Tuesday, September 14, 2010

America on Credit

My friend pointed me to an article in Time Magazine, the September 6, 2010 issue (also available on-line), called, “The Case Against Home Ownership,” in which the journalist, Barbara Kiviat, proposes that there are some valid reasons for not wanting to own a home in this day and age.  The article sounded like an interesting piece, and so I chased it down at my local library.

Her main points are that, most often, owning a home has more costs than one would first assume, and that ownership hasn’t been a sound investment for many people in the last few years given the terrible downturn in home prices, unpaid mortgages, and foreclosures abounding.  She also mentions that there is a higher percentage of the general population who lease as opposed to those who own property in many other countries, and that these people lead content lives doing so.

I didn’t find her claims to be backed up with many good examples.  The pains of failed mortgages, the slip in value and how hyped up the market was a few years ago are now all known and felt by everyone, and this recession is already a five year-old phenomenon. I didn't get any real sense of why homeownership may inherently be a bad idea from her article, the last five years not withstanding.

In fact, in Kiviat’s noting that she doesn’t think that it has been a good idea for the government to promote homeownership as being part of the “American Dream” by giving home owner tax breaks, she works against her own argument.  Tax breaks definitely are positive advantages of owning property, and in the final analysis, she never supports her opinion with any real benefits of renting, with the exception that one could more easily relocate for new job opportunities if one is leasing.

I felt that she wrote this article to appeal to the masses because a lot of people are finally understanding what happened with the mortgage meltdown; the bad lending practices, the inappropriate loans written by loan officers who didn’t understand the loans themselves, and the pressure on lenders to get people into loan contracts so that the loans could be diced up, packaged and sold on Wall street. 

However, Kiviat, as a journalist, should be writing on the cutting edge of what’s happening in real-time. She ended her article with the thought that she would think again before purchasing a home at this time.  I don’t expect anyone, male or female, to have ‘crystal balls,’ but really, her article should have been written five years ago; now that would have been TIMEly.  And in fact, if one has a lot of cash lying around, I think now would be a good time to invest in property while things are on the skids.  There are just not a lot of cash buyers coming out of the woodwork right now.

However, I do believe that Kiviat wrote a well-intentioned piece, which brings up some important issues.  The article got me thinking deeply about our society’s dependency on credit.  Because, ultimately, once one peels back all of the layers of the onion on any major negative issues of home-ownership, it’s really an issue about credit.

Banks and lenders make huge profits on interest rates; we know that.  The money you’ve borrowed for whatever product you’ve purchased via credit ends up being enormously more costly than it’s initial price.  I think that most people still have a limited awareness of this, even if by denial.  Yet, most people are aware that banks make even more from overzealous late penalties and overdraft charges in our personal accounts than even their interest rates.  So there is definitely an intention to not only profit, but to deliberately gouge you.

If you buy a house for, say, $500,000 with 20% ($100,000) down with a 4.5%, 30-year fixed loan, you will end up paying $329,626 in interest on the $400,000 you initially borrowed by the end of the loan's life cycle; that's an 82% increase on what you borrowed).  So your house will actually end up costing $829,626, or 65% more than it would have had you paid cash for it.  Think about it.  That would be like going to buy a blouse on sale for $19.99, and then because you used credit for it, paying and extra $12.99 of compounding interest for an end charge of $32.98 for the blouse.  That doesn’t seem like a bargain to me.  It’s a slow-motion robbery in progress, like the gradual boiling of frogs.   But people want to own a home so badly that they strap themselves to this kind of commitment when they really shouldn’t.  Are you surprised to hear this from someone who works in the real estate industry?  I can see how the system works much more clearly now that I have been in the business of home and lending transactions.

It’s not that no one should ever get a loan to buy a house, but rather that even now, after home prices had fallen off a precipice, I still witness a push to get people to borrow money towards the top whatever range they have been approved at with little to no concern of what that will mean for their daily lives.  It’s been drilled into their heads that they should own a home or to get a “great deal” in this market, that they don’t know what they are getting themselves into.  There is no real advocate for them to make a sensible decision based on what would actually work for them in comfortable monthly payments.  Instead, people still get into lending contracts that require them to keep up a more than hardy pace on the hamster treadmill. That is why I always suggest to my clients that they work backwards, thinking about what kind of payment would be comfortable for them, and then finding the right priced home that would fit into their life needs.

And honestly, prices of homes in Southern California are still so high, not in regard to their valued proximity to great things such as the Pacific Ocean, the mountains and the desert, but with respect to the cost that they were originally built for.  Many of the wood and stucco homes in the San Fernando Valley, built in the pre to post war years, originally sold for $10,000, and even $6,000 in many instances.  So even before the real estate bubble burst, one has to wonder how those same structures could possibly be valued at upwards of $700,000.  With 20% down (140,000), one would be stuck with a $560,000 loan.  That just seems unreal for the actual dwelling that they are getting married to.  I have to note here that in 2005, I went into an 1100 square foot home in Burbank listed for sale, 3 bedroom, 1.5 baths, no pool, nothing special, near a major street with an asking price of $1,100,000.  Clearly, minds had been lost.

My friend Eric, who initially pointed me to the Time article, and with whom I bantered emails on the subject back and forth for a day or so, also feels that having a large mortgage is ultimately too costly for many people. 

Eric writes, “The other thing I would like to have read about was the actual meaning of "home ownership." I mean, if you think about it, what does a homeowner actually "own?" If a homeowner loses his job and can't pay his mortgage, he will find out very quickly who really owns his home. The bank. The people whom I really see making the money from all of this home ownership are not the home owners, but the banks (and maybe in some cases the developers).”

“For me, this article added more weight to some ideas I've been thinking about for the last couple of years about home ownership. What I have observed is that for average middle to upper middle class people, owning a home is very, very important, despite the tremendous financial sacrifice they make. What I see is that this class of people are usually salaried employees who have a 30-year mortgage.”

Eric continues, “So making monthly mortgage payments is a huge chunk of their income. The rest seems to barely be able to cover other necessities, such as food, insurance, car payments, telephone, cable, etc. So much of their income and their life-focus go into their house -- the mortgage, upkeep and maintenance, and remodeling projects. They have very little money left over to live an interesting and exciting lifestyle. Most of these people lead very unglamorous and boring looking lives.  I just keep thinking, is there a better way? A sort of "third" alternative that the majority of people don't know about.”

I think, in particular, the point that Eric makes about quality of life as one grinds away, trying to make enough for his or her mortgage payments and have maybe a little cash left over, is far more illuminating and thoughtful than any that Kiviak included in her article.  I think the quality of life is the key to all of this.  If one can’t create and have interesting experiences because they are trying to make their payments each week, then what is the sense of it all?  And if you lose your job and have no income, it all comes crashing down pretty quickly, and you’ve got nothing left.

I was just saying to my girlfriend how I can't understand how so many people have mundane jobs that they just do year in and year out with no hope of growing into anything or achieving some dream.  They have a job that basically pays the mortgage and allows them to go do something two weekends out of four.  Most people don’t go to night school or extension classes in order to pick up new skills that might help them expand themselves. And at the same time, right now, while money is hard to come by for so many people including me, that stability seems somewhat attractive, if only temporarily, until opportunities blossom again.

When Kiviat is critical about the government promoting home ownership as being part of the American dream, one must think about how strong the banks’ and lenders’ roles are in our society.  You only need look at the fact that the government bailed out some very large lenders to know how entrenched credit is in our society.  For instance, just think about making a flight reservation, a hotel accommodation, or reserving a rental car. It is a much more difficult thing to do, if not impossible, without a credit card. We’re told that we must have a good credit score...”Always keep your credit average 700 or above!” So, in essence, we're being told by our infrastructure that we must always operate, at least to some level, on credit.  I don’t mean this in any conspiratorial way; I simply state this because it illustrates how most of our daily interactions have evolved into those, which either require or rely on credit.  The benefit to you is the ease with which one can have something.  The cost in little bank charges to you here and there is directly proportional to the profits that the lenders make over huge expanses of time.

I seldom if ever hear anyone in my business say, "You should just see if you can work the deal out with cash." Most people just don’t, and will never have enough cash to buy a $500,000 home straight out. The auto response of real estate agents is to get buyers hooked up with a lender and get them signed onto a mortgage.  And do you know how many people buy cars on credit?  I was actually surprised.  It turns out that for the last fifteen years, car dealers make more money from the interest rates of auto loan financing that they offer their customers, than on the mark up price on the vehicles they sell.

With what I have been seeing and learning, I am becoming more committed getting in the habit of paying cash and not credit for many of my transactions. There’s something much more immediate and tangible when you hand over a Federal Reserve Note to a vendor, then when you swipe your credit card.  One actually witnesses the trade of the earned money for the product. I just don't have any ‘interest’ in giving lenders extra money out of my pocket.

At the risk of this all sounding like some nutty manifesto (too late), I truly think that, as Americans, we all really need to rethink and readjust our prevailing relationship and dependency on credit.  We will greatly benefit from breaking the mindset of ‘swipe and spend’ purchasing when it’s done to a degree that we become disconnected from our own financial condition.  Little by little, it’s eating up our money and ultimately, as Eric said, our quality of life.