Saving Plan Needs Better Approach

As a would-be homeowner, I am always keenly interested in people’s new ideas to break into the housing market, an idea very remote for most of us young people.

Donald Jason-White, in his article “Fresh Plan for Buying First Home” (Sept. 10), discusses a plan for potential home buyers to get into the market. Unfortunately, he ignores some of the most pressing problems, concentrating only on the financial workings of his suggestion and how it will help the government.

I’m sorry, but given my current housing situation, helping the government is not very high on my priority list. In fact, it is the government that should be helping people like me.

But we should at least examine Jason-White’s proposal to see if it makes financial sense.

He would like to see young people getting into a savings program for 10 years, then purchase a home at the end of that time and have it paid off in the next five years--a 15-year method to own your own home, free and clear.

Saving for Home

Sounds pretty good, in theory, but there are a number of serious flaws in this proposal.

First, the proposal requires the example couple (earning $40,000 a year) to save $650 a month.

A modest sum, to be sure, considering that this couple will also have to pay about $700 for rent, $400 for food, $400 for cars, $150 for insurance, not to mention clothes, VCRs, going to a movie once in a while, or maybe saving for a child.

I am being facetious, of course. To save $650 a month would kill me, or anybody else making that kind of money. And that is where the real problem is, the one Jason-White ignores.

If the example couple follows his program, they will be spending 50% of their net income on housing or saving for housing. And half of that is not contributing to their future in any way. Non-tax-deductible rent is the biggest obstacle to saving for home ownership.

If the government truly wants to help the young get into the market, they should allow deductions on rent paid. Of course, that creates some other problems for the government, specifically reducing revenue when it needs it the most.

Eliminate Tax Deduction

Another major problem with the proposal is that it advocates low-leverage transactions. This is not a good idea. The less a person puts into an investment that he or she is controlling, and that is appreciating, the higher that person’s return on his or her investment.

Low leveraging also will almost eliminate the only tax deduction still available to individuals--the mortgage interest deduction.

The trade-off, Jason-White claims, is that you will be saving $256,000 in your lifetime earnings. Let’s examine this proposal.

If the example couple follows his plan, in 15 years they will own a $300,000 home free and clear. However, what happens if that same couple follows a different path?

Let’s say they purchase a starter condo for $125,000 and finance it with an FHA 95% mortgage. Let’s also assume that our couple has no money to put down, so they take a $10,000 advance on their credit cards to make the down and closing costs, and pay it off (at 15%) over five years.

Higher Appreciation

Their monthly payment for housing (including condo fee) would be less than if they opted for Jason-White’s proposal, and they would own their own home.

But most important, they would get any appreciation on the property. Using Jason-White’s numbers, I calculated that he used an appreciation rate of 10% and an inflation rate of 5.5%. The condo buyers, if they sell at the end of five years, will realize a profit of $75,000 (a return of over 30%), to be applied against a new home, which could now be a house of about $235,000. Their payments would still be less than those advocated by Jason-White.

At the end of the next five years, their proceeds from the sale of the house (again, using the same assumption factors) would be $200,000.

At this point, if the buyers wanted to own their home free and clear in five years, they could opt for Jason-White’s financing packaging, with the same monthly payment, but get a house worth about $400,000. If they opt for traditional financing, they could afford a $600,000 home.

Ignores Politics

Other major problems that Jason-White ignores include the direction of national politics, which have been tending to promote slow-growth initiatives, down zoning and other anti-development factors. These will force the housing supply to grow at a much slower rate than previously.

And where will housing be located? Today, for affordable and decent housing, young people are being forced outward, at least an hour’s drive from business centers in Los Angeles. Prices jumped upward of 20% in Palmdale last year, making it too expensive for many people. Where to now? Indio? Mojave?

Of course, there are a number of flaws with my proposal also. I do not recommend purchasing a home by getting a cash advance on your credit card. There are ancillary costs, fees and it will appear on your TRW credit report, severely diminishing your chances of getting adequate financing.

The FHA financing I proposed is also an impossibility, given current maximum loan amounts, but that is a problem the government could, and should, address.

Jason-White thinks we need “fresh thinking on how to finance home ownership,” but before we can do that, we need to break some old habits of thinking.

First and foremost, the mortgage-interest deduction, that mainstay of American housing policy for decades, does not foster home ownership.

Homeowner Savings

According to the latest Smolker Letter, a real estate newsletter published in Los Angeles, “The federal government now spends, through tax subsidy, about four times more on middle- and upper-class housing than on housing subsidies for the poor.”

While it may be justified to state that renters should simply save more money, their paltry return on savings accounts (which is taxed), can not possibly keep up with inflation in the housing market. Moreover, statistics show that homeowners managed to save 16% of total household income, while renters could save only 4% from 1983 to 1986.

Jason-White’s thinking that it is good to own a home free and clear is also somewhat flawed. Already mentioned is the fact that you lose any tax deductions you might have had otherwise (which over a 30-year loan period would be $200,000).

The other problem is that you have $300,000-plus of equity locked up in a house, doing neither the homeowner nor the economy any good. This is a very big problem for the elderly, who own homes free and clear, but have made no arrangements for a regular stream of income from which to live.

Recently, the government has approved, on a limited basis, the use of reverse mortgages. These provide cash flow to the owner each month, and the lender gets the home at some certain date in the future. Many elderly people are afraid of these mortgages, because if they live longer than the term of the loan, they are without housing.

French System

A “fresh” way of thinking might be to develop a system similar to what the French call viager. This system provides for young people to make deals with older people who own homes free and clear, where the young provide a regular monthly sum to the elder (based on the home’s worth and an estimate of how long the elder will survive--tricky tasks), and in return, when the elder dies, the young people receive the home, free and clear.

Depending on individual circumstances, it could be very beneficial for one or the other in the deal, but as they say, nothing can be gained if nothing is risked.

Risk is really what it’s all about, and if history is any indication, it’s a big risk not to be in the real estate market.

I cannot just sit by while people are being told to wait 10 years to buy. Buy now.