I Bought a House Right Before the Market Crashed

And we lost six figures of home equity.

Let’s take a trip in the good ol’ “way back time machine” to 2007: Steve Jobs unveiled the first iPhone, the final Harry Potter book was published, and I was about to lose my house. And I wasn’t alone: Sometime between Britney Spears shaving her head and Barry Bonds breaking the home run record, millions of American homes took a nosedive into the deep end of the housing market.

I don’t want to get into too many torrid details, but during that time we lost six figures of home equity, stopped paying our mortgage, and strong-armed our way into loan modification. It was a nightmare, but we were lucky. We came out of it with a roof over our heads and (very little) money in the bank. But too many Americans saw much harder times.

Sure, we fell victim to loose lending practices, inflated real estate prices, and Wall Street fraud, but we also made some big mistakes.

Today, as home prices rise to pre-recession numbers, the market heats up, and there’s talk of deregulating financial institutions, I worry we are heading down the same path. That’s not to say anyone should avoid buying a house. Heck, we just bought one again in October.

But there are a few mistakes we made the first time that we made sure not to repeat. Here’s what we did differently the second time:

Location, Location, Location

The 2007 housing market in San Diego was totally out of control: $500,000 could get you a one-bedroom “condo conversion” in a pretty OK part of town. You’d be lucky to get two bedrooms, and we’re talking 900 square feet or less. So, to get more for our money, we settled on a relatively nice house in a pretty terrible part of town with a ton of potential.

I don’t exaggerate when I say this: We endured drive-by shootings (which, on one occasion, sent a bullet flying through our garage), our cars were broken into, and our house was regularly spray painted with graffiti.

But the location of the neighborhood was ideal. It was rich with culture and history. We absolutely loved our neighbors and the community, and there were several redevelopment projects in the works.

While the neighborhood was ripe for investment, it was not immune to the economic downturn. The entire city saw massive dips in real estate valuations, but our home value was annihilated — from $550,000 when we purchased the home to $130,000 just a year later. The “better” areas, where we could have purchased a small condo, bounced back more quickly and experienced fewer foreclosures.

To this day, home values in our old neighborhood still haven’t completely caught up. That’s great for today’s investors and first-time homebuyers, but it’s tough news for anyone who purchased there when we did. However, our old house sold last year for just $20,000 more than we paid for it 10 years ago. Ouch.

When we bought our second house, instead of picking the best house on the worst street, we followed that old real estate advice and bought the “worst” house on a great street. This area took a much smaller hit when the housing bubble burst, and demand remained relatively consistent. If things go south again, we aren’t as worried about getting stuck in a house we can’t sell or losing the money we put into it.

So, if you are in the market for a new home and you have the choice, pick the better street.

Buy for the Long Haul

Timing is one of the hardest things to predict in real estate: the right time to get in and when to get out. The first time around, we went in hoping to sell the house for a profit in five years. This time we’re taking a long-term approach. Home ownership for us is no longer about a continuous cycle of buying, selling, and climbing our way into a better neighborhood. So, when we bought our last house, we planned on it being just that — our last.

If the market goes through another downturn, we’ll still be in this house. It’s safe, the schools are good, and we don’t really have any reason to move. We may be living in this house for the rest of our lives — and I’m totally OK with that.

I no longer have dreams of upgrading, although that’s easy to say when you live in a good neighborhood. I’m just not even thinking about the next house because there may not be one. Our financial strategy has nothing to do with moving, so we are not relying on timing the real estate market to make a profit.

Don't Expect Your Income to Increase

Part of our original plan to buy and sell our way into a better neighborhood included the crazy idea that our incomes would increase substantially over time. Well, that dream was trashed when my husband got laid off in 2008, our second year into home ownership.

As my husband searched for a new job, we found ourselves looking at a 30 percent decrease in income. There were very few jobs available in his field to begin with, and the companies that were hiring weren’t paying as well.

It was a big mistake to assume that our incomes would significantly increase in five years. A 5 percent annual raise is pretty generous by industry standards, and two to three percent of that just covers inflation and/or cost of living adjustments. To significantly increase our income, we would have needed to receive raises of 10 percent or more, which sounds great, but is totally unrealistic.

Today, our future plans aren’t built on the assumption that we’ll be making more money year after year. In fact, we have a contingency plan in case our incomes drop precipitously. Of course, we hope to continue to move up in our careers and increase our salaries, but our lifestyle, savings plans, and retirement strategies aren’t relying on it. Worst case scenario, we’ll eat ramen and work double jobs, but we’ll still have our house.

Rethink the Housing Budget

There’s a 30 percent housing rule that many financial experts recommend when figuring out how much house you can afford. Essentially, the rule is that no more than 30 percent of your income should go towards the cost of housing. When we bought our first house, we used that rule, and it was a big mistake.

This percentage is totally arbitrary. If you’re making $30,000 a year, then you may not be able to afford 30 percent in housing. However, if you’re making $150,000, then you may be able to afford more than 30 percent. And those numbers fly out the window if you have kids or other dependents to care for, let alone student loans, car payments, or medical costs. This rule assumes you have control over what you spend on everything else — and sometimes you don’t.

We had our first child the first year we owned our house. We naively assumed we could afford it because we had relied on this 30 percent golden rule. So, after our daughter was born, when it came down to paying for daycare, as well as my student loans and all the other fixed costs we had, I ended up staying home. It made more sense.

Except now our 30 percent mortgage payment was more like 50 percent, and we found ourselves with a home we could no longer afford. In hindsight, it was totally stupid, and we take full ownership of that huge mistake. And we won’t do it again.

This time, when we figured out how much house we could afford, we didn’t consider percentages at all. We took a more holistic approach to our budget, rather than basing it solely on our incomes. We also were honest about our future plans, which meant deciding not to have any more children or going back to school, plans we had talked about for a few years. For us, those are the trade offs to homeownership.

Today, when people ask if we are going to have another baby, we say, “No. We have a house instead.” It’s a little sad to think about it, but we know now that we can’t have it all. But with everything we’ve been thorough and where we are today, we’ve come close enough.

Join the Discussion

9 Responses to “I Bought a House Right Before the Market Crashed”

  1. Jesus Castillo

    Everything they did wrong was the basic rule of thumb back then. In act it was the rule of thumb for all 20 year olds back in the 70’s. People need to realize to make money on homes either you go in with the idea of altering the property in upgrades or you buy cheap homes and flip them. That is if you intend to use properties as income. If you just want to gain on your home investment think before you jump.
    Never buy a home that you cannot afford if your income is reduced by 20 %. This idea is you may lose your job and have to start over by taking a 20 % cut.
    Then always buy a home with the idea of living there at least 10 years because first you are buying the home in the current market and the market will fluctuant. 10 years guideline allows you to ride the market while reducing the mortgage and watching interest rates and local property values. Remember there is a limit of property and land. The values may occasionally take a hit but they will always go backup given time.
    Finally decide where you finally want to end up and target that area for your final home. then chose a home which you do not have to alter too much to match your needs. All improvements only return half of their cost to the value of the property and you will never recoup the costs for remodeling bath or kitchens. These are looks and everyone has different tastes.

    • Diana Alvear

      That’s all excellent advice! Thank you.

    • Diana Alvear

      That’s excellent advice. Thank you.

    • janmaus

      And don’t expect to get something cheap enough to actually make money with a flip. We have tried numerous times to get a house at a price that would allow us to just break even after doing repairs and updates, mostly with our own labor. We did actually make money once with a rehab–but we lived in it 8 years before spending the last one in a construction site with most of our furniture and other possessions in storage.

    • Jesus Castillo

      Not sure what you bought, or what improvements you had to do. If you want to flip houses you need to realize that you cannot make major renovations, even though that’s what they do on those shows, you need to keep the repairs down to basic painting and clean up. The idea is not to sink a lot of money into the property but to just make it attractive.
      Rule of thumb every house is unique and every buyer is different.
      So you need to keep the colors basic whites and light beiges. If you need to change bathroom fixtures keep them simple white and the same for kitchens.
      Folks for the most part do not want to do a lot of painting when they move in and the last thing they want is to be changing a lot of fans stuff. Keep it simple and cheap.
      Never buy a house that is in a bad area . Location ,location, location.

    • janmaus

      I hear what you say, but it is still easier talked about than done. Even ugly houses in good locations can be hard to make money on–the folks I know who manage to do so are already in either real estate or construction. We have put bids on plenty of homes needing minor fixes low enough to allow us to make a few bucks–not looking to get rich–but never found any that would allow us to even break even

  2. A. White

    I keep seeing the 30% rule for housing bandied about, and it’s totally unrealistic for almost everyone I know. So I challenge you, Daily Worth, tell us where that rule came from and examine it. Is it time for an update? What do most people pay? Did it come from some Depression-era text like The Richest Man In Babylon? Why do people still use it?

    Thanks. I’ve been curious about this for a while now.

  3. Lindy Todd

    Let me tell you what I know from being a Senior Mortgage Underwriter, an SVP of Operations etc. The old DTI (debt to income) rules were 28/36% respectfully. With the Dodd/Frank everything went wild. I was still working in 2007 and it was terrible. Actually everybody want to blame the banks, Wall Street etc. What really happened was that the “regulations” change. Congress decided that “everybody deserves a home.” They do, but the bottom line is: can they afford one?

    It turns out that many could not afford what they obtained. Yes everyone broke some of the rules/regulations, policies and procedures. Regs allowed what was called an Option ARM Loan (Adjustable Rate Loan). There was three payment options to that loan. You could pay the interest, the minimum payment or the fully amortized payment. They used this loan to get people who could not qualify any other way. Which payment do you think they made? Of course the one that was the minimum. If no principal was paid, the total mortgage amount never decreased. These were usually expensive homes for many because they wanted more than they could adequately pay for. What happens when no principle is paid over 3, 5 to 10 years.

    That was one mistake, there were many. As mentioned above- home prices skyrocketed. The seller wanted their equity, the realtor wanted their commission and the borrower wanted the seller to pay the closing cost. So that is one of the reason that housing prices went up. When you add the realtor commission to the sellers price, (7%, usually) plus the closing cost. (very often 3-5% or more)..what do you have? A house that is worth less than it is selling for. Just the truth.

    The mortgagee (loan officers) wanted to make all the loans they possibly make for the months, and of course the mortgagor wanted as much house as they could get. Desk Top Underwriter for FNMA was used to qualify the borrowers and of course, the rules were more lenient. If you had excellent credit, your DTI could often be 50%. You believe that, I hope, because it did happen in some instances. The housing debt was basically ignored in some instances and the total debt to income was used.

    As the article above indicates, some of the blame does to the purchaser/borrowers of the mortgage. What people forget is that 30 days is not that long anymore, and you just cannot skip a payment, and if you do your credit will be damaged. They forgot that they still WANT to go out to eat occasionally, need a new car, have to pay the utilities which often go up, still buy clothing, child care, and all of the other incidentals that do not go away.

    As the author states above- you do not know if or when your next income increase will occur. You cannot bank on the unknown. People did, their wants were far out of line with what they needed. Yes, they wanted the big house like their friends.

    Nothing about the mortgage underwriting regulations should have been changed, and they definitely should not be changed again. Having a home is a wonderful part of a life experience, however if you cannot afford something, it is less than a financial burden. It doesn’t go away for 30 years most of the time, unless you do have income bonuses, income raises etc.

    Sorry this long but I could write a book or an essay because I worked through this terrible situation and thought I sympathize for the borrowers; they did buy more than they could actually afford. You can read more here-http://mortgageloanfact.com/.

  4. Lindy Todd

    I wanted to add. The Sub-Prime Market regulations is what actually killed the success of mortgage lending. The credit, the bad credit, the un-conventional lending practices…was the downfall. The banks did not make the rules, Government regulatory agencies made the rules….congress etc. “The regulations that you are talking about changing again.”???? Look out, disastrous games coming again, and that is crazy. Although, some of the lenders may have learned some good lessons to follow their own higher leveled rules. Some banks do not allow as low of a credit score as FHA does. That is in their favor and I applaud them for using certain restrictions. FHA will allow down to 500 (if certain other criteria is met), most banks wan to see at least a 620 or above. That is better news.