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Speculative Real Estate: Odds in Whose Favor?


Refinancing what you already own is still best option.

With yesterday's announcement that the Federal Reserve will be buying Treasuries and MBS, I can hear those real-estate agents already: "Now is the time to buy that vacation home you've always wanted. The government is almost paying you to do it!"

While I hope that Minyans take full advantage of Federal Reserve-subsidized mortgage rates to refinance their homes, I'd be very careful about using these low rates to go out and purchase speculative real estate. And here's why:

Last night, just for laughs, I looked at the monthly payment on a $100,000 30-year mortgage at 4% (admittedly low, but where I think first mortgages are likely to go before the Fed is done). That payment turns out to be about $477 per month. Assuming that the monthly payment can't exceed about a third of a person's compensation, (where I also think the regulators are headed) you'd need to earn $1,431 a month to take out this mortgage.

Now, let's say that the economy turns around, the Fed stops buying Treasuries, and rates go back up to 6% - and you go to sell your house. At 6%, that same $477 monthly payment only gets you an $80,000 mortgage. Or, alternatively, the same $100,000 mortgage requires a monthly income of $1,799. So either your buyer needs to put down $25% more than you did, or have an income that's more than 25% greater than yours, just to own your same house - and that's before any hope for appreciation!

I don't know about you, but these are the kinds of figures that make me go, hmmm. And they help to remind me that over the past 30 years, we've had nothing but tail winds (falling interest rates) when it comes to real estate. But now, after this final gift from the Fed, interest rates are likely to be a head wind for as far out as you can see.

So again, take advantage of the Fed's refinancing opportunity with what you own. But if you're considering speculative real estate, I'd check your math.
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