What Were You Thinking When You Purchased Your Home?

August 19, 2007 at 10:05 PM 6 comments

In the Sunday Real Estate section of the Washington Post Michael Rosenwald wrote an article called Was the Mortgage a Mistake. The article discusses Michael’s own decision to purchase a townhouse in Germantown, with an interest-only mortgage, at the peak of the housing market. In essence, just after his purchase the housing market cooled and interest rates began their creep upwards.

So one might wonder, why Michael purchased a home he could not afford. His rationale, an interest-only loan helped us buy a house in an expensive county where we wanted to live and eventually send our children to school. With an interest-only mortgage we could buy a nicer, larger home. Michael admits that he could have lived farther from the District for less money… Could have continued to rent…, but instead he decided he deserved a nice home and reasons he did what we had to do to get one.

He rationalized the purchase saying that he fully intended to sell the home within five years. He assumed that the market would continue to rise and that he would earn a profit just like the previous owners of his home. This thought process makes absolutely no sense. From Michael’s prior statements it is clear that he had no intentions of downgrading to a smaller home at any point in the near future. Let’s assume the housing market continued to rise. Michael would have sold his current home for a profit, but he also would have purchased a larger home that would have cost even more money in the wake of a rising market. It seems to me that Michael would have perpetually dug himself into deeper holes with larger mortgages. Let’s face it, the decline of the housing market has not hurt Michael’s financial situation, Michael has hurt Michael’s financial situation. In fact, I believe the current market decline may have saved him from purchasing an even more expensive home, and getting into even deeper trouble.

What’s even more amazing is that Michael and his wife seem to make a decent living. He mentions that his wife is a physician and that he pays taxes in the highest bracket. Yet Michael hasn’t made any preparations for his loan’s conversion from an interest-only mortgage to a 30-year fixed. In fact, in his own words, he bought a flat-panel television, took a nice vacation, bought a dog, hired a dog-walker, and then we got pregnant. All this while knowing that his interest rate could jump as high as 10.125%.

After talking with a real estate agent and a financial planner Michael now believes he has three options. Save money for the ultimate conversion of his mortgage. Refinance now to a 30-year fixed mortgage, and then refinance again if mortgage rates drop, or sell his home and move to another state where his housing dollars can go a whole lot farther.

Michael’s case is an interesting one. It seems to me that with a little more saving and a little less fruitless spending he could afford his home. While a lot of people are facing foreclosure because they can no longer afford their homes, it seems that there are also quite a few people with high incomes that could afford their homes if they simply stopped spending elsewhere. Either way I think it’s a good lesson for all involved and all those who are watching. No matter how much you love a home, you shouldn’t buy one you cannot afford.

Entry filed under: mortgage, stories. Tags: .

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6 Comments Add your own

  • 1. Clever Dude  |  August 20, 2007 at 2:28 AM

    I don’t like dropping links, but this story sounds exactly like my own history. I wrote about it here.

    I also have a follow-up post for tomorrow to discuss why we financed 100% :)

    But in our case, we can afford our loans, and we’re planning for the change in loan/housing 2 years from now. We’re not overspending on anything now, and we’re going to be out of non-home debt in 2 years.

    Thanks for the read!

    Reply
  • 2. Anonymous  |  August 20, 2007 at 2:46 PM

    Interest-only or negative amortization loans have a place in the world of financing, but the buyer must take these loans with the full knowledge of what they are doing. Taking an IO simply because it allows you to “buy” the house you think you deserve and couldn’t afford otherwise is a serious risk that seems to have turned into a disaster for this man an many others. It’s all about greed. Greedy lenders, brokers and borrowers that don’t understand or care that these good times will turn bad and the home has to be paid for.

    Reply
  • 3. Anonymous  |  August 20, 2007 at 8:38 PM

    Check out the comments people have posted at the end of the article. Not much sympathy out there.

    Reply
  • 4. One Frugal Girl  |  August 21, 2007 at 1:42 AM

    Clever Dude — I checked out your blog but I’m still not convinced. I would like to see a specific breakdown of your mortgage payment. What you would have paid with a fixed, what you are paying with a 5/1 IO, and what you will pay once principal becomes due.

    The problem with interest-only mortgages is that you, the home renter, cannot time the market. Also, you may think that you will only live in a house for X number of years, but life has a funny way of spoiling the best laid plans.

    When the principal becomes due you will be responsible for paying the mortgage and your payments will increase significantly. At that time you have two options: stay in the home or sell it.

    If the market is flat or sinking when you sell, you may very well lose money. Don’t forget that you have already shelled out money for closing costs and other mortgage related fees.

    On the other hand, if you decide to stay you may quickly realize that you are shelling out a whole lot more money for an interest-only loan than you would have for a 30 year fixed mortgage.

    The risk is too great for me. But then again I have a 15 year fixed mortgage.

    Reply
  • 5. Super Saver  |  August 27, 2007 at 2:11 AM

    Frugal Girl,

    It seems the Mortgage Companies (e.g. Countrywide), CEOs (eg. Ford, PIMCO) and now the Media are laying tracks for requesting a government bailout of people who made bad mortgage decisions. As a result, they won’t learn from their mistakes, and will likely cause simliar issues in the future :-(

    As usual, the cost will likely be shouldered by those that have managed their mortgages (and personal finances) well.

    Here via CoPF.

    Reply
  • 6. Everyday Finance  |  August 27, 2007 at 12:39 PM

    Hey there, not one to drop URLs too, like clever dude, but I thought it would be instructive for folks to see a full break down of an interest only vs conventional and how the int only can actually be lower risk. Int only is sometimes confused with negative amortization or option ARM. A conventional ARM is not risky at all, especially if you put some money down initially.

    With a conventional 30 year mortgage, most of the money you pay during the first few years is interest as confirmed by the amortization schedule, which is standard for all loans. Therefore if someone thinks putting 10% down on a 30 yr fixed vs. 20% down on an ARM is less risky, they’re incorrect. Full numerical analysis and excel model available to those interested. Several other benefits include tax, ROI, etc. Hope your readers enjoy!

    Dan

    http://everydayfinance.blogspot.com/2007/02/is-interest-only-mortgage-really-that.html

    Reply

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