Reader Question: Market Stability & Interest-Only Loans

Here’s a question I received via email from a reader, whom I shall refer to as Malcolm:

I will be getting married next August and am beginning to look at buying my first home that we could be in for 5-7 years before children would demand a bigger home. My fiancée and I have a combined income in the ballpark of $90,000 and have 50k available if needed to down payment and closing cost. However, I would like to keep the 50k invested where it will make me 8% annually but at the same time keep my monthly down. I have found that zero down and a low monthly can be conflicting goals. However, in my research I came across a fixed 30 year interest only loan with 100% financed and lender payed PMI. This would allow me to keep my 50k invested and take the saving from the interest only loan and pump back into the same or new investments where my money is working for me to prepare for the future. Also, I know that interest only loans are not for everyone and can be risky and have thoroughly researched the pros and cons. I am looking for unbiased feedback from someone completely unrelated to my situation. Now that I have explained my situation I have three questions.

  1. From the the above description do I sound like a good candidate for an interest only loan? I should also mention that I am fortunate to have significant upside for compensation in the years to come.
  2. From your knowledge do you feel that the Seattle real estate market will hold for 5 to 7 years when I look to sell or refinance my interest only loan? Obviously, my fears are depreciation and significantly higher interest rates at the time of sale or refinancing. I know that I don’t want to take the interest only into the 11 year but I want to be comfortable that I can refinance or sell at that time even though I will be carrying the original principal amount after 5 year of interest only payments.
  3. Do you think it would be a good idea to make the extra payment every other month on principal to decrease the amount of risk I carry?

First off, I should point out that while I obviously do not have an emotional attachment to Malcolm’s decision, I’m certainly not “unbiased.” Everyone has biases to one direction or another. The best I can do is try to give rational advice based on my own perspective. Here is a slightly condensed version of my response to Malcolm’s questions:

From the scenario you describe, it sounds like you and your future spouse have made the decision that buying a home is the way to go, and the advice you are looking for is about what kind of mortgage to get. Personally, I would look into renting a nice house for at least a few years (see this post for a strictly financial comparison between renting and buying similar homes in the Seattle area). However, if you have the funds, the “intangibles” of buying are more important, and you can stomach the financial downsides of buying in today’s market, then buying would be your best bet.

That said, I’m afraid I can’t offer much specific advice about loan types, except to offer a general warning to stay away from adjustable rates if at all possible. For the best advice on mortgages, I would have to recommend that you talk about your situation with a mortgage professional. I highly recommend Rhonda Porter, who has a website here that contains information on how to contact her. I’ve met with her a couple of times, and she is both knowledgeable and personable.

To address your second question, a lot can happen in 5-7 years. My “gut feeling” is that we’re going to see 3-5 years of 5-10% price drops, followed by another 3-5 years of stagnation. It could be better than that, or it could be worse. Alternatively, you can believe those in the real estate industry, who are much more optimistic, and are not expecting price declines to last beyond next year, followed by a return to 3-5% yearly appreciation. Personally I have a hard time accepting their predictions, given that they have been calling the “bottom” since December of last year.

As for your third question, my personal financial inclinations are decidedly anti-debt. I will most likely be taking on a home mortgage some day, but I will be making every reasonable effort I can to start with a large down payment and pay the debt off early. I highly recommend making extra payments whenever possible, as long as it’s not at the expense of a prudent retirement savings plan, and whatever other savings plans your personal budget entails (e.g. – emergency fund, stock investing, etc.).

Malcolm replied with a few more thoughts:

It sounds like you feel as if the Seattle housing market will slow and depreciate or stay flat in the coming years. That being said am I correct to think that interest-only loans may not be the best idea in a depreciating housing market? For example, if I buy at home at $370,000 and prices drop 20% over 3-5 years I am left owing $370,000 while my home may be worth considerably less. Is that the correct thinking? It seems that interest only loans are only advantageous if you are in a strong market that is on the up swing where you can be confident in the home’s appreciation. Anyway, I am curious to see what comments we get on the blog after Monday.

He also pointed out a few upbeat articles in the Seattle Times as possible reason to believe that “Seattle will continue to be stable riding a strong economy.” In order to keep the comments on this post more focused, I will address those in a separate post. For now, let’s hear your advice for Malcolm’s situation.

Personally, I’m of the mind that you really can’t lose right now by renting for at least a year or two while all this nasty stuff plays out. 2007 was really just the beginning of the unwinding, and things seem likely to get worse throughout 2008, before they get better. What advice do you have for Malcolm?


About The Tim

Tim Ellis is the founder of Seattle Bubble. His background in engineering and computer / internet technology, a fondness of data-based analysis of problems, and an addiction to spreadsheets all influence his perspective on the Seattle-area real estate market.

57 comments:

  1. 1

    RECESSION INDEXES LOOK GRIM FOR INTEREST ONLY RENT MORTGAGES

    Looks like the GDP indexes for this Q4 2007 and Q1 2008 may not be as rosy as most MSM likes to project. See Dr. Roubini’s prediction in part for Dec 1 2007:

    “…There are plenty of forward looking indicators of economic recessions, including various asset prices (yield curve, risk spreads, equity markets, etc.), macroeconomic variables, the consensus of experts and analysts as well as more quirky indicators (such as sales of St. Joseph statues to indicate housing recessions, or sales of lipstick, a proxy for cheap make-up in tough belt-tightening times). Certainly many of these indicators are now pointing in the direction of a very high probability of a US recession in the very near term. US growth in Q4 may be closer to 0% than 1% and will, in my modest view, turn negative (recession) in H1 of 2008….”

    The rest of the URL:

    http://www.rgemonitor.com/blog/roubini/229948/

    Assuming Dr. Roubini is right [I do], interest only rent payments to banks to buy a house is slamdunk a stupid choice, especially when you add in closing costs, realtor fees, etc, etc….

    But Seattle will just be stagnant in price the next few years, and the troops will all be home by Christmas too.

  2. 2
    b says:

    There are only a very slim set of circumstances where buying an overpriced house with an interest only loan that you are going to live in for only a few years is better than renting a house for less money.

  3. 3
    BubbleBuyer says:

    My personal view is that if you can’t afford a 30 year fixed mortgage with 20% down you should not buy. Also, unless you are able to negotiate a HEALTHY discount on asking price (and the price of comparables) today, I would pass. RE is in for a rocky year or two or three… Rent until you get a feel for where the market is going or you hook up with a rational seller in a position where they are forced to sell and negotiate.

  4. 4
    MisterBubble says:

    Snarky response:

    if you can’t spell “lender-paid”, then you probably shouldn’t be considering a mortgage.

    (More) Serious response:

    There is absolutely no advantage to taking out an interest-only loan, unless you are 100% certain that “your” property is going to baloon in value by more than (at a bare minimum) 50% over the 7-year life of the loan. Any less than that, and you’ll be taking a loss, once you consider maintenance, taxes, agent fees, utilities, etc.

    If you spend 7+ years paying interest to a bank, you could just as easily spend 7+ years paying rent to a landlord. And in Seattle, at the present time, you’re going to be paying 1/3-1/2 as much to a landlord. In short, you’d be a fool to “purchase” a property with such a risky loan right now, unless you knew that the property was sitting on an undiscovered oil field.

  5. 5
    bud says:

    Seems like a pretty good example of why home ownership is not a good option for some. Anyone who is signing on the dotted-line of a 30-year obligation worth over a million dollars (calculate the interest–it is), should have a better grasp of what they are getting into.

    Plus, what if said $370k home needs repairs, etc? At best you are getting what you paid for. At worst, you are getting something that might require a big outlay of cash to repair.

    Lots of risk. Very little upside over the next few years.

  6. 6
    Brian says:

    I am hoping we are entering the era of sane financial decision making. If that is the case, no one should consider zero down or interest only loans.

  7. 7
    explorer says:

    First, Og he is as financially comfortable as he appears to be, he should be asking and paying a financial planner to answer his investment questions. He seems to be skewing his perspective too much on the “investment” aspects of buying now.

    Second I think he answered some of his own questions in the response that was included.

    Not intended to be snarky, but if he has indeed done his homework, he appears to be looking for validation to a decision he and his fiance have already made.

  8. 8
    Dave0 says:

    Assuming that you have already decided to buy a house at a given price, I don’t see anything wrong with a 30 year fixed rate interest-only loan. If you take a 30 year fixed interest-only loan you should determine what the principal & interest payment would be on a 30-year fixed and make that payment every month. The only difference is with the interest only loan is that your principal payments are not required. That is nice because then if due to some emergency you can’t afford to make the principal that month you won’t incur any bank charges. You just have to be very disciplined to make up that payment the next month to get back on track. If you don’t think you can be this disciplined then interest-only loans are not for you.

    The problems come in when you start using adjustable rate loans.

    just my 2 cents.

  9. 9
    Sniglet says:

    I concur with BubbleBuyer. You should NEVER get an interest-only loan, unless it is part of some sophisticated asset management scheme and you really do have piles of cash parked around in other assets (which is clearly NOT the case with the example in this post).

    If you can’t afford a 30 year fixed mortgage with 20% down, you shouldn’t be buying. Period.

  10. 10
    Will Powers says:

    Rent Malcom! Enjoy your first years of marriage unburden my home moaner-ship. Build the nest egg, and enjoy each other. Your incomes should afford you a better home choice, than what is currently on the market, and your affordability is just improving by the month. Don’t stress out your new marriage, paying over 1/2 of take home on a mortgage payment. Better the economy by taking your wife out to dinners, and buying un-necessary gifts with the extra disposable income.
    My family and I are returning Seattle homeowners, and are choosing to wait it out and see. We will rent, because I refuse to pimp out my wife and latch key my kid so I can send all my income to a bank. Seattle is increasingly filling with overstressed home-owners as it is!

  11. 11
    Brian says:

    explorer: From what I can tell, he’s not financially comfortable enough to need the services of a financial planner. $90k a year with $50k available for a down payment isn’t terrible, but in a sane/rational world, that is not that much in this market. $50k is 20% down on a $250k home. $90k puts him at the median income level of some communities in King County. At his current level, paying a financial planner to tell him something he can learn himself is a waste of time and money. There is nothing wrong with renting if you are thinking about what makes the most sense from a financial perspective. I would advise that if he wants to buy a house that costs $370k that he save the extra $24k needed for the down payment, plus an additional $20k for a safety net fund before he even thinks about buying a house. It may be the conservative route, but based on today’s environment, safe and conservative is the play (unless you can parlay your savings into properties that are cash flow positive and income generating).

  12. 12
    Brian says:

    Does anyone else realize that interest only loans were created for wealthy investors that didn’t want to lock up their cash, but could afford to provide equity if needed (like in a down market if they could not sell the property before the interest only term eclipsed and decided to refinance or take a financial hit).

  13. 13
    rose-colored-coolaid says:

    Whether or not one should consider an ARM at all should never hinge on what the market as a whole is going to do. If you get a 30 year fixed, and move in 5 years you will have not built up all that much equity anyways.

    Instead, consider an ARM if a) your income today is drastically lower than expected income when the ARM resets, and b) you can reasonably expect that in X years when the ARM resets you’ll be able to refinance into a fixed rate mortgage with a rate comparable to today’s fixed rates.

    For Malcom, they make $90,000 a year today, if he expects $150,000 annual in 3 years, then look at arms. If his anticipated increase is to $100,000 then the ARM probably doesn’t help much. As for interest rates, with the looming threat of inflation and the fact that rates are still near all-time lows, I would suggest that today is a very good time for a fixed rate mortgage (if you insist on any mortgage at all).

  14. 14
    rose-colored-coolaid says:

    Dave0, no such thing as a 30 year fixed rate interest only loan. Did you mean 0% down? IO means you only pay on the interest, and never pay down the principle.

  15. 15

    UNEMPLOYMENT AND CPI RATES ARE COMPLETE JOKES

    If you use these MSM rates to justify a zero interest loan risk, the NYT’s issued the following warning that should horrify you this weekend:

    http://www.nytimes.com/2007/12/01/business/01spend.html?_r=1&ref=business&oref=slogin

    I call the understating of American unemployement the “Ghost Unemployment Rate” they’d have us all believe.

  16. 16
    steve-o says:

    Dude: Commit yourself to putting down all your free cash. If you have a hard time doing it, then you should NOT buy the house. Consider it a reality “gut check”. If you can’t stomach putting down 50k today, how are you going to stomach possibly loosing 100k in five years?

    It’s easy to assume that things will be more rosy in the future and that even if the market goes down 20%, your income will be a lot higher and/or your 50k will double.

    But you will be trading a guaranteed huge (and risky)debt today against a possible high income/investment gain in the future.

    You can rent for less than for what your interest only payments would be. Assuming it’s a 500k house, and assuming your interest only payment is 4%, then you’re paying 1660/month for your debt. Throw in taxes ($420/month) and insurance ($210/month) and maintenance ($200/month) and you’re paying about $2500/month. I GUARANTEE you can get an equivalent 500k house for that amount of rent or less. I’ve looked at renting a 600k house in Bellevue and the rent is less than that.

    For you to gain 100k on your house, the market would need to appreciate 5%/year for the next five years (.28 x 500 = 140k, minus 40k commision equals 100k), for you to loose 100k on your house, the market has to only drop 3%/year for five years (.15 x 500k = 75k + 25k commision = 100k loss).

    Look at the negative yoy data for the top twenty metropolitan areas in sept (case-shiller). Only three markets are positive, the other 17 are all negative and getting more negative each month. Seattle’s yoy will be zero early next year and then about -5% late next year. That is amost a 100% CERTAINTY. So if you bought that 500k house today it would be worth about 95% of that value this time next year (a 25k loss even before the 30k commision loss). At that point, house values would only have to drop about 2%/year for the next four years to get to that 100k loss. Look at all the charts on this blog and tell me that you think house pricess will start going back up 3%/year in a year or two. You wanna bet 50k on it? You wanna bet 100k?

    And a word (two actually) to all the people out there who like to point out spelling and gramatical errors: “grow up”.

  17. 17
    Ira Sacharoff says:

    I’d never recommend to anyone that they go with an interest only loan. …And 100% financing with no PMI?
    ….There are a lot of scumbags in the Real Estate field, all aspects, but i think the lenders tend to be the worst.
    Oh, you’ll get your 100% financing with no PMI alright, but they’ll charge you the 200 dollar photocopying charge and the 150 dollar courier charge and the 200 document inspection charge and then charge you a 9% interest rate.

  18. 18
    Dave0 says:

    rose-colored-coolaid said,

    “Dave0, no such thing as a 30 year fixed rate interest only loan. Did you mean 0% down? IO means you only pay on the interest, and never pay down the principle.”

    My brother has one, and Malcom refers to one at the top of the post (“I came across a fixed 30 year interest only loan…”). This is where the interest rate is fixed for the entire 30 year period, but the minimum payment each month is just the interest.

    A good example is Quicken’s smart30 loan:
    https://www.quickenloans.com/loan_programs/smart30.html

  19. 19
    PetiteChouRose says:

    In today’s finance climate I think Malcom should be wary of the 0% down, interest only, “bank won’t try to ream you” type of loans. I think the banks, when it comes time to actually funding a loan, want to see you take on more of the risk than in the past. I.E. Show them the money. My husband and I just refinanced a few months ago and the banks say one thing, and when it comes time to get the loan they come back with about 30 weird requirements, question the appraisal amount, and dragged their feet on actually funding the loan. And this was for a house where we have a significant amount of equity built up and our debt-to-income ratio was in the very good range.

    Bottom line: if you are going to buy a house next year, try to put something down. It will also affect the rate and terms that you get.

  20. 20

    First of all, The Tim, thank you for recommending me. I am humbled and honored.

    There are many loan programs being referenced here…I’ll give my quick 2 cents as I’m a bit busy today.

    LPMI (lender paid mortgage insurance) is not a scam if you’re not working with a scammy lender. I prefer it over pmi as mortgage interest is still tax favored and so far, the pmi “tax benefit” is over at the end of the year.

    I just sent a client a Total Cost Analysis which compares FHA and 100% LPMI 30 Year Fixed. Here is why I prefer the LPMI 30 Year Fixed for this individual (everyone’s circumstances vary) over FHA:

    No upfront mi (FHA charges 1.5% of the loan amount which is financed into the loan)
    No monthly mi (FHA charges 0.5% for monthly mi)
    The interest rate for the LPMI product is 0.375% higher than the FHA rate I quoted. However, the payment is less once you factor in the MI.
    Mortgage interest is tax favored beyond 2007, currently the pmi “tax benefit” is over at the end of this month.

    The client can save the 3% they would have put down into the home for costs that will come up with owning a home. If the home depreciates or has stagnant value, the 3% will not make a huge difference…I think it’s more important they have the liquidity in this case.

    The more you put down with LPMI, the better your rate will be (5/10/15% etc).

    I agree with The Tim on ARMs for the most part. Currently the 30 year fixed rate is very competitve and there’s not a huge difference between fixed period ARMs and fixed rates…so why take the risk? The ARM should only be considered for short term financing and I would not recommend buying a home right now with the intention of not owning it for a longer period of time.

    I don’t have a problem with the 30 year fixed with 10 or 15 year interest only payments for the right borrowers. If you’re doing this to squeak into a mortgage payment; this is not right for you. Consumers should also be aware that after the interest only period is over, the mortgage is reamortized at the balance for the remainding term.

    And last but not least, there is nothing wrong with renting. Underwriting guidelines continue to tighten. I posted new guidelines this morning at RCG–March 1, 2008 Fannie and Freddie have price hits for credit scores below 680 with less than 30% down. Some lenders are not waiting for March to roll around…they’ve started the price hits now and limiting how low they will go with credit scores regardless of whether or not we have an approval from their underwriting system.

  21. 21
    [troll] says:

    20% w/30 yr fxd r dn’t by t? f vryn ctd lk tht, w wldn’t hv bbbl nw. :) (nr wld ‘v md ny mny n my lst fw hms ;). Jst kddng..

    Thr’s nthng wrng wth lns – f y’r sllng hm nd hd t mv nt nw n whl stll sllng th ld n, n ln (mst f thm, t lst) wll llw y t rclbrt th mnthly mrtgg pymnt fr yr nw hm whn y pply th prcds f th sl f yr ld hm twrd th prncpl f th nw hm.

    f y gt cnvntnl (fxd PR) mrtgg, thn nlss y rfnnc, y cn nt rdjst (shrnk, typclly) th mnthly pymnt by pyng dwn th prncpl. ll y’d b dng s shvng ff yrs f npd ntrst ff yr ln trm (whch s lwys gd thng, MH, wng lss t th bnk lng trm), w/n rdjstng th mnthly pymnt (.g. ncrs yr crrnt csh flw). Y’d hv t rf f y r stck wth fxd PR ln.

    ls, f y yrslf mrtz th ln by ddng prncpl mnt ch mnth, thn th ln rsmbls cnvntnl (fxd rt) ln whn th trm xprs. Mst ppl wh gt th lns ‘frgt’ t d ths, s whn th trm xprs, thy gt stng wth hg mntly nstllmnt, bcs, l nd bhld, thy pd NTRST NLY p t tht pnt nd njyd grtr mnthly csh flw.

    h, nd f y wt 2-3 yrs ntl th “nsty stff plys t”, y’d b ltchng n t th bttm f th ‘nstnss’. Whch s why y shld tk ths blg nd ts prvlng pssmsm wth grn f slt…

    Bt thn gn, ‘m n th mnrty hr :) s thr’s prbbly smn ls wh hs n xprt hndl n th ‘trth’ by bng bst bdds wth Mr Ggl wh wll tsmrt m. Sftwr ngnrs cm t mnd…

  22. 22
    Joel says:

    Not intended to be snarky, but if he has indeed done his homework, he appears to be looking for validation to a decision he and his fiance have already made.

    Not snarky at all. If he really is looking for advice, why does he try to convince The Tim that the market is going to do ok after he’s told that what he’s proposing is very risky?

  23. 23
    jesse says:

    Hey Malcolm, I don’t think there’s a free lunch with IO, ARM, or whatever. You will pay a premium to use someone else’s money. The way you come ahead of all this is speculating on the future value of your house. This has risks that you and your family bear. You may come out OK but remember if you are unlucky you are in big trouble — the other side of the leverage coin. I’d have a talk with your family about your risk tolerance and be comfortable with what can happen.

    One thing to consider is that if banks continue to be tight with money in conjunction with declining asset values, your only reasonable option may be to have a large downpayment ready — “cash is king.” In such a situation I am guessing it would be as tough then as it is tough now to buy a place; even though prices are cheaper you would never know where and when the bottom would be and you’re still on the hook.

  24. 24
    MacAttack says:

    “Dave0, no such thing as a 30 year fixed rate interest only loan. Did you mean 0% down? IO means you only pay on the interest, and never pay down the principle.”

    My brother has one, and Malcom refers to one at the top of the post (”I came across a fixed 30 year interest only loan…”). This is where the interest rate is fixed for the entire 30 year period, but the minimum payment each month is just the interest.

    A good example is Quicken’s smart30 loan:
    https://www.quickenloans.com/loan_programs/smart30.html

    No, that’s NOT an example of an I/O loan. Have a look at it -it’s I/O FOR THE FIRST TEN YEARS ONLY, then payments RISE SHARPLY in year 11 because you must begin repaying the principal.

  25. 25
    Markor says:

    Malcom, an 8% return can be had only by taking the risk that it may end up being -8% instead. I’d rather have a 5% guaranteed paperwork-free tax-free gain by paying extra principal on my house payment (a gain which is unaffected by what happens to your house value). Even if you do get 8%, it’s only 3% after you subtract the 5% you’re paying on your mortgage after discounting for your mortgage interest tax deduction. That’s 3% for bearing a lot of risk.

    I say don’t bet the house—go for a fixed rate traditional loan, and don’t invest elsewhere, except maybe in a 401K, until you’ve paid it off. Especially since you have kids. (I won’t invest in even a 401K until my house is paid off.) If you really want to take a risk then rent. That may well pay off for the next couple years.

  26. 26
    b says:

    Markor,

    Your advice can be summed up as “put all of your eggs in one basket”, which is a terrible investment strategy.

    As to Malcom, I would suggest getting the largest teaser-rate ARM, no money down loan possible on the largest house you can. Do not make ANY payments on it once you have settled in. If Paulson and the rest of the industry have their way, you will get that 1% teaser rate locked in forever and get a much larger home subsidized by everyone here who is fiscally prudent.

  27. 27
    50%off says:

    Tim, ask Malcolm how much he’d pay to rent the same house. That interest only thing is the same as a rental payment except you can’t just move out with 30 days notice. (Well, you can but there’s that black mark thingy on your credit) It seems that IO is for a limited period of time and once that passes, the new payment will be higher than a regular 30 yr fixed even with the same rate. (cause it’s now amortized over a shorter time period) Let’s not even talk about the market outlook here. That throws a whole nuther wrench in the works.

    If Malcolm ‘must’ buy now, he needs to keep his overhead as low as safely possible (i.e. use that $50k for a downpayment).

    Remember that $90k income is joint. So this means that both HAVE to work. Not good with potential economic problems and/or ‘family additions’

    Life is not quality because one owns a house. Life is quality when one can live without fear.

  28. 28
    jon says:

    I have a 30 year IO that is a fixed rate for 10 yrs. I seem to recall I could have paid extra for fixing the interest for longer, but after 10 years my youngest will be out of the house, so there was no reason to fix the rate for longer. I think the same applies to the original post. If he knows he will sell in about 7, there is no need to lock the rate for longer than that.

  29. 29
    Kime says:

    Anyone who is looking to buy a home, and thinks of that home in any way as a financial investment, should wait. If you wouldn’t mind seeing the home drop by 25 to 50% and not recover for at least 10 years, then you are OK. If you have to get a mortgage and you have it an unbreakable contract with your employer that you will not get laid off or suffer a pay cut no matter how bad the economy gets, then you are OK to buy a home because you will probably still be able to make your payments, even if your home is only worth 80% of what you owe. If you have 10-20% to bring to the table if you have to sell for some reason before the housing prices recover and you don’t mind losing it, you are OK. (This actually happened to my sister-in -law and her husband in California in the last bust, except that of course they did mind losing it and then they had to live with my in-laws for 2 years while they got back on their financial feet.)

  30. 30
    Kime says:

    “Oh, and if you wait 2-3 years until the “nasty stuff plays out”, you’d be latching on to the bottom of the ‘nastiness’. ”

    Do you mean that at the bottom there won’t be anything nice for sale at a reasonable price? If that is what this means, then I have to say I don’t believe it. There will still be nice places for sale, just at a lower price than now. There will probably be plenty of ruins for sale for a while, too, but you don’t have to buy them.

  31. 31
    Jonny says:

    I think buying a house right now is a terrible investment. The main reason to buy one would be in spite of the market conditions. For example, the quality of your marriage may be more important than making a good investment if that’s at stake. If you can be comfortable for a while, I still think prices are going to drop dramatically in Seattle. Not 5%, but I think more like 20-30% and there’s an outside chance of an adjustment more like 30-40%. It’s a terrible time to buy because Seattle housing is an overpriced asset. The question is how important is it to you to own an overpriced asset? If your family happiness is somehow at stake, even a bad investment can be a good one.

  32. 32
    Ubersalad says:

    I am a bit lost Tim. Aren’t you an engineer by trade? Why are you attempting to respond to these questions?

  33. 33
    EconE says:

    I’m puzzled as to why Tim would even bother responding to this guys inquiry.

    Not only does he want to buy…but his primary question seems to be “Am I a good candidate for an I/O loan”

    What would the question need to be to have been instantly roundfiled?

    “Am I a good candidate for a Neg-Am Loan?”

    What kind of advice does he expect to get from a bubble blog? Sounds more like he wants validation…or it was a troll email.

  34. 34
    squidier says:

    It doesn’t feel like a troll email. I think in his guy, Malcolm knows that this isn’t the best idea, but perhaps wants to start off his marriage on the best possible foot. It’s also possible that his fiancée wants a house very much and he might feels some pressure with that. Hopefully, Suzanne didn’t research this.

    Maybe Malcolm was hoping for some rock-hard reasons he could use to talk his fiancée down from the buying precipice.

    Personally, getting married is a big enough decision; I can’t imagine throwing buying a house in this declining market onto that pile at nearly the same time. One mind-harrowing experience at a time, Malcolm!

  35. 35
    Markor says:

    “Your advice can be summed up as “put all of your eggs in one basket”, which is a terrible investment strategy.”

    That’s false. A debt is an egg that you borrowed; it should not be treated the same as an egg that you own. For example, if you invest $x for a 5% risk-free gain, when you owe $x at 5% interest, you will do more work than if you just paid off the debt, for the exact same net gain (0%) and risk. Putting your eggs in two baskets is worse than putting them in one basket every time in that case.

    If you invest in the stock market or some other risky place for a 3% net gain, you’re asking for trouble.

  36. 36
    Mike2 says:

    Unless that $370K home is a fixer in a good neighborhood I have a hard time believeing that any home in that price range could be both turn-key and a good investment at this point in the cycle.

    If you can pick up a moderate cosmetic fixer in a good location at a discount you’ll be significantly better protected than if you buy new construction. Not sure how hard that is to find now in Seattle. Are flippers still buying up fixers in large quantities the way they were earlier this year?

  37. 37
    YUNGLIN says:

    After doing some simple math calculation, I figure putting money in the stock market and use IO loan for fund a house for 30 years is a bad decision.

    Let’s say if you buy a 400k house using 30 yr IO loan and the rate is 6%.

    Every year, the after tax out-of-pocket is about 26,000(interest you paid, plus property tax, minus tax saving) per year. This is the fixed amount you have to pay for 30 years.

    In your income range, for a couple, if you don’t have any house payment, you should be able to save around 27k(or 30% of your income) a year.

    So that’s start our simulation:
    year 0, you have 50 k in your brokerage account. no payment, no debt.
    year 1, you will have 51k (50 + 27 – 26) in your brokerage account, and it make 3.06k after tax (51* 8% * 75%) for you. By the end of this year, you will have 54.06k in you pocket and 400k debt.

    year 2, you will have 55.06k in your brokerage, and it make 3.3k for you, by the end of this year, you will have 58.36k in pocket and 400k debt.

    year 3, you have 62.92k and 400k debt

    fast forward….
    year 30, you will have 342.50k in your brokerage account and 400k debt.

    BUT what if you borrow a 30 year fix loan at 6% and use that 50k to be your down payment??????

    If you do so, amazingly, your yearly payment is 26k which the the same number you get if you borrow a IO loan.
    AND Amazingly, after 30 year, using the extra 1k you saved, you will have 72k in your brokerage account.
    AND Amazingly, you will have no housing debt. You are debt free and have 72k in your pocket. (Sadly, because of the tax saving will be fewer and fewer each year as you pay back more principle and less interest, you might not be able to save 1k per year)

    342.50k cash + 400k debt v.s. 72k cash + 0 debt
    I think the winner is pretty clear here.

  38. 38
    bitterowner says:

    Ubersalad said,

    I am a bit lost Tim. Aren’t you an engineer by trade? Why are you attempting to respond to these questions?

    Uber, do you think a realtor is more qualified to answer?
    Realtor answer: “buy big, no – buy bigger” (cha-ching!).
    or a loan originator/mortgage broker?
    Mortgage broker answer: “yes, I think the largest, riskiest loan imaginable would suit you well”(cha-ching!)

  39. 39
    Bellevue Ave says:

    analytic skills trump self interest

  40. 40
    greenthum says:

    “Life is not quality because one owns a house. Life is quality when one can live without fear.”

    50%off:

    Wow! Great quote! I completely agree.

  41. 41

    Hi Malcom,

    Children are very expensive. The additional income that you’ll be making 5 to 7 years for now will easily be eaten up by all kinds of other family-type expenses that it would be hard to even imagine right now. Let’s not have the diaper cost discussion. Let’s just move right into the money that was allocated to diapers goes right into other things like clothes and shoes and soccer registration fees and school field trips, and oh, do you have a pet? How about an $800 vet bill here and there, and so forth.

    My advice is when you’re ready to commit to becoming a homeowner, qualify for a loan that amortizes at a payment that you can afford. Your additional earnings will go toward all the additional family expenses, let alone the expenses that come with maintaining a home.

    You will want to be able to:

    sleep at night without worrying constantly about money
    have sex with your wife without constantly being resentful about money
    enjoy your kids without constantly seeing them as a financial drain

    The two top reasons why people divorce are money and sex. I say make sure that you and your significant other are aligned with the same values in regards to money and, of course, sex.

    Then it really won’t matter where you live or when you buy. The decisions will flow naturally.

  42. 42
    laxtosnoco says:

    Malcom,

    You’re asking a few of the right questions and some good advice has already been posted. If you read Rhonda’s response and you didn’t understand what she’s talking about, you have some more reading and research to do.

    Personally, I think now is a bad time to buy if you’re planning to be in a property only 5-7 years. Keep in mind that it costs 8%+ to sell when you figure in agent fees and excise taxes. If you put nothing down and prices stay absolutely flat, you would be upside down for 6+ years whether you go I/O or fully amortized.

    Why not rent for a while and save up a 20% down payment? You’ll get a better rate on the loan (just because a loan has lender paid PMI doesn’t mean it is free) and have the chance to see how merging your finances with your new wife works. It’s much easier to see how a combined budget works out when you’re not stretched to make a mortgage payment. Given your combined incomes, it shouldn’t take more than a year to meet your goal. Don’t forget to set aside at least 6 months living expenses as an emergency fund too.

  43. 43
    Ubersalad says:

    I agree and disagree, if you guys are comfortable with an industry outsider offering advices, then so be it. The way I see it, either Tim has too much time (and not so good at work) or not enough of a life. Personally if I am Tim’s boss, I would wonder if he’s performing at what I am paying him =).

  44. 44
    bitterowner says:

    Ubersalad said: “I agree and disagree, if you guys are comfortable with an industry outsider offering advices, then so be it. ”

    Ubersalad,
    It is unfortunate that one cannot get advice or opinions that are divorced from the advisor’s own potential for personal gain, but that problem is certainly not unique to real estate. I do think that it is probably useful to get the opinion of people who have no financial stake in your decision, and as was mentioned above, to seek such an opinion from a RE bubble blog probably means that the person asking the questions is looking for a specific type of answer.

    I have to mention that it is interesting that Ardell is the only other person besides you whom I have seen use the term “advices”,(rather than advice) which she uses regularly in her posts. Are you guys the same person or did you just go to the same school?

  45. 45
    bitterowner says:

    Jillayne said:
    “You will want to be able to:
    sleep at night without worrying constantly about money
    have sex with your wife without constantly being resentful about money
    enjoy your kids without constantly seeing them as a financial drain
    The two top reasons why people divorce are money and sex. I say make sure that you and your significant other are aligned with the same values in regards to money and, of course, sex.”

    Hmmm…good point. I’ve avoided the toxic loans so now I better get off the internet and go take care of business…

  46. 46
    what goes up comes down says:

    Excluding Nostradumb-ss, why oh why would anyone buy now? Is it not abundantly clear that the risk factors are against buying. I find it amazing people can be sold the same old crappy story.

  47. 47
    The Canary says:

    I’m impressed he has $50k saved, but, lets face it, $90k in income between the two of them is peanuts in Seattle and he’s looking at a $370k house. I’m at 6 figures by myself and 300k doesn’t make since for me, without even thinking through the financial crisis we are in.

  48. 48
    bud says:

    Two quick points:

    1) Quicken and Quicken Loans are two completely different companies, having no affiliation other than name.

    2) Anything called a “Smart Loan” probably isn’t.

  49. 49
    Huh?? says:

    I’m amazed at all of the “expert” advice given on this blog. I’m a mortgage loan officer and have been for 8 years. Even I couldn’t give advice to Malcolm with the information he provided. Malcolm should in fact go find a highly recommended financial analyst and sit down with that person to discuss in more detail their short, mid and long term plans financially. That analyst should be able to recommend a good loan officer. That loan officer should meet with both the analyst and Malcolm.
    A mortgage is the largest debt a person most likely will ever have. Go into it with eyes wide open.

  50. 50
    Ubersalad says:

    Why waste time and money to meet with experts? Just email Tim, he’s an expert…a free one!

  51. 51
    explorer says:

    Jonny said,
    “The question is how important is it to you to own an overpriced asset? If your family happiness is somehow at stake, even a bad investment can be a good one.”

    Not when it causes the divorce rate to soar…. If you are doing this to satisfy a nesting instinct, you are doing it for the wrong reasons, unrelated to an investment.

    50%off:
    “Life is not quality because one owns a house. Life is quality when one can live without fear.”

    Are you feeling lucky, are ya, and that Seattle is special?

    Jillyane… (points to nose)

    There are caluculated risks, but only with eyes wide open.

  52. 52
    Markor says:

    “Malcolm should in fact go find a highly recommended financial analyst and sit down with that person to discuss in more detail their short, mid and long term plans financially.”

    I don’t think so. Most financial planners make the bulk of their income from financial products they upsell and that are not the best choices for their clients. Most financial planners give their clients the strong impression that the stock market will average the same in the future as it has in the past (only as far back as just after the Great Depression of course).

    The financial advice young adults need is mostly just this: Be as frugal or ambitious as it takes to live comfortably on no more than 75% of your income, build up a 6+ month emergency fund, buy a house during normal (e.g. not bubbly) times with a traditional fixed rate loan, refinance whenever you can lower the interest payment at no cost, pay off debts in order of highest to lowest interest rate and including your house mortgage before you invest elsewhere, except when a mostly risk-free investment (like a CD) pays a higher rate, and incur no new debt besides the house mortgage (e.g. pay cash for cars).

  53. 53
    The Tim says:

    Excellent summary, Markor.

  54. 54
    alex says:

    “Malcom”, please buy my 1360-sqft house in a prime location in Woodinville. I’ll sell it to you for 320k (it used to be 350k in the MLS, so it fell ahead of Tim’s prediction already). It is a perfect house for a new couple, and great for anyone who is skittish about the market (smaller investment, smaller risk, smaller payments).

  55. 55
    what goes up comes down says:

    Huh?? said,

    “I’m amazed at all of the “expert” advice given on this blog. I’m a mortgage loan officer and have been for 8 years. Even I couldn’t give advice to Malcolm with the information he provided.”

    Surprise, surprise — why would anyone think a mortgage loan officer could give great advice — a loan officer is a clearing house to get loans not much more — I would never ask a loan officer for advice. I would research the loan options first and run the numbers myself the go to the loan officer and Tell them what loan I want period.

    Ubersalad — what is your problem? Too much dressing?

  56. 56
    Chris says:

    I think Malcom’s question is interesting because it shows the mindset of most Americans – “We are going to buy a house, and we are going to stretch to do it.” I think most buyers want the house enough that they are willing to reverse engineer the necessary assumptions to justify it.

    That means that housing prices will be determined largely by incomes and by the amount lenders are willing to lend against an income. Until recently, lenders were throwing money at people like Malcom. Based on the recent “buy for less than a cup of coffee” post, I’d say they still are to a lesser extent.

    However, with the huge losses banks are taking on these loans, they are going to have to rein in lending. And as they do, they will no longer be willing to give Malcom an interest only loan (the problem with the I/O isn’t for Malcom, its for the lender: Malcom isn’t building an equity cushion in case he hits hard times and they need to forclose). As the lending tightens, the prices will come down. Not because folks like Malcom are any less willing to borrow, but because banks are less willing to lend.

    For people on this blog, I think the implication is that buying a home as an investment is a risky proposition, since the ratio of income to home price is going to tighten as lending does. If you intend to buy a home, don’t do it because you think its a sophisticated investment strategy. If your justifications are as complex as Malcom’s, there is a good chance you are trying to rationalize something that doesn’t make much sense.

  57. 57
    TheDexter says:

    Yes, there are fixed rates available with up to fifteen year term and balloon/loan call. Why bother with an ARM when you can lock in at favorable percentage now? As an investment strategy, 8% is aggressive, anticipate 3% and enjoy your house. Live in it…..to live.

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