owned, at least 20% of it, to start with. You still had the debt overhang of 80%, far worse than the 60% maximum which the business world tolerates, but hey, you had a good job, and could make those mortgage payments month after month.

Not today. No job in America is secure. You have no guarantee that you will be able to make mortgage payments month after month five years down the line, two years down the line, or even a year down the line. So, even if you paid 20% down today towards your home, you would still be taking some risks. But the risks would be lower, because you would have equity built-in you could borrow from, if you lost your job, for example.

Unfortunately for more than a million Americans whose foreclosed properties are up for sale, this home-equity cushion was not available. They succumbed to the social pressure of owning a home at any cost, not to mention the creative financing schemes from sub-prime lenders and the cajolings of their real-estate agents. They bought homes with zero down when the prime lending rate was at historic lows. And then Alan Greenspan had to increase the Fed funds rate, and mortgage rates followed. Once the low, fixed mortgage rate of a 3 year or 5 year honeymoon was over, much higher variable mortgage rates kicked in, and these gullible Americans, with no equity built into their homes they thought they owned, defaulted!

This million plus foreclosed properties, on top of more than two million vacant homes up for sale, has created a supply glut in the U.S. housing market. Stock of sub-prime lenders like New Century Financial Corporation and NovaStar Financial Inc. are trading at 52-week lows at the time of this writing, even as Dow Jones and Nasdaq are trading at 52 week highs. Second-lien financiers like the Household International Inc. component of HSBC Holdings PLC. are revamping management. Buying a home at 100% debt is going to be more and more difficult for Americans in the future, reducing demand for home ownership further. As demand plummets and supply rises, the real-estate bubble will slowly burst. It will not happen overnight, but it will happen. Home prices will come down this year and the next…

Accordingly, I recommend that home buyers do the following:

1. Save towards your down-payment, so that you can pay at least 20% down. Don't buy a home for zero down, or 5% down. You will be perpetually under a debt overhang.

2. Monitor home prices every week, for fifty to hundred weeks (one to two years). In particular, monitor the number of vacant homes, and the number of foreclosures weekly. As long as these numbers keep climbing, home buyers are going to be in a stronger and stronger position, not just this spring-selling season, but also the next one (Spring 2008). Don't make 2007 a spring-selling season; make 2008 a spring-buying season for you.

3. There is a positive correlation between Fed funds rate and mortgage rates. Monitor the moves of the Fed, and the speeches of Fed Chairman Ben Bernanke, closely. As long as he keeps the interest rates steady, or hikes them very slowly, the mortgage rates won't increase further. Alternately, we publish the latest mortgage rates from the Mortgage Bankers Association on the top of this page for your convenience, so please bookmark this site focused on analysis and insights on the current real-estate bubble and the housing market meltdown.

4. Be patient while you build equity towards your home, and don't succumb to the "social-pressure": you are still renting, when will you buy that dream home? In most of metropolitan American, renting is still cheaper than paying mortgage, even with the tax-breaks one can get from those interest-only mortgage payments. If you really need to live in a home, you can rent one. Close to 3% of U.S. homes are vacant, and not all of these are up for sale.

5. If you still need to buy, look for fixer-uppers or foreclosures. Negotiate hard with the seller, the seller's real-estate agent, and your own real-estate agent. Half of these real-estate agents are part-timers, and will not be selling homes very long. Use the Pareto Frontier to maximize your returns on your home-buying and mortgage negotiations.

6. Once you have found that real deal you really want to clinch, shop for the lowest mortgage rates from credible primary mortgage lenders such as SunTrust, Wachovia, Bank of America, Wells Fargo, and Chase. Check on the pre-payment penalty clauses. Pre-payment penalty often deters borrowers from mortgage refinancing, if the interest rates go down in future.

Note: Recommendation is not advice. Please read our Terms of Service.

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