Interesting comment regarding "Record Low Mortgage Rates Make Now a Terrible Time to Buy a House ".  TheAMD.com response follows.


Whitney--

Agreed, for the most part. I cringe every time I hear most NAR solicitations. However, in my opinion there is one disconnect in your analysis. The argument that "low fixed rates are a terrible deal if the value of the house purchased declines materially" is not valid IF one doesn't care whether the value declines. And this can manifest itself in two ways-- first, if someone plans to stay in the house for the long term, and ride out any price volatility (though even here, I admit that one might be concerned with a mostly paid off house whose value after 20 years is still less than the price paid).

Second, one might not care about the price depreciation if the degree of leverage is so high that walking away from an underwater house does not present the borrower with any financial pain. To use your stock analogy, if you were able to not only get a good margin rate, but also finance 99% of the cost of the stock, you would be able to benefit immensely from any appreciation in the stock price. If the stock value declined, however, you might be inclined to hand over the devalued stock to the margin lender, since the consequential loss of your 1% equity share is not material.

Of course, this argument assumes that lenders will not pursue defaulting borrowers for deficiencies which remain after default. As you know, this assumption isn't far off in today's market-- lenders are either prohibited from pursuing deficiencies by state law, or encouraged by government policy to modify loan terms and thus sustain losses, or the foreclosure process is so cumbersome that lenders may not choose to pursue it, or if they do, may fail. (I know a lot about this last one, as many of my recent attempts to collect deficiencies on behalf of lenders have not survived challenges provided by the legal system).

All that said, the reason I make this observation is that the extremely high LTV levels that, even in today's market, are still deemed acceptable by GSEs (most notably the FHA), may cause your thesis to be wrong. If I can borrow 99% of the purchase price, and the cost of servicing my debt is artificially low due to the historically low, government-manipulated interest rates, WHO CARES if my home value declines? I'll just walk away! At that point, I'll only have paid a low imputed rent for my house while I was in it. For that reason, if I could maximize my leverage, I would think that the NAR's claim about low interest rates being a good reason to buy a house was valid (though not for the reasons they claim).

Hopefully, the government will understand this, and either (i) raise interest rates, (ii) stop allowing GSEs to accept woefully low LTV percentages, or (iii) change the foreclosure laws to allow lenders to pursue deficiencies on defaulting borrowers with greater efficiency. Any one of these would have a positive effect on the situation, I think ...


John,

You make interesting observations.

Not caring whether the value of one's home declines does not make it a good time to buy.  You are simply insensitive to price.   

People may plan to stay in a house for 20 years but you know what they say about the best laid intentions.  Americans and their careers have never been more mobile.  Unemployment, a new job, a transfer, family requirements, divorce, a death in the family, retirement, health problems, personal preference, a reduction/increase in income or wealth, etc... may all trigger unplanned moves.

Being able to voluntarily default on a mortgage obligation also does not make it a good time to buy.  It simply reduces the expense associated with overpaying for a house.  There are still costs attached to foreclosure which must be endured by the borrower.  A lower credit rating, reduced access to credit and a higher cost of borrowing being the most obvious.  

Being insensitive to price does not make it a good or bad time to buy a home.  Someone who did not care about price performance might be perfectly satisfied with their June 2006 house purchase, but it was still a terrible time to buy.  And many of the people who thought they were insensitive to price have since experienced the joys of foreclosure.

The World's Largest Predatory Lender Promotes Speculative Derivatives Trading

Your observation that a miniscule equity investment in a home purchase makes it easier to voluntarily default is at the core of the self-sustaining, foreclosure driven, housing price, death spiral.  If mortgage debt is non-recourse and the Government, through banking regulations and GSEs, willingly finances low down payment mortgages, falling prices trigger foreclosures, which cause prices to fall, creating more foreclosures.  The Government is throwing fuel on the fire. 

You make a fascinating observation.  You convincingly argue that the Government's loose credit and low down payment policies have essentially converted the purchase of a home into a subsidized call option. 

If prices drop you walk away and taxpayers bear the burden of leveraged equity losses.  If prices go up you benefit from leveraged equity gains. 

I still argue that it is better to purchase your call option when valuations are reasonable and prices are not falling.  I further presume that there is a maximum number of times that one may access the Government's subsidized housing call option.

I have heard another argument which lends itself to your line of thinking.  A friend advocates buying as much house as one can today because he expects rampant inflation in the coming years.  Hyper inflation will rapidly depreciate mortgage debt and generate leveraged equity gains, albeit in nominal dollars of reduced value.  My response to him is the same as it is to you.  An interesting strategy but why execute it while prices are falling.  Even during conditions of hyper inflation, asset prices may fall if they started out overvalued.

A Case Study 

In 2006 I knew a co-worker who bought a house.  I told him at the time that prices would collapse and that it was a terrible time to buy.  He advanced several reasons for the purchase including the intent to live in the home for an extended duration.  I acknowledged his rationale but maintained my position.

Four years later this gentleman works for a different company and lives in a another state.  When he chose to relocate his home was materially underwater.  He had the option to voluntarily walk away and endure the costs of foreclosure, but instead chose to pay out-of-pocket accumulated equity losses.  Unlike most Americans he had the ability to preserve his credit, but at significant expense.

I observe that neither his initial intent to live in the home for an extended period of time, nor his option to default on the underwater mortgage made the original timing of the house purchase a good idea.