Time Magazine: "Ignore the Headlines"

There was an article in Time Magazine a couple of weeks ago titled, "Ignore the Headlines."  Ironically, I couldn't agree more with the headline, but less with the content of the article.  So, I suppose in this case, I would argue, "read the headline, ignore the article."

Essentially, the article give a snippet of advice from famed investor, Peter Lynch, that there has always been news to make investors wary, but despite the gloom and doom headlines of each era, investing in stocks over the long term has been a good thing.  This much I agree with.

But then the writer digresses to real estate.  He makes the mistake of quoting the Chief Economist of the mortgage lending firm, Lending Tree.

But let's say you are emotionally ready to be a homeowner. You have good credit, plan to stay put for five years and have been waiting for the perfect entry point. It's time to get serious--before an inevitable rise in interest rates wipes out your advantage. "The thing that will make home prices stop falling is the very same thing that will push mortgage rates higher," says Jim Svinth, chief economist at mortgage firm Lending Tree. So anything you gain by a further drop in prices might be offset by rising financing costs.

First of all, what is this a puzzle?  What is the thing that will make home prices stop falling, and is the same thing that will push mortgage rates higher?  I'm going to guess that he is talking about inflation.  However, I remember some pundits saying that prices would not go down unless caused by a dramatic rise in interest rates.

But that's not all.  Based on this thinking, the article goes on to provide a scenario that is fraught with problems in logic:

Consider a typical home that sells for $218,900. You put down 20% and get a 30-year fixed-rate mortgage at today's rate of 5.5%. Monthly principal and interest come to $994.31. Let's say that 12 months from now the same house goes for 10% less, or $197,010. But by then the recession is history and the Fed is jacking up rates to stem inflation. If mortgage costs rise a point, to 6.5%, your monthly payment would be $994.94 and you'd have saved nothing. Meanwhile, home prices might steady and sellers might become less willing to negotiate. And you have spent a year living someplace you'd rather not be.

The last line, I would agree with.  Standard of living may trump the details of the dollars and cents.  However, don't try to make a financial argument where there isn't one.  The problems?

1. In this scenario, by waiting, your purchase price is $21,890 less.  This means that...
2. Your down payment was $4,378 less.  Could you use an additional $4,378?  Sure.
3. Property taxes are lower.  Based on an annual rate of 1.25%, they are $273.63 less.  Every year.
4. If, at any time, you refinance, your loan amount to refinance is less, meaning lower payments
5. If you decide to pay additional to principle, your additional amount goes further.  For example, if you pay $1,100 per month instead of your normal payment, in the first case your loan will be paid off in 23 years and 10 months.  In the second example, an $1,100 payment would pay your loan off in 23 years and 1 month.  Nine months with a minimum payment of $994 is $8,946.
6. If you sell in ten years for $300,000, you pocket a gain of $81,100 in scenario #1, and $102,990 in scenario #2.
7. Income taxes.  Let's say you stay in the house for 30 years, diligently making your $994/mo mortgage payments.  At the end, you happily throw a "burn the mortgage" party.  By overpaying, more of your payment went to principal.  Yes, your interest portion was higher in scenario #2, but that part is deductible.  Over the life of the two loans, you will have paid $182,832.36 in interest in the more expensive scenario, and $201,020.32 in the cheaper.  This is because we are assuming a higher interest rate.  Well, that amount is tax deductible.  If you are in the 28% tax bracket, that is an additional savings of $5,092.63.

That last point may be confusing to people.  Why would you want to pay more in interest.  You are only getting back 28 cents on the dollar.  But this assumes that payments were the same.  If you had a mortgage of $994 for 30 years, would you want more of it to go to interest or principal?  The answer is interest.  That portion is deductible, principal is not.

The bottom line here is that we have no idea whether or not the very thing that will cause prices to stop falling will also cause interest rates to go higher.  Nor does Mr. Svinth.  However we do know that given the choice of higher prices and lower rates or lower prices and higher rates, the latter is preferable.