How the American Dream has become the American Nightmare

Part II: Housing: 

How your traditional mortgage is a 30-year game of Russian Roulette, and why your home is only worth One Thousand Dollars

Once upon a time, but not too long ago, there existed a well developed yet evolving country where a family could raise multiple children on a single income, afford a nice house in the suburbs a new American made car and healthcare.  However, over time, that reality slipped away and became a fairy tale.  Now we are merely left with the memories of what this life was like from our grandparents, as we will likely never see it again in my lifetime. So, what happened?  What caused home ownership to slip away and become a fairy tale from the past and a nightmare of the present?  The answer is a multitude of factors, which can all be boiled down to one simple word: greed.

Back in the 1950s to the 1980s, a house was actually a home. It was a place where children were raised to be adults, and served a simple purpose: to provide adequate shelter for the family.  But starting around the late 80s to early 90s, this trend shifted and suddenly families of 4 were living in McMansions with ten times the square feet necessary to provide shelter.  Homes transitioned into houses, that were used as more of a status symbol, than an actual residence for a family.  Since one large home wasn’t enough, many families doubled down, buying a second vacation home somewhere else so they could visit three times a year on holidays.   Simply put, homes transitioned from shelters to status symbols, which were bought with overextended credit.  In 2008, this fairytale lifestyle transitioned from dream to nightmare.  

The decline in the markets in 2008-2009 was a rude awakening slapping many Americans back into reality.  It was a double whammy, because suddenly the large stock accounts that Americans had hedged their frivolous house buying against, were now worth a fraction of what they were just a few short months before.  Many lost their jobs, and unable to pay 1 or two mortgages, foreclosed on their homes.  Unfortunately, many Americans have already forgotten this hard lesson taught just a decade ago, and have once again begun to get over extended and once again hedge their bets against their investment accounts.  It’s a sleeping giant waiting to be awakened, and I am afraid COVID 19 is about to wake the sleeping beast.  

A traditional home mortgage is a 30-year game of Russian Roulette.  You have 360 chances over a 30-year period of time, or nearly half a lifetime, to have something go wrong prohibiting you from making that monthly payment.  Unfortunately, the odds of having something significant in a 30-year period of time are very high, and as we have seen with COVID19, can effect nearly every American.  The faster you can eliminate your mortgage, the less your chances are of having some adverse life event that could result in the foreclosure of your home.

Research shows that the average American switches homes 3 times in their lifetime, averaging 13 years in a home before moving.  Unfortunately, I have already “owned” 3 homes by the time I was 30.  The problem with this trend is this: every time you sell a home and move to the next, the majority of Americans buy a larger more expensive home, using any equity from the previous home in the down payment for the next home.  This also hits the reset button on your mortgage, meaning instead of having 17 years remaining on your original 30-year mortgage, you now have another 30 year mortgage.  This has a significant negative effect on those who are older when they purchase a new home.  For instance, I worked with a lady who bought a new home when she was 42, opting for a 30-year mortgage, meaning she would be 72 when the mortgage would be paid in full.  Do you expect to work to 72 to pay off a mortgage? Do you have enough savings to cover a mortgage well into your 70s, or better yet, do you want to be chained to a mortgage when you’re retired? If this wasn’t bad enough, another issue comes from the way a mortgage is designed. 

Your typical 30 year mortgage, or any mortgage for that matter, is front loaded with high interest and low principal payments. For instance, a 30 year mortgage at 5 percent interest will result in a monthly payment of 1073.00, not including taxes or insurance.  According to the amortization schedule for this loan, the first payment to the bank will include 883.00 of interest, and 240.00 in principal.  The very last payment, 30 years from now, will be 44 dollars in interest and 1069.00 in principal.  As you can see, interest makes up the vast majority of the payment, in fact taking 15 years of payments before principal paid in the monthly payment is more than interest paid.  Since the average American hits the reset button every 13 years starting over in a new home with a new mortgage, they spend a lifetime paying more interest than principal on their home.

An additional mortgage related POS that effects primarily young home buyers is mortgage insurance or PMI.  I absolutely despise this POS as it punishes first time buyers, lower income Americans, and those who think that home ownership is the American Dream they want to capture.  Basically, thanks primarily to 2008 and the fraud completed by the lending institutions, the lending institutions now require you pay PMI on most loans where you pay less than 20% down on your home.  For instance, a Federal Housing Authority loan or FHA loan, requires a 1.75% up front fee, followed by an annual .5 to 1% fee on your outstanding loan balance.  This means on a $100,000.00 mortgage balance, you pay $1,750.00, and an additional $1,000.00 annually.  Sure this rate will drop with time, but remember, since the majority of your initial payments are interest, it takes years for this rate to decline.  What’s even better about this program is its extremely difficult to get rid of PMI payments.  The only way to get rid of PMI is to either pay on the loan long enough that you reach more than 20% equity in the home, or if your home goes up in value, and you get an appraisal to show your equity is above 20%. Either way, this will cost you a significant amount of money as the average home appraisal cost is around $500.00, and/or paying that extra 1% until you reach 20% equity in the home.  Either way, PMI is a POS that effects your ability to buy a home, thanks primarily to the events of 2008.  

Why your home is only worth $1,000.00

Americans should wake up and get back to the mentality of our parents and grandparents- a house should be a home and simply put, a safe place to lay our heads at night. Since the average rent payment is around 1000.00 per month, a homes value should only be 1000.00 per month.  This is because no matter how long you live or where you live, you will have to come up with one thousand dollars a month on average to keep a roof over your head.  Even if you do own your home outright, it should still be only considered to be valued at $1,000.00 monthly.  Why? Well let’s say your home is appraised at $250,000.00.  That’s awesome, especially if you own it outright. However, since you need a roof over your head, its only worth $1,000.00. This is because no matter where you go, you will still need a home.  If you sell the initial home for its $250,000.00 value and buy another home at $250,000.00 then you don’t have any money in the bank.  If you sell your home for $250,000.00 and buy a new home for $200,000.00 then you pocket $50,000.00, but your new home is still only worth $1,000.00 since that’s the rent/mortgage payment you would have paid. Put simply, your home may be worth $250,000.00 to your heirs should they sell it, but to you its only worth the $1,000.00 you would have spent each month on rent or your mortgage to provide shelter for you and your family.  Americans should not “bet the farm” and ever risk or hedge their primary mortgage or take out a home equity line of credit. Furthermore, Americans should refrain from any secondary home, including rentals, until their primary residence is completely paid for, eliminating the possibility of the bank stealing the home and its equity, leaving just the government capable of that instead of two entities.  Unfortunately too many Americans forgot, and now I am afraid COVID-19, and its effect on incomes and the ability to pay the mortgage once again, including rentals, will once again be another rude awakening for Americans hell bent on getting over extended. In my opinion, passive income from rentals, or secondary homes should never be considered in the FIRE community and in fact is extremely dangerous as long as you have a mortgage.  They should only be considered as an investment strategy if they are fully paid for and owned outright because if the renters can’t pay, the bank doesn’t come after them, they come for you.  Depending on rental income to cover the mortgage should never be considered as the primary way to repay the debt on the investment.

In conclusion, a house should be a home, not just a house.  It should serve its purpose to provide shelter in a safe location.  Your home should never be valued at anything more than 1 thousand dollars, as too many factors could negatively impact your homes value.  I’m certain the people of Pripyat Ukraine didn’t expect their home values to drop to 0 overnight, but it happened.  The thousand dollar value comes from the fact that the average rent payment would be just that, and you want to own your home outright, so you aren’t dependent on any income to ensure you have a roof over your head and a safe place to sleep at night for your family.  Mortgage interest is front loaded, taking 15 years on the traditional mortgage for you to begin to pay more towards principal than interest, refinancing resets this, starting over with an even larger interest payment.  Most importantly remember to achieve FIRE, you need to ensure you have a home for the rest of your life, don’t bet that rental income or any passive income will cover your payments because as we have seen twice in just over ten years, unforeseen factors can destroy your best laid plans, leaving you homeless.