Monday, January 12, 2009

Debt to Income Ratios or "What do you mean we can't afford peanut butter?!?"

Happy New Year everyone!

Yes, I'm way behind. If you've noticed that things have been quiet around here it's because I took a much needed 2 week vacation in December, away from work, and trying to stay away from the PC and spend more time with my wife and daughter, and catching up on some projects around the house. Last week was spent trying to remember what I do for a living (oh yeah, high tech marketing, check) and getting work projects back on track. This week I'm settling back into a more normal routine. So on to the post!

This morning I came across two great blog posts on ratios including:

1. Debt to income ratio
2. Mortgage to rent ratios.

These articles were an important reminder of what drives home prices values at the end of the day.

This first article talks about why mortgage payments should be less than rent payments for a comparable home given the inherent risks in "investing" in a house these days:
"It is not the job of government to prop up house prices to the point at which mortgages cost more than prevailing rents. In fact, right now, it is entirely rational that a new mortgage should cost less than prevailing rents. Here's a few reasons why:

1. Mortgage rates are extremely low -- which means that when you come to sell the house, they'll probably be higher. Since resale value is an enormous part of the price you're willing to pay for the house, this is a very important consideration."
The second article is from the Irvine Housing BLog and talks about how debt-to-income (DTI) ratios have driven up the price of housing, especially in California with STI ratios of 50% are common. As a side note, I have lived in the SF Bay Area off and on for 9 years and never owned a home there. The fact that you needed to allocate 50% of your income to your mortgage always seemed stupid to me, but I was in the minority. It now looks like I might have been right, not a common occurance in my investing portfolio.

"Typically debt-to-income ratios track interest rates. As interest rates decline, it becomes less expensive to borrow money so borrowers have to put less of their income toward debt service. The inverse is also true. On a national level from 1997 to 2006 interest rates trended lower due to low inflation and a low federal funds rate. During this same period people were increasing the amount of money they were putting toward home mortgage debt service. If the cost of money is declining and the amount of money people are putting toward debt service is increasing, the total amount borrowed increases dramatically. Since most residential real estate is financed, this increased borrowing drove prices up and helped inflate the Great Housing Bubble."
It's a bit of a long article, but well worth the read. Good insights there.

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