Approximate cost to own mortgaged property vs. renting. An approximate formula for the monthly cost of owning a home is obtained by computing the monthly mortgage, property tax, and maintenance costs, accounting for the U.S. tax deduction available for mortgage interest payments and property taxes. This formula does not include the cost of foregoing the standard deduction (required for taking the tax deduction). Assuming a home cost of P dollars, yearly interest rate r fixed over N years, marginal income tax rate , property tax rate (assumed to be 0.5–2% of P), and yearly maintenance cost rate (assumed to be 0.5–1% of P), the monthly cost of home ownership is approximatelyA derivation for the monthly cost is provided at usenet's sci.math FAQ .
For example, the monthly cost of a $250,000 home at 6% interest fixed over 30 years, with 1% property taxes, 0.75% maintenance costs, and a 30% federal income tax rate is approximately $1361 per month. The rental cost for an equivalent home may be less in many U.S. cities as of 2006. Adding a down payment or home equity to this calculation can significantly reduce the monthly cost of ownership, while significantly reducing the income stream that the downpayment would generate in a long term CD. Including the monthly cost of forgoing the standard deduction ($10,000 for a married couple), the added cost (the reduction in tax savings) of (deduction * tax_rate / 12) would increase the cost to buy a home by $250/mo, to $1611 for a married couple filing jointly in the example above.
This calculation focuses on monthly cash-flow costs and does not account for changes in net worth associated with homeownership. In particular, it excludes equity accumulation through principal payments, the conversion of a down payment from cash to home equity, and potential home price appreciation. While these factors do not reduce monthly expenses, they may significantly affect long-term wealth outcomes and are relevant when comparing renting and owning over longer time horizonEquivalent price-to-earnings (P/E) ratio for homes. To compute the P/E ratio for the case of a rented house, divide the price of the house by its potential yearly earnings or net income, which is the market rent of the house minus expenses, which include property taxes, maintenance and fees. This formula is:
For the example of the $250,000 home considered above, the P/E ratio would be 24 if this home rents for $1250 per month. Fortune cites a historic range of 11 or 12 for the simpler price-to-rent ratio. Observers and analysts have attributed the reasons for the 2001–2006 housing bubble and its 2007–10 collapse in the United States to "everyone from home buyers to Wall Street, mortgage brokers to Alan Greenspan". Other factors that are named include "Mortgage underwriters, investment banks, rating agencies, and investors", "low mortgage interest rates, low short-term interest rates, relaxed standards for mortgage loans, and irrational exuberance"A Summary of the Primary Causes of the Housing Bubble and the Resulting Credit Crisis: A Non-Technical Paper By JEFF HOLT Politicians in both the Democratic and Republican political parties have been cited for "pushing to keep derivatives unregulated" and "with rare exceptions" giving Fannie Mae and Freddie Mac "unwavering support".
According to a 2018 review of existing evidence, "inflated house-price expectations across the economy played a central role in driving both the demand for and the supply of mortgage credit before the crisis". The review concluded that the crisis was not driven by reckless lending by lower classes, but rather greater mortgage lending across all income groups.
Government policies Housing tax policy
In July 1978, Section 121 allowed for a $100,000 (~$ in ) one-time exclusion in capital gains for sellers 55 years or older at the time of sale.1. Proposal for Amending I.R.C. §121 and §1034 U.S. House of Representatives In 1981, the Section 121 exclusion was increased from $100,000 to $125,000. The Tax Reform Act of 1986 eliminated the tax deduction for interest paid on credit cards. As mortgage interest remained deductible, this encouraged the use of home equity through refinancing, second mortgages, and home equity lines of credit (HELOC) by consumers.Impact of 1986 Tax Reform Act on Homeowners Today HomeFinder.com, August 5, 2008
The Taxpayer Relief Act of 1997 repealed the Section 121 exclusion and section 1034 rollover rules, and replaced them with a $500,000 married/$250,000 single exclusion of capital gains on the sale of a home, available once every two years.1. Proposal for Amending I.R.C. §121 and §1034 U.S. House of Representatives. This made housing the only investment which escaped capital gains. These tax laws encouraged people to buy expensive, fully mortgaged homes, as well as invest in second homes and investment properties, as opposed to investing in stocks, bonds, or other assets.
Deregulation
Historically, the financial sector was heavily regulated by the Glass–Steagall Act which separated commercial and investment banks. It also set strict limits on Banks' interest rates and loans.
Starting in the 1980s, considerable deregulation took place in banking. Banks were deregulated through: The Depository Institutions Deregulation and Monetary Control Act of 1980 (allowing similar banks to merge and set any interest rate). The Garn–St. Germain Depository Institutions Act of 1982 (allowing Adjustable-rate mortgages). The Gramm–Leach–Bliley Act of 1999 (allowing commercial and investment banks to merge).
Federal Home Loan Bank Board allowed federal S&Ls to originate Adjustable-rate mortgages in 1979 and in 1981 the Comptroller of the Currency extended the privilege to national banks. This regulation, enacted during times when fixed-rate loans at 17% were beyond the reach of many prospective home-owners, led to a series of innovations in adjustable-rate financing that contributed the easy credit that help fuel the housing bubble.
Several authors single out the banking deregulation by the Gramm–Leach–Bliley Act as significant. Nobel Prize-winning economist Paul Krugman has called Senator Phil Gramm "the father of the financial crisis" due to his sponsorship of the actThe Gramm connection. Paul Krugman. The New York Times. Published March 29, 2008. but later revised his viewpoint saying repealing Glass-Steagall is "not what caused the financial crisis, which arose instead from 'shadow banks. Nobel Prize-winning economist Joseph Stiglitz has also argued that GLB helped to create the crisis.Who's Whining Now? Gramm Slammed By Economists. ABC News. September 19, 2008. An article in The Nation has made the same argument.John McCain: Crisis Enabler. The Nation. September 21, 2008.
Economists Robert Ekelund and Mark Thornton have also criticized the Act as contributing to the Subprime mortgage crisis. They state that while "in a world regulated by a gold standard, 100% reserve banking, and no FDIC deposit insurance" the Financial Services Modernization Act would have made "perfect sense" as a legitimate act of deregulation, but under the present fiat monetary system it "amounts to corporate welfare for financial institutions and a moral hazard that will make taxpayers pay dearly." Critics have also noted de facto deregulation through a shift in mortgage securitization market share from more highly regulated Government Sponsored Enterprises to less regulated investment banks.Michael Simkovic, Competition and Crisis in Mortgage Securitization
However, many economists, analysts and politicians reject the criticisms of the GLB legislation. Brad DeLong, a former advisor to President Clinton and economist at the University of California, Berkeley and Tyler Cowen of George Mason University have both argued that the Gramm-Leach-Bliley Act softened the impact of the crisis by allowing for mergers and acquisitions of collapsing banks as the crisis unfolded in late 2008. "Alice M. Rivlin, who served as a deputy director of the Office of Management and Budget under Bill Clinton, said that GLB was a necessary piece of legislation because the separation of investment and commercial banking 'wasn't working very well.' Even Bill Clinton stated (in 2008): 'I don't see that signing that bill had anything to do with the current crisis.Joseph Fried, Who Really Drove the Economy Into the Ditch (New York: Algora Publishing, 2012) 289-90.
Mandated loans Republican Senator Marco Rubio has stated that the housing crisis was "created by reckless government policies".full text of Sen. Marco Rubio's (R-FL) Republican Address to the Nation, as prepared for delivery Republican appointee to the Financial Crisis Inquiry Commission Peter J. Wallison and coauthor Edward Pinto believed that the housing bubble and crash was due to federal mandates to promote affordable housing. These were applied through the Community Reinvestment Act and "government sponsored entities" (GSE's) "Fannie Mae" (Federal National Mortgage Association) and "Freddie Mac" (Federal Home Loan Mortgage Corporation). Journalist Daniel Indiviglio argues the two GSE's played a major role, while not denying the importance of Wall Street and others in the private sector in creating the collapse. Did Fannie and Freddie Cause the Housing Bubble? Daniel Indiviglio June 3, 2010
The Housing and Urban Development Act of 1992 established an affordable housing loan purchase mandate for Fannie Mae and Freddie Mac, and that mandate was to be regulated by HUD. Initially, the 1992 legislation required that 30 percent or more of Fannie's and Freddie's loan purchases be related to affordable housing. However, HUD was given the power to set future requirements. In 1995 HUD mandated that 40 percent of Fannie's and Freddie's loan purchases would have to support affordable housing. In 1996, HUD directed Freddie and Fannie to provide at least 42% of their mortgage financing to borrowers with income below the median in their area. This target was increased to 50% in 2000 and 52% in 2005. Under the Bush Administration HUD continued to pressure Fannie and Freddie to increase affordable housing purchases – to as high as 56 percent by the year 2008.Peter J. Wallison, "Dissent from the Majority Report of the Financial Crisis Inquiry Commission", (Washington, DC: American Enterprise Institute, January 2011), 61, www.aei.org. To satisfy these mandates, Fannie and Freddie eventually announced low-income and minority loan commitments totalling $5 (~$ in ) trillion.Joseph Fried, Who Really Drove the Economy Into the Ditch? (New York, NY: Algora Publishing, 2012), 121. Critics argue that, to meet these commitments, Fannie and Freddie promoted a loosening of lending standards - industry-wide.Joseph Fried, Who Really Drove the Economy Into the Ditch? (New York, NY: Algora Publishing, 2012), Chapter 6.