A BIT OF FINANCIAL APOSTASY: USE LOWER RATES TO SAVE MONEY RATHER THAN BUY MORE HOUSE

5/19/13

While working out this morning, I heard an ad for a mortgage broker on WBBM AM, Chicago’s news radio station, that went something like this. (Since I don’t have a photographic memory and can’t write as quickly as a person can talk, I can’t quote the ad precisely.  Its words and numbers may be slightly different from the below, but only slightly, and the point is the same.):

If you have $1,350 to spend on your mortgage, at today’s 3.5% 30 year rate, you can support a mortgage of about $301,000.  But if you wait until rates go back to a more normal 6%, that $1,350 will support a mortgage of only about $225,000.  That’s $76,000 more home that you would be giving up.

While there will (would?) be more market adjustments to deal with when (if?) mortgage rates get to a more “normal” 6%, this is an interesting argument based on the application of some simple present value concepts and appears to be an effective way of selling one’s mortgage services, or at least of persuading people to borrow money.   After all, who, especially in America, where people seem to always want to spend more, even if they don’t have more, would want to leave $76,000 of house on the table?

But here’s another thought….

If you have $1,350 to spend on a mortgage, why not pass on the $301,000 loan you think you can afford and instead borrow $225,000 at 3.5% and buy a home selling for $76,000 less?  Your payment on such a loan would be about $1,010.   You could then take the $340 per month you save and invest it.   The result would be…

• You would still have a nice, more than adequate home.
• You will be building, or adding to, your nest egg.
• You will have more money for emergencies or just the all too frequent but expensive non-emergencies that come with home ownership; you therefore sleep better at night and are therefore probably more pleasant, sharper, and hence more effective at work and in your interpersonal relationships.
• If things don’t go according to plan, as is common in this economy, you will have both a lower mortgage payment to make and some savings on which to fall back.
• If everything goes according to plan but you don’t stay in the house thirty years, you will have built up a substantial sum of money to go toward the down payment, or outright purchase, of your next home.
• If everything does go according to plan, you stay in the home for 30 years, you religiously put the extra $1,010 away and don’t spend it, and can earn, say 5% on your money (a not at all unrealistic, perhaps even conservative, proposition; since this would be a 30 year effort and would involve the dollar cost averaging that inevitably accompanies monthly level payments, most of the money could be put into stocks), you would have about $840,000 set aside by the time the 30 year term is over.  If you could earn 7%, you’d have about $1,230,000 by the end of the 30 year period.   Taxes would reduce these numbers, unless you were able to invest in a tax deferred vehicle, but the numbers would still be considerable.

You win.   The country wins because you are saving money.   The only thing you give up is the ability to say that you live in a house that you can barely afford.

I realize such a suggestion amounts to apostasy in a country obsessed with spending and displaying (usually false) wealth.   But it would have made such perfect sense, and be such standard practice, only a generation or two ago that I wouldn’t have had to make the suggestion. 

I SPENT MINE. YOU STILL HAVE YOURS. SO GIVE IT TO ME.

5/12/13

Some of my musings on financial matters can be attacked by those who consider themselves sophisticated as a mere restatement of the obvious, and I freely plead guilty to such criticism, e.g., S&P YIELDS VS. BOND YIELDS:  I’M YOUR MAN WHEN IT COMES TO STATING THE OBVIOUS, 4/16/13.   Sometimes (usually, really) the path to the truth, and much enlightenment, lies in a firm grasp of the obvious, e.g., ANOTHER OF THOSE TRITE BUT TRUE INVESTING MAXIMS, 5/8/13.   So please bear with what might seem like simple logic in this post; such simple logic seems to escape not only our policymakers but also many people of my generation when considering their finances.

A common theme of my writings through the years in many forums has been the financial irresponsibility of my generation, e.g., THE ATTACK OF THE McMANSIONS FOR SALE:  A SECULAR BRAKE ON THE HOUSING MARKET, 4/23/13, which doesn’t hurt the popularity of my writing as much as one would think.  Apparently, people aren’t afraid of hearing the truth; they are just afraid of acting on it, but I digress.  My generation, as a group, simply doesn’t save money.   Oh, yes, our savings rate has gone up…from abysmal to merely miniscule.   Only a generation ago, the U.S. savings rate was twice as high as our current savings rate, which the baby boomer and younger talking heads describe as “healthy” and “balance sheet restoring”; two generations ago it was three times as high.

Rather than save money, my generation has spent itself silly in order to achieve a borrowing induced lifestyle of which its parents could only dream but to which this generation feels entitled.  Luxury cars, ostentatious homes, yearly “trips of a lifetime,” private colleges whose most salient feature is not their academic superiority but their snob appeal, personal trainers, weekly “spa treatments,” multi-hundred dollar shoes, regular attendance at “priced for the tax code” professional sporting events, restaurant bills that could feed a family, in America, for weeks...you know the drill.  Luxuries are now necessities.

Now my generation nears retirement.  They are, by measures of only a few decades ago, deeply in debt and have, of course, saved nothing.   Yet they are used to a lavish lifestyle.   While they probably haven’t thought about this (They have been too busy “acquiring” things.), they will be heading toward retirement with nothing…okay, maybe a 401k with about a year’s worth of income in it if they have, by standards of my generation, saved assiduously and refrained from borrowing against the 401k for that Lexus that makes last year’s model look, well, “so last year.”   AND YOU CAN’T FINANCE A LAVISH LIFESTYLE WITH NOTHING.

So we will soon be faced with a generation that has grown accustomed to living like kings but can only afford to live like paupers.   They either will be forced to adapt a lifestyle that would make even that of yours truly seem lavish or, following the great American tradition of late, they will look for someone else to not only blame but also to pick up the bills for what they consider “the necessities of life” or a “bare bones lifestyle,” which doesn’t involve less gaudy living quarters, trips to Wisconsin, or non-“luxury brand” cars.

When large groups of people no longer have access to things to which they feel entitled, trouble ensues.  Look at Greece and much of southern Europe.   This story will soon play out in America, as legions of what we used to call “yuppies” and their wannabes can no longer afford the lifestyles they spent through generations of seed corn to attain.  Besides the obvious financial consequences of their spendthrift ways, e.g., enormous debt to foreign countries, there will be societal consequences.   People will feel deprived and turn their greedy eyes on others.  Those few who have been responsible, who have lived modest lifestyles and managed to save (and surprisingly somehow never felt deprived or that they had missed something by doing so) could become the targets of vilification campaigns led by politicians eager to appease the broke majority.  The savers will be castigated as “the rich” and various schemes, like direct or indirect wealth taxes, will be concocted in order to transfer funds to those who spent their vast, or not so vast, incomes on foolish attempts to fill the voids in their lives with material things.

The nearly incessant message of all my even remotely financially oriented writings is to save your money and invest it wisely.  Sadly, in our increasingly crazy world in which politics, the art of pandering to the inattentive or the downright silly, trumps good sense, that advice may turn out to have been silly.  You save, but the government punishes you for it; notice I didn’t use the future tense; this is already happening.  See, inter multa alia, STUDENT LOAN FORGIVENESS:   THE OBAMA ADMINISTRATION’S (?) ASSAULT ON THE RESPONSIBLE, 5/10/13.

I, however, will continue to save and will always encourage you to do so.   Saving is not the ultimate act of optimism; having children is.  But saving still requires more optimism than is normally advised.  So, yes, it is surprising that the advice to save is coming from yours truly, who equates pessimism and cynicism with realism and optimism with refusal to face the plain truth.   One supposes that a spark of optimism still exists in those of us who save, that the habits of a lifetime, perhaps genetically implanted, are simply impossible to break…or that we are foolishly and naively setting ourselves up to be fleeced to pay for those whose most salient characteristics are their financial idiocy and sense of entitlement.  

THE ATTACK OF THE McMANSIONS FOR SALE: A SECULAR BRAKE ON THE HOUSING MARKET

4/23/13

My generation is known perhaps most saliently for one thing…spending money, and lots of it, on things we don’t need.   One of the most grotesque manifestations of this destructive tendency is the money people have put into their homes.   We have bought, and built, in many, if not most cases, far more house than we need.   Why?   Who knows?   But one suspects that a gaudy, over the top, tasteless gargantuan home is one easy and obvious way to display one’s wealth, and the need to display one’s wealth seems to be an ever present, and ever growing, need among the vast legions of terminally insecure that comprise huge swaths of my generation, but I digress.

We hear constantly about how my generation (Surprise!) is not at all prepared for retirement.  The typical high (and middle and low) income member of the boomer generation has spent his or her last nickel and then some.  While many have 401Ks, IRAs, or similar retirement plans, those plans are woefully underfunded when one considers the cost of just a decent retirement, let alone continuing to live the profligate lifestyles that seemingly have become the object of existence for so many of my generational colleagues.  Increasing one’s income, by whatever means, has proven to be no solution to the problem; new income is spent even faster than it is earned as what once were luxuries suddenly become necessities and people somehow “just can’t make ends meet,” even at higher income levels.   Those payments on the Lexus lease are a bear but, again, I digress.

All this talk about “deleveraging” and “fortifying of balance sheets” has some, but not much, validity; our saving rates rate has improved…from its negative pre-recession levels to a whopping 2.6%.  This compares to our 6% plus savings rates throughout the ‘80s, our 7%-10% rates in the decades following World War II, and the current 10% and 25% savings rates in the Eurozone and China respectively.   Our debt to after tax income ratio is down to around 106% from its peak of 130% in the third quarter of 2007, but nowhere near as low as the 85% average for the decade of the ‘90s.  Want to feel even worse?   That ratio was 69% in 1985 and 36% in 1952.  The share of income used to service debt has fallen, from its peak of 14% in the third quarter of 2007 to about 10% now, but much of that improvement comes from the Fed engineered artificially low rates, or what yours truly likes to call Ben Bernanke’s war on the elderly.

 So my generation lives in too much house, has too much debt, and too little saved for retirement.   So when (if) my faux wealthy generation retires, what will it do?  It has to find some place to save if it hopes to avoid the ignominy of having to adopt a more rational approach to life.  One obvious place to cut expenses is the home.   Homes, especially homes built as gaudy monuments to one’s self, are expensive not only to buy but also to maintain.  Property taxes are outrageous.  Upkeep is high.   And the new kitchen every five years or so (“I just couldn’t LIVE in the old one!”  (especially when the neighbors got a new kitchen)) gets really expensive. 

Simply put, my profligate generation, due to its overspending and under saving, will soon find itself in the position of not being able to afford the McMansions that seemed such a necessity only a few years ago.    Assuming that members of my generation are capable, collectively, of making a wise financial decision, which admittedly is a brave assumption, a logical thing to do would be to sell the big house and get out from under the expenses such an extravagance entails.   Even if the sellers don’t clear anything from the sale, they would have saved themselves a ton going forward.  And, in at least some cases, they can do so while saving the all important face, to wit “We loved our old house, and could certainly afford it, but, with the kids gone, it was time to downsize.”   Their equally in the hole, backs to the wall friends will believe this load of baloney because, after all, they will be doing the same thing themselves and a collective lie starts to take on characteristics of the truth.

The forced sale by the boomer generation of the houses they never needed and could never really afford could thus potentially create a huge overhang of houses on the market.  On the other hand, the federal government could get involved and bail these profligates out by sticking those who save with the bill, much as it is doing now with HARP programs, artificially low rates, and the like.   Such a move might save housing, at least temporarily, but would not only offend any decent notion of fairness but also ultimately further devastate the economy by further punishing saving to reward spending…all in the interest of “solving” a problem born of too little saving and too much spending.