Avoiding the Home of the Hard-Up

Picture it; March 1636. It was the peak of the Dutch tulip "bubble." Tulips brought to the wooden-clogged nation from India were so popular, some bulbs sold for the equivalent of $150,000 in today's dollars. Trading was more fierce than competing on "RuPaul's Drag Race," as bulbs traded on exchanges like stocks today.

By March 1637, tulip bulbs were so expensive, the market dried up and caused many would-be wedding bouquets to desiccate faster than your skin in the Arizona sun. Estimates are that tulip bulb prices crashed as much as 90 percent. Consequently, the Dutch economy suffered and took years to recover.

Fast-forward 369 years to March 2006, when the U.S. housing market peaked and subsequently crashed; prices dropped faster than pants at a bathhouse. The impetus for this irrational exuberance, like the Dutch tulip bubble, was over-valuation. Through the 1990s and early 2000s, the belief was that real estate only appreciated. As Carleton Sheets (the best-selling author of the "No Down Payment" home study course) suggested in his 1990 infomercials, "Real estate never loses." Up until then, Sheets was generally correct because controls were in place to protect the housing market and homebuyers.

When those controls were removed and property values began and continued to rise - like hands on many a dance floor - banks lent to homebuyers who previously would not have been considered credit-worthy. Home loans were sold to "sub-prime" buyers with poor credit scores and required no down payment. Buyers bought homes they couldn't afford with loans they didn't understand.

Sub-prime buyers were earmarked for, and sold, risky designer loans, such as interest-only, zero-down and adjustable-rate mortgages. Those designer loans, like designer jeans, cost more than they're worth. Gone were the days of 30-year fixed-rate mortgages with 20 percent down payments. Buyers became over-leveraged.

The housing market collapse degenerated into a financial contagion that crippled banks, caused money market funds to break, unemployment to skyrocket and the economy to fall into a greater depression than Lana Del Ray at a music festival.

Between the Dutch tulip bubble and the U.S. housing bubble, there have been many other bubbles that have grown and burst. It seems that no matter how many calamities investors experience, they run from bubble to bubble like hipsters to trends.

SIZE MATTERS

What should you consider when you buy a house?

The first thing to understand, is that unlike your entrance for the party of the year, you will never time the market perfectly. You will never knowingly purchase or sell a house and be able to time the market with 100 percent of the economics in your favor.

Secondly, buy the right size. What we mean by that, is only buy a house valued at no more than three times your annual income and only with the square footage you need. Don't buy amenities you don't need, or really can't afford. Consider renting; no one ever lost their life savings by renting the wrong house.

BATTLE OF THE BULGE

Just as you can't know if the bulge is abundant until you strip away the underwear, you can't know how a house affects your net worth until you strip away the liability. It isn't accurate to claim 100 percent of your house's value, like your partner's assets, as yours, unless your house is completely paid off. It isn't accurate to add a home's equity to your net worth unless your house is paid off, or you have the cash to pay it off. Until then, it's a liability.

As an example, let's say a condo was purchased for $130,000, let's say it's now worth $150,000. Taking into consideration the mortgage payoff, the balance owed is $120,000. In simple terms, that allows for $30,000 in equity. One can't include either the house's value of $150,000 or the house's equity of $30,000 in one's net worth because the balance owed is $120,000. The house isn't paid off until the $120,000 mortgage payoff is met.

Monthly figures show the mortgage still has 22 years of payments to go. If the mortgage isn't paid off early or refinanced, a total of $324,000 will be paid over the life of the loan. Based on the 22 years of payments still left, the mortgage holder will pay roughly $237,000 more than they already have. In general one can expect, but cannot be assured, the condo's value will appreciate over the next 22 years. As illustrated back in 2008, the appreciation Carleton Sheets spoke of, is not guaranteed. Therefore, with all things constant, a liability is retained at $87,000.

Current Home Value $150,000
Remaining Expense - $237,000
Liability - $87,000

Looking at how housing costs affect your net worth in this way, you can see why we advise buying a house that fits just as perfectly on you, as your favorite designer's jeans.

HOW TO MAKE IT BIGGER

If you still want to consider your house as an investment, follow these rules.

A house should be considered a long-term investment. If you're not sure where you'll be living in the next five years, don't invest in a house. If you need a designer loan in order to afford the house you want, the truth is you can't afford the house you want.

� Buy a house below your means with a fixed-rate
mortgage and a down payment.

� Don't be duped by convenient offers to upgrade or up-size your home.

Once you've paid off your home, it will then become a realized investment and its value can be included in your net worth. Until then, you're at the mercy of your bank and the housing market.

It is up to each of us to decide what we want in life and make our life work accordingly. Most are not Dolly Parton or Madonna, except perhaps on weekends, and we must all weigh financial trade-offs. A house is only a portion of your "somewhere over the rainbow..." Don't let one dream steal from others, and don't let the expectations of others ruin yours.

David Auten and John R. Schneider, III are The Debt Free Guys. For more information to help you get out of and stay out of debt, visit their blog at debtfreeguys.com. For high school and college students who need help saving and managing money for college, download their book #MoneyConscious Student