It’s Not About The Monthly Payments
Yes Virginia, housing prices are officially insanely high right now. The amount of price increase we have seen is recent years in clearly unsustainable, and many people are overpaying at the moment. The recent surge in prices is, however, part of a natural cycle of relatively flat housing prices followed by a sudden jump. This has happened before, and it will happen again. The price surge in the late 70’s and early 80’s was the previous run. Unfortunately, people who do not know what is going on can get themselves in big trouble by assuming current conditions will last forever.
The big problem is that a house costs so much that people stop thinking about it as a $500,000 house, and just look at the monthly payments. This is a huge mistake. When the house loses 5% of it’s value, you still will be on the hook for that $25,000. It’s not about the monthly payments, A clever loan officer can make the monthly payments, at least for the first year of a 30 year mortgage, any number they want, but that doesn’t mean you can afford that house.
There was very scary cover story in Business Week about toxic mortgages recently. With brokers getting less concerned about defaults, and more creative in their lending practices, people are taking on much more house than they can afford. Since this is a home, people are likely to figure out how to keep the payments up for a while, but with interest rates rising, yes these are variable rate loans, defaults are going to start increasing.
So how can you figure out how much house you can really afford? The best idea is to figure out what it would cost to buy the house with a traditional 30 year fixed loan, if you can’t afford that monthly payment, then you can’t afford that house. If you can’t put at least 10% down, then you can’t afford that house. This isn’t to say you should take a 30 year fixed mortgage. I have a 5/1 ARM, but I could afford to pay for the 30 year fixed, I just decided it was better to take the lower interest rate for now. I can always refi later.
My gut says that housing prices are likely near a peak, and at the very least price appreciation will slow way down. Never chase a market that had a good run recently, things get priced assuming the current huge price increase will continue forever, and it won’t. Be patient, wait for the market to turn. In three or four years people will be expecting housing prices to stay flat or decline forever, such is the herd mentality of a market.