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Real estate

Should you pay off your mortgage?

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Preparing to write the next installment in a series on achieving financial freedom, I ran some figures to compare the result of paying down a mortgage with extra monthly payments toward principal with investing the same amount monthly in a mutual fund. What I discovered runs against my theory that you’re well served to pay off a mortgage as fast as you can.

I still think that’s true if you’re getting close to retirement. In retirement, every debt should be wiped off your books, because you will need all your cash flow to live on. However, if you’re younger—say, anywhere between 20 and 45—and your mortgage rate is low compared to returns on equity investments, it would be to your advantage to invest extra dollars in a mutual fund earning around 8 percent. At today’s rates, this strategy allow you to accrue enough to pay off the principal faster than will throwing a monthly amount at the loan principal. Here’s how this shakes down:

M’hijito and I have a 30/15 mortgage at 4.3 percent. This means that for the first 15 years, we make payments at the 30-year amortization rate, but after the 15 years have passed, we either have to pay off the loan or we have to refinance it. The loan’s principal is $211,000.

We chose this mortgage because, at the time we bought the house, we believed the real estate market was nearing the bottom. We believed the house would drop in value another $4,000 or $5,000 and then begin to rise, probably at around 3 percent p/a. We figured that in five to ten years we could sell or rent the house and either break even or make a small profit. As everyone now knows, this was dead wrong: in fact, real estate was in free-fall, and the house is now worth at best $170,000, but more realistically around $150,000. This turns the loan into a real albatross. One strategy we are considering is to try to pay down principal with whatever extra monthly payment we can make (which ain’t much!), so that in 15 years, the amount to refinance might at least be no more than the house is actually worth, possibly allowing us to sell the house at that time.

In 15 years, with no extra payment toward principal, the loan balance will be $138,338. Monthly principal and interest payments are $1044; PITI comes to something over $1200.

Note that the projected loan balance is less than the most pessimistic present-day valuation. If the market finally has bottomed out and housing increases in value at 3% a year (a figure that is now being bandied about), in 15 years the house will be worth $233,695. That is less than we paid for it, but at least if we sold the house at that time we would walk away with a little cash in our pockets.

With me out of work, about the most we can afford to pay extra toward loan principal is about $100 a month.

Using Excel’s full value (=FV…) formula, I calculated the the return on a $100/month investment in a mutual fund earning 8% per annum. (Over at Vanguard, a number of stock funds and even a few bond funds are returning at this rate; one of them is Windsor II, in which I happen to already have a little cash.) I then used Quicken to run an amortization schedule, and compared the amount a $100/month investment would be worth in 15 years with the amount an extra $100/month principal payment would reduce the loan balance.

Assuming that our mutual fund investment averaged an 8 percent return, if we sent Vanguard $100 a month, in 15 years we would accrue $34,604 (full value =(.08/12,15*12,-100). If we paid an extra $100 a month toward the loan principal, in 15 years we would have paid the balance down by an extra $18,000 ($100 x 180 pay periods). According to Quicken, we would still owe $113,116.

With no extra payments, remember, we would still owe $138,338.

$138,338 – 113,116 = $25,220

Compare that with the $34,604 we would have earned in the mutual fund. Clearly, we would be ahead—by over $9,000!—by investing the money in a mutual fund with low overhead, such as Vanguard and Fidelity offer.

Well, now. Suppose you were not out of work, and so had plenty of cash to throw at the principal. Let’s suppose you really have plenty of cash and you decide to pay the equivalent of an entire P&I payment toward principal. Then what?

If you put $1,044 into a mutual fund every month, in 15 years you would have $361,264. If you paid $1044/month toward principal (in addition to your regular payment) on a $211,000 loan, you would pay off the loan in 10 years.

But by putting the cash into a mutual fund returning 8 percent, in 10 years you’d earn $190,995. Since in 10 years, with no extra payments, your loan balance would have dropped to $167,901, you’d still come out ahead:

$190,995 – $167,901 = $23,094

In other words, if you put the amount of an extra loan payment in an 8% investment, in ten years you would have enough to pay off the mortgage and still leave $23,000 in your pocket. If you used the same amount to pay toward the loan once a month, you would pay off the debt but would have no cash left over.

The conclusion is obvious: If your goal is to pay off your mortgage, you’re better off investing a regular payment in a decent mutual fund than paying the same amount toward principal.

This assumes your mortgage interest rate is lower than the rate of return from an equity fund. Note also that my figures do not take into consideration the small tax advantage gained by paying mortgage interest; this factor also would tend to improve the picture if you invested in the market.

Risky? Sure. But we now know that investing in real estate is wildly risky, too: more so, it develops, than the stock  market. My stock investments are rapidly regaining their pre-crash value, but there’s no credible sign of any recovery in the real estate market here. Even if the value of the house starts to increase at 3% p.a. today, in 15 years it won’t be worth anything like what we paid for it. If property values remain flat for any length of time (as it appears they will), we will lose not only our shirt but our pants, socks, and underwear.

I used to think my father was crazy because he refused to buy a  house until after he had saved enough to pay for it in cash. All the time I was growing up, we lived either in company housing or in rentals. His reasoning indeed was crazy—he bought into The Protocols of Zion, an irrational tract that led him to believe all mortgage lenders were part of a hallucinatory international Jewish conspiracy. However, the effect was that when he retired at the age of 53, he had enough cash to buy a house and a car and to support himself and my mother in a middle-class lifestyle without having to work.

Crazy like a fox, that old boy was.

A rabid fox, but still…

Mortgage loan modification strategy

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Just sent off a wad of paper to the loan officers at the credit union. My favorite spy there tells me that because I’ve been laid off my job, we have a shot at getting our mortgage payments reduced, at least for a while.

I’ve asked to have the principal cut, since the so-called “investment” house is now worth about $50,000 or $60,000 less than we owe on it. What a flicking fiasco!

What We’re Hoping For

Of course, they’re not going to do that. The credit union’s loan officer says they have been cutting the interest rate by reamortizing the loan over 40 years. This is a temporary arrangement, lasting at most two years. After the period is over, the customer may be given an opportunity to refinance, or simply to allow the rate to revert to what it was, with no detriment to credit rating.

Because the credit union has never been involved in federal loan programs, this is a private loan modification, not part of a government stimulus plan.

Rates are at 5.09 percent today, and so, since our rate is already down to 5.3 percent, I’m afraid this wouldn’t make much difference for us. However, if the loan were reamortized over 40 years, then our mortgage payment would drop by $141 a month for the next year or two. That would help a little. Not much, but some.

I’ve also asked them to change the terms from 30/15 to a straight traditional 30-year mortgage without zinging us for refinance costs. In a 30/15 mortgage, your payments are based on amortization over 30 years, but the payment comes due in 15 years. If you haven’t sold the house by then, you have to refinance. Because we thought we would own the house for five or at most ten years, this looked like a pretty good deal at the time.

Now, though, it’s beginning to appear that the house will not regain in its value in the 12 or 13 years remaining to run on the 15-year part of the present mortgage. And if history repeats itself, in another decade you can be sure that interest rates will be through the roof. Even if we  have paid down the principal some, we could end up with payments that are no less than what we’re paying now, which is WAY too much.

If the property value has not risen significantly after the initial 15 years ends, we’ll have to bring cash to the table to keep from losing the house, since we will not be able to refinance it at that time unless we add a chunk of money to the equity. And because I will never get another full-time job at my age, we will simply not have the cash to do that. Effectively, we will have been paying rent on that house at a rate far above the going rental rate in that neighborhood.

Nightmarish

M’hijito is feeling trapped. He’d thought we would be in a position to sell in five years, given that the market seemed to be at or near its lowest point at the time we bought. Because we failed to recognize that real estate was in free fall, we completely misjudged the actual value of the house, and now, along with 25 percent of the other mortgage payers in this state, we are nailed into an investment that is worth nothing like what we bargained for. Because you don’t realize a loss until you sell, we’re hanging on and hoping values will turn around. But realistically: it’s going to take a long, long time to break even on that place, and we certainly will never make a profit.

Meanwhile, he would like to go to graduate school (can’t, as long as he has to make that mortgage payment) and he would like to go back to San Francisco (can’t, as long as we have an albatross tied around our necks). Because we can’t rent the house for what we’re paying on it, our options are very limited.

What Else Can We Do?

There’s really only one option if he wants or needs to leave: I sell my house, use the proceeds to pay off the mortgage on that house, and move in there.

It’s a pretty little house, and the truth is, it’s a better size for me. It has no pool, so that would be one fewer cost and lots less work. It’s more centrally located—within walking distance (sort of) of the light rail line and my favorite upscale grocer (where I no longer can afford to shop…).

On the other hand, the summer utility bills are much higher than mine, and the neighborhood is not the best. Although my neighborhood also has some dangerous slums nearby, it at least doesn’t have a Walmart around the corner jacking up the crime rates, and I do have a very pleasant park less than two blocks from the front door.

Really, in terms of living conditions it probably would be a toss-up. I certainly could stand to live there. If that’s what we have to do to make it possible for him to get on to the next stage of his life, the world won’t end.

Would you buy a house near a Walmart?

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Mighty Bargain Hunter has a new money site, called Cash Commons. It’s pretty interesting: readers ask questions, others answer them, and people earn “reputation points” whose value is unclear but which make for a fun gimmick.

One of the questions, “Is having a Walmart hundreds of feet from a property a good or a bad idea,” led me to draft a response that was way too long for the site, which apparently is designed for the short & the quick. The more I thought about it, the more my response began to look like a whole new post. So I decided to cut it short there and hold forth at greater length here at FaM.

There’s a Walmart within walking distance (more or less) of the house M’hijito and I co-own in mid-town Phoenix. His neighborhood is on the low side of middling; it’s one of the few in-town areas that have been seriously thumped by the recession—in general the worst-affected districts are outlying suburbs. The main source of the property devaluation in that specific residential area, sandwiched between a slum and a very upscale district, has not been the nearby mall—also the scene of a Costco and a Target—but the many foreclosures that have driven down comparables.

The shopping center, which is extremely busy, has a correspondingly high rate of car break-ins, thefts, and robberies. So, when you look at one of those online maps of crime rates, it appears that the entire area has a high crime rate, even though the neighborhood to the east of it, where the pretty little house resides, is relatively safe. This factor undoubtedly will influence some potential buyers.

The area just to the south of it, on the other hand, consists of run-down apartments and is the scene of almost nightly cop helicopter fly-overs. A few years ago, a friend of mine, who lived in one of those dumps, was murdered in the parking lot by some guys who were trying to steal his car. The low-rent apartments were there before the WalMart went in and probably were neither created nor worsened by the nearby commerce.

Reds show high criime areas, yellow middling rates, greens relatively lower rates. The Walmart shopping center forms the bull's-eye here.
Reds show high-crime areas, yellow middling rates, greens lower rates. The Walmart shopping center forms the bull’s-eye.

The City has built a light-rail line that passes about a half-mile from the house and has a terminal in that Walmart shopping center. This has turned a substantial part of the mall’s parking into a park-‘n’-ride for those who are brave enough to leave their cars there. We are told that light-rail is supposed to increase property values in bordering neighborhoods. So far we haven’t seen that happen in the area; this could be attributable either to the scruffy shopping mall and tenement district or to the deprecession.

On a slightly tangential note, friends owned a house that backed onto a Fry’s Supermarket. In our area, Fry’s caters to a downscale crowd, and in this case that was true with a vengeance. The Fry’s and the shopping center owners were particularly insouciant about the neighboring residences. They arranged for garbage to be collected (illegally) in the wee hours of the morning (commercial garbage collection sounds like a wrecking yard—SDXB and I lived several blocks away and could not leave a window open on a nice night without being awakened by the racket) and allowed homeless mentally ill to camp in the parking lot and throw trash, garbage, and human waste over the neighbors’ walls.

At the top of the bubble, the couple arranged to have a new house built.  Lacking a crystal ball, they decided to stay in their existing home while construction proceeded, rather than selling right away and squatting in a rental until the new house was ready. We know what happened next. After the market crashed, they couldn’t even give away the old house. No one in their right mind would buy a house—or rent!—behind a Fry’s, not when far more desirable property could be had for a song. After several years of struggling to sell it or to keep it rented, they finally defaulted.

The bank hasn’t been able to unload it, either.

Extrapolating from that, I’d advise that the instant you get wind of a new Walmart or any other large commercial retail about to go in near your home, sell!

Image: Phoenix Police Department Uniform Crime Reports, Monthly Maps, Property Crimes

Ghost developments

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Inflation-adjusted housing prices in the United States by state, 1998–2006. Click on the image for a larger view.

Yesterday I spent the afternoon hanging out with my friend Kathy, who lives up against the White Tank Mountains that form the Valley’s western boundary.

The far west and east sides of the Valley were the scenes of the most frantic building campaigns during the late, great Real Estate Bubble, whose collapse has affected the Phoenix area possibly more than any other major metropolis in the country. Phoenix, like Las Vegas (another hard-hit town), has a typically Southwestern boom-and-bust economy. Based on nothing solid, our spates of prosperity evaporate into the dry desert air at the first breath of a hard wind.

The west side has been filled with toss-’em-up tracts, styrofoam-and-stick houses that go off like Roman candles if a fire starts somewhere in the structure, that split and fall apart as the poorly compacted clay beneath them settles, and that stand eave-to-eave, crammed so close together that you might as well be living in an apartment as in one of the laughably dubbed “single-family homes.” Even the most expensive housing there is built this way: people packed in like hens in a commercial chicken farm.

These tracts are half empty. As housing prices ran up, new housing sold for even more than existing housing, which itself was selling for far more than what it was worth. As buyers defaulted, builders went belly-up, leaving many developments only partially built out and many houses standing empty.

Because the frantic building took place on the edges of the sprawl (Phoenix’s City Parents carefully study Los Angeles so they can imitate everything L.A. did wrong), the bust has affected the new areas far more than the central parts of the city.

I was amazed at what we saw as we drove around: mile on mile on mile of shiny new strip shopping  malls, all of them empty. One mall had a single Italian restaurant in it. Another had housed a couple of businesses that had closed and cleared out their equipment, while other space evidently had never been leased.

In one development, an empty mall had a dusty sign next to an empty bank building: “Citibank: Coming Soon!”

We went by a shoe store we both like, because it sells European styles that look nice on your feet without crushing your bones.

Gone.

By and large, the surviving commerce consists of big box stores, beauty salons and supply houses, and a few chain restaurants. Everything else is absent.

It’s eerie to drive through a vast area and see swaths of empty buildings. The place looks like an empty movie set. Or like it had been evacuated and the residents never returned.

Kathy was surprised when I said that our part of town has no empty shopping malls, and in fact centrally located strip malls are being renovated and are fully occupied. She has seen these ghost strip malls for so long, she’s come to think of them as a normal part of the landscape.

What a landscape it is! Vast Potemkin villages of ghost neighborhoods and ghost shopping malls. If this is going on all across the country, America is in deep trouble.

Image: “United States Housing Bubble,” Wikipedia. GNU Free Documentation License.

Wow! Real estate update…

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The other day, as you may recall, I was ruminating about the wild range of prices for very similar houses in the tiny 1970s tract that is my immediate neighborhood. Asking prices just now range from $130,000 to $294,900. All the houses are similar in size, construction, and quality.

Well. The Mexican contractors who bought two houses just to the north of me and cherried them out with only the classiest of flair quietly put one of them on the market. La Maya spotted the selling price in the paper:

Three hundred and ten thousand dollah!

Holy mackerel! That’s what these houses were selling for at the height of the bubble!

They did do an exceptionally nice renovation. But still: no amount of style changes the fact that it’s just another aging three-bedroom tract house a block and a half away from the destruction that was once a light-rail project. Or that it is right next door to a run-down slummy shack that has been rented out for the past several years to an endless succession of down-at-the-heels men—often as many of six of them at a time. These guys use the front yard as a parking lot, so that one of them can use the garage to practice his drums. They have large barking dogs, and by way of making their neighbor Manny crazy occasionally shine lights directly into his yard.

I don’t know how the Contractors pulled that off, but whatever they did, it’s good for the neighborhood. As La Maya pointed out, it indicates that prices have held fairly steady here in spite of the crash.

And well they should have. Yesterday afternoon I spent an hour or so biking around the area, which surrounds a small park. It really is a beautiful neighborhood. Some of the houses are spectacular. Others are just very nice. Except for a few properties in my part of the ’hood and a few more in the tackier section just to the north, most houses are well maintained. The benefit of living in the low-rent section of a fancy neighborhood is you get to enjoy the swell ambience without having to pay upwards of a half-million dollars for the privilege.

I’m glad I didn’t panic and bolt to Sun City along with SDXB in the wake of the vandalism drama. And I hope I can hang onto my house in unemployment. This is a great place to live!

Real estate prices gone nuts

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Amusing myself in the wee hours by cruising real estate listings in my zip code, I came across one of the neighbor’s houses, comparable to mine, on the market for $199,000, some $36,000 less than I paid for my place.  The sales pitch shouts,

UPGRADED CABINETS, JENN-AIR APPLIANCES, ENGINEERED WOOD FLOORS, NEW LUSH LANDSCAPING WITH 12 ZONE IRRIGATION SYSTEM. NOTE**SQ FT INCLUDES 300+ BONUS ROOM OFF KITCHEN**COULD BE FAMILY ROOM,DEN/OFFICE,KIDS PLAYROOM OR???**THIS KNOELL HOME SITS ON A LARGE LOT(OVER 11,000 SQ.FT)LOTS OF YARD FOR THE KIDS TO PLAY**SEPERATELY FENCED SPARKLING DIVING POOL OFF COVERED PATIO**LONG DRIVEWAY W/ROOM TO PARK AT LEAST 4 VEHICLES

Gee, thanks, guys: Let’s invite some more chuckleheads to turn their houses into used-car lots!

It’s not an especially pretty model, and it’s a bit too close to the light-rail construction on 19th Avenue. But still…it has most or all of the amenities my house has, and they’ve set the price in the basement.

Ah, yes: the light-rail construction. Make that nonconstruction: the City has changed its mind, after having ripped out the better part of an entire row of homes in our neighborhood and spread hideous cement-gray gravel over the resulting scars. The SOBs came in here, wrecked our neighborhood, and then walked away! They’re now considering other routes to serve the west side (read “the multimillionaire developers who own the new stadium out there, not to mention the occasional politico and city official”). It’s pretty clear the proposed line past our area will be abandoned, leaving us with devalued homes and enhancing 19th Avenue’s premier characteristic as a conduit of blight.

That would explain the cut-rate price on this house, which is owned by a couple who have lived there for many years.

Not the cuttest of all possible rates, though: a house on the street just to the south of me, which was wildly improved by a speculator who bought on the deflationary edge of the bubble, is offered as a short sale at $130,000.

Meanwhile, about 100 steps down the street from the first house, another neighbor is trying to unload a bland little house, “as is” with no photos at the Realtor’s website, for $229,000. That place has been on the market for quite a while. It’s not a short sale or foreclosure, but between the lackadaisical sales effort and the unexceptional front elevation, one could easily think it is. The house doesn’t look all that bad, but it’s nothing special, either. Houses around it, though, are badly run down: the Rental Baron’s slum property was bought by a woman and her son who put way too much money into fixing up but succeeded in selling at the height of the bubble to Adam the Pool Guy, not the brightest decorative light hanging in the backyard gazebo. Adam now owes over $325,000 on a house that he has allowed to go right straight back to pot. The kids across the street from Adam inherited their house from his mother, and they also are letting the place crumble away.

It costs a lot to water a lawn around here. So people who can’t afford the water bills will just let the grass die. Xeriscape it? That costs a chunk of change, too…if you can’t afford a $300 water bill,  you sure can’t afford to have someone come and convert your bermuda grass to imitation desert.

“SEPERATELY FENCED.” Heee! Well, I guess you can’t expect much better than a pitch to people who use the front yard as a parking lot from sellers who can’t run a spellchecker and haven’t heard much about periods. Another house around here is described as having an “UP GRATED KITCHEN.”

😀

Someone wants $239,900 for a very pretty little house that has been massively overimproved in the seedy neighborhood just to the north of us. What could they have been thinking? Our friends who moved out of that tract several years ago finally had to default on the house that backed on to the grocery store. The bank wants $129,000 for it.

A bank is trying to sell a house that fronts on the seven-lane main drag that forms our neighborhood’s southernmost border: $251,500, rather more than anyone should pay to live on a feeder street for Interstate 17.

"Must be seen to be believed!!"
"Must be seen to be believed!!"

Next street to the north of me, a neighbor wants $264,000 for a place that has been “upgraded” in fun-house style: red kitchen cabinets, black countertops, blue carpets. While the price is what you’d think of as about right for this area, it would take a special buyer to fall in love with this place. The present owners so loved the eyeball-popping scarlet cabinetry that they put it in the bathrooms, too.

The folks who want $289,900 for the house with the view of the 19th-Avenue nonconstruction site are still waiting for their dream buyer to come along. That place has been on the market for months. Many months.

And in the what were they thinking department, a house on my  old street, about two blocks to the north of the present manse, recently came on the market for $294,900. It has some recent upgrades (2008), but it has no pool and its exterior is so undistinguished I can’t even picture which house it is—and I walk or drive by there every couple of weeks.

The $199,000 model is the same or a similar model, and it does have a pool. That’s a $95,000 range for identical houses in the same six-square-block neighborhood!

Add the slightly more decrepit tract just to the north of us into the mix, and you get a spread of $160,000, for housing that’s all pretty much cut out of the same cloth.

Think of that.