People Who Were Alive Through the Housing Bubble Do Not Consider Homeownership "a Way of Obtaining a Firm Financial Foothold"

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Wednesday, 15 January 2014 06:00

The NYT had a piece on mortgage financing that was written as though the housing bubble and crash never occurred. It includes the incredible assertion that homeownership is considered a way to get a firm financial foothold as though there were not overwhelming evidence that this is often not the case. Even before the bubble, housing was often a volatile asset.

There are many markets where people have seen their house prices crash along with their local economy. For example many people in Detroit saw the value of their homes plummet even as job opportunities disappeared. This means that at the same time that their prospects for a good paying job were vanishing, they saw their life's savings also disappear. It was not clever to tell people in Detroit to invest in a home in the 1970s or 1980s.

In the bubble years house prices became much more volatile making the risks of homeownership far greater. Since housing is always a highly leveraged asset, the potential loss of wealth is enormous. If someone buys a home putting 20 percent down and it loses 10 percent of its value, they have lost almost half of their investment. If they just put 10 percent down, they will have lost almost all of their investment with a 10 percent price decline.

In addition, there are large transaction costs associated with homeownership. The round-trip cost of buying and selling a home are around 10 percent of the sales price. This means that if a house is selling for roughly 15 times what the annual rent would be, a homebuyer would throw away 1.5 years' worth of rent in transactions costs. (If the price-to-rent ratio is 25, as was the case in many bubble markets, the transactions costs would be 2.5 years' worth of rent.) In an economy where people often have to move to get a job, many homeowners will be forced to sell their homes much earlier than they expected.

For these reasons, people who paid attention to the housing market over the last decade generally think of homebuying as a way to make the financial sector rich. Its benefits to homeowners are far more questionable.