Is it FINALLY a good time to buy a home?

In last Thursday's edition of the Wall Street Journal, Brett Arends makes the case that it might be a good time to buy a home:

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So let me play devil's advocate and consider the positive case for buying a home right now.
The key factor: Interest rates.

If you can borrow at 4.5% or 5% over 30 years, many purchases start to look appealing. Especially if we get a hefty dose of inflation down the line.

If that happens, your monthly payments will be low and you'd get to repay the principal over time with devalued dollars. That's a double win.

Inflation isn't guaranteed: The bond markets are only predicting about 1.4% inflation over the next 10 years, and BCA Research recently reminded clients that deflation, or falling prices, remains a danger. Unemployment is still rising and recent wages actually fell.

Yet if you had to bet from here, you'd bet on inflation in due course. The government is running massive deficits and has the printing presses at full throttle. That's the classic recipe.

And inflation is the debtors' friend -- which is why it is surely going to prove the politically expedient way out of this mess.

Anyone purchasing hard assets like real estate, with a 5% fixed rate loan, ought to make good money if that happens.

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First of all, I want to mention that I am a frequent reader of Brett Arends' series of "R.O.I." articles. I think he offers decent advice with a touch of skepticism, and much of his advice is grounded in common sense.

For the first time in many, many years, I tend to agree with Brett's argument that buying a home is a fairly good deal right now. If we focus on Brett's inflation argument, I believe we will see a significant rise in inflation in the next 3-5 years. For 2009 and 2010, I think we will see very low inflation or even deflation over this period, but once the economy recovers, the huge budget deficits will add trillions of dollars to the national debt and likely devalue the dollar. This means U.S. citizens will have to pay more for imported goods (a weaker U.S. currency relative to foreign currency makes foreign goods more expensive) and those who have fixed-rate debt will do better than those who have variable-rate debt (because inflation typically shows up along with rising interest rates).

Another excerpt from the article:

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When it comes to the house prices, it's true they may not have fallen as far as you might expect.
A recent analysis in the Financial Analysts Journal ("When Will Housing Recover?") suggested prices nationwide still weren't cheap by historical standards in relation to household incomes.
Homes were much cheaper, say, as recently as the 1970s.

Furthermore: the bigger the bubble, the bigger the bust. Considering how sharply home prices climbed from 2002 to 2006, one might expect real estate to end up really, really cheap before bottoming out. And you wouldn't expect a quick rebound either. Japan still hasn't recovered from 1989.

But if you are thinking of buying a home, here's the more positive news: While overall market averages may not be as cheap as you might have expected, you can probably ignore them.
There are plenty of deals taking place far below the official average levels. The indices are masking a huge disparity in prices.

Even the National Association of Realtors concedes distressed sales – including foreclosures and short sales – are closing about 20% below "normal" market rates. (Never mind how to define "normal").

Aggressive buyers are finding some simply terrific deals. And they're paying with cheap debt, too.

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Mr. Arends is saying that maybe we haven't quite reached the bottom on average, but there are probably some neighborhoods out there that have reached the bottom. I believe this is especially true for lower-income housing which had the biggest rise and fall in housing prices. Much of the low-income housing became a speculator's paradise during the boom years, and many of these homes became detached from the incomes that people would normally make in these neighborhoods. Now that we are a couple years into the bust period, these houses have declined the most on a percentage basis. Middle- and upper-income housing also rose significantly during the boom years and have come down during the bust, but not as large an amount on a percentage basis as low-income housing. You can see this in areas like Manassas, VA and Woodbridge, VA, where housing prices have plummeted but sales are way up compared to last year. This likely means that housing prices in these areas don't have much further to fall.

My advice?

• If you are going to buy a house to live in it, the first priority is to make sure that the house and the neighborhood are acceptable to you if you need to live there for 5-10 years. In other words, your home isn't just an investment --- it's also the place where you are schmoozing with neighbors and raising a family. If you end up in a negative equity situation, you want to make sure that you don't feel "stuck".
• Get a fixed-rate mortgage with monthly payments that you can currently afford. Note that affording a mortgage is much different than qualifying for a mortgage. Just because some broker says you qualify for a mortgage doesn't mean you can afford it. You have to look at your own income and your own budget, and determine the size of monthly payment that makes sense for you. Use one of the many free mortgage calculators on the web to determine your monthly payment. Do NOT get a variable-rate mortgage in this environment --- rates are at historic lows (actually they are artificially low because the Federal Reserve is buying treasury bonds to knock down mortgage rates) and a variable-rate mortgage will almost certainly go up over the next few years.
• If you are a first-time home buyer or have not owned a home in the last 3 years, you can get up to a $8,000 tax credit (there are price and income limitations which I will cover in my next post). Unlike the tax credit from last year, this credit does not have to be repaid. This credit, along with artificially low mortgage rates, provide a significant incentive especially for first-time home buyers to own a home.

A couple caveats:

• Note that I said you want to be comfortable living in a place for 5-10 years if you end up underwater on your mortgage. This is because I'm not predicting the bottom of the real estate market here. In many areas of California, Florida, and some of the other bubble states like Nevada and Arizona, the real estate boom was so massive that I believe many of the house prices in these areas still have further to fall. In fact, in some of these areas, I would not recommend buying a home now because the real estate market was so corrupt over the last several years that some areas won't recover for quite some time.
• If mortgage rates increase significantly over the next few years, this will end up holding down house prices. For every 1% rise in the mortgage rate, the price of a house needs to decline about 10% to keep the same monthly payment. At some point, the artificial subsidy on mortgage rates will end (supposedly next year, but who knows for sure?) and rates will better reflect the current market.

Note that I'm writing from the Baltimore-Washington corridor in Maryland, and I believe this area is more solid for buying a home, but if prices fall a little bit more after you buy, make sure you buy in a place where you would enjoy living at a price you can afford. Buy with a reasonable down payment and keep paying down that principal, and eventually you should have a decent equity cushion.