24 May 2006

Against Home Ownership

The Low Income Homeowner Problem

In my post on the State Economic Freedom Index yesterday, I noted that Colorado has a record high foreclosure rate and that a quarter of the people in the state can't pay their utility bills (not for the first time on this blog).

An anonymous commentator to that post (I have my suspicions, but the argument speaks for itself) took me to task for failing "to connect the dots in your previous attack (A Cause Worth Fighting For?) on low-income homeowners, who offend your delicate sensibilities by having ugly houses they can't afford repair."

Am I a hypocrite? I think not. And the reason that I'm not, while it takes a while to set forth, is worth exploring.

An abundance of unrepaired homes in Boulder, late utility bills, and high foreclosure rates are all symptoms of the same problem. We have many homeowners who can't really afford to own the homes that they are in.

While it seems harsh, in many cases the real solution is not to cut them extraordinary slack from the forces that threatened their continued home ownership. Banks can't pay depositors or continue to loan money if loan payments aren't made (banks are extremely leveraged organizations with surprisingly low asset to equity ratios). The natural gas and electricity can't continue to serve homes if the utility companies can't maintain the cash flow needed to buy coal and natural gas from third party suppliers at market rates. Broken windows and unrepaired garage doors, along with other kinds of disrepair are bad for neighborhoods and not what homeowners would want for themselves either.

Home Ownership Is Overrated

Home ownership is overrated. Right now, given the nature of our economy, too many people own homes. Not everyone should own a home, and one of the main sources of Colorado's woes of stretched low-income homeowners is that we have many people in this state who were unwisely encouraged to become homeowners.

Simply maximizing home ownership is bad policy, and we are finally starting to realize that now that homeownership rates are at near record highs.

The home ownership rate for 2005 was 68.9%, down slightly from the recent high of 69.0% recorded in 2004. The 2004 rate was the highest rate since the Census Bureau began reporting these statistics in 1965.

Incidentally, homeownership was lower for almost all of the period before 1965, because until the GI Bill, Fannie Mae and Freddie Mac made mortgages with long amortization periods available at reasonable rates, home ownership was far more difficult to achieve. But, the changes wrought by those innovations were more appropriate than the steps we see today. Those institutions largely were important because they created secondary markets that allowed lenders with only modest funds of their own, to provide mortgages to credit worthy people in transactions structured to be extremely safe for any lender. More recent innovations have created homeownership options for low income, low asset, bad credit families who are ill served by owning homes.

The Economics of Home Ownership

What are the differences between home ownership and renting?

Increasingly, so called home ownership looks a lot like renting. Only a small minority of households own their homes free and clear. Most households either rent or have a mortgage. Either way, one must make a hefty monthly payment to a third party to keep a roof over your head. But, the risks and costs associated with the two different ways of providing shelter for a family are materially different.


Most of us are familiar with the typical residential lease. Typically, the tenant pays a fixed monthly rent in exchange for possession of an apartment or house. Typically in a residential lease, the landlord is responsible for paying property taxes on the premises, maintaining homeowner's insurance on the structure, paying the mortgage, if any, on the premises, and making major mechanical or structural repairs for problems not due to tenant negligence.

Some leases are month to month, one or two year leases are common, and residential leases as long as five years are not unheard of, but rare. Beyond the terms of the lease, there is typically no protection against rent increases and the expectation is that if the rent increases that the tenants will move.

The tenant's security deposit is typically in the vicinity of one or two months rent, and typically is returned at the end of the tenancy with some deductions for damages to the premises, within a couple of months of the tenant's departure, if the rent is current. Any appreciation in the property, or depreciation in the property to due to changing real estate market, accrue to the landlord.

If rent is not paid as agreed, the eviction process takes a month or two, the security deposit is lost, and the tenant may end up subject to a judgment against him or her for a moderate amount of attorneys' fees and unpaid rent. Generally speaking, a tenant unable to pay the rent who can locate a subtenant can avoid all or most of the liability associated with the balance of the lease obligation. Often, a landlord will seize the entire security deposit and not bother suing if the tenant leaves voluntarily, as landlords know that usually the tenant misses rent payments because he or she is unable to pay and uncollectable in the near future, and the amount owed is typically modest compared to the costs of collection.


If you own a home, you typically make a down payment on the house and borrow the balance with what is commonly called a mortgage (in Colorado, the proper name is a deed of trust in almost all commercial transactions). The down payment for first time home buyers usually ranges from 0% to 25%. If the down payment is less than 20%, the mortgage is "non-conventional" and the home owners must pay, in addition to a mortgage payment, "mortgage insurance" which reflects the extra risk the lender is undertaking in a low down payment loan.

Typically, a first time home owner will pay property taxes and homeowner's insurance through an escrow whose monthly payment is included with the mortgage payment and mortgage insurance if any.

Maintenance is the homeowner's responsibility, and while the right is rarely enforced, failure to maintain the property is typically a ground for default under the mortgage, even if the payments are current. Almost no mortgages set aside an escrow or require insurance for maintenance issues. Typically, people assume that owned homes are better maintained than rented homes, and on average they are. This is because owners have a better chance of recovering their repairs than tenants, while landlords have a hard time knowing that their properties will be treated well by tenants and knowing what needs to be fixed. But, the other part of this perception is that traditionally, home owners have been affluent enough to keep their homes in good repair. An landlord is usually better able to make repairs than a low income homeowner with no little or no savings, and only de minimus equity.

A mortgage is generally amortized over a long time period. The norm is 30 years. Shorter term mortgages are available, by first time buyers almost never get a mortgage for a term of less than fifteen years, and mortgages of that length are uncommon. It is now possible to get a loan amortized over as long as 50 years.

Except in the case of reverse mortgage (typically marketed to long time, elderly homeowners with ample equity and inadequate retirement savings), monthly payments cover all current interest due (so interest is not paid on interest) and the amortized share of the principal payment, which very small at first, and the bulk of the payment at the end of the amortization period, in addition to mortgage insurance, and the escrow payment for property taxes and homeowner's insurance. A significant proportion of new mortgage loans are "interest only" with a balloon payment scheduled after a long mortgage term at which point the owner is expected to refinance, to have paid off the principal sooner than required, or sell the property.

Interest rates are a function of the owner's credit, the amount of the down payment, the term of the loan, and whether to interest rate is fixed, variable or a hybrid. A homeowner with excellent credit, a down payment of at least 20%, a 15 year term, and a variable interest rate pays the lowest interest rates of any kind of loan available to anyone. A homeowner with bad credit and a small down payment must pay "subprime rates" which are often only marginally better than financing a home with credit cards.

Homeowners with good credit frequently choose to pay the modest premium associated with a fixed rate. Homeowners who are stretched often get variable interest rates or hybrid interest rates that cause payments to rise (or fall) when interest rates do, in exchange for a smaller initial payment, and an amortization period of at least 30 years.

Loan eligibility is typically governed by a ratio of payments to income. The smaller the payment, by hook or by crook, the more the home owner will be permitted to borrow.

Foreclosures are overwhelmingly concentrated among subprime loans, loans with small down payments and loans where a variable rate or hybrid loan rate increase has caused payments to increase significantly.

Outside of Colorado, almost all mortgages are full recourse loans. This means that if the house appreciates, the benefit goes to the homeowner, but if the house gets "upside down" because the amount owed on the loan is more than it is worth, the homeowner owes the difference if the house is foreclosed upon.

The foreclosure process takes a long time, typically in excess of six months, and if the owner doesn't leave voluntarily, must be followed by an eviction. Selling a house can take a long time as well, often three to six months or more, and usually takes longer in the bad markets when foreclosures are common, than in the good markets when foreclosures are rare. Often securing a quick sale means selling for less than a fair market value price.

Except in the rare cases when a foreclosed upon house has so much equity that it provokes competitive bidding (and metropolitan Denver has a healthy foreclosure market so this does occasionally happen), the bank typically bids the amount of its loan at the foreclosure sale and the owner ends up losing all of his equity if he has any, and owing money to the bank, if the amount of the loan, including typically many months of very high default interest rates and late fees, plus the substantial collection costs associated with the foreclosure, substantially exceed the fair market value of the property.

Also, even when foreclosure is avoided by a home sale, typically more than 7% of the fair market value of the house or more, which may exceed a first time home buyer's equity in the house, may be lost to realtors' commissions, closing costs and repairs that have to be made to make the house marketable.

The ability to avoid foreclosure by selling is also complicated by the psychological reality that while renters are often resigned to moving on if they can't make the rent, that home owners, even when they clearly can't afford their homes, often hang on until the biter end refusing to give up a home that they own, often the only major purchase they have ever made in their lives. In part this is the "my home is my castle" philosophy, and in part this is a perceived loss of socio-economic class as one moves from being a home owners to a renter.

Why Rent?

Why would someone want to rent? The basic reasons are the allocation of risk, financing terms and financial ability.

If a prospective home owner doesn't have the cash on hand for a 20% down payment (plus a little extra for closing costs and a little cash on hand as a modest emergency fund), and good credit, the financing costs associated with being a homeowner are quite high.

Suppose you are buying a $250,000 house (which is a low end starter home in metropolitan Denver). If you can pay $50,000 down and have good credit, you can probably get a $200,000 loan at a fixed rate, for a 30 year term with a 6.5% interest rate. Thus, you are paying $13,000 a year to the bank to live in your home (in addition to property taxes, insurance, maintenance and paying back the principal).

In contrast, if you have bad credit and can only afford to put 5% down on the same house, you will probably pay a 10% interest rate, may only be able to have the rate fixed for three years after which it floats based on some interest rate index (and interest rates are still historically low), and will also have to pay mortgage insurance which could easily be $100 a month or more. Thus, your loan amount may be $212,500, your annual interest payment including mortgage insurance may be $22,450 per year, and in addition to this, you face the real risk that your interest payment will go up in a few years, increasing the cost of home ownership even further.

The market reality is that landlords to not pass on the difference between the good credit rating conventional financing they can obtain, and what it would cost for a tenant to finance a home to the tenant. Indeed, in times when housing prices are in an inflated bubble, monthly rents are typically less than what a landlord with good credit needs simply to cover good credit financing at current market rates and the costs of ownership -- because many landlords see their main source of profit as appreciation in the value of the property itself, and have relatively low financing costs because they financed their purchase for a smaller principal amount when home prices were lower.

Encouraging moderate to low income families with little cash and bad credit to pay a $10,000 a year plus premium over what their landlord can obtain for the privilege of having a residence that is harder to get out of the family's income is disrupted or a maintenance problem or increased utility bills disrupt their ability, and more costly to the family in the event that a substitute occupant of the premises cannot be found, is a no deal to that low income family.

Indeed, the low income family often cannot receive as much of a tax benefit from having tax deductible mortgage and property tax payments, because they are in lower tax brackets than middle class families that qualify for conventional financing. And, they tend to have less stable employment, which is a big concern when you are making a loan that must be paid every single month, on time, if you remain in your home.

For most families who don't qualify for a prime rate loan or don't have enough of a cash cushion to make payments without fail in the event of a maintenance emergency or brief period of unemployment, and for many families who can't afford a full 20% down payment in addition to that emergency fund, buying a home is a bad idea fraught with risk and likely more expensive than renting.

This advice is mitigated in the case of low down payment purchased made when housing prices are soaring, because hot real estate markets create equity, reducing the downside risk of not being able to make payments and having to sell the home, possibly at a loss, but it still rarely makes sense to buy a home when you are paying subprime interest rates and could be renting from someone who isn't paying those rates, particularly because rents tend to be particularly low during hot real estate markets.

At times like the present in Colorado, where the real estate bubble is deflating through stagnate real estate appreciation, the general rule that home ownership really only makes sense for those able to get good financing terms and have a decent financial cushion makes sense.


Many of the economic woes we are seeing right now in the Colorado economy are a product of low income families buying homes they can't really afford. Many were lured into buying houses with subprime loans, low down payments accompanied by mortgage insurance payments, interest only loans, and variable interest rates that have caused monthly payments to surge as interest rates have risen from their previous historic lows. These homeowners, who are often paying more to own a home than they would to rent a comparable home, and who often live pay check to pay check, making them vulnerable to relatively minor bumps in the road like an illness, rising utility and gasoline prices, or repairs that need to be done, find themselves leaving homeownership the hard way and hard pressed to even sell their homes through a realtor and recover their investment of what little savings they have accumulated.

Proponents of the subprime mortgage market argue that they are giving people a chance to be homeowners. But, the reality is, that a very large share of people who answer that call are making decisions that are economically unwise for them. The problem is not that there is anything sacred about a particularly numerical interest rate, but that rational participants in the market would not make the choice and government appropriately protects people who make economic choices primarily because they are ill informed, or, equally often deceived by slick mortgage brokers offering them bad deals.

Let's hope that this issue is mitigated, at least a little, by having Governor Owens sign the widely supported bill to regulate mortgage brokers in this state passed by the General Assembly this session. If criminals are taken out of the mortgage brokerage profession, many of these economically harmful deals for low income consumers might not happen at all. I'm not optimistic, but one can always hope.


There is an entirely different set of arguments against homeownership for middle class people who can afford conventional mortgages, not addressed above. But, in this case the argument is not that middle class condominium buyers or those selling them are making unwise decisions given their individual circumstances, but that the tax incentives for homeownership over leasing that drive those transactions encourage ownership arrangements that are not desirable in the absence of tax incentive.

This is particularly true in high rise buildings that go from apartments to condominiums. In these kinds of buildings, the collective action issues associated with homeowner's associations, make favoring home ownership a dubious choice from a non-tax perspective. Homeowner's associations tend to favor maintenance at the level desired by a median homeowner, even if some owners would favor much more maintenance, and require much more effort to make even easy decisions. Landlords, who wants to maximize the rental value of all the units in the aggregate and can make decisions quickly, in contrast, usually make better maintenance decisions in situations, like high rises, where the interests of each homeowner are often quite different. Consider, for example, the issue of elevator maintenance.

The best solution to this problem is to either (1) eliminate the mortgage interest and property tax deductions, or less disruptively, to (2) create a rent deduction and a deduction for casualty insurance on a principal residence. Either approach would create near tax parity between renting and owning and eliminate the kind of individually rational, but economically unwise tax driven decisions that our tax code's bias in favor of home ownership creates.


karen m said...

It's an interesting argument against home ownership. Thanks for that.

There's also, at least there seems to be, a big social stigma attached to non-homeownership. Once while we were living in the Midwest, I was on a job interview for a financial services company, as a file clerk/data entry person. The interviewer noticed that my husband and I were long-term renters, and asked me "what was our problem" - basically asking me why they should hire a deadbeat like myself. Whether or not the question was legal - the attitude exists. I believe it's a big part of why the foreclosure rate is skyrocketing, and I'm not sure how one would address that. Having the same or similar tax incentives for living at the same address, say, for over a year or so, would be a nice start.

Anonymous said...

Couple of things:

you say: Many of the economic woes we are seeing right now in the Colorado economy are a product of low income families buying homes they can't really afford

Another part of the problem is a lot of middle-class people are buying multiple properties with ARM and Zero interest loans. They are trying to get rich in real estate and they are getting burned as well. I have a
number of friends who went from "dot-com" to "real-estate" without batting an eyelash.

Andrew Oh-Willeke said...

Could be, but if that is the case, that part of the problem is self-correcting. Ir does not suggest that there is any need to address that part of the problem. Low income people making irrational choices with their homes is a problem. Middle class people making poor investments with excess funds is not.

Anonymous said...

No. I still need to take you to task on this.
I am not talking about the recent advent of the 0% down loans, and the loans offered to those who usually would not qualify.
I am talking about the people who are 20 to 25 years into their homes, and have convential loans. Folks who are late middle age, who were honorably employed and credit-worthy. People who have been down-sized and outsourced. People who were legitmately working in the manufacturing industry.

I think you make a lot of assumptions about people that have no basis in fact. I think you show a tremendous amount of ignorance pertaining to the loss of work in the new economy. And before you get on a rant that "they" should have changed professions, it is not easy to access higher ed while working 60hrs a week, and living within ones legitimate means, and being credit worthy.

It is arrogant to assume that lower income people have chosen to be irresponsible in their decisions. Somehow, you have a tremendous misunderstanding of what happens to people when the traditional middle-class has been destroyed by market forces. You also assume that late middle aged workers are going to instantly find work, when the manufacturing base has been destroyed.

Andrew Oh-Willeke said...

If you look at:

"[P]eople who are 20 to 25 years into their homes, and have convential loans. Folks who are late middle age, who were honorably employed and credit-worthy. People who have been down-sized and outsourced. People who were legitmately working in the manufacturing industry."

You will find that they have very, very low default rates on mortgages. In Colorado, high subprime lending rates are a significant factor in high foreclosure rates.

Since 1998 more than half of the foreclosures in Denver have taken place in a fifth of its neighborhoods, nearly all of which are high proportion minority areas where subprime lending is concentrated.


"A study by the Denver Post found that subprime home loans and home foreclosures occur mainly in minority neighborhoods. Blacks, for example, are more than three times as likely to borrow from subprime mortgage makers than whites. And according to the findings, differences in earning power can’t entirely account for the discrepancy. In fact, the Denver study showed that in 1999 a black family earning more than $70,000 annually was more likely to get a subprime rate than a white family making less than $30,000. On a loan amount of $150,000, the difference between prime and subprime rates can bump a house payment $300 a month."

You see the same thing in Detroit. Whose manufacturing industry, is the for the most part, long gone, and whose foreclosure victims don't look like the portrait you suggest.

As one study notes:

"Although information about subprime loans is not formally collected by any government agency, there is ample evidence that there are real problems in the mortgage market. For example:

Between 1980 and 1998 the rate of home foreclosures in the United States increased by 384%. That means that even though interest mortgage rates were almost twice as high in 1980, as they were in 1998, almost four times the number of homes were foreclosed upon in 1998 as in 1980. More significantly, the foreclosure rate is substantially higher for subprime loans than for prime loans.

This increase in foreclosure rates cannot be traced to the increase in homeownership rates, which was only about 3% during the same period."

Current Colorado law does very little to limit these practices.

Are the people you describe hurting? Yes. But, people in these shoes sell their homes or survive on emergency funds (perhaps set aside for retirement) until they are on their feet again, and in the process manage to avoid the catastrophic loss of equity that comes with owning a home. They do have a problem, but it has little or nothing to do with the structure of the housing market, or decisions on owning v. renting a home.

People with good credit, reasonable savings, at the time steady employment, and reasonable down payments should become homeowners, and the vast majority of people in that situation do become homeowners.

Andrew Oh-Willeke said...

A similar view to the one I expressed in the post above is found in this Business Week article from November 1, 2004.

Anonymous said...

Which brings me back full circle to my original point concerning the so-called progressives who have fully abandoned the working/labor classes. Limosine Liberals are so far removed by socio-economic position that you feel justified in making snide remarks about the "owners of ugly houses" and the struggle to preserve older working class neighborhoods against eminent domain decimation, as their longterm owners find themselves displaced by market forces beyond their control.

Your resultant intellectual contortionism exhorts, "oh, well sucks to be you, but people in your shoes must sell your home or survive on emergency funds (perhaps set aside for retirement) until you are on your feet again." I sure am glad the city planners and deep pocketed developers have come along just in time to condem your neighborhood, so I don't have to endure being exposed to your broken garage door locks and broken windows while you look for work. What a relief, I am SO excited about the new lofts they will be putting in where YOUR house once stood! The assault on my good taste, has simply been unendurable! And since I can't imagine having the same good neighbors and friends for for twenty-five years, your stange attachment to your ugly little house, in your ugly little neighborhood is too irrational for me to bother contemplating.

What I find offensive, is not that you have that opinion, but that you would be identified as a progressive while holding that opinion. It is politically indefensible, and intellectually dishonest.

Snobbery has no place in the progressive movement. May Kharma visit upon you that which you so richly deserve.

Anonymous said...

I'm not arguing your facts. Your facts are solid. I think the conclusion you have come to is wrong..

From what I can gather, your conclusion about housing is "poor people with limited discretionary income should not buy a home"

My conclusion is "predatory mortgage lending should be stopped and the g'ment has a responsibility to protect people from dishonest mortgage brokers"..

and you say: Middle class people making poor investments with excess funds is not a problem.

So you have two sets of standards here, one for poor people and one for middle class?

Middle class people dumping a house at less than retail (because it was a poor investment) will have THE EXACT SAME AFFECT on housing pricess as a poor class person dumping a house at less than retail (because they can't afford it).

Oh, and the 20% down on a house went the way of the dodo bird about the same time the average house in colorado went to $250K..

Oh and just curious. Did your parents, or your wife's parents give you ANY MONEY TO HELP WITH THE DOWN ON YOUR FIRST HOUSE?

You know why I ask don't you? Too many urban progressives conveniently forget all the times their parents helped them out financially. Poor people don't have parents who can write the big checks. They have to do it all by themselves..

Anonymous said...

You are confused. There is more than one reply marked "anonymous", and more than one person so termed.

I never said, "Middle class people dumping a house at less than retail (because it was a poor investment) will have THE EXACT SAME AFFECT on housing pricess as a poor class person dumping a house at less than retail (because they can't afford it)."

As to MY downpayment on MY first House (my ONLY house ever!)was 20% down, and my spouse and I saved for 9 years to accumulate that. We purchased "a little pink house" like in the John (Cougar)Mellencamp song. An affordable home in a working-class neighborhood. Good friends, good neighbors, many nearing retirement and many displaced from their employment.

I never addressed the Middle Classes at all. My objection was to your rant about ugly houses and the fight against eminent domain.

Andrew Oh-Willeke said...

The Denver Post notes many of the key points made in the original post.

Andrew Oh-Willeke said...

The original post incorrectly implies that mortgages in Colorado are non-recourse. The intended reference was to 2008.

Andrew Oh-Willeke said...

Brain fart. The intended reference was to California and not Colorado.