Dollars and Sense
You would think that most people who are investing or borrowing money to buy a house are relatively smart people by nature. If this is the case, how did we get in the situation we are today in terms of the economy?
If you were an investor in the late 1990’s and early 2000 decades you probably remember what is now termed as the “dot.com” era. This was the age of internet companies and they were springing up all over the place. Before they even got off the ground, they devised some business plan and would perform an IPO (initial public offering of stock) and raise millions in a matter of days. The stocks would shoot through the roof at an amazing pace. Often the only plan to make money was through internet advertising, which of course did not pan out. Even investors would get excited because they could buy the stocks and wait a few weeks and sometimes double or triple their money. It was crazy, the market was moving like a roller coaster. People threw fundamentals out the window at a chance to get rich quickly and make a fast buck.
Fast forward to 2005, to a new era, the start of the real estate bubble. It’s almost the same scenario repeated, but this time on a different playing field – real estate. Our government encouraged home ownership and banks followed suit. Lending rules were relaxed and banks followed each other’s lead. A bank who was a tough lender could lose millions because the bank up the road would make the loan anyway and get the proceeds. In most cases banks were selling off the loans anyway, so they did not care. So the spiral begins….
People who should have been buying $150,000 houses were buying $300,000 houses on loans such as interest only for 5 years. The idea was the house would become a $500,000 house by then and you sell and pocket a large sum of money. People were not just buying 1 house; they were buying 2 or 3 and then renting them. However, you know the rest of the story, the fast moving train hit a wall. Real estate values stopped rising, there was a glut of houses and other real estate development on the market, and the bottom dropped out of it. People could not afford the payments after awhile or sometimes they lost a job, or both, and the ship sank.
As educated people, why did we let history almost repeat itself less than 10 years later? There are many reasons. First, the ease of credit made this possible. Second, people’s desire to make money or get a bigger house consumed them. Last, we forgot the fundamental rules of common sense. For example, if I make $50,000 annually at my job, I cannot afford to be in a $300,000 house and should have said no when my real estate agent or lender said they could get me in that house.
There is speculation what the next bubble is. Perhaps some commodity like gold will be the next big thing. I do think some positive steps are coming out of the latest boom and bust. It will be harder to get credit and bank’s will be more strict on who they lend too. If someone has a terrible credit score, it is usually for a reason, and they might not necessarily be candidates to own a home. Also, we are becoming a nation of savers, which is never a bad thing. We still need improvement in this area, but the goal should be to spend less than you make.
I know I have certainly learned a lot by watching the last 2 boom-bust cycles. Thankfully, I was able to keep a job and my house, but all my investments like a 401K have suffered. I have decided to reevaluate my diversification and I would encourage other people to do the same.
At the end of the day, if someone tries to sell you something you know you cannot afford, it’s okay to say no and walk away. That’s just good dollars and sense.