When we talk about home ownership we usually mean giving a bank a mortgage. We borrow money, our home becomes a lien and if we don't pay they take it away. We don't have any equity in the home until it is worth more than what we owe on it.
This is just an opinion but I don't like 30 year mortgages. Twenty year 20 year mortgages make more sense, and shorter term is even better. They are less expensive and it doesn't take as long to accumulate some equity and over the life of the loan more money is put toward principal and less is paid in interest. The idea here is that more money is being put toward actually owning the home.
Most people don't think in terms of paying off a home mortgage but it can be done. Using a $100,000 home mortgage as an example, take a look at a 30 year loan Vs. a 20 year loan:
$100,000 Home Loan
Payment $536 on a 30 year fixed at 5% = $193,256
With first payment the borrower is mostly paying interest and after 120 payments, the borrower is still paying more interest each month than principal. This is just an example. The actual payment would probably include 1/12 of the annual home owners insurance and 1/12 of the property taxes. After it is all paid off the borrower will have paid $193,256
Payment $659.96 on a 20 year fixed at 5% = $158,390
In this example it is a 20 year loan at the same interest rate with the same amount borrowed. Yes the payments are higher, but there is a savings of $34,896 and after the very first payment the borrow has twice as much equity as he would have with the 30 year loan.
I know that people don't think this way when they buy a house and if they did I suspect that the thirty year mortgage would not be as popular as it is. The payments are lower with the thirty year and for most that means they can afford a more expensive house. A more expensive house is wonderful but owning one free and clear has some advantages too.
A return to high equity for Americans will necessitate a very slow return of appreciation, if it returns at all, in the near term.
The less leverage applied to an asset, the less price inflation will be seen. I personally hope this is the case, since low leverage and fast repayment puts households in a far superior financial position.
House prices will continue to languish due to the following factors:
1) Lower wages for both private and public sector employees are the future.
2) Interest rates have more room to rise than to fall.
3) The Alt-A and Option Arm waves are now starting to create their expected losses in the financial system.
4) Loan-to-value ratios can’t drop much, but there is plenty of room for them to rise. Even a small increase in the FHA minimum would have a noticeable effect on purchasing power, and therefore prices.
5) The tax credit once again took buyers from the future in order to pump up the market now.
6) During the boom, mortgages were given to people who never should have received them. Additionally, we have seen the destruction of many people’s credit rating. The available pool of buyers will be much smaller for a while.
Home prices are a function of wages, access to credit (qualification criteria), interest rates, and
supply. All of these factors weighted more heavily on the negative side for prices.
At this point, it might be risky to conclude that prices are going to rise in the near term, since we have not seen the effect of the removal of government support. The support will eventually have to be decreased, since the government does not have unlimited dollars to give away to promote housing.
Already we have roughly tripled the nation’s annual deficit. This is not sustainable. At some point, the cost of housing will need to find free-market equilibrium.
Another interesting item is the the Federal Reserve’s mortgage purchase program ends around March or April, a key interest-rate support will be removed.
In short, the government postponed the day of reckoning, which was to be expected. That day will come at some point, and prices must fall to reflect that reality.
Note also that this analysis does not even take into account the possibility of inflation and the fact that higher mortgage rates in an inflationary environment will cap prices as well.
Side note-
If rates rise to 6%, the mortgage amount falls to about $89,500 for the $536 monthly payment.
If rates climb to 7%, then the target price is around $80,500.
Couple that with the decreasing pool of available buyers and the low US savings rate (no one has a big down payment), and you see the outcome.
PB – thanks for the comments. I see you are still a patient buyer, I hope you will let us all know when and if you buy.
Great information but I think your chart for the 20 yr amortization is off. There is no month 360 in a 20 yr loan.
Yes I did mess it up, the loan would have been paid off for 10 years. Thanks I think I can kins of fix it.
Your article makes a lot of good points. I sell real estate now but was a loan originator for 13 years. One of the reasons I think most people elect the 30 year mortgage is that the lower payment allows them to borrow more money, and therefore to buy more house. We still live in a world where most people think more is better, and keeping up with the Jones is still the thing to do unfortunately.