Is Your Home an Investment?

The colossal housing meltdown we’ve experienced, in the wake of the unprecedented boom in home appreciation, has turned many people sour (and not without good reason) on the concept of house-as-investment. Many arguments in favor of renting, rather than buying, have come out of the woodwork, and have their fair share of merits. The better among these arguments ought to provide sobering considerations to those tempted to jump on the next bandwagon of “never-ending” price spirals, treating their home as a short-term, get-rich-quick instrument.

Of course, the same arguments don’t serve to convince those who place a higher value on home ownership’s intangible benefits: a long-term residence at which one establishes roots, builds memories, raises a family, and modifies as they wish.

The benefits of home ownership, however, are not limited only to those intangibles that play to emotion or nostalgia. There are very real long-term economic benefits as well (note the careful choice of words: I did not say, “It’s a good investment”). Of primary consideration (and what the arguments in favor of renting over buying often neglect in their calculation) is the hedge against inflation that a mortgage provides. The cost of housing, including rent, is going to go up over the long-term, just as the price of a gallon of gas or of a hamburger will go up.

A (fixed-rate) mortgage payment, on the other hand, remains the same. Property taxes do go up, but in most areas voters have passed initiatives to limit the annual increase of property taxes to a lower percentage than that of inflation. Moreover, property taxes are only a small portion of the mortgage payment, so even if they were increasing at a similar rate as inflation, the total aggregate mortgage payment, 80% or more of which is not property taxes, is still going down over time when adjusted for inflation. Property taxes are often reduced when you reach a certain age, as most states have partial (sometimes even full) property tax exemptions for senior citizens. Finally, most people also get a tax break by virtue of being able to deduct mortgage interest from their taxable income, so the tax benefits of home ownership often end up a wash with the tax burden. So it’s safe to say that the home owner’s overall housing payment, adjusted for inflation, is going down with time. The same cannot be said for the renter.

Many homeowners of the generation before mine are a living example of this principle in action, having bought their home 30-40 years ago for $40,000 or less. Yes, many of them still have a mortgage because they’ve refinanced a few times through the years, the wiser ones pulling out equity for various updates and improvements to the property rather than using the house as an ATM machine, thus keeping their mortgage at or near the same level as their original purchase price. Consequently, many have enjoyed a mortgage payment of $500 or less to this day, and have a home that even in today’s depressed housing market is worth several times more than what they owe or what they paid for it. But the property’s appreciation is only a side benefit, not the thrust of my argument. If they have no intentions of selling, that aspect is a moot point anyway. The real benefit is that they’ve fixed their housing cost (that is to say, lowered it year after year when adjusted for inflation), knowing that the cost of rent would eventually outpace their expense as owners.

Someone will counter with the argument: “Yes, but they could have instead invested that $40,000 and watched it grow at 12% ROI in mutual funds all those years on the road to millions.” No, they couldn’t have. For starters, most of them did not have $40,000. They might have had enough (with help from parents) for a 25% down payment on a $40,000 house. There’s a big difference. Even assuming they could get 12% over 40 years, and that it didn’t get wiped out in a stock bubble, it doesn’t come anywhere close to doing as well for them as buying a home did. Plus, then they would have had to rent, and would not have had the benefit of all that extra disposable income to invest in the years subsequent to when rent outpaced the mortgage payment they could have fixed, because their housing expense would have continued to increase at a comparable rate to their income.

Moreover, if they had invested the amount they originally put down on that house, the net value of that cash asset would still not have equaled what their home is worth today because their home, even if it appreciated at a lower rate of return, was gaining ground on the full value of the leveraged asset, not merely on the amount they had invested. If I put $10,000 down on a $200,000 home, I’m going to net much higher gains at a nominal rate of appreciation than investing that same $10,000 would at a phenomenal rate of appreciation. In other words, I’d forego the 12% rate of appreciation on $10,000 in cash, for the sake of getting a 4% annual rate of appreciation on the $200,000 house, and have more money to invest in stocks or mutual funds in subsequent years because I’ve fixed my housing expense as a hedge against inflation.

So, at the end of the day, is a house a good investment? In a very real sense, no. Let’s look at that $200,000 house. Assuming a long-term average rate of appreciation of 4%, that house might be worth $662,000 in 30 years. If someone takes out a $190,000 mortgage on a $200,000 house at 6% interest, they will end up putting $420,000 into that house over the same span of time. $420k invested to yield $662k over 30 years is a pathetic rate of return of 1.52%, which is illiquid, only converts from unrealized to realized gains when you sell, and that’s before you factor in taxes and maintenance. Nothing to write home to mom about.

That being said, now entertain this more accurate way of looking at it: It’s inappropriate to ask whether or not a home is a good investment. It’s a false question, akin to exploring whether or not food is a good investment. Housing is a basic necessity that one has to pay for whether they own or rent. In that sense, home ownership is a “bad” investment, if one insists on calling it an investment at all. And rent would be a far worse investment by that standard, involving not even nominal gains, but rather a negative return (i.e. the loss of 100% of your principle invested each month). But the case I make isn’t that either is a good investment. Rather, that a mortgage, under the right circumstances, can be an effective inflationary hedge against the rising cost of housing, allowing someone to “fix” their housing cost (or lower it, relative to inflation), so that they can soon pour more money into other, better forms of investing, while at the same time reducing their monthly liabilities for their retirement years.

Exposing the Exposé

Living through a major media story from an industry-insider’s perspective has been eye opening to say the least. Going forward, I will be much less quick to pass judgment on the major players that get “outed” in a media exposé. No doubt there has been a plethora of unscrupulous activity that has contributed to this present credit crunch, but these days I tend to fantasize about writing a book looking at the day-to-day operations of the mortgage business—from the perspective of those of us on the street level—in order to set the record straight.

The company I work for, Countywide Home Loans, has been at the forefront of the firestorm, and I can understand why. We are the largest mortgage lender in the United States, leading in both originations and volume of servicing portfolio for several years running. The spotlight upon us culminated in a scathing feature article in the New York Times last week, followed the next day by a press conference held by Senator Charles Schumer, where this article was referenced and cited as fact in spite of its numerous inaccuracies.

Pause here for a disclaimer: I am by no means Countrywide’s shill; this is about pride in what I do and how I conduct myself in business dealings. I am smacked both with personal offense and with an objective sense of repulsion when I see fiction passed as fact in order to create a convenient villain to rally the base, or to tell a credibility-be-damned story under the conciousness that its spiciness will sell.

Egregious logic gaps serve to refute the very case made in the Times article. As an example, Countrywide was accused, in surprisingly direct language, of steering borrowers into subprime loans even when they could have qualified for prime loans, in order to generate higher profits. Yet the same article admits that the amount of subprime loans Countrywide originated last year represented only 8.7% of their total loan originations, whereas, according to the independent Mortgage Bankers Association, 13.5% of industry-wide originations in the nation last year were subprime. The obvious question here is: if it were true that Countrywide was steering prime borrowers into subprime loans, wouldn’t it logically follow that their percentage of subprime loans originated would be higher than industry average, rather than lower?

Quite the contrary to the steering allegations, this statistic seems to confirm a business practice to which I can personally attest: putting a borrower into a prime loan whenever possible, even when it means making underwriting exceptions in order to do so. In fact, the vast majority of borrowers who apply for financing even with Countrywide’s traditional subprime division, Full Spectrum, end up getting a prime loan instead. Less than 20% of Full Spectrum originations are subprime loans, and we’re talking about the so-called subprime division of the company! If an unscrupulous loan officer were to attempt to put a prime borrower into a subprime loan, the underwriting department would recognize this and not even approve the loan until it was properly converted to a prime program.

It also seems a foregone conclusion to the media that Countrywide had overly-aggressive underwriting guidelines as compared to the rest of the market, resulting in bad loans with higher default rates. The fact is, Countrywide’s delinquency rate (loans behind on payments by thirty days or more), which stood at 4.9% at the end of the second quarter of this year, is right in line with the rest of the market according to the MBA-published industry averages.

Furthermore, the overly-aggressive-underwriting conclusion betrays an ignorance of who is actually determining guidelines, the risk management bar, and the rate of return required in exchange for that risk. Countrywide is not a portfolio lender (neither are any of the other major lending institutions), loaning people money out of their own vault like in the olden days as portrayed in It’s a Wonderful Life. The capital for the loans it makes is acquired from investors, either through the Government Sponsored Enterprises (GSEs), Fannie Mae, Freddie Mac, the Federal Housing Administration, and Veterans Administration, or through private, non-GSE investors via the secondary markets. With the exception of some small-town banks and credit unions that might still do some limited portfolio lending, it is the exact same investor pool utilized by every major lender in order to make loans.

If it were true that Countrywide condoned reckless underwriting standards or unethical behavior on the part of their employees in order to get their loans closed, then it would logically follow that loans were sold to investors on the secondary markets under false pretenses and that consequently, Countrywide loans would perform sub-standard to the rest of the industry. But the statistics don’t support any such claim.

Another allegation from the article was that Countrywide loan officers, for the sake of boosting their commissions, put borrowers into higher-cost loans than what they qualified for. This claim, however, fails both of the obvious logical tests we could put it to:

First, if it was true, the public at large would have wised up to this loan ago and stopped giving Countrywide their business. We have lived in an unprecedented competitive environment for the last several years; it is extremely easy for borrowers to shop for competitive rate quotes. If even a small percentage of the borrowing community could arguably be duped into paying more than they should, it wouldn’t take long for the public to catch wind of this failure to remain in lockstep with the competition and simply cease giving such a company business. If such a practice were taking place, how would Countrywide not only have continued to thrive in the competitive environment we’ve been in, but also come out consistently month over month as the top lender?

The second logic test on this claim: if it were true that Countrywide’s loan officers, for the sake of boosting their commissions, steered borrowers into higher-cost loans than what they qualified for, then it would logically follow that a higher percentage of Countrywide customers would find themselves with more difficult-to-afford payments as compared to customers of other lenders, causing Countrywide to have an above-average delinquency rate when compared to the rest of the market. As previously stated, however, the delinquency statistics do not support this claim.

To name a couple more patently-false assertions: “Adding a three-year prepayment penalty to a loan would generate an extra 1 percent of the loan’s value in a commission,” and, “Countrywide’s software prevented the input of cash reserves so borrowers would have to be pitched on pricier loans.” These negligent and slanderous claims could have been dispelled with the simplest of fact-checking missions, had the author not self-admittedly relied merely on the testimony of off-the-record, disgruntled former employees as her source.

A plethora of other misstatements of fact, which are documentable as false, have infuriated me over the last several months. But I’ve already cited more examples than I’d intended to. With the media clearly subject to inadequate standards of accountability to the truth, it wouldn’t be possible to systematically refute every false statement that has been made. So what is my motivation and reaction in this?

Let’s start with my motivation in writing this: although Countrywide has been a good employer to me over the years, I’m really not a corporate cheerleader. My impassioned defense is more accurately described as a righteous indignation toward the ill-gotten gains of witch hunters and mudslingers. I just happen to have greater first-hand knowledge of the facts in this witch-hunt than I do about others.

My proper response (and hopefully, by extension, an exhorting word to any who have been prone to the same mistake in the past): a more measured evaluation of the facts, tempered by grace, of any story that drives the jury toward a hasty conviction. At the very least, barring the expenditure of effort required to adequately learn all the facts, we ought to exercise restraint in drawing a conclusion of any kind. In short, to paraphrase a significant chunk of the wisdom of Proverbs: be quick to listen, slow to speak, and slow to anger. How many people have I judged as a result of a sexy media exposé, with no further knowledge of the facts than that which was presented by a profit-driven media outlet? Let this be my wake-up call. I’ve come to realize the court of public opinion rarely contains a fair and impartial jury, because the dissemination of news is a business, not a court of law. And sex sells.