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Saving Plan Needs Better Approach

September 24, 1989|CHRISTOPHER WELCH | Christopher Welch is a financial analyst for Raleigh Enterprises, a West Los Angeles real estate conglomerate

As a would-be homeowner, I am always keenly interested in people's new ideas to break into the housing market, an idea very remote for most of us young people.

Donald Jason-White, in his article "Fresh Plan for Buying First Home" (Sept. 10), discusses a plan for potential home buyers to get into the market. Unfortunately, he ignores some of the most pressing problems, concentrating only on the financial workings of his suggestion and how it will help the government.

I'm sorry, but given my current housing situation, helping the government is not very high on my priority list. In fact, it is the government that should be helping people like me.

But we should at least examine Jason-White's proposal to see if it makes financial sense.

He would like to see young people getting into a savings program for 10 years, then purchase a home at the end of that time and have it paid off in the next five years--a 15-year method to own your own home, free and clear.

Saving for Home

Sounds pretty good, in theory, but there are a number of serious flaws in this proposal.

First, the proposal requires the example couple (earning $40,000 a year) to save $650 a month.

A modest sum, to be sure, considering that this couple will also have to pay about $700 for rent, $400 for food, $400 for cars, $150 for insurance, not to mention clothes, VCRs, going to a movie once in a while, or maybe saving for a child.

I am being facetious, of course. To save $650 a month would kill me, or anybody else making that kind of money. And that is where the real problem is, the one Jason-White ignores.

If the example couple follows his program, they will be spending 50% of their net income on housing or saving for housing. And half of that is not contributing to their future in any way. Non-tax-deductible rent is the biggest obstacle to saving for home ownership.

If the government truly wants to help the young get into the market, they should allow deductions on rent paid. Of course, that creates some other problems for the government, specifically reducing revenue when it needs it the most.

Eliminate Tax Deduction

Another major problem with the proposal is that it advocates low-leverage transactions. This is not a good idea. The less a person puts into an investment that he or she is controlling, and that is appreciating, the higher that person's return on his or her investment.

Low leveraging also will almost eliminate the only tax deduction still available to individuals--the mortgage interest deduction.

The trade-off, Jason-White claims, is that you will be saving $256,000 in your lifetime earnings. Let's examine this proposal.

If the example couple follows his plan, in 15 years they will own a $300,000 home free and clear. However, what happens if that same couple follows a different path?

Let's say they purchase a starter condo for $125,000 and finance it with an FHA 95% mortgage. Let's also assume that our couple has no money to put down, so they take a $10,000 advance on their credit cards to make the down and closing costs, and pay it off (at 15%) over five years.

Higher Appreciation

Their monthly payment for housing (including condo fee) would be less than if they opted for Jason-White's proposal, and they would own their own home.

But most important, they would get any appreciation on the property. Using Jason-White's numbers, I calculated that he used an appreciation rate of 10% and an inflation rate of 5.5%. The condo buyers, if they sell at the end of five years, will realize a profit of $75,000 (a return of over 30%), to be applied against a new home, which could now be a house of about $235,000. Their payments would still be less than those advocated by Jason-White.

At the end of the next five years, their proceeds from the sale of the house (again, using the same assumption factors) would be $200,000.

At this point, if the buyers wanted to own their home free and clear in five years, they could opt for Jason-White's financing packaging, with the same monthly payment, but get a house worth about $400,000. If they opt for traditional financing, they could afford a $600,000 home.

Ignores Politics

Other major problems that Jason-White ignores include the direction of national politics, which have been tending to promote slow-growth initiatives, down zoning and other anti-development factors. These will force the housing supply to grow at a much slower rate than previously.

And where will housing be located? Today, for affordable and decent housing, young people are being forced outward, at least an hour's drive from business centers in Los Angeles. Prices jumped upward of 20% in Palmdale last year, making it too expensive for many people. Where to now? Indio? Mojave?

Of course, there are a number of flaws with my proposal also. I do not recommend purchasing a home by getting a cash advance on your credit card. There are ancillary costs, fees and it will appear on your TRW credit report, severely diminishing your chances of getting adequate financing.

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