Investing V – Buying a home

In my previous posts about investing I’ve mentioned more than once that buying a home is almost always a great investment. From my own experience I can say without equivocation that buying homes has had more positive economic impact on my life than any other investment I’ve made.

I’m talking about buying a home, here. I’m not talking about buying an investment property. These are two different things.

That being said, the first home I ever bought turned into an investment property, pretty much by accident.

I lost my job in 2000. The company I was working in was going under, and I had plenty of warning. But the only reason I lived where I did was because of the job.

If the job was going away then I wanted to move away.

But I'd just bought a condo 4 months prior.

I had thought that I'd be working and living in the city in question for years, and so buying a home made sense. But with joblessness on the horizon and no great love for the city in question, then buying a home there was looking like NOT my best decision ever.

I could turn around and sell it for what I'd paid for it, but there are closing costs that have to be paid when you're buying or selling, and I didn't want to pay them each time without realizing an offsetting profit.

It was every first-time-homebuyer's nightmare.

I rented it out. Rather, I found a property manager who would rent it out for me. At the price for which it was rented I didn't make a profit, but I didn't lose money, either.

So suddenly I no longer owned a home. Instead I had an investment property.

What’s interesting is that if you have a rental property and can provide a copy of the rental contract to a lender – proving that your costs on your original loan are being met – then you can go out and buy another property in which to live.

I did exactly that. I moved back to my metropolitan area of choice and was able to buy a second condo – this one as my primary residence.

Now each time I purchased a condo – in 2000 and 2001 – I did it using a 30-year-fixed loan from my bank. This was, as far as I was concerned, the only way to buy a home.

Then in 2004 I bought a house. And evidently the rules had changed. My realtor and my finance officer offered me “creative financing.”

I was skeptical, but I read the fine print and asked lots of questions. It was a little iffy, but it was doable. In the end I bought a house using the types of loans that have come under a lot more scrutiny in the last couple years. But I had a plan, and in retrospect it actually appears that I might have known what I was doing.

80% of the purchase price of my house was financed using a 3 year ARM – an Adjustable Rate Mortgage. This gave me a really, really great interest rate – less than 4%, I think – for 3 years. After the 3 years it would begin to fluctuate and almost certainly to trend upward.

The plan was to refinance before the 3 years were up, and this is exactly what I did.

Another 15% of the purchase price of my home was financed using an Interest Only loan. This was the scariest piece, to me. This is a loan that is designed NOT TO BE PAID OFF. You don’t have to pay anything toward the principal of the loan. You just have to pay the interest. Every month. Forever. At the end of each month you would the bank the same amount as the previous month. It’s the debt that never ends.

The plan was to end it. To pay off the principal on that loan as soon as possible, and this is exactly what I did. About 5 months after I bought the house, that interest-only loan was gone, thanks to the sale of my investment property – my first condo – and a bit of money from Savings.

And let me say at this point that my first condo – to which I referred earlier as “every first-time-homebuyer's nightmare” – really worked out well for me. I had not intended to own an investment property, but it paid for its own mortgage each month, and then when I sold it less than 5 years later, I did so at a 23% profit (minus closing costs and some sales-prep work I had done. It was probably a 14% or 15% net profit).

Oh, the remaining 5% of my house was financed using some of the proceeds of the sale of my second condo. And that turned out to be another great investment. I sold it at a 37% profit (minus closing costs, etc. It was probably at least a 30% net profit, though).

Since refinancing a year ago I have also made an effort to pay down additional principal on my new 30-year-fixed mortgage whenever possible. As of this writing I stand to get somewhere between $40,000 and $55,000 out of my home if I were to sell it today.

I got lucky. Or I was the right combination of lucky and careful and attentive.

If I had not been careful and attentive – and didn’t really understand or care that I had a 3 year ARM and an Interest Only Loan – then this would have gone badly for me. I would have had a mountain of debt and rising monthly payments. I would have metaphorically drowned.

So is Creative Financing a bad thing? Are banks to blame for offering these kinds of loans?

I have to say no. My situation is proof that one can use these kinds of loans to one’s own advantage and come out ahead.

But you have to have a plan that involves GETTING RID OF THOSE LOANS. And in retrospect it looks like a lot of people got those types of loans without having a plan to get rid of them.

That being said, a lot of the people who are now defaulting on these types of loans are people who had bad credit. Banks gave these types of loans to people who had a bad track record of dealing with money.

Most disturbing of all, the banks were able to bundle these somewhat-iffy-loans-to-people-with-less-than-perfect-credit into investment securities. And the ratings agencies – for-profit companies whose job it is to rate investment securities – rated these investment securities as really good and really safe investments: Triple-A rated securities.

And so a lot of investment companies, banks, and even countries put money into these securities.

Thus the mortgage crisis was born. When homebuyers’ ARMs started adjusting upward and the homebuyers in question started defaulting on payments then these triple-A rated securities started producing less-than-triple-A results. And because so many entities had invested in these securities, the repercussions have been felt everywhere.

I’ve gone pretty far afield, here. I intended to write a little piece using my own story to illustrate why owning a home is the best real estate investment one can make. Instead I've tried to explain the mortgage crisis while I'm at it. Let's get back to the point:

I could have been renting for the last 8 years, but by owning (and buying and selling with a bit of luck) I find myself with $40,000 to $55,000 in home equity.

That’s if I sold the home today, though. And because of the mortgage crisis I have no plans to sell my home today. It’s not a good time to sell.

But it’s a great time to buy! Buying a home is a great investment, as I hope I’ve demonstrated. And thanks to the mortgage crisis home prices have been driven down. If you don’t already own a home then I strongly suggest you look into it.