Monday, June 30, 2014

The True Cost of a Mortgage

It seems sometimes that the advice that you get from your parents (if any, sadly, in this day and age) can be boiled down to mindless platitudes of the sort you’d find on inspirational posters, which don’t fully deal with the truth behind the situation.

"My Dad told me that life is 90% positive attitude.
Maybe you're just paralyzed because you aren't being positive enough?!"

For example, people in my generation were told by their parents to buy a home as soon as they could upon entering the work force.  This was a result of that generation’s generally making decent money on their homes, as home values increased during that time period.  The cynic in me also thinks that driving up demand for homes by encouraging your children to buy them is also a good way to increase the value of your home, too, but that’s just too cynical for me to buy into fully. 

Why would I be suspicious of a group of people who spent all of their retirement,
voted to spend the social security trust fund, and now expect my generation to fund their 30 year vacation starting in the prime of their working life, because they haven't saved enough to fund it, themselves??

The issue is that they never really explained to us the true implications of home ownership, and the pitfalls therein.  “Buy a house, as soon as you can” does not translate into “oh, and make sure you get a good deal on it, and that when you buy, the prices aren’t artificially inflated by a housing bubble created by the government encouraging risky business practices for political means.” 

Also, “buy a house as soon as you can” doesn’t translate very well into “on a fixed-rate mortgage that you can afford.”  As I’ve discussed before, the Boomers handed down to us a very poor understanding of taking on debt to buy something like a home.  It essentially boiled down to “can you afford the payments?” and didn’t deal with any of the other pertinent things like “will you be able to afford them once the ARM resets?  Will you be able to sell the house in five to ten years, because, oh, yeah, you really don’t want to pay a house off over the term of any mortgage out there, because holy shit, have you looked at how much you’ll pay for the house if you do?” 

I'm not excusing the stupidity of the people in my generation that bought homes that they couldn't afford, but when "BUY A HOUSE AS SOON AS YOU CAN!!!eleventy!1!!" was their starting point, with no additional information, whatsoever, I think you can forgive them at least a little, right?

"NO!  I read in the newspaper that these 'millennial' kids are lazy and worthless,
and do the sex and smoke drugs, and I'm not about to change my opinion about the generation
that I expect to fund my retirement for me! They need to stay the hell off of my lawn!"
I had some good training in basic economics, so when I bought my home in 2003 for $132,000, I knew damn good and well that if I paid the house off per the term of the mortgage (I got a 30 year fixed rate because those ARM mortgages and subprimes are for people more concerned about what their payments are going to be NOW than they are any other aspect of the loan, which is moronic) that I would pay for the house three times over (or more) by the time I got it paid off. 

Yes, holy shit, that’s actually true.  Did you ever sit down to calculate it?  360 payments of $1,084 (the payment for my loan) is just shy of $400,000.  That, my friends, is why I scrimped and saved to make sure that I paid my house off in ten years.  That way, I “only” spent $225,000 on a home that I bought for $132,000. Great deal, right?

"Thanks for the awesome investment advice, DAD!"
My home, after owning it for 11 years, and with the improvements I’ve made, is now worth about $250,000.  I’ve sunk another $50,000 in improvements into it over the years.  So I’m still $25,000 behind on it, but based on Boomer math, which ignores the interest cost, improvement cost, and everything else imaginable, I’ve actually “made” $125,000 on it in ten years.  Yay me!  The way I look at it, I’ve paid $25,000 for a place to live over the last ten years, which is pretty good – that’s $208 a month in rent payments. That's how you make home ownership pay off - by manipulating the inputs to make it so that you pay a lot less per month than you would in rent, because SOME of that value going out every month returns to you in equity.  So the good people own a home to lose LESS money, not to make any.  

I say all of this to explain one thing: I’ve spent $25,000 more on my home over the last ten years than I will get back from selling it, and I am one of the few home-ownership success stories.  I paid my home off in ten years, did a massive amount of sweat-equity improvements, and I’m STILL behind (if you don’t count the value of having  a place to live).  

I'm told it is not over-rated at all
I’m not saying this to discourage home ownership.  It’s treated me well.  $208 a month in rent is pretty damn good for the place I’m living.  I’m saying it to encourage people to understand the real costs of home ownership, and to understand that your home is not a piggy bank.  It is not an investment on which you should plan to “make” money.  It is not your retirement account.  It is, like paying rent, a thing that you do to provide a home for your family and a place to live.  If you can make it work out that the true cost would be lower than paying rent (which is actually pretty common if you’re smart about it), then go for it.  But don’t do it thinking you’re contributing to a nest egg, because you’re not. You don't spend more money on an investment than that investment makes you in return, and call it an investment.

There is a huge cost to owning a home.  If your $132,000 home won’t be worth $400,000 plus a decent rate of return in 30 years, you need to understand that, like renting, you will have a net OUTFLOW of money over that thirty years for your housing costs, and your home will not be an investment.

"Uhh, this isn't penciling out, Mr. Thompkins.  Let me run the numbers again"

The Boomers put home ownership out there to my generation like it really was the biggest investment that you will ever have, when it isn’t an investment at all, except for rare instances..  I had a guy tell me that the other day, and like always, I was just shocked that an otherwise sentient adult would look at the numbers associated with home ownership and think that it is perfectly okay for your home to be your largest investment. 

Mine isn’t.  Your's shouldn't be.  If it is, do something now, and do something drastic, because you are not in good financial shape.
NO, something more than that!


  1. I am I the only person who bought their home as a place to live?

    1. No. That is why I bought my home, too. I went into it clear-headed, with no illusions that I'd "make" a dime out of the deal.

      I went into it with the thought that I might be able to get my rent down lower than I could just paying rent, which I did. By that metric, it was a good deal.

  2. You make a lot of great points there. And yet you just scratch the surface. The first thing you mention with the interest rates are just the start of the issues. I don't own my own house. (Fun that I can talk about another time, I'll leave it at a divorce and surprise credit finds..) I do agree that much of the boomer generation tried to sell on buying a house for an investment. One of the better decisions I've made is to do the opposite. I saw a house as a place to live. I wanted to do it just once and as my early life had me being very nomadic it did not make sense to buy a house. I also (This is going on 15 years ago now..) thought that the fact that houses were over priced and due for a correction would really be important later.
    So what's the first take away with the mentioned ARM's and people with less than perfect credit buying an investment they could not pay off? Well we had a surge in home prices. I live in the Twin Cities where the market is still in the stratosphere. Especially for the mid west. All because it seems that everyone has to own a house to invest their equity in to. Which in short means that the market drives its own cycles as everyone gets the same bad advice.. (But the boomers love it as their homes are overpriced.. Sell now and get that nice retirement home and live like a king!) In short, home prices have effectively priced out much of the middle class. This becomes important when the market does finally correct itself, suddenly that home that you bought at a market value of 350K is now worth half of that. The bank still wants that loan which will pay out 700K by the way. This becomes very problematic when people do what we've seen them do. Sometimes moving or purchasing a home every few years, and that's when this really starts to catch up to the market in general. What I thought the old advice was for home purchasing was to buy a home, and you live there for decades, not move every few years so you are effectively moving out of your equity you've built up. At least in my opinion.

    The other issue is that you state you've put in lots of money back in to the home, I'm guessing for upgrades or needed repairs like any sane person would. That fact alone seems to be lost on many home buyers these days as well. They end up "house poor." They work to only barely pay off a mortgage payment every month with out any leeway. God help them if something goes wrong, let alone the day to day home expenses. You know, what guys? Its not just the bank you have to pay for. That roof needs to be fixed. The siding needs an upgrade. The bathroom needs an overhaul. You have to pay for that too! Too many of my friends have gotten in to just that trap. They lost sight of using a home to live in and just hopefully have a cheaper way to pay rent.

    1. "House poor" is a good way to put it. All of their disposable income is tied up in mortgage payments and improvement and maintenance costs.

      If anyone actually sat down with them and showed them, time value of money and so forth, what the total cost of their $400,000 McMansion actually was, they'd have a coronary.

      That counts for paying rent, too, but many people pay far more for a house than they ever would for rent, and those people are total numbskulls.

      "But I sold it for more than I bought it for!"

      There's more to it than that. Most 30 year mortgages are arranged so that you've paid the original purchase price of the home after ten years (meaning, around year ten, if you bought a $350,000 home, you've paid $350,000 in mortgage payments). The next twenty years? That next $700,000 you're going to pay?

      Piss in the wind.

      Oh, and you do know what $700,000 could turn into over 20 years if you invested those payments at 5%, right? Can you say $1,2 million dollars?

      That's right. That is the actual cost of buying a house on a mortgage. Like I said, most people would have a coronary.

  3. I bought my house three years ago.
    The mortgage payment was $75.00, a month more than rent, and I doubled my living space, got one extra bedroom, (3 to 4), and dropped my power bills 80% due to the homes recent (1986) construction compared to the rental(1950).
    True, I am house poor, but I'd have to pay to live someplace, and this is a better deal. I did not, and do not ever think that this house is any part of my retirement plan. But then, like many folks my age, (51) I don't think I'll ever be able to retire. Changing jobs, lost 401k's, and lousy wages have all conspired to effectively insure that I'll work forever.
    But, I'm not really complaining. I have a decent House, and I live in a time when back-breaking labor is rare. I could do a lot worse.

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