Was buying a lower price home a good bubble strategy?

A lot of people think that they made a smart decision during the bubble by only buying a house they could afford based on traditional debt to income guidelines.The reality might be quite different.

A good rule of thumb is to buy a house priced at 2.5 times your yearly household income.  This will result in monthly mortgage payments that will allow you to put money into other areas including savings. The median house price to income ratio had skyrocketted during the bubble as lenders relaxed their standards and most buyers went along for the ride. Nationally, the house price to income ratio hit a high of 4.6 in 2006. In Bergen County, NJ the house price to income ratio hit its peak in 2005 at 5.63. This means that home buyers were paying around 2 or more times what sound financial planning indicates they should be spending on housing.

For most that were able to purchase a home using more traditional guidelines, they would have bought a home on the lower end of the price range. As we can see from the chart on the left showing the tiered data for the NY-Metro Case-Shiller Index, there is much greater volatility in lower priced homes.

The chart shows the overall, low, middle and high groupings' Case-Shiller Indices in blue and the red lines indicate the year over year change in the Case-Shiller Index for the low and middle price groups compared to the high price group. Compared to high priced homes, low priced homes did the worst. When house prices were rising, lower priced homes were increasing as much as 9.03% faster than high priced homes. When house prices started to fall, lower priced homes fell as much as 5.01% more than high priced homes.

Medium priced homes weren't much better. At times, they were increasing up to 5.14% and falling up to 4.76% more. While all home prices will undergo a correction, the lower and middle priced homes will have to correct more.

The point where low and middle priced homes break away from higher priced homes is around the same time that the origination of subprime first mortgages started to rise dramatically and conforming first mortgages dropped significantly.

So what does this mean for people that tried to be sensible while others were going nuts? They bought a home they could afford and if they bought it to live in for many years chances are it isn't a big deal to them. Even if they sell it years down the line, they will have a harder time seeing any appreciation. If they bought the home as a place to live and not an investment, it may not matter to them. But if they hit hard times, they most likely will not have much equity in their homes to draw upon.

Compare that with people that bought more house than they could afford. Since their mortgage payments are a hardship, they are more likely to be able to argue and get a loan modification or to qualify for programs to help them. For those that bought a house they could afford, there are no programs to help them make up for the lost equity.

It seems that if you're going to be part of a stampede, you're better off staying with the herd, no matter where it's headed.