Brain Fertilizer

Is there really no simple explanation of mortgages and housebuying on the web?

The reason why I ask is that three years ago I decided to buy a house. I was receiving a monthly housing allowance of $800, and I didn't see how I could pay nearly $30,000 on a house loan and not make money, even if the house's sale price remained flat. If I rented, that money would just go to a landlord and I'd have nothing to show for it, but if I purchased, that $30,000 would go into my pocket.

Wouldn't it?

I'd heard that if you buy a house, you need to live in it a minimum of three years to even break even, and five years to build up any real equity.

So I took the plunge. And I got lucky.

Here's what I've learned:

Let's say you buy a house for $250k, with a down payment of $50k. The closing costs on that are going to be somewhere in the neighborhood of $5000 or so. Part of that includes paying money up front for a lower interest rate, so it's not all lost, but the shorter time you own the house, the less worth it is to "pay down the interest", i.e., "points". I may get into that later.

So you start out $5000 in the hole already.

You've got that $200,000 loan. If you do it for 15 years, I think your payments are around $1500 a month. Wow, eh? $1500/month should pay that loan down to nothing real quick, right? In fact, you do the math and is should be paid off in less than 8 years. So why does it take 15?

Have you looked at an amortization scedule lately? Your first month, the $1500 gets divided and something like $780 goes to interest, and and $720 to the principle. In fact, by the end of the first year, after shelling out $18,000, you've probably paid your loan down a whopping $300 or so. $17,700 of it went to the bank for interest. The second year you pay the loan down about $600, and it slowly goes up from there. You pay the bulk of the loan back in the last three years.

That's why it's vital to pay extra on the loan to pay it down as quickly as possible, because you an amazingly less amount of interest.

But I digress.

So take your house. In the three years you've owned it, you have paid down the loan less than $3000. You've been unlucky and the housing market has been flat the entire time, so you sell your $250k house for $250k. You still owe $247k, for a grand total profit of $3000! But wait, you started $5000 in the hole because of closing costs, right? And in selling, you have to put another $5000 or so fixing up the house, painting over the crayon marks, replacing the carpeting your daughter's gastric juices bleached out... And don't forget to pay the selling agent his 6% commission, which would thus be about $14k. So you made $3000 on the house, but lost about $24k on fees and expenses associated with buying and selling a house, for a grand total impact on your pocketbook of negative 21 Thousand Dollars!

Sort of. Don't forget taxes. Remember that $18k that went to the bank the first year? And the $17k that they pocketed the next year? Sucks, doesn't it? Well, the govt agrees, and so they don't make you pay taxes on it. Write off $18000 of your earned income from your taxes that year, saving you probably about $6000. For three years, that means you saved $18000 in taxes, meaning you are only $3000 in the hole now.

And I assumed a flat market for ease of computation and worst-case scenario. It's not hard to think that the market is going to go up at least $3000 on a $250k house over three years. If for some reason it does, rent out the house for 18 months, and the renters pay down your loan to the point were all these expenses vs remaining principle is in your favor and you almost cannot lose money.

So if you want to buy a house but aren't sure you can stay more than 3 years, what do you do?

First, buy a house in good structural condition with cosmetic problems. You can get a house with bad carpeting and a bad paint job for $15000 less than the market, probably, and do those things yourself for less than $5000, especially if you do the engineered wood flooring (cheaper than carpet and lasts longer). That's sweat equity of $10000 you just made for your effort.

Second, buy less than you can afford. My housing allowance in Hawaii is going to end up being something like $2600/month. I supposedly could afford a $400,000 house. But if the housing market doesn't go up, I could lose lots.

So I'm probably going to buy a $200,000 condo in okay shape and work to fix it up. Plus the maintenance association fees add on to the monthly payment, and taxes, and utilities, leaving me about $600 extra a month to pay down the loan. And remember, that's a housing allowance. That means even with a flat housing market, I'll make at least $10000 dollars after 3 years, absolute worst-case scenario And maybe as much as $50,000 if things go well.

I'll keep you posted on it.

Now you should understand why owning a house 3 years or less is a bad risk, but 5 years or more is nearly a guaranteed profit.

Is there a mortgage website that explains any of this? I never found one. I hope you can learn from my experience so as to make better decisions.