Originally published in the Daily Record, July 6, 2010
Hindsight, per usual, is 20/20, but in looking back on the subprime mortgage crisis, and resulting recession, we really should have seen this one coming.
Why? Because there is no surer sign of trouble on the horizon than being the topic of a reality television show.
As soon as "Flip This House" was first broadcast on the A&E Network in 2005, all lenders immediately should have reinstituted standard mortgage lending practices.
Unfortunately some lenders — including many non-bank mortgage lenders — were too busy making bad loans to spot the harbinger on the television programming
OK, perhaps it wasn't that obvious, but the correlation of the creation of "Flip This House," a reality show based on buying undervalued, dilapidated homes, renovating them and re-selling them usually within six months of the original purchase for a supposed substantial profit, is quite remarkable. Enough so, that it indeed could cause one to wonder how much popular culture influences the fabric of society.
"Flip This House" originally was created and pitched to A&E in 2003, at the tail end of the previous, techfueled recession. At the time, existing and new home sales started their meteoric rise, creating our next bubble-fueled recession du jour.
At the same time, the National Association of Realtors Inc. reported seasonally adjusted annual existing home sales at roughly 5.3 million in 2001, modestly higher than the prior year's 5.2 million. By the time the "Flip This House" pilot was pitched to A&E in 2003, seasonally adjusted existing home sales reached 6.1 million. By the time "Flip" aired in 2005, existing home sales had increased to a whopping 7 million.
Everybody got in on the flip. However, by the end of post-mortgage bubble in 2008, existing homes sales had fallen to 4.9 million - 5 million to 7 million and back. I believe that's more like a flop.
So, what do we do now? Our flipping days are over, and we used up all of our equity in the process. During the heyday of the mortgage bubble, it was common for lenders to provide mortgages or home equity loans in amounts up to or exceeding 100 percent of the value of the home, commonly referred to as loan-to-value or LTV. The result is that many homeowners who want to sell their home now find themselves unable to do so because they are upside-down on their home investment, that is they owe more than they can sell the house for.
Are we really expected to live in these homes we were expecting to flip, and how can we renovate them to our standards? Imagine, us baby boomers - like me - unable to get that new home or major renovation that we want right now, so that we can "flip" the house for our big windfall, or renovate our home to be the type
of 4,500-sq. ft. home we believe we are entitled to. Oh, what to do?
Brace yourselves, boomers. This may come as a shock to the system, but here are some suggestions. Treat your house as a long-term investment or, in
other words, treat it like a home.
When we were growing up, our family's house was not something to be casually "flipped;" but rather was a place that provided shelter, a place where memories
were made and cherished. Over time, our home was a wonderful investment that provided meaningful return over 20 to 30 years.
The return was driven by two factors, appreciation of the home's value and the repayment of the loan, which, when taken together, established meaningful equity for
When a home is treated like a short-term investment and flipped, only the appreciation of the home's value can drive any meaningful equity back to the homeowner. Consider, for example, a home with a purchase price (value) of $210,000, financed at a 95 percent LTV - common prior to 2008 — resulting in a $200,000 mortgage. If we assume the house is "flipped" after three years, the results will be that the homeowner/borrower will have repaid about $39,000 toward the total loan over three years, reducing the principal by only about $6,000, with the remainder of the total paid being credited toward interest.
If the home's value increases by 1 percent annually, its value has grown to about $216,000, and the total equity accumulated for the homeowner is roughly $12,000. If that same homeowner/borrower held on to the same house for six years, the difference in accumulated equity is significant: After six years, the value increases to
about $223,000, while the principal is reduced by about $16,000.
The resulting total equity in the home after six years is about $40,000 - an increase of more than 250 percent in the total equity for the borrower.
"Time is money" has more than one meaning and, when it comes to home equity, it usually means more time equals more money.
We've established that the best first step is getting back to thinking of the home as a long-term investment, but what do we do when we have no equity and our home is in desperate need of improvement?
There are a few options:
- Wait until enough savings is accumulated to invest directly in the home, and fund improvements yourself. That may require the $50,000 dream kitchen you have in mind to be scaled back to a $30,000, perfectly functional kitchen that meets your family's needs and is truly affordable. Over time, you should get more than an adequate return on the investment and still have a great kitchen full of family memories.
- Take out a loan that is fully-secured by your savings. While you are unable to write off the interest on your taxes because you are using liquid collateral instead of the home, you will pay less interest than you would if you borrowed unsecured, and your capital will be preserved over the long term.
- Consider an unsecured loan. While it is the least desirable option, because a borrower most likely must deal with a significant interest rate, it does enable the borrower to accomplish improvements despite lacking equity and, hopefully, increases the value of the home, ultimately generating more equity than if nothing were done.
While owning a home is the American dream, the idea is that we own to live in our homes, not to trade speculatively - that should be reserved for the stock market.