Friday, March 20, 2009

Housing And The Financial Crisis

Economist Mark Thoma gives a good overview of all the factors that came together to create the financial crisis with Who's the Villain in the Crisis? Of course, housing is part of the story and it makes me think of what my wife and I have encountered over the last several years while looking for a house (we rent an apartment now).

It always ended up that once we figured in a down payment of about 20%, that our monthly payment, including the mortgage, fees, taxes (maybe condo fees in those cases), etc. would be $300 (or more) a month than our rent. And the house that we looked at would not be as nice as our apartment, maybe it would be a little smaller and required some work. Then there would be a lawn to mow. Sometimes the backyard was just dirt that would turn to mud when it rains.

Some people say that if you buy a house "you build up equity." So? That only does you any good if later on take out a home equity loan (some owners have been borrowing against their equity or the value of their homes for consumption spending-I don't know how much this went on but less is going on now since the price of houses has fallen). Even if you can sell your house at a profit years later, you then have to find another place to live. If you buy another house, then it eats up your profit (unless you are lucky enough to find an under priced house or are just plain good at finding bargains). You could move back to an apartment and enjoy spending the profit, but you are right back where you started.

Also remember that if you are spending alot less on an apartment over the years, then you are also building up money due to compound interest, just like building up equity in your house. There was never any guarantee that home values would continue to rise so you had no guarantee that housing would be a better investment than putting the money in, say, a retirement account.

Then you could say, "at least you have a house, it is a place to live." But so is an apartment. And recall that the houses my wife and I looked at were not so great. Our rent was much less than what our monthly house payments would have been. I have had extra money taken out of my paycheck for my retirement account. So in that way, I have been building up equity.

And the strange thing is that housing prices did not rise as much in San Antonio as they did in other parts of the country. The discrepancies between buying a house and renting an apartment would have been bigger elsewhere, meaning they made less economic sense. It seems like we all should have been able to figure out something was terribly wrong. Maybe some peopled did, but not many of us.

This site shows that the vacancy rates for apartments were high and still rising when the crisis hit Housing Vacancies and Homeownership. Homeowners can deduct their interest payments from their tax returns and government sponsored entities like Fannie Mae make it easier to buy houses. One reason given for this has been that homeowners are better citizens and more community minded so that there are positive externalities from owning homes. But it might not have been a good idea to push so many people into home ownership. Maybe people who liked to buy and own houses in the past were good citizens and community minded. It is not clear that owning a house made them that way.


Anonymous said...

When you talk about owning a house and the benefits being tax deductions and building equity. What are your thoughts on buying a home to own it out right, the idea being, at some point, you will not have anything to pay but property taxes. Then at that point when the house is paid off, the money not spent on a mortgage will go into savings and earning interest (hopefully).
Thank you,

Cyril Morong said...

You raise a good point that eventually you will not have to pay the monthly mortgage and just pay taxes.

For most people, the interest deduction does not add up to alot. You need to own a fairly expensive home for that.

Mortagages are usually for thirty years. So it takes along time to get to when you don't have to pay anything each month. Imagine if you save $100 a month because you rent an apartment instead of buying a house. If you save that each month, for $1200 per year, after 30 years you would have $79,000 if you earned 5% interest each year.

Now if you let that $79,000 earn interest each year at 5%, you are earning $4,000 a year. Probably not enough to cover the rent, but it will help. I am not going to explain the math, but if your annual rent was $8,000, and you paid it out of this $79,000 (plus the annual 5% interest you would earn), the money would last an additional 14 years before it hit zero. And that is just saving $100 month on the apartment. Imagine if it were more. It would take even longer for the house to make sense.

I am not even counting expenses on the house. For some people it might pay eventually to own the house, but not for everyone. It will depend on rents, home prices, interest rates, etc. I am just saying that it can cost alot to get to the point where you don't pay anything.