patrick.net

Excellent article.

If everyone walked away the problem would be solved, and the debt based ponzi scheme that steals wealth from the young, and transfers it to the old would collapse.

Patrick, from a housing point of view, you and Irvine Housing Blog are my heroes, and the reason that I was able to strategically default on my own mortgage.

I like to think of myself as a rational person, and after being influenced by your logic, how can I continue to pay for an overvalued investment.

Thank You.

"Try walking into a bank and asking for a loan to pay your rent. You know what the answer will be. So why is it that the bank will lend us vast amounts of money to take out a mortgage and take on expenses that will be much higher than rent for the same place?"

As we've hashed out so often, home buying can make sense even if PITI is higher than the monthly rent, since historically, buying has allowed people to front-run inflation. Every decade since the 1940s has seen significant inflation. 1950s -- 20%. 1960s -- 25%. 1970s -- 100%. 1980s -- 60%. 1990s -- 30%. 200s -- ~20%.

And once the place is paid off, the cost of ownership will be much smaller than renting, even without inflation.

So analyzing the rent vs. buy requires a rather sophisticated model and a lot of guesswork about what's going to happen in the next several decades.

But to answer the question, the loan is secured by the property itself. This historically has been as "safe as houses".

Of course, widespread abuses of new bubble lending "affordability" products -- and the transient income booster all this bubble activity generated -- propelled the housing market past all sanity 2004-2005, and we are still in the shadow of that.

Whether renting and saving the difference is a better strategy now is an unknown. Equity investments did see some good bull markets starting in 1980. $1 invested in 1980 would have appreciated to $5 in 1990, and $25 by 2000, a stupendous return. But for the 2000s, the picture is not so nice, the market has lost ~10% since 1999.

"So we have the Fed printing cash to buy up those bad mortgage bonds – which weakens everyone’s wealth by inflating the currency – to get the banks off the hook."

Anybody talking about the macro picture of the dominant economy of the world really can't make any definitive statements about how X is going to do Y to Z. Nobody Knows Anything, really.

While the idea of keeping the banks "on the hook" for their egregious lending seems of high probity, what that really means is a trillion or three of people's savings will be going up in smoke, kinda like the bank scene in "It's a Wonderful Life".

Prices are now back to 2003 levels but mortgage debt is still +50% what it was back then:

http://research.stlouisfed.org/fred2/series/HHMSDODNS

$10T vs ~$6.5. That implies a rather serious debt overhang that we have to deal with. Mortgage interest rates have been pushed a lot lower than 2003's levels, from the high 5s to the low 4s, and there have been various refinancing programs put in place to lower the rate and effective debt burden even more.

"There is a feeling of terror that if house prices were allowed to be set by the unmanipulated free market, all consumer spending would stop and a permanent deflation would take hold. "

The core challenge facing us now is that the entire system

http://research.stlouisfed.org/fred2/series/TODNS

was allowed to go parabolic. The money has already done been printed, by the banks. The Fed's tight money policy in reaction to the 1929 crash-boom gave the world the Depression and mass unemployment that makes today's difficulties look good.

Andrew Mellon's "Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate . . . purge the rottenness out of the system!" sounds good, but it was easy for him to say since he was a multi-millionaire.

There will be real introduced costs if we choose GD2 over QE2. Patrick might be safe in a semi-fortress area like Menlo Park, but much of the country might in fact get quite "unruly", shall we say.

Good job Patrick.

I must admit, I'm surprised you wrote for the Christian Science Monitor.

“Try walking into a bank and asking for a loan to pay your rent. You know what the answer will be. So why is it that the bank will lend us vast amounts of money to take out a mortgage and take on expenses that will be much higher than rent for the same place?”

I agree with Patrick 99% of the time, but this claim doesn't work for me. If you default as an owner, the bank can take your home. Whether they loan it out for the true amount and what that amount should be is another story. If you default as a renter, there is not collateral to be gotten. If your credit is really good and if your limit is high enough on your VISA, theoretically you could pay your rent with a credit card or credit card checks.

Moved back to the states after 14 years abroad. Obviously, I decided to rent while I see prices plummet. Next week I'm moving to a much nicer house for the same rent, as a result of a very troubled house owner that had to move. Still now, in late 2010, people look at me funny when I mention I'm renting. Rather than explain, I mention Patrick's website, but some people still come back with the conviction that there's something wrong with me.
This CSM article is great. It shows credibility and is short enough that people may actually read it all before dismissing it as nonsense. Good job.

Well done, which other newspapers should be target for a hard-hitting opinion article?

Troy says

So analyzing the rent vs. buy requires a rather sophisticated model and a lot of guesswork about what’s going to happen in the next several decades.

Exactly right. And that's what makes such calculations difficult. Additionally, you have to factor in that after 15 or 30 years (depending on the loan) you do own the house. No rent. There is value in that.

Troy says

And once the place is paid off, the cost of ownership will be much smaller than renting, even without inflation.

So analyzing the rent vs. buy requires a rather sophisticated model and a lot of guesswork about what’s going to happen in the next several decades.

Not around me. Even completely paid off, it would cost more in property tax, maintenance, and foregone interest to own than to rent the same thing.

I say don't worry too much about the long-term guesswork. Concentrate on the cash flow right now. If you win every month, you win. No one really knows the future, but we do know the present.

Well done Patrick! As GiR said above - its refreshing to see common sense being presented so earnestly. Comments appear to be civil even in disagreement.

If I haven't thanked you in a while - here another one for creating this site and saving me from the mortgage trap I was heading for 3 years ago.

Not around me.

Menlo Park is *really* an exception, one of the handful of true fortress communities. It's where damn near every Googler wants to end up and plenty of houses are simply going to be off the market forever thanks to Prop 13.

Additionally, you have to factor in that after 15 or 30 years (depending on the loan) you do own the house. No rent. There is value in that.
There's also some negatives:
1. If you had children, you own a house that has a lot of 'extra' space that is no longer needed. This adds to utility and ongoing maintenance costs. Not to mention taxes (exceptions, cough, cough, of course for Prop 13er's). Sentimental attachments are not going to cause a renter to make bad financial decisions.
2. A lot of your wealth is tied up in the house, which, on average, is an inflation hedge. Admittedly, this can be a net positive if it coincides with retirement objectives, but it is also a large amount to be invested in real estate.

Troy says

And once the place is paid off, the cost of ownership will be much smaller than renting, even without inflation.
So analyzing the rent vs. buy requires a rather sophisticated model and a lot of guesswork about what’s going to happen in the next several decades.

Not around me. Even completely paid off, it would cost more in property tax, maintenance, and foregone interest to own than to rent the same thing.
I say don’t worry too much about the long-term guesswork. Concentrate on the cash flow right now. If you win every month, you win. No one really knows the future, but we do know the present.

Yes, it is a bit more complicated than 'rent equivalent for less' but Patrick's rule of thumb is a very, very good one. The value of this rule of thumb is evidenced by the awkward machinations required to justify a mortgage PITI that exceeds equivalent rent: i.e. one MUST calculate a 30 year timeline, make assumptions about tax benefits that are often over-stated, etc.

pkowen says

Yes, it is a bit more complicated than ‘rent equivalent for less’ but Patrick’s rule of thumb is a very, very good one. The value of this rule of thumb is evidenced by the awkward machinations required to justify a mortgage PITI that exceeds equivalent rent: i.e. one MUST calculate a 30 year timeline, make assumptions about tax benefits that are often over-stated, etc.

What struck me about Patrick's article was how straightforward and logical it was. Whenever I see an argument trying to justify a debt-based housing market, it is always complex.

pkowen says

but Patrick’s rule of thumb is a very, very good one.

Doing some more noodling in Excel, I can see that for Patrick's case renting does make more sense in most scenarios, but it's really sensitive on certain variables.

The current MP median is ~$1M, and that's a lot. Event with a 3.5% 15 year 20%-down mortgage the total cost-of-ownership is going to average $2000/mo over the 15 year life of the mortgage.

If Patrick can rent that place for $2000/mo for the next 15 years, and his investment yields are 4%, then the numbers in 2025 look like:

Buy: $1.36M in total cash outgo, and you have the house free & clear with a $1200/mo cost of ownership in 2025.

Rent: Deducting $380K in total rent from the above $1.36M means you can invest ~$1M in whatever instead, and with 4% compounding yields you should have $1.5M in the bank by 2025.

$1.5M @ 4% throws off $5000/mo in cash, nothing to sneeze at in nominal terms.

So if we fall into that neutral scenario then renting looks to be an immense win.

Now, if the rent is actually $2500/mo starting and goes up 3%, and investment yields are also 3%, then by year 2025 the renting route will only have built up $1.1M in savings, and the yield on that is only $50/mo better than the cost of ownership once the house is paid off.

Patrick
Well done on CS article.

This is great because it is a main-stream media exposure... not a forum where bunch of doom-and-gloomers (as portrayed by Perma Bulls) hanging out :-)

You/We should target more main-stream media. If you 'syndicated' and appear in lot of other papers it is more eyeballs. Not sure how the syndication stuff works though...

permanent_marker says

Patrick

Well done on CS article.
This is great because it is a main-stream media exposure… not a forum where bunch of doom-and-gloomers (as portrayed by Perma Bulls) hanging out
You/We should target more main-stream media. If you ’syndicated’ and appear in lot of other papers it is more eyeballs. Not sure how the syndication stuff works though…

Yes! It frustrates me to no end that the mainstream media continues the high prices=good and debt=affordability mantra. I would love to see the word get out that low prices = affordability. It is such a simple idea, yet it is being suppressed from the public's consciousness.

shrekgrinch says

Yes, very well done.
Some choice quotes I liked in particular:

Older sellers depend on young families’ getting themselves into debt. Less debt for the young means lower selling prices for the old.
People in the Midwest and South should not be forced via their tax dollars to guarantee $729,750 jumbo Fannie and Freddie mortgages for Californians when they cannot get such a guarantee for themselves. The injustice is galling.
Banks should be heavily fined for leaving foreclosed property empty and deteriorating. Foreclosures don’t ruin neighborhoods – empty houses do. If the banks won’t take care of their houses quickly, the title should be auctioned off to people who will occupy and take care of them. Yes, even if the auction lowers comps or forces the bank to take a loss.
Encouraging debt has resulted in disaster. Instead, we should promote savings, and outright ownership without any debt at all, in every generation.

romeotybalt says

the reason that I was able to strategically default on my own mortgage.

Yo Romeo! I’d be interesting in hearing what your particular experience was with your default. Only what you feel comfortable talking about, of course.

My experience is well documented here. But in short, after asking for a loan modification in 2009, the bank advised that I missed 3 payments of over 4k in order to receive a modification.

I obliged, only to find the bank now wanted my over 12k and would not agree to NOT foreclose. I told the bank to shove it!

I got an attorney that advised me to legally fight the fradulent foreclosure. That was 13 months ago.

I guess it will take another 10 months or so.

The funny thing though, is that without Patrick.net and IrvineHousingblog, I never would have questioned the validity of my loan documents.

Rest assured, when I move, it will be without a mortgage. People say that I am a POS by defaulting. This may be true. Some people talk about what they would like to do. Some do what they need to do.

Troy says

... And once the place is paid off, the cost of ownership will be much smaller than renting, even without inflation.
So analyzing the rent vs. buy requires a rather sophisticated model and a lot of guesswork about what’s going to happen in the next several decades....

Troy makes a good point there. While you can argumentatively say that the renter is better off cause he could have investing his savings and be way ahead financially then the owner after 30 years. In reality what happens 9 times out of 10 is the extra money the renter saved is pissed away on crap, not invested in anything at all unless you call a cappuccino, a flat screen TV or a visit to the massage with a happy ending an investment.