|
|
|
|
Home Mortgages: Look Before You LeapBy P. Padmanabhan and B. KrishnamurthyThere has been a staggering appreciation in real estate and housing.The trend has been in existence for the better part of the past decade, though to the casual observer, it might seem that the boom was a phenomenon restricted to the year gone by. This runaway boom has been spurred on by three factors in addition to the normal desire of the average citizen to own his home. Professional speculative interest to make a quick buck, dip in interest rates and a concomitant drop in qualification levels for credit availability. The median price of a home in many parts of the country has gone beyond the reach of most. San Francisco Bay Area is an example. To keep potential borrowers for investment in homes interested, lenders have come up with a bewildering array of fresh and original schemes involving combinations of
These may be quite attractive to begin with, but you need to be careful. You don't want to end up with a commitment difficult to service and an expense you can ill-afford. For example, let us say your monthly take-home pay after taxes and other deductions like 401k etc is $3000. You find that the home down the street is up for sale for $300,000 and as luck would have it, you have found a lender willing to lend you 100 % of the loan. Assuming an interest rate of 5.84%, a 30-year fixed FHA Loan comes to $1768 a month, not including taxes and insurance. With taxes and insurance let us assume the monthly payment now comes to $2100. Is it really affordable? Will $900 be enough for the monthly expenses for the entire family? What about your car payments? Payment relating to children's education? A good rule of thumb is that your cost of housing should not exceed 20% of your net monthly take home pay, after taxes and other deductions. This means that for a $1,000 monthly mortgage payment, your net monthly income should be at least $5,000. Of course this precept is very subjective and does not take into account the totality of calls on one's income. Also the foregoing are palpable and pertinent points relating to current cash-flow in the context of a very large housing loan. Nevertheless the number of people overlooking even the obvious is not inconsiderable. Even the average citizen not normally given to speculative ventures, is not entirely averse to being drawn to over-leveraging ignoring current realities, given the opportunity to make an easy buck on the side "on a sure thing". But there is another aspect to the problem than meeting current living expenses. That involves an evaluation of soundness of investment and the hidden costs of poor timing of investment. What if the boom in housing, peters out, as it surely has to sooner or later. What if one is the last fool to bandwagon. The uptrend has lasted far too long unabated. Many analysts are predicting an end to the surge. Industrial equities have taken a relative back seat for most of this period in question. The gradual flight of capital from the housing sector (with its potential for profit realization given the level of advance) is but a natural corollary to the increasing attraction of the coming bull market in other spheres of the economy. It could be commodities, Metals and Industrial equities in the foreseeable future. Speculative funds have no permanent fancies or loyalties. It is certainly not the purpose of this article to call a mandatory, imminent and long-lasting downturn in the housing sector. But some sort of realignment bringing rates to be in tune with the secular trend for this sector, which incidentally is much less steep, is not only possible but seems highly likely. Let us do some realistic computations: Let us assume your disposable monthly income after taxes is $ 3000. Assume that the lender offered you an interest only loan for a $300,000 home. It is a 5/1 Interest only ARM. The monthly payments at current rates work out to only $1400 including taxes and insurance. You take the plunge. Time goes by. Five years later you find that the interest rates is at 7% for a 30 year fixed. The qualification criteria for loans are a trifle more stringent now. You have made some headway in your work and enjoyed raises, but so have other calls on your income. In effect, you have been running on a treadmill. You possibly have more mouths to feed. Your children have to live away for higher education. Then there is the ever present inflation. Now, we would not like to be prophets of doom. Let us say that there has been a minor recession in the housing market and the value of your home has dropped by around 7%. The following medley of thoughts will cross your mind while wrestling with the wall of worry.
|
Home