Being the glutton for irrational debate that I am, every once in a while I cruise over to the Craig's List housing forums. Most of the content consists of participants anonymously posting links or observations to affirm their strongly held belief of a bursting housing bubble, or a rising housing market. On rare occasion, participants will start a thread seeking advice, such as the quality of certain neighborhoods, or landlord/tennant issues. Today, I came across a post that I believe to be a fake. Well, I hope so anyway. The post is written to the Los Angeles board, but available for all to read:
Okay, here's the deal: my wife and I have combined yearly income of $140,000, but we've always had a heavy expense load and only have around $10,000 in savings and maybe another $20,000 in an IRA. We figure buying a house will do two things: help us financially prepare for the future by building equity, and also force us to be a little more thrifty on our spending.
We've made on offer on a place down the street, but it is very expensive ($1,499,000 asking price, but they took our $1,459,000 offer). We are pre-approved on this, got an unbelievably low interest rate, and our payment is only $3940 a month.
HOWEVER, I'm having second thoughts. Our take-home income is around $8000 a month, and this mortgage payment about 30% more than we pay in rent (although with the tax refund it should even out). It doesn't leave much "wiggle" room, so to speak, and we have some hefty CC balances to pay off still. My wife is very intent on buying this place because she's tired of renting, plus she wants to be able to buy out the lease on her Range Rover by getting a home equity credit line, which does make sense to me.
So honestly, are prices going up or down in LA? This is a big gamble for us. I mean, if prices go down short term it doesn't matter because we have such a low fixed payment, but I would obviously sleep better if prices rose 20% next year.
Also - do we need a home warranty?
That this writer should not buy a house for more than ten times their annual household income is obvious. But like I said earlier, I don't think this is a true story. I know a lot of people are ignorant, but to be pre-approved for a $1.5 million purchase with a negative amortization loan on less than a tenth of that in household income? Here's what smacks of fiction. He had the wherewithal to head over to Craig's List after he made an offer for a house ten times his income. If he spent any time online, he would have found plenty of warning before making the offer.
Also, the leased Range Rover is too conveniently stereotypical of an over extended Los Angeles resident. I had a good chuckle at, "she wants to be able to buy out the lease on her Range Rover by getting a home equity credit line." Huh? What equity? Sadly, if this is real, they would be able to take out a 125% equity loan from DiTech or some other sub-prime lender at double digit, non-deductible rates.
If this letter is real, I'm even more afraid than I was before. The payment of $3940 is 3.25% of the value. Current rates - fixed, variable, or otherwise - are not that low. A fully amortized payment at a low rate rate of 5.5% is $8,284 per month, not including taxes, insurance and maintenance. An interest only payment at the same low rate of 5.5% is $6,687 per month. So, we know that it's a negative amortization loan. The best case scenario for our anonymous home buyer is that they are adding about $2,750 to their loan balance every month. And that's at the beginning. As their loan balance increases, so will the amount of interest that is being added to the loan balance. By the end of the second year, they will be adding over $3,000 per month to their loan balance.
If we assume the writer and his wife plan to pay the minimum, and it appears to be a safe assumption, by the end of the fifth year their loan balance would be $1,648,221. And that assumes an extrememly generous 5.5% underlying interest rate. Realistically, for a loan that size, and percent to value (100%), it would be higher. If we assume the neg-am part to run for five years before amortized payments are due, their fully amortized payments would spike to $10,121. He had better hope for the 20% price increase. Either that or a huge raise!