Seattle Bubble

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?

I’m not one to monopolize the conversation on home prices. In the interest of fairness, I present to you the following counterpoint, which I received in an email today.

Can we please stop all of the doom and gloom?

As you have probably have seen in the news, the real estate market has been going through some big changes, good and bad. Our local market had years of double digit growth that became unsustainable. At the same time as the slow down, lenders were getting hit hard with record foreclosure rates. The driving force behind the problem was a meltdown of the sub prime mortgage market that had been making risky loans.

While many other areas of the country are reeling from all of this, Washington State has held strong with low unemployment and economic growth. Although, the pool of real estate buyers in our area has dried up, buyers from California with all cash offers and high risk loans for buyers with questionable credit scores have gone away the home values are NOT in a free fall as has been reported in some of our local papers. The high inventory is a direct result of the scarcity of buyers due to the stricter lender guidelines, seller’s high expectations and public opinion. Recently a story was printed that the average sales price in Pierce County had slipped twelve thousand dollars yet, in reality, last summer and fall, it was difficult to find a jumbo loan. A jumbo loan is a purchase price over $417,000. The average reported on did not include many of the upper end properties we normally see selling in the late summer, thus greatly pushing down the average. I believe that the average prices on homes under $417,000. have been steady increasing, though not at the double digit rate that sellers have come to expect.

On a positive note, this situation has created new opportunities for investors looking to purchase rental properties that can cash flow now. The rental market is hotter than it’s been in years and the reality is people are working and everyone needs somewhere to live.

Buyers looking to move up from a starter home to a jumbo type property have lots of good properties out there to choose from. Mortgage interest rates have remained low and available for those with good credit and the jumbo programs have started to make a comeback. Analysts are saying that the market is poised to come storming back this spring.

Remember when the high tech stocks crashed, I still scratch my head and wonder why I didn’t buy, buy, buy!

Gregory Loe
Better Properties North Proctor
Tacoma, WA

I think Mr. Loe’s letter speaks for itself.