A few years ago, it was a seller markets. In the Baltimore area, a home would list on Friday and a contract would be signed on a Monday. At the latest, it took until a Tuesday until it was finalized as buyers would compete with each other to get the house. List prices were the starting point, not the ending point, and if you really wanted a home you’d have to pay top dollar. The home I now own was listed at $270,000, I paid $295,000, and a competing buyer offered as much as $330,000 for the home*.

Today it’s totally different. I believe that right now, and for the next six months, you’re seeing the lowest point for sellers from a psychological perspective. Whether or not the housing market is factually at the bottom of the valley remains to be seen but I think we’re at the lowest possible point a seller can be and still keep their home on the market. If the market gets any worse, you’ll probably see any optional sellers, those that don’t have to make a move, pulling their homes off the market if they haven’t already. Homes that have languished on the market for months will probably slide a few renters in to tread some water and those foreclosures? Scooped up by opportunists or just left sitting on a bank’s balance sheet.

Why do I believe that we’re at the low? The stats don’t lie and there are only so many punches you can take. Home prices take the largest tumble in 25 years? Homeowners and builders offering all sorts of freebies like leases on cars and free appliances. I mean it’s so bad that the government is stepping in and thinking about freezing ARMs in order to stop the bleeding. Oh, and to pile on even more, it’s now winter which has historically been the slowest season for home sales.

If I were in the market, I’d probably turn to new constructions first because builders need to move inventory. They aren’t like regular sellers where they can opt to just live in the house a little while longer, they need to free up the capital they’ve invested so they move onto other opportunities. They are also more likely to offer up huge incentives for buyers because of this need to rid themselves of inventory. If new constructions are out of your league, I’m sure there is plenty of inventory in most of the US so pick your spots and you’re likely to find yourself a great deal.

What do you all think? Things will get worse? Much worse? Things will get better?

* The reason I got the house was because I was willing to rent it back to the seller for two months as they bought their new house. The competing buyer wasn’t willing to do that, so I lucked out big time.

Okay okay, earlier this week I wrote seven irresponsible and fun ways to spend your holiday bonus and now I’m going to throw a bone to the responsible crowd out there and list the seven responsible things to do with your holiday bonus. Personally, I think everyone is a mix between the two (or at least I am between the two). If you spend your entire bonus on fun things, then you aren’t saving enough for the future. If you save the entirety and do responsible things with your bonus, then you aren’t really enjoying the fruits of your labor. What I think you really need to do is find a nice happy medium between the two without going overboard in either direction.

1. Eliminate Debt

Are you carrying any high interest credit card debt? Before your spend any of that bonus on anything, put it towards your debt. Before you save for your retirement, pay down your debt. Paying down a credit card debt at 19.99% is like earning 19.99% on an investment (not exactly, but you get the idea), so pay down that credit card debt as soon as possible. Before you can build your personal finance house, you need to firm up your foundation. In this analogy, firming up your foundation means getting rid of all of your debt so that you can start fresh.

2. Pump Up That Roth IRA

You have until April 15th of next year to make a contribution for this year, using your holiday bonus towards this is a great opportunity to save for your retirement. Now, if you haven’t put anything in your Roth until now, I recommend that you revisit your retirement savings strategy for next year and put a little away each month. You may not get a bonus (or as much of a bonus) next year so waiting for it to arrive before making a contribution is risky. If you’ve contributed for this year, consider saving it and contributing it towards next year. By making the contribution as early as possible you let your money grow as long as possible.

3. Bolster Your Emergency Fund

Do you have three to six or twelve months of expenses saved away in your emergency fund? If not, then you should consider saving a part of your holiday bonus into a high yield savings account for a rainy day. An emergency fund is a crucial part of your overall savings picture. It allows you to weather the emergencies in your life without having to put you in a debt hole that you have to climb out of. At a minimum, I recommend three months. I personally keep around four months but that’s because we have two incomes (I would recommend at least six months if you only have one income).

4. Consider A Home Renovation Project

Now is a great time to consider a home renovation project if you own your own home. What’s great about a renovation project is that you get the benefit of the renovation plus the potential increase in home equity. Now, not all renovations are created equal so don’t think that you’ll get back every dollar you put in. Adding a bedroom or a bathroom will increase the value of your home nearly as much as it costs to add it, putting on a sun room isn’t as as valuable. Lastly, this year is the last year to get a tax credit for making energy saving home improvements.

5. Make Another Mortgage Payment

If you don’t own your home, then you can skip this one. If you do own your home, consider paying down a little extra principal this month. By paying down more principal, you reduce the amount of interest you end up paying but just a little bit. What actually happens is you accelerate your amortization schedule, a schedule that is front loaded with a lot of interest that benefits no one except the bank. So, by making an additional payment, you are shortening the loan terms and saving yourself significant money on the back end. If you end up doing this each year, then you can shave years off your loan. For example, on a $300,000 loan at 6.25% interest for thirty years, you would normally pay approximately $365,000 in interest over thirty years. If you make a one time payment of $1,000 after the first year (say you started the loan in January and made that extra payment that December), you would reduce your total interest paid by over $5,000.

6. Predict Your Potential Needs & Save

Look towards the next year and try to predict any large capital expenses you may encounter. For example, we’ve been using a water heater that has been here for the last twenty years. It’s a water heater that may or may not need to be replaced in the next year and it’s an expense we’re prepared to pay because we’ve planned ahead and saved enough. An emergency fund is great to handle those emergencies you can’t see coming, but if you think you’ll need some funds for a specific reason it’s often better to save in a separate fund for those cases.

7. Go On A Vacation

That’s right, the seventh responsible idea for spending your bonus is to go on a vacation. Why? It’s because you need to be rewarded for a year’s worth of hard worth and great performance (or at least good enough performance to warrant a bonus!). Your employer saw it fit enough to reward you for your hard work so far be it from me to advise that you don’t actually reward yourself for that hard work. So, go on a vacation, enjoy yourself, and send me a postcard!

(Photo dntanderson)

A recent article on Wall Street Journal talks about how some people are glad they rented instead of bought because of the recent housing slowdown. What I want to know is why timing the housing market is okay, but timing the stock market is the greatest sin in all of personal finance (it’s not, but sometimes people make it seem that way). The argument against market timing in the stock market is that the market is random, that it trends upward, and your horizon should be far enough away to handle any hiccups. The idea is that with it being random, trying to sell at peaks, buy at valleys, and all that mumbo jumbo is a losing proposition, especially after fees.

Real Estate Timing!

So why is timing in the real estate market any different? The prices aren’t random and don’t move quite so much, but they’re difficult to predict. Here in my neighborhood, five houses have sold in the last twelve months (of the six listed) and each sold within a week to two weeks of being listed. Each sold for about 7%-10% than what I bought my house for two years ago, which shows some year over year growth (not the crazy growth of a few years ago, but healthy reasonable growth). The lone house that sat wanted a good 20% more, which was clearly over-priced. If you waited to buy a house in this neighborhood, it wouldn’t have mattered.

However, in the city, where newly renovated rowhomes and brand new condos were being build and listed with ridiculous prices; those prices sank like a rock. Homes that were once listed around $500k are now at $400k. The only difference was that those homes were newer, being purchased by people with more money than ability to recognize value, but the same geographic area (Baltimore, MD). So, why did those fall more than other areas? Who knows. It’s difficult to predict when supply will outpace demand.

I’d Probably Be Renting

That being said, I hate unyielding adherence to conventional wisdom (which says you should always buy and not rent because rent is throwing away money). Conventional wisdom works if you’re conventional, except most people aren’t conventional and even if they are conventional, they’re usually not in a conventional environment. If I didn’t own a house, I’d probably be renting right now only because I don’t like putting myself into long term relationships (mortgage) in an uncertain environment (housing).

What about you? Renter? Buyer? Glad you did either? What are your future plans?

I asked a few friends of mine why they didn’t maximize the contributions to their 401(k) each year and the number one reason was that they were saving up money for a downpayment on a home. All of my friends are young professionals with good salaries but with your typical rowhouse in the area costing around $200,000 to $350,000, with many far more, it’s extremely difficult for someone to come up with the $40,000 to $70,000 required for 20% down. What’s adding to the difficulty is that it doesn’t even consider the closing costs which can get up to $10,000. So, what are some strategies you can use to come up with the 20%?

First, How Much Will You Need?

This is step one, calculating how much you’ll need to save in order to reach your goal of a 20% downpayment. After you have this target number, you can start employing the strategies below to figure out how you’ll get there. Let’s say you want to buy $300,000 of house in 2 years, so that means you have 24 months to save up the $60,000 downpayment. I think you can use a conservative estimate of 4% for the appreciation of your money in savings (let’s ignore inflation because the estimates for inflation and its effects over two years are too variable to use historical numbers).

Now, calculate how much you’ll need to save over 24 months to reach $60,000. Here’s a savings calculator (you will need Java installed, but it should ask if you don’t have it) that you can play with to reach your answer (I used a business calculator). Enter in $60k for the savings goal, 2 for the years to save, and all the other pertinent data. If the graphs aren’t updated, click on the Calculate button. The answer is $2,375 (the white boxes). You can enter in your current savings to see how far away you are, but $2,375 is your target number each month if you want $60k in 2 years at 5% appreciation. So, how do you get there?

Find A Smaller House, Different Location

Now that you have the target number, it’s time to play with it. While this sounds like a no-brainer, it isn’t that clear when you’re searching around for homes that you should settle for less house. What used to be a “starter home” in an area ten years ago is no longer a starter home as home prices, even after the recent slipping, have vastly outpaced inflation and wages. In your mind’s eye you have an image of what you’re first home was going to be, I know I had an image of a first home that looked like the home I grew up in (my parents still live there and have done so for the last 27 years). The problem was that home is at least half a million dollars in the nicer areas of Maryland, if not more depending on the home’s age and specific location, so it wasn’t within reach.

Next step? Think townhouse. Single family home on my salary was an impossibility unless I was willing to sacrifice other factors such as the location, which I wasn’t, so a townhouse was my next option. If you’re a handyman or handywoman, consider getting a fixer-upper. If you’re not picky about the location, pick a less desirable location. Ultimately the first step is finding out how little you’re willing to pay for a home and how much you’d be willing to pay and check out your options.

So, let’s say you are now willing to live in $200k worth of house and thus need only $40k in a downpayment in two years. $1,583 is now your target savings per month, a difference of $792 each month.

Ask Your Parents (Relatives, Grandparents, Etc)

This is how I was able to come up with any type of downpayment (I was only about to get around 10%, even with my parent’s help) and it’s something that requires a little of preplanning because of gift taxes. The donor must pay gift tax on any gift over $12,000 in 2007, so if your parents can help then it will help their tax situation to spread the gift out over the years. If you do this, keep this sample gift letter template in your back pocket because you’ll need to send a version to your lender when you request a mortgage.

Let’s say you’re back to a $300,000 house and your parents (or benefactor) gives you $10k right now. Enter that as your “Amount currently saved” in the tool and you’ll find that your magic number per month has fallen from $2,375 to $1,939, or a difference of $436 of savings each month.

Cut Back On Retirement Savings

This is another option that I and many of my friends did to help save a little extra. I still put in my maximum Roth IRA contribution and the minimum needed to get the employer match for my 401(k), but I didn’t contribute any more to retirement outside of what I consider the bare minimum. Some might not even contribute to a Roth IRA, but I would consider that a mistake. At this point you’ve stopped reducing the magic number and started focusing on increasing your savings, so it doesn’t make much sense to look at the calculator anymore.

Cut Back On Discretionary Spending

Start finding trimmables in your budget so you can get your savings up to your target savings rate to achieve your goal. The trimmables post I wrote back in October of 2005 still applies today and it was motivated by my own savings plan when I bought a house. It’s easy to cut something back when you think it’s only temporary and when you have a goal in mind.

I hope that with a little bit of math and some suggestions I’ve been able help some prospective homebuyers wrap their heads around where they can look to get that 20% downpayment, it was the approach I took and it ended up working for me so I hope it works for you. If you have any suggestions or ideas that I’ve missed, please let me know and I’ll add them to the list. I hope that this helps people understand that while getting 20% is difficult, it’s not impossible if you’re diligent.

I’ve read in a lot of places, from mainstream media to little bloggers like myself, about how debt is such an evil thing and I wonder how our financial markets would’ve fared if the concept of debt and leverage never existed. We wouldn’t be as prosperous as we are now, that’s for sure, because debt is not a bad thing! In fact, debt is a good thing. It allows you to do some of the things you might otherwise not be able to do, such as buy a house, go to college, and buy a car.

However, like many things in life, it’s good in moderation and when appropriate. I don’t think anyone can make a good case against getting a mortgage and buying a house (though I have tried). I also don’t think anyone can make a good case against going to college (again, I’ve tried). However, anyone can make a case against using a credit card and carrying a balance so that you can keep your three a day Starbucks habit. That’s where the moderation and appropriateness tests come into play and that, also, is up to your own personal preferences.

Ultimately, debt is important because allows you to do the things you want to and should be doing. It allows you to leverage some of your future in order to enjoy something now. While you can’t buy a home outright, you can still enjoy it while paying a fee to do so (interest). The only problem is that you can’t leverage the future so much that when it does come, and it will, you find yourself struggling to keep up. That’s why you must exercise moderation.

Appropriateness is a matter of personal opinion but even if you fail this particular test, being moderate in your debt accumulation will leave you in a good enough situation that all won’t feel lost. So you go through life spending on transient things, let’s say you go to movies all the time, and rack up a little credit card debt. While you have nothing tangible to show for the debt, if it’s kept in moderation it’s not something that will be a life changer. A few thousand dollars of credit card debt, while still bad, isn’t something that will play with your psyche… twenty thousand dollars of credit card debt will require much stronger fortitude to overcome.

So, don’t approach the idea of debt as something that’s evil and loathsome, think of it like a tool that can cut both ways and use it with care.

When shopping for a mortgage, you have many choices, including typical fixed products such as a 30 or 15 year fixed mortgage, or more aggressive programs such as adjustable-rate mortgages, option-arms, and hybrid option-arms.

Considering the average time people spend in a home is roughly three or four years, why settle for a high-priced fixed mortgage? You can get a 5, 7, or 10 year hybrid arm that comes with a significantly lower interest rate, plus the safety of a fixed period for longer than you’ll likely stay in the home.

Even if you do stay in the home for longer than anticipated, you can always refinance into another option-arm or hybrid arm program and reset the fixed period.

Be sure to include an interest-only option on your mortgage as well. It makes no sense to pay down your principal. You’ll probably move out of the home in the next five years, and with market appreciation almost guaranteed, you’ll have enough equity to part with the home and still make a decent return.

Additionally, if you make interest-only payments, you’ll be able to invest the difference in the stock market and get a better rate of return than the 6% interest rate on your mortgage. During the 1990s, the S&P 500 provided an annualized return of 17.3%.

Better yet, you could get an option-arm that comes with payments as low as 1%. Sure you’ll experience negative amortization, which will eat away at your equity, but why pay the mortgage down when you make more money investing in stocks or other securities?

If you pay 1% on a $500,000 loan amount, the monthly payment is a mere $1,600 versus a monthly payment of $3,200 on a fully-amortized 30 year fixed program at 6.625%.

And all that interest is tax-deductible, so you’ll get it back in April. Any money paid towards principal is not.

Don’t believe what Suze Orman says, the choice is simple. Invest your money at a higher rate of return than your interest rate, using your home as leverage and you won’t be sorry.

This is a guest post by Colin Robertson, a mortgage professional and chief writer for financial blogs: The Truth About Mortgage and The Truth About Credit Cards.

One of my friends recently purchased a home and she was sent a letter (if you recently purchased a home, you’ll probably be familiar with how many letters you will get informing you of great refinancing rates) about a program that would speed up her mortgage payments by sending them in every two weeks instead of just at the end of the month. She was primarily wondering whether it was a scam and whether it “worked” because I suppose the letter, which always looks shady, probably did a poor job of explaining why it would pay off her mortgage faster.

The biweekly mortgage payment strategy is one that’s been in existence for quite some time. It is legitimate and there are two reasons why it’s legitimate:

• More Payments - Let’s say your mortgage is $1000 a month. When you make one payment a month, you pay a total of $12,000 each year towards your mortgage. When you make two payments a month, you’re now talking about twenty six (26) payments (fifty two weeks divided by two) of $500 which is equal to $13,000 a year - or $1,000 extra. Clearly, if your budget can handle it, this will pay your mortgage off faster simply because you’re paying more.
• Less Interest - When you pay the standard once a month, interest accrues on your balance for that entire month. When you pay twice a week, a greater percentage of your payment is applied towards the balance and you speed up where you are on your amortization schedule. The principal, in theory, has less time to accrue interest.

So, now that you’re convinced this is a legitimate way to speed up the rate at which you’re paying down your mortgage, let me give you the advice I gave my friend if you’re thinking about getting one of these “services.” Don’t. You don’t need to pay some fancy expensive company for this service, you can usually talk to your lender and they can set something up for you. If they are unwilling and you have no prepayment penalties, just send in the payments yourself. With online banking, it’s easy to schedule regular payments automatically so you won’t even have to buy any more stamps.

So… does anyone know why companies were sending me letters asking me to refinance a month after I just got a mortgage? And why would they ever think I’d accept their offer?

ING Direct has been running a promotion for quite some time offering flat $555 closing costs on their mortgages (this promotion will be over at the end of this month, Feb 2006). The reviews on their service has been mixed and I haven’t had first hand experience with ING with products other than their Orange Savings Accounts. But is the $555 flat closing cost promotion actually a good deal financially?

If you’re looking for a fixed rate mortgage, you’re out of luck. ING only offers 3/1, 5/1, and 7/1 adjustable rate mortgages at competitive rates. That alone may make this a non-deal for many but for those of you who are not anti-ARM because of your circumstances, read on.

A lot of various fees and costs are lumped into the term “closing costs” and so it’s sometimes difficult to compare them. When I was looking for a house last year, the fees that were listed as closing costs with LendingTree were a tax service fee, underwriting fee, processing fee, document preparation fee, and credit report fee to the tune of nearly a thousand dollars. (follow the link for a breakdown). ING’s closing costs fees covered by the flat fee include an administrative fee, application fee, funding fee, processing fee, tax service, and an underwriting fee. They calculate the average you’ll pay for those is $1,459 - which is $500 more than LendingTree’s quote about 8 months ago.

What it doesn’t cover are the things that are called closing cost fees but that aren’t actually fees in the sense that you get “nothing” for them. You’ll have to pay the seller whatever utility and tax prepayments they’ve already made and you’ll also have to cover a few other title related fees, such as title insurance which can be pricey.

The reviews I’ve read about ING’s customer service leave much to be desired but that’s to be expected if you’ve ever opened up a savings account with them. They make money because they cut back on their customer service and have lower upkeep costs. If you can handle just sending in a check each month, chances are you’ll be happy with paying $500-$1000 less in closing costs.

Go to this $25 ING Referral page if you want a referral for an ING Orange Savings account, offering a promotional 4.75% until mid-April. If you sign up, deposit $250, you’ll get a $25 bonus and I’ll pick up $10.

Take this quote from a 2003 study by Robert Dietz, professor of economics at Ohio State University, titled “The Social Consequences of Home Ownership” [.PDF, 180kb]: “You are happier and more satisfied with your life[,] your children are better educated and less likely to get into trouble[,] your daughters are less likely to become pregnant as teenagers[,] you vote more often and are more active in your community[,] you are more likely to recycle and less likely to get mugged.” (I added in some comma’s and the emphasis was mine) Doesn’t that add a little wrinkle into the rent vs. buy question?

Essentially, what it comes down to is that homeowners feel more vested in a community than renters do. I didn’t really care who my neighbors were when I rented because I was probably moving in a year, not so with my neighbors now. I’m more likely to be active in my community now because I know I’ll be here for a while. I’ll be more active in the political process because those decisions will now have lasting effects on my life and my finances.

On a personal note, I know of friends who own row homes in the city who have gone to town hearings on construction permits for roof decks. A rule is that if you construct a deck, it can’t block the “view” of your neighbors and anyone can challenge your permit for that reason. If you rented, you don’t care if a deck blocks your view. If you own it, you certainly do care because you don’t want to see another deck in the way of your view of the cityscape, you want to see the cityscape!

(Photo: Jay)

Does it matter if you have a $300k mortgage at 5.5% or a $270k mortgage at 6.5%? In the the last few years we’ve seen housing prices skyrocket while mortgage interest rates have remained extremely low. Now that rates are increasing, we’re probably going to see housing prices slipping a little as to keep the relative monthly cost at about the same levels (plus a bit of appreciation) and thus the total payout at the same levels (if you keep the home until you fully pay off the mortgage). Recall that the payment has a principal and an interest component so with interest rates rising, a greater portion of the total payout will shift from the interest column to the principal column. One would anticipate housing prices slip a little, or not rise as quickly, as interest rates rise because buyers don’t have any more money when the rates rise and thus the total monthly price must remain the same.

Assuming a 30 year fixed interest rate mortgage loan:

Now one would argue that part of that interest will be returned to you each year because of the mortgage interest deduction so to make that comparison (and to make it simplistically) we’ll simply take the difference in interest payments, divide by 4 (assuming a 25% marginal tax rate), and find that the difference is about $7800 over 30 years between the 6.5% and the 5.5% interest rate rows. Granted, the rebate should be heavily skewed towards the front of the loan but it’s a mere $7800 on a six figure loan (2.8%). When you compare the difference between the 10% and 5.5% loan, it’s a more significant $26,689.94 (13.7%).

However, one thing this does illustrate is that the price of the house should fall as interest rates rise because the monthly payment should remain the same for one house. As rates approach 6.5%, one would anticipate that a $300,000 house would sell for only $270,000 and that you shouldn’t worry when it does. This doesn’t bode well for people who are flipping homes and could be why existing home sales have slowed down?

Caveats: This simple math ignores or simplifies a lot of things like how the mortgage is amortized, the type of mortgage (30-year fixed), transaction costs, inflation, etc. I think it’s conceptually right though and if I’m wrong, I’d really like to hear about it.