The housing market: as bad as we think, or worse?

The existing home sales figures released today offer little cause for optimism. Sales fell 2%, and the inventory of unsold homes ticked upwards--there is now enough supply in the housing market to satisfy almost ten month's worth of demand.

A deflationary mindset has entered the market. Buyers are holding out because they think house prices will go even lower, and this is becoming a self-fulfilling prophecy. I've been thinking about buying a house recently, and a number of people have told me that I should wait until it bottoms. Some of them are the same people who back in 2004 were telling me to buy before America ran out of houses.

Trying to time the bottom is a fool's game, and anyway I want to live in the house, not flip it. But as long as most people feel as they do, the housing market will continue to crater.

Indeed, the economists surveyed by the Wall Street Journal suggest that the problem may be even worse than we think, because so many homeowners are holding back from selling until they can get what they think of as a "fair" price--i.e. at least 10% above what they paid for it in 2005. The people who are selling now are the ones who really have to sell, either because they can't meet the mortgage payments or because they have to move to another city. I looked at eight houses last Wednesday, of which two were foreclosures. All of them had been on the market for two months or more. The agent told me about one client who was moving to another city but couldn't sell his condo because he'd have to show up at the closing with a check for $40,000.

Eventually some of those people who are holding onto their houses by their fingernails will have to sell too, into a market where most buyers are demanding super bargains. If you don't have much equity in your house, now would be a good time to tighten the belt and start paying extra on the mortgage.

Comments

Whoa, wait a minute.

If you don't have much equity in your house, now would be a good time to tighten the belt and start paying extra on the mortgage.

Now would be the worst time to do this. Any additional principal payments you make now will be wiped out by the declining price of the property. Your best bet is to make your payment, but only your payment. If some emergency arises that would force you to move or otherwise make it imperative that you dump the house, any additional principal payments you make right now would just be gone. Poof.

Stay as liquid as you possibly can until the crisis has passed. That means not putting cash into the property that you can avoid putting into it.

Posted by Brian | April 22, 2008 3:27 PM

MM,

you're a shill, of, at least, some seriously baa-d financial advice..

Whoa, wait a minute.

If you don't have much equity in your house, now would be a good time to tighten the belt and start paying extra on the mortgage.

Now would be the worst time to do this. Any additional principal payments you make now will be wiped out by the declining price of the property. Your best bet is to make your payment, but only your payment. If some emergency arises that would force you to move or otherwise make it imperative that you dump the house, any additional principal payments you make right now would just be gone. Poof.

Stay as liquid as you possibly can until the crisis has passed. That means not putting cash into the property that you can avoid putting into it.

Posted by Brian | April 22, 2008 3:27 PM

X2

relative housing prices are headed further South..
"Stay as liquid as you possibly can until the crisis has passed." X3

Posted by MEH | April 22, 2008 3:34 PM

That depends on whether you want to walk away, stiff the bank, and end up with a 150 point drop in your credit score that will severely impact your ability to get a new house, or walk away even. Me, I borrowed the money, I try to pay the money.

Posted by Megan McArdle | April 22, 2008 3:50 PM

Isn't there a natural bottom to housing prices - namely, the equivalent market rent? I can't imagine housing prices would fall below the point where the monthly mortgage payment + taxes is below the monthly rent on an equivalent property. The only question is how far above that point the 'bottom' is.

Posted by Independent George | April 22, 2008 4:00 PM

I'm one of those crazy people that thinks you should buy a house, because you want to live in one, and assume that it's like renting with some perks. If you take the amount of money you spend on a house over it's lifetime, you never come out ahead, in money terms, but you may enjoy living there, and isn't that part important? If you eventually get money out of it, well hey, you won the kewpie doll. If not, then was it worth more than renting? Maybe.

If you are in it as a business, treat it that way. If you want to live there, then consider it an investment in yourself, like food. You'll be a lot happier in the long run... IMHO

Posted by SwissArmyD | April 22, 2008 4:03 PM

Waiting for the market to hit bottom before you buy makes good sense, of course, but you have to do two things: (1) stay informed of price trends at all times, using the best possible information, and (2) be able and willing to move very quickly once the bottom's been reached. Changes come quickly and rapidly.

Posted by Peter | April 22, 2008 4:04 PM

You aren't this ignorant, you can't be.

How about, instead of putting that money into a declining asset, where it will almost assuredly lose value, you put it into an online savings account, where it will almost assuredly appreciate? If you must move, you can bring that money to the closing table. Isn't this sort of obvious?

Posted by Somebody | April 22, 2008 4:06 PM

Me, I borrowed the money, I try to pay the money.

If you had initially written that the most moral thing to do right now would be to start paying off your mortgage as quickly as possible, then you'd still be wrong (there's no moral obligation to pay anything but the payment), but at least your above quoted response would have some relevance to what you did write about now being a good time for low equity homeowners to start paying extra on the mortgage.

Posted by keatssycamore | April 22, 2008 4:09 PM

Megan,

The problem would be - let us say you have an extra $500 a month. If you use that to make extra principle payments and find yourself unemployed in 2011, you may find that while you have paid 18,000 towards your mortgage the value of your house has fallen such that there is still no equity. However, had you saved that 18k you might be able to continue paying your mortgage until you find a new job.

Part of the concept of "home as ATM" was that you could also make deposits. Some people made extra principle payments safe in the knowlege that if they got into trouble they could get a HELOC. Now, with a decline in equity, that may be impossible.

Posted by jmo | April 22, 2008 4:09 PM

There's another possible negative feedback loop here worth mentioning (albeit anecdotal):

For the past two years have been sinking money into a couple mutual funds in anticipation of buying a house in the next 24 months.

Now would be a good time to buy, given the decline in housing prices, but on the other hand, the value of my mutual funds has tumbled along with the housing sector, such that I do not wish to sell my shares until the market value has recovered. The problem is, the market value of the fund may not recovery until housing starts show that they're on the wax.

I'm sure I could use those losses to simply offset taxes on future income, but then again, selling those shares at a loss would force me to admit that I made a mistake in not choosing a more conservative investment vehicle.

And I'll live in shitty apartments for the next five years before I do that, goddammit.

Posted by Jeff | April 22, 2008 4:13 PM

That depends on whether you want to walk away, stiff the bank, and end up with a 150 point drop in your credit score that will severely impact your ability to get a new house, or walk away even. Me, I borrowed the money, I try to pay the money.

Posted by Megan McArdle | April 22, 2008 3:50 PM

MM, you should stop wondering why some of your critics are nasty to you..

note that this: "Your best bet is to make your payment, but only your payment. If some emergency arises that would force you to move or otherwise make it imperative that you dump the house, any additional principal payments you make right now would just be gone. Poof."

was in Brian's post..

care to try again?

Posted by MEH | April 22, 2008 4:15 PM

For those of us who have affordable, fixed-rate mortgage payments, wouldn't the best strategy be to just pay the payment and invest any excess cash in something that might beat the after tax ~4% interest rate? (Assuming a 30% federal tax rate, a sub 6% mortgage interest rate and that you're not in the AMT--a farfetched assumption, perhaps.) If you believe that the Fed will choose inflation over recession, then the real after-tax mortgage interest rate may well be less than zero, while the nominal value of the house may well inflate... at least back to what you paid for it.

Posted by Jerry | April 22, 2008 4:19 PM

Somebody: She isn't that ignorant. Assuming that foreclosure is an option to be avoided (as she clearly states above) it's better to put your money into paying off a loan that's set at say 6% apr (e.g. a typical mortgage) than to put that money in a savings account that earns only 3%.

Posted by chas | April 22, 2008 4:20 PM

I've been thinking about buying a house recently

If you want to live in a house, one thing you may want to consider is renting one.

There's bound to be some absentee owner looking for a little extra income and willing to get something rather than nothing while she waits for prices to go back up. For instance, my part of the country has lots of houses for rent for apartment rent prices (same monthly payment but further from town). You get to enjoy the benefits of a house, but fewer of the costs.

Posted by Nelson | April 22, 2008 4:20 PM

Per chas @ 4:20PM McArdle is not as ignorant as some of you claim. Further, avoiding damage to one's credit report in the present yields cheaper loans in the future.

One's cost of funds rises as one reneges on loans. This is simple corporate finance; it applies to man (or woman) as well.

The morality of paying back a loan is not really relevant.

Posted by Dave | April 22, 2008 4:27 PM

what's funnier is that our gracious pro-Carbon tax Hostess is looking for new accomodations, but she never discusses the Economic costs, of her actions, in those terms (energy-usage/intensity)

Posted by MEH | April 22, 2008 4:34 PM

That depends on whether you want to walk away, stiff the bank, and end up with a 150 point drop in your credit score that will severely impact your ability to get a new house, or walk away even. Me, I borrowed the money, I try to pay the money.

Huh? I'm not getting this at all.

If you are strapped to the point where you are near default on the mortgage payments, cutting $100 (or $1000, or whatever) out of the budget so that you could send it in as additional principle would not help you. You'd be better off saving that money, to give yourself cushion in the event of job loss or other personal financial strain.

From the point of view of your house as an investment vehicle, it also probably doesn't make sense. The real return on additional principle is pretty small, and it concentrates your investments in one asset, which happens to be the asset that holds the most weight in most people's portfolio.

Posted by Brad L | April 22, 2008 4:36 PM

One's cost of funds rises as one reneges on loans. This is simple corporate finance; it applies to man (or woman) as well.

Dave, why do you think this is about "reneging on a loan"?

Tightening the belt and paying extra on the mortgage each month is what Megan advised. Others have advised making just the payment and not a dollar extra.

Neither implicates credit reports or foreclosure or renenging. However, one is sound financial advice and the other is not so smart.

Posted by keatssycamore | April 22, 2008 4:36 PM

Dave & Chas,

If you are worried about saving your credit the best thing you can do is try and save as much money as you can. Your credit won't be impacted if you are out of work for 6 months if you have six months in savings.

If you use that six months of savings to prepay your mortgage and get laid off then you're SOL. Your credit takes an even bigger hit as you will be in forclosure in addition to being behind on all your other bills. If you had just kept that money in savings you could stay current on all your bills.

Posted by jmo | April 22, 2008 4:38 PM

Dave & Chas,

If you are worried about saving your credit the best thing you can do is try and save as much money as you can. Your credit won't be impacted if you are out of work for 6 months if you have six months in savings.

If you use that six months of savings to prepay your mortgage and get laid off then you're SOL. Your credit takes an even bigger hit as you will be in forclosure in addition to being behind on all your other bills. If you had just kept that money in savings you could stay current on all your bills.

Posted by jmo | April 22, 2008 4:38 PM

X2

Posted by MEH | April 22, 2008 4:46 PM

One should always have a reserve for bad times, but once this is taken care of, the only relevant question in regards to paying extra on the principal is this: what would you do with the extra money otherwise? If you have options for investing it that pay a relatively certain, higher return than the net interest you pay on the mortgage (accounting for the interest deduction, of course), then paying off early isn't worth it- it costs you money.

If you are worried that you might have to sell the house at a lower value in the near future, you shouldn't have bought a house in the first place.

As for Megan's question about whether now is the time to buy, who knows. If I were in the market to buy a house now, I would be tempted to wait a bit longer- I do think prices have farther to fall, but they may not fall quickly, so one could be waiting a while for the bottom. However, nothing prevents you from making offers today, you may even make the right offer to someone willing to drop their price significantly in order to sell.

Posted by Yancey Ward | April 22, 2008 4:49 PM

Your credit won't be impacted if you are out of work for 6 months if you have six months in savings.

Having 6 months (or more) of liquid savings is a good idea for all people regardless of their home ownership status. The investment type decisions should come after that safety net is established. Assuming the "rainy day" savings are in place, and the credit cards are payed off, etc... I see nothing wrong with Megan's proposal. Paying off debts will usually (though not always) give a higher rate of return than any other guaranteed investment.

Posted by Nelson | April 22, 2008 5:01 PM

Maybe it depends on where you are. I know in AZ where there are a lot of new developments with hundreds of for sale signs the realtors have resorted to playing games to keep the house price (more so than usual).

Many houses are listed 20k or more below a price that they will actually sell it for. As in the list price is 200k and if you offer 200k they will reject it in the hopes that you and the other people they rejected will get involved in a bidding war.

Is this happening elsewhere?

Posted by sam | April 22, 2008 5:03 PM

The general order if you are strapped for cash/in a financial bind is:

Pay off highest interest rate items first:

Pay off lower interest rate items later:

Invest when investment returns exceed the interest on loans remaining or there are no loans left.

Mortgages are generally the last thing anybody should pay extra on if they are close to the edge. If you have 6 months of cash in the bank/CD's and you already have your credit cards paid off, and you have an ARM or a HELOC then sure, consider making payments to principal. On the other hand, if you have these things you aren't in a financial bind are you.

I would make minimum payments and wait. More than likely one or more of the following things will happen:

Interest rates will fall to the point that you can re-finance the house at a lower rate IF your credit rating is good

The housing market will rebound

The government will come up with some sort of snake oil program that will probably benefit you only if you are under deep water, and will screw you if you tried hard to make extra payments

Posted by Eric Gagen | April 22, 2008 5:03 PM

"Assuming that foreclosure is an option to be avoided (as she clearly states above) it's better to put your money into paying off a loan that's set at say 6% apr (e.g. a typical mortgage) than to put that money in a savings account that earns only 3%."

The assumption is that the extra principle that you put in will allow you to sell and payback the loan. If the extra principle is not enough to do this you have wasted all of that money.

FWIW, I don't think that you'll need to time the bottom all that well to get a good deal. You may pay a few percent higher than if you timed it perfectly (more a matter of luck than anything), but the bottom will likely be a U and not a V. This would follow the model of the housing busts of the 80's and 90's. Or NASDAQ which stayed at the bottom for a year, and still hasn't come close to the previous peak.

Posted by JordanT | April 22, 2008 5:04 PM

If you're in the market for a house right now, then you certainly will not be timing anything, or buying with the intent to flip!

Given that the natural price floor is historic rent/price ratio, I expect dramatic further declines, although claiming that an inevitable reversion to the mean is "cratering" is nonsense. If you don't care, then by all means, buy a house.

Posted by winterspeak | April 22, 2008 5:09 PM

The problem Megan poses is multi-dimensional. Morality is one dimension (will you go to hell? will you sleep at night? etc). But, leaving that aside, there are many more dimensions and variables to take into account.

Blowing your credit score may have costs. True enough. But before crunching to continue paying a mortgage, let alone building equity with extra payements, one ought to look as many steps ahead as possible. Say you bought a house in 2006 with zero down. Now you are underwater, more or less, depending on where you live. Should you rush to build equity by putting extra money in? That depends on more factors:

Will putting more money in now save your "owenership" of the house? What if it is your last $50,000 it would bring you to a 10% equity position in the house, but you thought the market could drop another 20% in the next two years? And what if you think there is a 50% chance you will need to move for your job in two years? What then? You might get stuck with a ruined credit score anyway AND lose your $50,000.

Continuing to make the mortgage payments is one thing, increasing equity to bring down payments when you will stay in the house long term is another, and putting more equity into a house you may lose anyway is a third thing, and wouldn't be wise.

There more possibilities than these, too.

One general lesson of all this is that the housing crash (which was caused by the boom, which was caused by greed in unregulated credit markets, etc) has the added social cost of gumming labor markets, screwing up family life, discombobulating financial planning for the future, etc.

Posted by joe shmoe | April 22, 2008 5:19 PM

Hmmm should I feel like a jerk for hoping house prices keep dropping? I'd like to afford one someday.

Posted by LnGrrrR | April 22, 2008 5:23 PM

There's a strong argument that the bottom will likely be more of an L than a U or a V - dropping some more and then remaining more or less flat for several years while inflation brings house prices back in line with income and rents. That reallignment could happen entirely through an actual drop, but then prices would then have to drop more than the 20-30% on average most people seem to expect. An L shaped recovery is probably the softest landing the housing market can hope for.

Posted by Kathryn | April 22, 2008 5:24 PM

There's a strong argument that the bottom will be more of an L than a U or a V - dropping some more and then remaining more or less flat for several years while inflation brings house prices back in line with income and rents. That reallignment could happen entirely through an actual drop, but then prices would have to drop more than the 20-30% on average most people seem to expect (winterspeak's point). An L shaped recovery is probably the softest landing the housing market can hope for.

Posted by Kathryn | April 22, 2008 5:28 PM

I don't want to hijack Megan's thread, but as long as we are talking about housing markets and credit ratings and stuff, maybe somebody could answer a question for me:

I want to buy a house, but I'm not in a big hurry, and I'm waiting for a good bargain to come along. In my area, the current asking prices for acceptably nice houses are about $300,000 (But I don't know what the actual selling prices are). I have about $150,000 sitting in the bank (and earning very little interest), but I also owe about $50,000 in *low-interest* credit card loans ( ranging from ~5% to 7%.)

My question is: Should I pay off those credit card loans now? Will the existence of those loans give me a 'bad credit rating' and hence higher mortgage interest rates if & when I do find my dreamhouse?

Posted by john w. | April 22, 2008 5:52 PM

I think people should have 1 year savings, rather then just 6 months. Also all credit cards always paid off at the end of the month. The only debt you should carry is your house loan.

Posted by FreedomLover | April 22, 2008 5:53 PM

"increasing equity to bring down payments"

Does anyone actually have a mortgage that does this? I mean, other than (in an indirect manner) payment option loans. I've never seen the mortgage loan that reduces payments b/c the principal is reduced; that's accomplished by re-financing.

Megan's scenario is of a semi-forced sale for a price below the payoff amount of the mortgage. As many other have pointed out, the best strategy to avoid that is NOT making extra principal payments, but rather having cash available to make up the shortfall.

Sure, the net return on the cash is probably going to be somewhat lower than the net return on avoided mortgage interest, but the cash is a lot more useful--it can serve the same purpose of facilitating a sale by paying off the mortgage or it can allow you to rent the property at a loss for a period while prices recover or it can be used for hookers and blow as you descend into chapter 7. There's really very little to recommend making (significant) additional principal payments in the current market, unless one is very stable both locationally and financially.

Posted by zaleriana | April 22, 2008 5:58 PM

I think people should have 1 year savings, rather then just 6 months.

Lots of people wish for nice things, but in practice, six months is a lot more realistic, and is plenty of time to scour the job market for positions. If an experienced professional cannot find another job in six months, there's a good chance his or her field won't be in high demand for a long while, and s/he should contemplate a career change. Meanwhile the extra six months' worth of savings, if s/he actually has it, would do better service in a 401(k) or IRA, since it enters tax free and could always be withdrawn early (less the tax penalties) in the event of a genuine crisis.

Posted by aMouseforallSeasons | April 22, 2008 6:01 PM

John W. er, yeah, Pal do yourself a favor and get the old calculator out and run the numbers... Are you getting a higher return on the savings than on the amount you are paying in interest? Essentially that money in the bank is going to pay the interst in those cards no matter how low they are. Clear the cards, get rid of any that you don't really need, and then let your bank account grow. Even 0 bal cards will count against you up to the amount you can use on them for the mortgage loan, so only keep the ones you need. Get as short a term on the mortgage as you can.

Never forget that the extra money you pay to other people to use THEIR money is GONE. The fewer loans you have the more you can save, because every dollar of that is yours.

Really, really, really, most of these questions are quite easily done if you sit down and look at the real math.

Posted by SwissArmyD | April 22, 2008 6:27 PM

John w.,

First, pay off the credit cards but don't close the accounts. In general, the more credit you have available, but don't use, the better.

Second, don't put down more than 20% - put down just enough to avoid PMI. I had a buddy who wanted to use all his savings (about 120k) as a downpayment. I warned him that if he did that and got laid off he might not be able to tap his equity to bail himself out. Better to keep that cash liquid to protect yourself.

Also, if you are not maxing out your 401k you really need to be doing that.

Posted by jmo | April 22, 2008 6:40 PM

You can reduce your payment on a mortgage loan by paying towards principle, its called recasting and most lenders give you the option of doing it once in the term of your fixed loan. That doesn't make it prudent in most cases given the relative returns on those dollars. The simple math suggests that you should optimally choose between no mortgage at all or leverage your home to the max. The middle ground is not clear and people in that area rarely make the optimal decision.

Posted by beenthere | April 22, 2008 6:43 PM

since most of the basics are well covered, peep need to aware of the options in their 401(k) programs..most of those programs are 'long' biased, which can be fine, but, that Asset should also be "Insured", like, on a House, Car, Life--

There are many ETFs, currently trading like 'Stocks', that allow one to hedge/insure their 401(k) exposures

Posted by MEH | April 22, 2008 6:55 PM

The existing home sales figures released today offer little cause for optimism. Sales fell 2%, and the inventory of unsold homes ticked upwards--there is now enough supply in the housing market to satisfy almost ten month's worth of demand.

Starts and permits are dropping quite a bit faster, though. The case for optimism, I suppose, would be if the inventory of unsold homes is ticking upwards because people are finally putting their houses on the market/putting them back on the market, and beginning to accept reality. After all, the inventory was even higher-- 10.5 months-- in October, and then declined apparently because of people taking their homes off the market rather than accept the market value, rather than because of homes being sold. (And perhaps people taking homes off in the winter, though don't they seasonally adjust statistics?)

The sale price/rent ratio is pretty different in different parts of the country. I believe that it has to be somewhat relevant, even if it doesn't go back to exactly the historical average.

Posted by John Thacker | April 22, 2008 6:55 PM

" ... Pal do yourself a favor and get the old calculator out and run the numbers... Are you getting a higher return on the savings than on the amount you are paying in interest? ..."

I understand what you are saying. There is one other consideration though (that I left out of my original post in the interest of simplicity): There is a *slight* chance that I might be able to find a 'fixer-upper' for $150,000, in which case -- as long as I still have my entire $150,000 in the bank -- I could avoid a mortgage altogether. But once I pay off the credit cards and only have $100,000 in cash, the chance of avoiding a mortgage becomes absolutely Zero.

Posted by john w. | April 22, 2008 7:04 PM

zaleriana -

Adjustable rate mortgages will adjust the monthly payment. The adjustment usually happens once per year and is based on the interest rate AND what you still owe. Paying off the principal early a good way to make sure your payments either go down or at least don't increase as much if interest rates rise.

Posted by Nelson | April 22, 2008 7:12 PM

Of course, that "silver lining" is that it may be improving, but only if the existing ten months inventory has been underestimating the actual supply-- which it probably has.

Posted by John Thacker | April 22, 2008 7:13 PM

john w,

Pay off the 50k, take out a 100k loan + 100k cash to buy a fixer upper and fix it up.

Your monthly payment will probably be about 600/mo. And you'll have over 50% equity in the house.

But if it was me I'd shift that money in and out of various stocks and make an extra 1500+ (not too difficult when you're playing with 100k) a week on it.

Posted by sam | April 22, 2008 7:14 PM

But if it was me I'd shift that money in and out of various stocks and make an extra 1500+ (not too difficult when you're playing with 100k) a week on it.

Playing games like that is the last thing you want to do with your money before a big purchase. You can easily loose $1500 per week as well.

Posted by Nelson | April 22, 2008 7:25 PM

A couple things here.

First of all, making extra principal payments on your mortgage is almost always a bad idea. Mortgage interest is generally the lowest you can pay and it's tax advantaged as well. If you've got extra money each month, it's much better to put it in a more liquid investment in case of emergencies. On top of that, over the long term, a fairly safe index fund should out perform the rate on your home.

Second, if you have little equity now it makes even less sense to try to pay extra principal to try and build equity. Home values are still in free fall and if you experience a downturn you could lose your home and all the extra equity you poured into it.

Posted by Chuchundra | April 22, 2008 7:40 PM

Tapping your 401(k) is is one of the worst financial mistakes you can make. There are huge tax penalties, and worse, it takes money dedicated for your retirement and uses it for day-to-day expenses. Really bad advice, unless you want to be impoverished when you're old. If things are so bad that you have to tap a 401(k), you might as well consider bankruptcy--maybe you'll have some of your retirement savings left over in the end.

But Megan's idea to prepay your mortgage if you fear your short-term financial future is even worse. Almost as bad as borrowing against your home equity to pay off credit cards. As others have pointed out, you're better off with a six-month cushion of savings, rather than making early payments on your mortgage--if your lender even allows what Megan advocates, most don't.

And who in the world would get an adjustable rate mortgage, like one of the comenters suggests--at a time when interest not only are near historic lows, but really can't go that much lower. This person is financially brain dead.

This is some of the worst financial advice I've ever read. No wonder the country's in a housing/credit crunch.

Posted by Bluey | April 22, 2008 7:42 PM

And who in the world would get an adjustable rate mortgage, like one of the comenters suggests--at a time when interest not only are near historic lows, but really can't go that much lower.

I did. A few years ago. The fixed portion was 4.75% for 7 years. After those 7 years its LIBOR (1 yr) + 2.25% (but no more than 9.75% max). If it adjusted today, it would be about 5.25%. If I had gotten a fixed rate, it would have been 6%. The extra money saved each month I put into principal.

Posted by Nelson | April 22, 2008 8:26 PM

Assuming that a bad mark on your credit is going to make a difference in 5 years is a bad assumption. Too many people are going to be in bad shape for it to make a real difference. The models used to model payback rates are going to have to use this as an input, and it will not end up being that bad for someone.

I recommend walking away sooner rather than later. IF you walk away in 2008-2009, you will be able to get a good loan in 2011.

Posted by mickslam | April 22, 2008 8:41 PM

Re: That depends on whether you want to walk away, stiff the bank, and end up with a 150 point drop in your credit score that will severely impact your ability to get a new house, or walk away even.

Megan, assuming you can find a buyer, there's always the possibility of a short sale (meaning you sell for less than you owe and the mortgage holder agrees to sign off for that amount). This is becoming rather common in cases where people do need to sell and are upside down. Mortgage holders are accepting it because they know the alternative is jingle mail. A change in the tax laws has also made this a viable choice (there will be no tax liability for debt amnesty provided you are short-selling a principle residence).

Re: The only debt you should carry is your house loan.

Ideally, yes. But for most people a car loan and a student loan will also be necessary. Yes, cars lose value-- but they provide you with a vastly larger job search market (and other useful thinsg too). A college education is almost a prerequisite for any sort of middle class life today. Few people can afford eiter a car (even a decent used one) or a college education without borrowing-- though I did manage to avoid borrowing for the latter due to a unique set of circumstances in my life. But one must bow to reality in these things.

Posted by JonF | April 22, 2008 9:05 PM

Mickslam is right about the impact on credit scores. It's not going to mean as much to have a foreclosure on your credit score as it does now, nor will the social stigma be as great, when there are this many people that are having it happen to them. There's a significant chance that a foreclosure won't even stay on your credit report, at least not in certain situations.

Posted by Rez | April 22, 2008 9:10 PM

Tapping your 401(k) is is one of the worst financial mistakes you can make. There are huge tax penalties, and worse, it takes money dedicated for your retirement and uses it for day-to-day expenses. Really bad advice, unless you want to be impoverished when you're old.

I wasn't suggesting it should be the first choice. But if you are worried about a remote possibility of needing more than six months' savings to cover an emergency, the solution is not to keep a year of savings. There are better investment vehicles that money should be sitting in, and a retirement account is one of the first that most people should be contributing to.

Few people can afford eiter a car (even a decent used one)...without borrowing

Depends what kind of car you're after and how prepared you are to perform your own routine maintenance. In my case, I did end up needing a loan to replace my car last year, but I was able to find a good-condition vehicle on Craigslist, go through my bank's lending arm, secure the loan against the vehicle, and pay some of the upfront ownership costs with cash-on-hand. That put me at just under 9% interest with a $150/mo payment for three years, no prepayment penalty, and I don't have to deal with a shark if something bad comes down the pipe between now and the payoff date.

Posted by aMouseforallSeasons | April 22, 2008 9:49 PM

Mouse, why did you have to borrow that incredible amount ($5,400) especially at 9%? You should have cashed in your 401(k)like you told every one else to do.

By the way, are you poor?

Posted by Roger Dodger | April 22, 2008 10:55 PM

This isn't a housing crisis. It's a supply-demand imbalance caused by a financial crisis. The whole banking system was just rattled. A substantial part of the population of potential buyers have been disqualified by the tightening of credit standards. Prices will fall until many of them are once again qualified. If experience is any indicator, the Congress is about to exacerbate the problems.

Posted by wGraves | April 23, 2008 12:26 AM

Tapping your 401(k) isn't the worst financial decision you could make. Paying off the mortgage isn't the worst financial decision you could make.

The worst financial decision you could make is consistently spending more than you make. It's not that hard to pay off the credit card if you make that a real goal. Most people take an "Eat, drink and be merry, for tomorrow we die" attitude. The downside to this philosophy is we're usually still alive tomorrow.

Posted by Nelson | April 23, 2008 9:32 AM

Megan,

I'm not going to snark on you. I'm going to give you some advice. If you plan on living in your home for more than 5 years, don't worry about buying at the bottom. Prices have come down to reasonable levels, and interest rates are low. This is unusual. Usually when interest rates are low, prices are high. When interest rates go up, prices usually come down. We saw interest rates go up and housing prices stay high, like they were hanging off a cliff. Now they have taken their predictable plunge.

Really, the most important thing for you is to know your FICO, know how much you can borrow, and get your loan locked in with the lowest possible rates. So don't buy right now if you think Helicopter Ben will lower rates again. In 5 years this crisis will be over and housing prices will rebound (depending on your market, remember all real estate is local!).

If you are bargain hunting, you may want to look into REO properties.

Posted by freddiemac | April 23, 2008 9:52 AM

Life in the bubble - here in Boulder, CO housing is as tight as ever, offers coming in above asking price, closings getting scuttled at the last minute because of higher offers... Alas, that only applies to single family homes. Townhouse owners like me are stuck in flatland.

Posted by Derek Scruggs | April 23, 2008 4:02 PM

The advice MM gave was to pay extra on your mortgage if you don't have much equity. Not if you are in financial distress. Not as a generally good idea.

The reason to do this is to avoid being upside-down in your mortgage (i.e. having negative equity). Being upside-down sucks because it severely reduces your flexibility: you can't sell your house unless you have cash handy to close the gap between sale price (after closing costs) and your mortgage amount. Sometimes you need to sell your house because of financial distress--exactly when you don't have the cash to get out of an upside-down mortgage.

In short, MM's advice (avoiding upside-down mortgages) is simple financial conservatism, akin to having 6 months living expenses, often overlooked but important in this housing market.

Posted by Anno | April 23, 2008 4:16 PM

Megan - buy the house. Enjoy it. Pick a good mortgage - fixed rate means you'll be paying the same 20 years from now. Try that with rent.

If you decide not to buy, rent my house and I'll buy one. I may be on the wrong coast though.

I'm pretty impressed by sam. Jeff has already admitted that he's too stubborn to admit he put his $$$ in an inappropriate short-term investment. sam does him one better and claims that it's actually appropriate! Whew.

But the cake-taker is john w (to whom sam was responding). He suggests that it's worth having credit card debt because someday, maybe, he can avoid getting a mortgage?!?

Short-term cash goes to money markets. Or, for the paranoid, to CDs.

If you really want to time the market, volume, not price, is the key. Or so I've heard.

Posted by jwg | April 23, 2008 7:45 PM

Anno - Being upside-down sucks because it severely reduces your flexibility: you can't sell your house unless you have cash handy to close the gap between sale price (after closing costs) and your mortgage amount.

This makes no sense to me. If you have the money to pay down your mortgage so that you weren't upside down, you'd also have the same money if you put those same payments in a mutual fund or gold. Interest rates are low. Borrow if you can do it cheaply.

Posted by Ryan W. | April 24, 2008 1:33 AM

"For the past two years have been sinking money into a couple mutual funds in anticipation of buying a house in the next 24 months."

With that short a time frame, you shouldn't have been investing in anything but a money market or CDs.

"Pick a good mortgage - fixed rate means you'll be paying the same 20 years from now."

Your property taxes will keep going up though. I pay almost as much in property taxes as I do in mortgage interest -- one of the perks of living in NJ.

Posted by Fred | April 24, 2008 3:00 AM

Ryan W. - If you have the money to pay down your mortgage so that you weren't upside down, you'd also have the same money if you put those same payments in a mutual fund or gold.

This is true. Nevertheless, paying extra to make sure you don't get upside-down in your mortgage has certain advantages.

First, sitting on a pile of money equivalent to your negative equity seems pointless. You can't really take any risk with it (since the reason you have it at all is so that is available in a surprise crisis), so you will get a low return - probably about the same or lower than your mortgage rate (even after taking taxes into account on both sides). Even if you do come out a little ahead, is it really worth the headache of tracking it all?

Second, a big pile of money is tempting. Half the reason why people think home ownership is a financial winner is that it forces them to save more than they would otherwise; $20k in cash changes your spending patterns a lot more than $20k in home equity. Most people wouldn't treat -$20k in equity and $20k in cash as equivalent to $0. Paying extra to eliminate negative equity solves this problem.

Posted by Anno | April 24, 2008 8:28 AM

First, sitting on a pile of money equivalent to your negative equity seems pointless.

Unless you are trying to buy some rice.

Posted by keatssycamore | April 24, 2008 5:10 PM

Fred caught me. I should have known better. My aunt had to sell a great house in Florida a few years ago because her family couldn't (or didn't want to) afford the property taxes anymore.

I'm from California. Property tax rises are capped to 2%/yr, thanks to Prop 13. My parochialism was showing.

Posted by jwg | April 24, 2008 6:24 PM

"I've been thinking about buying a house recently, and a number of people have told me that I should wait until it bottoms...Trying to time the bottom is a fool's game, and anyway..."

The best strategy is to wait until prices begin to turn up. Housing prices don't turn on a dime, values will climb very slowly at first so there's no rush to buy. You may not get the rock bottom price, but it's better than trying to catch a falling knife.

"Isn't there a natural bottom to housing prices - namely, the equivalent market rent?"

Very interesting article on that here:
At the real bottom in real estate cycles, you can buy a house or apartment and rent it out at market rates--and make a profit on day one in cash-accounting terms.

If you can't rent the property out for a profit from day one, it isn't the bottom.

http://www.oftwominds.com/blogapr08/RE-bottom4-08.html?ref=patrick.net

Posted by booch | April 25, 2008 7:46 PM