Mary Owens: The Way Forward for Nevada County, continued
“The Way Forward for Nevada County”
Mary Owens, president of Owens Estate and Wealth Strategies and chairperson of the Nevada County Economic Resource Council, writes a monthly column, “Mary’s Minute,” for The Union’s Money Monday section.
Last month I went over the challenges of developers attempting to build more moderate priced housing and the difficulties they were facing with financing. This month I will cover the issues that home buyers are facing as well. Both have a common theme: the overzealousness of Dodd Frank.
One of the most expansive periods in the U.S. economy was during Baby Boomer household formation. Seventy-five million people were buying new items for their home. The economy became stronger and stronger as millions went into stores to buy carpet, drapes, appliances, furniture and other household items. That “egg in the snake” generation dominated the economy as they grew older.
Many do not realize that we have two new huge generations in the U.S. right now that could make our economy grow brightly in the future for a long time. The Millennials (born between 1977 and 1995) are over 83 million in population, followed by the Digital Natives (born 1996 to present) that are already over 82 million and still growing. The Millennials started to enter household formation in about 2010. But they are facing a headwind that is strong: housing prices are rising faster than they can reasonably save for a down payment.
Qualifying isn’t what it once was
With the passage of the Dodd Frank act in 2010, the home loan qualification standards became tougher than they had been in decades. Millions frustrated with rising rents want to purchase a home and begin building equity. Let’s explore their current home loan qualification standards.
The chart included in this article assumes the household income of the individuals borrowing is $70,000 per year, with a FICO score of 740, and no monthly consumer debt. Randi Schlitzer of Nevada County Mortgage provided the figures in this chart, which are subject to change. As interest rates change, so do these numbers. But even with slight changes, these numbers tell the story about loan qualification.
The first thing to notice is the need for private mortgage insurance (known also as PMI) if you do not have at least a 20 percent down payment. The smaller the down payment, the larger the monthly cost of the insurance. Also note that the federal government loans under FHA have lower interest rates than the traditional non-FHA loans. Our government is subsidizing the housing market in an attempt to bolster the housing market and the economy in general. The impact of PMI makes the house payment only $68 a month less for the $475,000 house with 20 percent down versus the $375,000 house with 3.5 percent down. Most first-time home buyers use FHA to get their first home loan.
So, why don’t they save longer and buy with a larger down payment? Let’s explore that math.
The U.S. is not building enough new homes due to the many issues I outlined in last month’s column. Because of a moderate priced housing shortage, both housing and rent prices are going up substantially. Let’s just assume that both housing and rent prices are going up 5 percent per year in order to calculate the challenges of getting into your first home. Let’s further assume the potential buyers are currently paying $1,700 a month for rent. Since they are making $70,000 per year, to save a 10 percent down payment in just five years, they would have to save $8,000 a year to buy a $400,000 house. That figure is 11.4 percent of their income.
Five-year savings period?
But wait, the house is appreciating at 5 percent a year. So that house they wanted to buy at $400,000 in five years will be costing $486,202.50. So the 10 percent down payment now requires them to save $9,724 a year, or 13.9 percent of their income. Their monthly rent went from $1,700 a month to $2,066 per month during that five-year period as well. So during that five-year “savings period” the buyer also had to pay an additional $10,723 in rent. That works out to another 3.06 percent of their income.
During this five-year period trying to save for the 10 percent down payment, they lost house appreciation of $86,202.50. Their loan to buy the same house is now $37,583 more. This means their qualifying income had to go up as well. The new house payment, assuming no increase in interest rates, would now be about $2,983.16 a month. In order to qualify for this new home loan, their annual income would now have to be $79,550 a year and with no consumer debt of any kind or they will not qualify.
Let’s use this same example with buyers who have a $200 car payment and a $150 student loan each month. Now their qualifying household income has to be approximately $88,885 per year to qualify for that house they dreamed of five years prior.
They would have been much better off using that FHA loan and starting with the lower down payment and the high PMI monthly costs. FHA loans have stringent requirements regarding the condition of the house at the time of purchase. If the house is a fixer-upper that many first-time home buyers prefer, the seller is concerned the house cannot be sold without substantial investment on the seller’s part. Sellers frequently steer clear of FHA qualified buyers if the home is being sold “as is” with lots of love required.
Dodd-Frank comes full circle
So where are FHA loans used most frequently without causing concern to the seller? A newly built home; it requires no repairs. And there we are: the vicious circle the Dodd Frank bill has created.
Dodd Frank discourages builders from building more moderate priced housing by limiting the availability of financing (see last month’s column). It also discourages those who are saving for their first home, because they cannot keep up with the savings rate required to buy a home that is rapidly appreciating due to the lack of home building. And it is all so fixable.
Amend Dodd Frank back to reasonable lending standards so more houses can be built! More inventory means lower prices and lower rents!
And now you know the rest of the story on why so many Millennials are living with their parents. They are trying to save for a home the smart way. Give ’em a break on the criticism. They can do the math and want to get ahead in this crazy housing world created by an overreaction to poor regulations in the past.
Next month I will be exploring what local and state governments can do to get the housing markets moving again. It’s a very complex picture.
Mary Owens, CPA, MS, principal, president of Owens Estate and Wealth Strategies Group, Branch Manager RJFS, located at 426 Sutton Way Suite 110 Grass Valley, CA 95945 | (530) 272-7500. The information herein has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of Mary Owens and not necessarily those of RJFS or Raymond James. The hypothetical examples are for illustration purposes only. Tax advice and/or services are not offered through Raymond James. Investment advisory services offered through Raymond James Financial Services Advisors, Inc. Securities offered through Raymond James Financial Services, Inc. Member FINRA/SIPC. Owens Estate and Wealth Strategies Group is not a registered broker/dealer and is independent of Raymond James Financial Services.
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The MEME stocks are on fire again. You remember these. My last article on the MEMEs was the called “The Game that is Gamestop.”