Now Is The Time to Buy!

I am convinced that there may never be as good a time to buy a home as there is right now.  That may not be the case for every market in the entire country, although I believe it certainly is in many areas.  Middle Tennessee is one of those areas and we may not see an opportunity like this again in our lifetimes.  I don’t deny that it could get even better, but it is tough to beat right now.

I believe I have adequate justification for the way I feel and will share the focal points here.  Most things (people, companies and markets to name a few) follow trends and behavior patterns, that while erratic at times, are still somewhat predictable over the long haul.  And sometimes, like now, the stars all align, or in this case, the patterns align, creating an opportunity that is unmistakable.  This is giving us an incredible opportunity right now to buy homes – as good of a time as most of us have ever seen.

What goes up must come down.  You throw a ball in the air, and it is going to quickly come back to where it started.  It may not be in the same location from where you threw it, but it will be back to earth.  We know this and we trust that this will happen – every time.  While all things are not as certain as gravity, most do tend to follow predictable patterns.  Just think about your daily routine. The time you get up in the morning, what you have for breakfast, the way you style your hair, the people you go to lunch with, the TV programs you watch at night, and many more, are all perfect examples of our lives following simple daily patterns. 

Markets are no different.  After all, who invented the financial markets?  They didn’t just pop up out of nowhere.  All markets, both financial and non-financial, were created by human beings.  These are the same human beings who live lives dictated by patterns and routines.  It is amazing to me when we experience things like stock market crashes and rallies, or real estate bubbles and bursts, or even rates rising and falling, that we feel like this is all happening for the first time.  In reality, these markets are following the same patterns that they have been following for many, many years.  It may be happening to us for the first time, but it is certainly not happening for the first time.

There are a couple of simple concepts that when put together create an unmistakable equation.  I have been originating loans in the mortgage industry in middle Tennessee for over 20 years.  In that time period, I’ve seen multiple peaks and troughs of sales volume and I’ve seen 30 year rates as high as 10.5% and as low as 4.5%.  While I’m not an economist, I’m smart enough to follow patterns and recognize when certain things align.  I can also do the simple math that supports my thought process.  That is really all we are going to look at here, patterns, numbers and historical data – certainly nothing very complex.  Home values, interest rates and economic activity in general, all follow a pattern.  It is great if you can understand the patterns well enough to have an idea of which direction they are moving and will be moving.  Understanding where the pattern is going is the complicated part as there are so many moving pieces that affect direction, particularly in the short run.  What really matters though is just simple recognition of where we are in the cycle of an overall pattern.  If we can recognize that, then it becomes easier to see why the timing on certain decisions is more beneficial at present versus later, or vice versa.

The primary focus here will be to gain recognition of where we are right now with a couple of those patterns and what it means for anyone considering a home purchase.  We are going to look at data on interest rates and home values, and then how those impact the affordability index.  We will also look at where rates have been, where they are now and where they logically are heading.  Similar type data will be reviewed on home values.  Putting these two together will allow us to analyze, via an affordability index and a couple of other basic principles, why I feel the way I do.  I believe that as you read through the next few pages, you will come to the same conclusion and will agree that now is a great time to be a home buyer in middle Tennessee.

RATES

A quick view of the chart below tells you pretty much all you need to know about interest rates.  As you can see we are still at rates hovering around 5% for 30 year fixed rates, which is historically low.  Most of the lending activity that has been going on over the past few years has been predominantly refinancing.  Many homeowners, who had a mortgage already with rates at or above 6%, have taken advantage of the lower rates and have taken out a new loan at the lower rates.  If this was a landscape and the 80’s represented the mountain, I’d say we are currently down in the valley!  For those people who don’t own a home now, or who own, but are looking to buy something else and will need a loan to be able to buy, the opportunity is here to do a loan that might not ever need to be refinanced.

For the 30 year period from 1970 until 2000, the rate that seemed to dictate activity was 8%.  In other words, when rates dipped below 8%, building and purchasing picked up.  And conversely, as rates rose above that mark, activity slowed.  Outside factors, such as an economic recession, can dull the response rate to some degree that activity will pick up as rates fall below the stimulating point.  From a historical perspective, that trigger point has been pretty accurate.  As rates dropped over time, particularly as the 90’s ended, the stimulating mark for rates has dropped down closer to the 6% mark.  Where now it seems activity is will only be stimulated by a lower rate than what we saw historically.  Still, today’s rates in the 5% range are solidly below the new trigger point where economic activity will pick up.

Over the 40 year period that this chart covers, the only the time period, and it was brief, that beats the rates available right now is in 2010.  So if the only thing being considered in the buying decision was rate, and I realize that there is more to it than that, now would be a great entry point if there will be financing involved with the home being purchased.  As you can see by where rates have been, and where they have the potential of moving to again, right now presents an amazing opportunity to finance a home and get a lower payment, as a result of the lower rates.  To give an example, let’s look at payments on a $200,000 loan calculated on a 30 year fixed rate payment.  At 8%, the monthly payment would be $1,467, at 7% it would be $1,331, at 6% it would be $1,199 and at 5% it is $1,073.  So a payment at today’s rates provides a significantly lower amount compared to everything prior to now.  The chart below gives a couple more loan amount figures, but basically supports the same argument at any level.

Loan	Payment at:	Payment at:	Payment at:	Payment at:
Amount	8%	7%	6%	5%
$400,000	$2,935	$2,661	$2,398	$2,147
$300,000	$2,201	$1,996	$1,799	$1,610
$200,000	$1,467	$1,331	$1,199	$1,073
$100,000	$734	$665	$600	$536

I really can’t stress enough how significant these numbers are.  Hopefully by simply looking at the example above, you get an idea of what higher rates will do to a monthly payment – and conversely why it is so meaningful to take advantage of the lower rates available now.

And more importantly, it provides a better entry point than where rates could potentially move in the near future.  Many technical signals point to that happening (rates moving up) and the Fed seems bound and determined to use its policies to stimulate growth in the economy.  The three things that the United States government, primarily via the Fed, appears to have towards the top of the list of things they want to accomplish are:

1.       Employment growth

2.       Business growth (and increasing stock prices)

3.       Reduce our trade deficit (by devaluing the US dollar and several other techniques)

Each of these items, as they get accomplished, presents inflationary pressures on the overall economy.  Mortgage rates, which move as the underlying mortgage bonds move, have one primary enemy – inflation.  Inflation can mean either the rise in price levels or an increase in money supply.  As inflationary pressures start, the automatic reaction to them is increasing rates.  And while contained inflation is not necessarily a bad thing, as it is the natural byproduct of an economy that is expanding, increasing interest rates and inflation go hand in hand.

A perfect example of this is to examine what the prime rate did in the most recent time period that our economy moved from a recessionary period into a period of growth – much of that growth was stimulated by the Fed back then as well.  As economic activity fell off in 2000, prime dropped from 9.5% down to 4.75% by the beginning of 2002.  Prime rate was at 4% in May, 2004, but check out what happened starting in the summer of 2004.  At this point, the recession had ended and the Fed began increasing the Fed Fund rate, which is the rate the bank’s prime rate is tied to.  By May, 2006, a time period of right at 2 years, prime was up over 8%.  See chart below that monitors the prime rate for the past decade - that is a 4% move upward in 2 years.  While long term mortgage rates did not move quite as dramatically as the short term, prime rate moved, the 30 year fixed rate still moved from around 5.25% up to the 6.75% range during that time period.  We could very likely see a similar movement again - and probably sooner than later.  We have seen an unprecedented stay at rock bottom rates for prime, but there is really only one direction, and that is up.  There is an old saying that goes like this, “Never fight the Fed”.  While that is not only smart advice to follow as it relates to investing, it is a good word of wisdom as it relates to interest rates and where they will be heading. 

In a very basic explanation, our government has a couple of fundamental techniques through fiscal and monetary policy (monetary policy is where the Fed comes in) to impact economic activity that are somewhat standard.  There are out of the ordinary measures too, like the recent stimulus for first time homebuyers, intended to increase home buying by providing tax relief.  But for the most part, the techniques are basic and consistent.  The first is dictated by the Fed and that is lowering the Fed Funds rate, which is the rate prime is tied to, making it less expensive to borrow money.  This has a stimulating affect because it allows businesses and individuals to buy things (equipment, land, property, services….) and pay the money back with cheaper payments.  But as mentioned above, this technique is quickly reversed when the economy starts to rebound, pushing rates back up.

Another stimulating method our government has in its bag of tricks, and one that no other entity possesses the ability to do, is to “print” money.  This is done by selling US securities, or creating debt, and using those funds in various governmental spending programs intended to accelerate overall economic growth.  This activity, while good for the short term, significantly increases our national debt and ultimately brings about long term inflation (due to the increase in money supplied to the markets).  At the end of February, our national debt stood at $14.66 trillion.  That is $14,660,000,000 if you are interested in the zeros.  It represents 96% of our 2010 gross domestic product (the market value of all goods and services produced in our country last year).  That, in and of itself, is a scary situation.  When a deficit occurs, which happens when our government spends more than it receives in any given year, the overall debt burden grows.  In other words, the government has to print money to make up the difference.  That figure grew by $1.7 trillion last year.  This can only lead to one thing from an interest rate standpoint and that is an upward movement over time.

Keep in mind that everything can change and make all bets off when unexpected events, both here and around the globe, occur that can be market movers.  Tragic events such as 9-11, almost a decade ago, certainly can play havoc on what is going on in the markets.  And we are no longer cushioned from what is going on outside the friendly confines of the US as well.  But understand that the underlying strength or weakness of the market tends to ultimately prevail regardless of temporary setbacks caused by unexpected events.  The recent tsunami in Japan is a great example of that.  The initial reaction in the markets was a loss of almost 700 points in the DOW over a few days, and a flight of money to the “safe haven” of US bonds.  Once the dust settled (although it will obviously be years before status quo is reached in Japan again) the markets have gone back to being driven by the impact of underlying economic stimulus and markets returned to the “pre-event” status.  The point here is that while financial markets will consistently move with the strength and weakness of the underlying economy, there are events, that are uncontrollable and unpredictable, that can impact markets and ultimately rates.  While it is difficult to predict these types of occurrences, they must be considered in the overall discussion about interest rate movement.

We can actually read even a little more into the recent event as it relates to where rates are heading.  In my opinion, if the tragedy in Japan had occurred prior to the government’s announcement of the latest round of Quantitative Easing, I believe the reaction would have been amplified.  Opposed to the smaller drop in the stock market accompanied by the flight of money into the safe haven of bonds, I believe the movement would have been amplified if there were not more underlying strength to the economic rebound, or at least perceived rebound.  If that event, coupled with the consistent unrest in the Middle East, had occurred a year ago, the severity of the decline in the stock market could have been significantly worse.  Instead of a drop of .5-.75% in 30 year fixed rates, which I believe could have easily happened and probably would have happened a year ago, we only saw a drop of about .25%.  And that could be very short lived.

So the big question now is where are rates going from here?  If we are students of history, it is pretty obvious that what goes down must come up – or something like that.  To get the best idea of what lies ahead, it is smart to look at what people who manage billions of dollars are doing with their money right now.  Two good examples are Bill Gross and Warren Buffet.  Bill Gross, who runs the world’s largest Bond mutual fund Pimco, has sold most of his Treasury positions in his $237B Total Return Bond Fund.  The assumption has to be that these investments will decline from current levels.  And Warren Buffet recently refinanced a lot of debt into long-term Bonds taking advantage of present attractive rates.  So unless the most recent round of Quantitative Easing falls flat on its face and the economy slips back into fears of deflation like we had in the latter part of 2010, the prudent move seems to be taking advantage of the longer term rates now – and least Mr Buffet thinks so.  And who am I to argue with one of the greatest investment minds this generation has seen?

There are no guarantees and rates could fall further from current levels.  But the reality is that mortgage rates are sitting in the range of the all time low mark.  History proves that we won’t be at levels like this for extended periods of time.  A phenomenal opportunity to take advantage of historically low rates exists right now.

VALUES

The chart below shows the median home prices for homes sold over the past two decades nationally and the most recent decade here in middle Tennessee.   The figures for the national prices are from the National Association of Realtors and the figures for middle Tennessee are from the Greater Nashville Association of Realtors.

				Middle TN
Year		US Median Price		Median Price
1989		94,600.00
1990		97,300.00
1991		102,700.00
1992		105,500.00
1993		109,100.00
1994		113,500.00
1995		117,000.00
1996		122,600.00
1997		129,000.00
1998		136,000.00
1999		141,200.00
2000		147,300.00		129,883.00
2001		156,600.00		133,476.00
2002		167,600.00		136,144.00
2003		180,200.00		139,514.00
2004		195,200.00		145,782.00
2005		219,000.00		161,787.00
2006		221,900.00		176,314.00
2007		217,900.00		182,135.00
2008		196,600.00		175,502.00
2009		172,100.00		164,058.00
2010		173,100.00		169,371.00

A couple of very specific things that I want to point out here that are pretty obvious.  First from 1989 until 2006, values consistently increased.  From 2006 through 2009, there was a 22.5% correction or drop in values.  If you consider the monthly numbers, the lowest month compared to the highest level reached before the drop, it is closer to a 30% correction.  But for our discussion purposes, looking at the annual average is accurate enough.  From a national perspective, this is an overall average of all markets - in many markets the drop is much more significant. 

I believe that both of these numbers serve as a wakeup call.  The first wakeup call snaps us into the reality that things, like the thrown ball I mentioned in the beginning of this article, don’t always go up forever.  Too many homebuyers and investors were lulled to sleep believing that you could not make a mistake buying real estate.  Thinking that it was the one investment that always grew – or at least held its value, was a mistake.  Real estate acts like a commodity from a pricing standpoint, much like stocks or even gold.  However, it is perceived differently because it is where we live and raise our families.  But don’t be fooled into thinking that it is the perfect investment.  It is suspect to the same fluctuations and patterns as most other investments.   Ask many of the thousands of investors buying homes to flip for a quick profit how quickly the tide turned on them and they will tell you firsthand that real estate is not a guaranteed place to get a return on your money.  However, like the stock market, despite its lack of guaranteed return, real estate has still proven from a historical perspective, to be an excellent investment over the long haul.  Just a quick look at the chart above tells you that.  If you bought the average home in 2000 for $147,300, that home would be worth $173,000 today.  That is still a 1.6% annual rate of return.  And if you go back to 1990, when you would have bought for $97,300, it is a 2.9% annual return over the 20+ years (and that includes the recent correction). 

Now I realize that those are not eye-popping return numbers.  But my point here is that over the long haul, real estate is an investment that historically grows at a rate that at least keeps pace with inflation.  During that same stretch, inflation averaged about 2.85% per year (inflation rates per year from 1989 are listed below).  As an example, as values increased from $94,600 to $172,100 (182%) from 1989 to 2009, median income increased from $34,200 to $61,100 (178.6%).  So property value growth also slightly outpaced income growth.  Outside of certain shorter time periods, like what we have just experienced, values have consistently grown.  When factored with the tax savings for property tax and interest, which we will discuss in a little more detail later, the total return is much better.  But for now, understand that as values go up and down at a faster pace over short intervals, over the long term, there has always been slow but steady positive growth.

Inflation rates as listed by the Bureau of Labor Statistics:

year	%	year	%	year	%	year	%
1989	4.83	1994	2.61	1999	2.19	2005	3.39
1990	5.39	1995	2.81	2000	3.38	2006	3.24
1991	4.25	1996	2.93	2001	2.83	2007	2.85
1992	3.03	1997	2.34	2002	1.59	2008	3.85
1993	2.96	1998	1.55	2003	2.27	2009	-0.34
				2004	2.68	2010	1.64

In middle Tennessee, we followed the same trends over the past decade.  However, I include those specific numbers here because another point needs to be made.  While we went through the same run up and run down, it was not at the same magnitude as the average for the rest of the country.  And while the average figure for the rest of the country peaked in 2006, ours peaked in 2007.  From 2000 to 2007, our average values ran up from $129,883 to $182,135 which was only a 4.95% annual appreciation rate.  And if you look specifically at 2000 to 2006, the run up was at 5.2% per year versus 7.1% for the national average over that same period.  So the magnitude of the overall run up was not as significant as the country’s average.  Likewise, the drop from 2006 to 2009 was a 3 year average of -2.4%.  From a peak in 2007 to the low in 2009, the total loss was 10% ($182,135 to $164,058) versus the 23% decline seen nationally from peak to trough from an average annual value standpoint.  Due to many geographical and economic reasons, middle Tennessee did not participate in the significant increase or loss that the rest of the country did.  That doesn’t mean that certain areas in middle Tennessee did not see more significant losses (many 20% plus).  But overall, our market did not see as significant of a run up in values nor has it seen near the loss in values that many other markets have seen.  We have certainly been well below the national average.

That should provide us with some tremendous confidence in considering a purchase here in middle Tennessee.  While not recession proof, our market has proven to be less threatened by same level of bubbles and bursts of many other markets across the country.

This brings me to my point about now being a great time to take advantage of the opportunity at hand.  Like buying any investment, the time to get it is when the value has its best chance of increasing.  If you take out the dramatic growth from 2000 to 2006 where average prices increased from $147,300 to $221,900 (an average annual return of over 7% per year) and just look at the returns from 1989 to 2000, when values went from $94,600 to $147,300, you will see that those years represented an annual return of 4%.  That is more in line with what values did for the 2 decades in the 70’s and 80’s.  The drop from $221,900 to $172,100 over the 3 year period of 2006 to 2009 represents a drop of 8.1% annually.  Even with that drop, you still get a 2.9% annual return, as mentioned before, for the 20 year period from 1989 to 2009.  That is less than the 4% figure, but still not bad considering a 23% drop from 2006 to 2009.

The way you improve on the 2.9% annual figure is to buy a home when values are depressed, or the term I will use here is “corrected” – the fast run up of 2000 to 2006 was corrected by the drop from 2006 to 2009.  At this point, we should be back in more of a traditional and stable price increase mode.  That alone should be enticing enough, but there is a good possibility that we could see a faster run up in value over the short term than the traditional 4% that we have seen over the past 40+ years.  As I mentioned in the discussion on rates, most of the techniques being used to stimulate our economy have inflation as the end product - and I believe that will be the ultimate result.  If that happens, then values will mirror inflation and will increase at a rate that is higher than the norm over the short term.  That makes buying at current values an even greater long term investment, as you would have the opportunity to take advantage of a potential short term run up that is more magnified than the typical long term rate of appreciation.

I’m not declaring this as the “bottom” of the market.  There are too many factors in play to make such a declaration.  One that you will hear regularly in the local and national media is the number of foreclosures that will still be hitting the market, thus prolonging the rebound in the housing market.  But as is the case with any investment, particularly a commodity type purchase, timing the bottom is a near impossibility.  The important thing, when making any type of investment, is to use all available information to determine when one specific time might be better than others for an entrance.  Even if we are not at rock bottom, I believe we are at a great entry point now for buying real estate in our local market.  And if we are not at the bottom, I believe we are close.  Just as declaring an end to a recession can only be done in hind sight, so too will be the determination of where the real estate market bottomed out.  The important thing is to be getting in when the best chances exist for increasing value, and my opinion is that we are at such a time.

My friend Edsel Charles, who runs Market Graphics - a local company that tracks inventories and supply levels of homes here in middle Tennessee and multiple other markets across the US, also sees values increasing.  His research reveals that inventories here are down in many areas in and around Nashville.  As a matter of fact, minus any new construction, he sees 40% of Nashville running out of inventory in 8 months.  Our market, just like many others across the country, will have to build new houses to meet growing demand.  As this demand for new construction increases, the cost of the raw materials such as lumber and drywall will increase as well.  Builders will have no choice other than to raise prices.  This is a cause and effect relationship with existing home prices, which will also see an increase in price.  Granted, he believes as I do, and that all of this is dependent on the economy continuing on its current path and the government not deviating from current policies.

In my opinion, purchasing now will enable you to take advantage of a price range that is at or near the bottom of where prices will drop and be able to take advantage of consistent growth from this point.  As I’ve mentioned, the stimulus that the government is applying to our economy will almost certainly produce this result.  Minus unknown or not yet realized factors, from both our economy and those abroad, we should see slow and steady growth ahead.

HOUSING AFFORDABILITY INDEX

The purpose of the housing affordability index is to determine if a typical American family, defined here as one earning the median income reported by the US Bureau of Census, can qualify for the mortgage on an average priced home.  In this case, an average priced home is defined as the median-priced, existing single-family home as calculated by the National Association of Realtors (NAR) and is the figure we have been using in our value examples.  And the calculation makes an assumption that the mortgage is 80% of the sales price with a payment qualification of 25% (where 25% of gross monthly income is being used for the house payment).  So for example, if we use the year 2000, we have an average priced home at $147,300 and the average income was $50,723 (divide that by 12 and you get a monthly income of $4,227).  An 80% loan would result in a payment of $865 per month (calculated at 8% - which was the median 30 year fixed rate in 2000).  $865 represents 20.46% of the monthly income.  This figure results in a composite score of 122% (25%/20.46%) and an affordability index figure of 120.5 (see chart below for annual housing affordability index figures dating back to 1989).

The index is simply a measure of the financial ability of U.S. families to afford a house payment.  A score of 100 means that families earning the national median income have just enough money needed to qualify for the mortgage payment on a median-priced home.  A score that is higher than 100 means they have more than enough and lower than 100 means they have less than enough.  Obviously, the higher the score, the more affordable housing is in that particular year (or month), because higher scores represent additional expendable income that is left over after paying the housing payment.

According to the NAR, here are the housing affordability index numbers for the past 2 decades:

1989 – 102	1994 – 118.3	1999 – 128.4	2004 – 120.3
1990 – 104.6	1995 – 119.5	2000 – 120.5	2005 – 110.9
1991 – 107.4	1996 – 122.4	2001 – 128.1	2006 – 107.1
1992 – 117.2	1997 – 123.6	2002 – 124.2	2007 – 115.3
1993 – 125.6	1998 – 131.9	2003 – 128.2	2008 – 137.4

In 2009, the housing affordability index was 169.2, the highest percentage in decades.  In 2010, it topped that number and averaged well over 170, hitting 184.5 in November.  As a further example, using 2009 as our example, the median price was $172,100 while the median income was $61,082 and fixed rates averaged 5.14%.  A monthly payment would have been only $751 due to the lower rate which only represents 14.75% of the monthly income.  The composite figure is 169.4 (.25/.1475) with an affordable index of 169.2.  So from a statistical standpoint, there is more money left over after making the monthly housing payment on the average priced home than there has ever been for the average American family.

Below is the average family income from 1989 to 2009 used to calculate the housing affordability index:

year	Ave Income		year	Ave Income
1989	34,213		2000	50,732
1990	35,353		2001	51,407
1991	35,939		2002	51,680
1992	36,573		2003	52,680
1993	36,959		2004	54,061
1994	38,782		2005	56,194
1995	40,611		2006	58,407
1996	42,300		2007	61,173
1997	44,568		2008	63,366
1998	46,737		2009	61,082
1999	48,831

That is the technical definition and a history of what the affordability index is and what the average has been over the past several decades.  But what does that mean to you today – in layman’s terms?  Simply put, because of the low rate environment and the current average price of a home, combined with average incomes, now is as good of a time to buy a home as there has ever been.

For first-time homebuyers, this presents an even better opportunity.  According to the National Association of Homebuilders, the 4^th quarter of 2010 marked the highest level that the Housing Opportunity Index (HOI) has ever been.  The HOI indicated that 73.9% of all homes sold, existing and new, were affordable to families at the median income level of $64,400.  That means close to 3 out of every 4 homes sold in America right now, are priced in the range where an average family can afford them.  Combine that with the fact that a first-time homebuyer has no home to sell and it truly becomes a great time to take action.

I need to add a disclaimer here that some feel that the affordability index is skewed by the NAR to promote home buying.  The issue is that the figures used by the NAR for their average home prices could be higher than what is completely accurate due to some markets selling fewer homes at higher prices – thus coming up with a higher overall average.  I am also not considering the cost of transportation into the equation which is considered in the overall Affordability Index. 

My argument for now being a good time to buy is still relevant even if the figures from the NAR are not exactly accurate.  If the numbers are inflated, they are consistently inflated over the years.  When viewing the overall picture, the resulting product for the home buying affordability matrix still leaves the figures higher now than they have been in the past.  So even if the numbers are not exactly precise, they are reported consistently the same way over the years – and the equation is consistent.  In other words, it would have been inflated over prior years as well.  So even if the actual index isn’t quite as high as it should be or should have been over the years, it is still higher now than ever before.  From an affordability standpoint, buying now still represents a better opportunity than in the past.

And the reason that I did not include the transportation piece of the overall affordability index (opting to just focus on the housing affordability index) was not that the transportation information is not relevant, it is just not as relevant to the exact topic being discussed here – which is specifically housing related.   I realize that there is a cost related to transportation and where you live versus where you work and do life.  But that same scenario exists whether you are renting or own a home – you still have to have adequate transportation to get to where you have to go daily, regardless of whether you own or rent.  So for purposes of this conversation, the focus is strictly on the housing affordability.

Again, the point here is that regardless of whether or not the figures are skewed slightly and values are not really as high as reported, the combination of income, average priced homes and low interest rates make this a great time to buy from an affordable standpoint.

And what if we have not yet reached the bottom of the housing market from a value standpoint?  I realize we have already discussed this, but let’s look at that again for a minute.  Let’s assume that values in the middle Tennessee drop another 10% (which is highly unlikely) and at the same time, interest rates move up 1% (something I think is very likely).  If you were buying a median priced home at $169,000 borrowing 80% of the price, your monthly payment would be $726 per month at 5%.  If the value dropped to $152,100 (90% of $169,000), and you borrowed 80% of that price at 6%, your payment would be $730 per month – virtually the same.  While I’m not trying to discount the loss in equity that a further drop in home prices would bring, I want you to see that from an affordability standpoint, the rise in rates is more detrimental to payments than a drop in price.  Based on current economic data, a rise in interest rates seems to be much more likely than further decline in home values.

Where we are going from this point is speculation.  It may be well educated speculation, but speculation nonetheless.  But where we have been and where we are now are concrete.  And based on average home prices, median income and the current mortgage rates, the affordability index is at an all time high.

Rent versus Buy          

I want us to briefly tackle the age old “rent versus buy” debate.  This is for those of you who do not own a home currently.  And let me point out here that I don’t think buying a home is for everyone.  There are many lifestyles that are more suitable for renting.  What I want to show is that from an overall investment standpoint, on average, buying allows you to get further ahead from a financial standpoint than renting.   Below are the national average monthly rental figures for the past decade according to US Census Bureau:

Year	Average Monthly Rent:		Year	Average Monthly Rent:
2000	452		2005	560
2001	487		2006	597
2002	534		2007	640
2002	536		2008	676
2003	556		2009	671
2004	575		2010	657

I give you these figures for two reasons.  The first is that we are going to use a couple of these in some examples later.  The second reason is that I wanted you to see how flat rental rates have been over the past 4 years.  Since 2007 the average rent has only gone up $17 – which is about 2.7% total and about .6% per year.  Mirroring home values, rental rates increased about 40% from 2000 to 2007.  So over the past few years, the growth in rental rates has been very flat.  Again, following historical patterns, the thought here is that rental rates are going to start heating back up at some point soon.

Housing units are not considered a part of the Consumer Pricing Index (CPI) as they are viewed as capital goods and not consumption items.  However, Owner’s Equivalent Rent (OER) and Rent make up over 30% of the CPI.  Shelter, which is the service that housing units provide their occupants, is the major part of the market basket that makes up the CPI.  Rent is simply the cost of that shelter.  Owner's Equivalent Rent is obtained by directly asking sampled homeowners the following question: "If someone were to rent your home today, how much do you think it would rent for monthly, unfurnished and without utilities?"  The OER carries the greatest weight as it relates to the CPI as it is the amount of rent that the owner or the residence will command.  I share this because the change in CPI is a key statistical measure of inflation and rent and OER make up a significant part of CPI.  Rising rental rates and inflation go hand in hand.  This is worth paying close attention to because as inflation rises, so will interest rates.  This takes us back to our interest rate discussion and how inflation is the primary concern for keeping long term rates down.  So it is a double edged sword.  Inflation will drive up interest rates and rental rates at the same time – all the more reason to take action on the buying decision now versus later.  After staying almost the same for the past four years, the cost of renting is likely heading upward.

I want to use a couple of examples using the figures we have discussed in the text above that I think will make these figures come alive for you a little better.  Let’s say that one average income earning family decided to buy the median priced house in 2001 and another family with the same income level decided to rent.  Both families stayed in the same place for the next 11 years.  The rental family would have paid an average of $590 per month over that time period using the average annual rent figures above (renting whatever type of space that $590 a month affords).  So in 11 years, they would have paid $77,880 in rent.  Let’s assume that the family that bought put 3% down and did a 30 year loan at 7%, which was the average rate in 2001.  The median priced home in 2001 was $156,600 so their monthly payment would be $1,010 not counting taxes and insurance.  They would also pay taxes of around $125 per month, homeowner’s insurance for another $50 and mortgage insurance for another $65 – a monthly total of $1,250.  So over the same 11 years the buying family will have paid $165,000, or $87,120 more that the renting family over the same period.

However, over that time period, the home’s value increased from $156,600 to $173,100 and the loan will have reduced from $151,902 to $127,250.  So the total equity gained from the home increase and the loan decrease would be $41,152.  Also, keep in mind that the interest paid on the loan as well as the property taxes paid would be deductible on the annual tax returns for the buying family.  I will make a conservative assumption that the family would be in the 15% tax bracket and use $55,500 as the average annual income over the period.  The total interest paid over that time period would have been $108,747 for an average of $9,886 per year.  If property taxes were $125 per month, that is another $1,500 per year.  So the annual federal income tax obligation would be reduced by $11,386 per year for an annual savings of $1,708 (15% of $11,386).  Over 11 years, that is another $18,787 saved.  Add that to the increase in equity and the total is $59,939.  So the additional cost of owning the home is really only costing an additional $27,181 versus the actual $87,120 paid.  This is a great example as it is very conservative in pretty much every way.  The values over that time period increased less than 1% per year (due to the aforementioned value correction from 2006 to 2009) which, as we have already looked at, is very low from a historical perspective.  And it is very likely that the homebuyer could have refinanced the home at some point during this time period to take advantage of a lower rate – thus reducing the payment.

Also keep in mind that I just used average rent for this example – not the rent that it would have cost to live in a comparable house.   This is significant as we are not comparing apples to apples.  It is highly likely that a home worth $156,000 in 2001 was likely to be much nicer than anything that would rent for an average of $590 per month.  In the end, the buying family would have paid an extra $27,181 total for buying versus renting – that is $206 a month over the 11 years.  What if the rent to live in a similar house had been $800 on average (which is probably more likely) versus the $590 average rent for the time period?  Then the rental family would have paid more, all things considered, than the family that bought, over the same time period.  What I want you to see here is that even in a market that has not increased in value like it has historically and using a rate that is approximately 2% higher than what is available right now, it still only cost $206 more to buy a $156,000 house versus renting a place for $590.  If you are renting now, you have an idea of what $590 will get you.  And a quick look around Nashville will show you what you can buy for $156,000.  You will quickly see that what you can buy for $156,000 is way nicer than what you can rent for $590.  I’d even go as far to say that what you can buy for $156,000 is way nicer than what you can rent for $800 (the rental figure that would basically break even the renter and buyer in this scenario).  So looking at this example, you have to ask “is it worth it”?  I’ll leave that for you to answer.

Let’s look at another example.  Only this time, we will use current figures and project out 10 years.  We will also use a rent figure that is more in line with what the cost would be to rent the comparable home here in middle Tennessee.  Let’s go with the median priced home here in middle Tennessee at $169,000 and again we will assume a loan of 97% of the sales price.  This time however, the rate is 5% versus the 7% from 2001.  We will also assume, I believe conservatively, that it would cost $1,000 to rent the same home – and we will assume that the rent never goes up over the next 10 years (highly unlikely).  We will use a conservative, although certainly higher than what we experienced over the past decade, appreciation rate for home values.  Instead of using the historical average of 4%, we will use 3% as the figure that homes will appreciate at over the next 10 years (that figure is in line with the value increase from 1989 until now).

The renter will pay $120,000 over the next 10 years.  The buyer will borrow $163,930 and his payment will be $880 per month not counting taxes and insurance.  Property taxes will run about $1,350 per year and homeowner’s insurance will be around $750 per year.  Mortgage insurance will be $124 per month so the total month payment will be $1,179 per month.  He will pay $141,480 over the next 10 years, or $21,480 more than the renter.

Using the 3% appreciation rate, the value will go up to $227,000 in 10 years.  The loan balance will drop to $133,344 in that same time period.  So the buyer’s increase in equity is $88,000 (approximately $30,000 loan amount drop and $58,000 increase in home value).  The tax savings on the income tax (still assuming that the buyer is in the lower 15% tax bracket) will be $11,252 for interest payments ($75,000 in interest paid over that time period *15%) and $2,025 for property tax payments ($1,350 per year *10*15%).  So the total savings for the buyer is $101,277.  Subtract that from the $141,480 and the net cost is $40,203 – meaning the buyer is coming out ahead of the renter by approximately $80,000 over this time period when you consider the equity built up (by the increase in value and loan reduction) and the tax savings.

Hopefully this example gives you a clearer picture of why buying is a better investment than renting over the long haul.   I believe this second example is a scenario that will play out for so many people over the coming decade – hopefully more than less will look back and be glad they took advantage of the opportunity at hand.

There are some phenomenal tools on my web site that can help you with many of the calculations involved in the financing part of buying a home, including a “rent versus buying” calculator.  Visit www.michaelsmallingloans.com and click on the Mortgage Calculators tab and you can take advantage of several tools that will help you with various decisions related to home financing.

Lending Environment

The last thing I want to address is the topic of mortgage financing.  There is no doubt that we have seen remarkable changes in the credit markets over the past 4 years.  The mortgage industry has changed more rapidly during this time period than any other time in history.  We have seen the near demise of Fannie Mae and Freddie Mac, the disappearance of the sub-prime market, the loss of all “non-verification” loans, an overall tightening of approval guidelines, the loss of 100% loans, credit scores have become the new driver of interest rates, negative amortization and “pick your payment” loans have disappeared, FHA has doubled its monthly mortgage insurance requirement, and many other restrictive type changes are now in place that did not exist 4-5 years ago.  Getting a loan today is as tough as I’ve seen it in my 20+ year career.

But despite all of tightening, the mortgage market is certainly not dead.  Financing is still readily available – for qualified customers.  Gone are the days of down payments or high credit scores driving the need, or lack of need, for documentation to support a loan.  Gone too are the days of no appraisals needed.  Today we live in a world where full documentation is required to prove credit worthiness and qualification guidelines are followed very strictly.  But we are still doing loans!  Buyers are still qualifying and able to buy their dream homes.  And maybe the pendulum has swung too far to the restrictive side.  But that is a natural reaction to the pendulum having swung too far to the side where restriction was lacking.  In time, a middle ground will be reached.  But even in this more restrictive environment, loans are still being made and buyers are still qualifying.

Now, income has to be documented fully, through a combination of tax returns, W-2’s, paystubs, employment verifications, or all of the above.  Outside of a few programs available for certain segments, which can be tied to income levels (such as THDA loans), geographical location (such as USDA loans), veterans (VA loans) and certain professions (such as in-house bank loans for doctors), all loans now require some level of down payment.  Assets to close have to be verified via bank and investment statements and have to be from acceptable sources (no unsecured loans, for example).  Credit scores must be high enough to meet the specific program guidelines and many loans have rates tied to these scores.  Debt to income ratios, for both housing and total monthly debt obligations, are being followed much more closely now than ever before, or at least more than any time in the past 2 decades.

Many feel that these changes are all in order and that mortgage lending should have never deviated from this type of stringent qualification requirements.  I tend to agree in many ways, despite the added challenges that now exist in my world versus where we were 4-5 years ago.  It only makes sense that all loans be made to truly qualified borrowers.  Instead of depending on the value of the home being sufficient for a lending decision, we are back in a mode of making sure that potential borrowers can actually repay the loans being made.  That is a good thing. 

Honestly, where the major frustration lies is with borrowers who already own a home and have an existing mortgage, and are now refinancing or buying something else.  They are the ones who are most likely to have gone through the mortgage process in the past 5-10 years and are not used to being required to provide the amount of documentation being asked of them in getting the new loan.  They don’t understand why they have to provide so much more information to get a loan now, when they did not have to provide it the last time they got financing.  First time homebuyers are new to the process so there is no prior experience to go by.  It is all new to them, so there are no changes from what they have been accustomed to.

Let’s again address the issue of first time homebuyers and talk about some specific scenarios that might be helpful for those buying for the first time.  Historically, the main source of funds for first time homebuyers has been FHA loans.  FHA (Federal Housing Administration) is a governmental lending arm of HUD (U.S. Department of Housing and Urban Development).  The down payment for FHA loans has typically been in the 2-3% range over the years.  As credit guidelines eased and lenders made 100% loans available, many first time homebuyers moved into those types of products.  Now that those products no longer exist, FHA has once again become the primary source for first time homebuyers.  Some of the nice features of FHA include:

·         3% down payment

·         Debt to income ratios that are a little less stringent than most conventional programs

·         Lower credit score requirements

·         Rates not tied to those scores

·         The ability to receive gift funds for the up-front cash required with no requirement of any set percentage of the funds coming from the borrower’s own accounts (most conventional loans require this)

·         The ability for the seller to pay all of the buyer’s closing costs

Another nice feature for first time homebuyers in middle Tennessee is the combination of an FHA loan done as a THDA (Tennessee Housing Development Agency) loan.  To qualify for a THDA loan, a borrower must have owned no homes in the previous three years and both his/her income must be under the county limit where the home is being purchased and the home being purchased must be under the county limit as well.  All of the information about THDA loans, including the income and sales price limits, can be found at www.thda.org.   The main reason buyers have used THDA in the past is that there is a discounted interest rate offered.  However, THDA also offers a couple of grant programs where money can be obtained to cover the down payment and part of the closing costs.  With the disappearance of 100% loans, I have found that this has become the most attractive use of THDA financing. 

For homebuyers who have good credit and income, but lack the needed 3% down payment and cash required to close, THDA can be a source of funds allowing the buyer to still essentially get in for no money down.  To do this, the seller will need to be involved offering to pay all or part of the closing costs required.  But this is very common as long as the seller is still netting the desired amount from the sale and there is no increase to the price that will negatively impact the appraised value of the property.  As an example, someone buying a qualified home in middle Tennessee, could ask the seller, as part of the sales contract, to pay closing costs up to 3% and use a THDA grant for 4% to cover the 3% down payment and any closing costs that the 3% being paid by the seller would not cover.  The effect in essence allows the homebuyer to get into the home with very little investment.  And cash to close is typically the biggest obstacle for first-time homebuyers.

THDA also offers some great education on home buying.  As a matter of fact, they require all homebuyers to go through one of their approved programs when using their program to finance a home.  I think this is critical for those using the grant programs allowing the down payment to be less.  I’m a big advocate of buyers making a down payment and having some of their own funds invested in the home.  So the more education a buyer can receive in those type situations, the better.

There are other programs that will accomplish a similar effect, but are a bit more restrictive.  VA (Veteran’s Administration) still offers a 100% loan, but you have to be a qualified veteran to be able to use the VA loan.  USDA offers a 100% loan, but only for properties located in rural areas that meet USDA guidelines.  You have to get a little further outside the Nashville MSA to find any predominant locations where USDA is available.  Some banks are still offering 100% financing to medical doctors.  But if you are not a doctor already, you will have to go to school for a long time to qualify for that loan.  J  Outside of other bank held products (to meet Community Investment Act requirements, some banks will offer 100% loans for borrowers who earn less than 80% of median income – but these are rare) there really are not many options for getting a loan with no down payment today.

The requirement for most borrowers to have a down payment is probably a good thing too.  While I would like to see everyone have the opportunity to buy a home, it does not need to be so easy that the commitment to make payments when times get tough is diminished.  There is something to be said for having some individual “skin in the game”.  When borrowers have their own invested funds, that they may have worked years to obtain, there is much more incentive for them to do whatever is legal and necessary to make the required payments on the loan.  It doesn’t take a lot of common sense to figure that out.  So while it is not as easy to get a loan because of the required investment, the loans that are being made are being made to borrowers who have more incentive to pay the payments.

I do believe that now more than ever, it makes a lot of sense that the very first move any potential buyer makes, is to get with a reputable mortgage lender and get pre-qualified for the proposed purchase scenario.   Because of all the changes that we have discussed in the lending environment, it is essential that you make sure that you not only qualify from a credit, employment and asset standpoint, but that you are looking in the correct price range.  Many times it is beneficial for you in the contract writing process if the seller knows that you have already started working with a mortgage professional and that your finances are in order before making an offer on a home.  For a first-time homebuyer, who has no home to sell and who has already been pre-approved for potential financing, an offer becomes much stronger from the seller’s perspective.

Another suggestion that I would make is that you define your monthly payment limitations, based on your budget, before you even hear what a mortgage lender tells you how much you are qualified to purchase (or pay per month).  And do the same thing with the amount of cash you are willing to put into the transaction.  This will help define your search and keep you from stretching your budget and cash position. 

The lending aspect of the home buying process is definitely more my specialty.  However, the scope of this article is focused primarily on timing and why I believe now is a great time to buy.  But I want you to be aware of the condition of the lending industry and hear a little about where we have been and where we are now.  While the going is much tougher than it has been, we are still doing new loans every day for borrowers that qualify for them.  If you have additional questions that are more specific than the generalities of the topics discussed here, feel free to call me and I will be happy to discuss any qualifying or budgetary type issues with you in more detail.

So there you have it.  Interest rates are still at all time historical lows.  Housing values have come down off of their highs and seem to have bottomed out, or are close to that point.  Values should begin their historical and very normal, slow but steady rise.  Due to some incredible help from our government, the economy has started to gain its footing.  But with that economic growth and added money supply, higher inflation has to be looming.  At some point when inflation starts to rise, so will interest rates and rental rates.  Buying has proven to be a better long term investment than renting.  And lenders are still making loans to qualified buyers.  It is my opinion that NOW IS THE TIME TO BUY!!