Question 2: Home buying when you have a major student loan.

Thursday, January 7, 1999

Q. In October you presented the views of Dr. Ed Yardeni regarding the Year 2000 problem, interest rates and future earnings impact on the economy. Assuming he is dead right, and the Year 2000 problem does cause a worldwide economic disaster, then where do you want to have your money when it happens? What would be safe havens and what would be the opportunities?

—G.M., Plano, TX

A. Most of that column was about how interest rates affect the valuation of common stocks, not about Y2K. I think the Y2K problem is a prime example of uncalibrated anxiety, not far removed from nuclear terrorism or global warming. Basically, it is unmeasurable. I have heard speculation that purchases of computer equipment and software will be delayed in 1999 because of Y2K. I have also heard speculation that well have a recession in 2000 simply because there will be massive layoffs of computer programmers who have been working on the problem.

As I said, were dealing with uncalibrated anxiety.

And thats the main problem. Markets dont like uncertainty.

Regardless of how the problem measures, we can expect two actual events as 1999 comes to a close:

  • The banking system, usually its least liquid and most stretched in the weeks before Christmas, will be even more stretched as people hoard cash and avoid deposits. Cash will be deemed a "safe haven."
  • We'll have a very heavy tax-selling season in November and December as investors increase their liquidity and reduce perceived risk.

As a result, bank earnings are likely to be reduced and stock prices will have unusual downside pressure late in the year. This tells me that having cash for making purchases of financial assets will be very useful late this year, with particular bargains in banks and brokerage.

Q. We are mid 20-somethings and are in the process of preparing to buy our first house. We have two incomes ($97,000 annual gross) and aside from our car payments ($677/month), our debts includes a simple interest wedding loan for $2,500 and a $65,000 government law school loan. As we prepare to buy a house, wed like your thoughts on three (3) issues:

  • What are the pros and cons of deferring student loans?
  • Should we start paying on the $65,000 student loan and look for a "modestly" priced house, i.e. $100,000? Alternatively, since interest rates are so great right now, should we defer the loan, borrow more money, and buy more house?
  • In figuring how much house payment we can afford each month, should we figure in "expenses" such as retirement savings and regular savings? How much should we be saving?

—N.W., by e-mail

A. Thats a big lump, that $65,000. Its a bit like having an extra arm or leg— you really cant pretend that it isnt there. More important, even if you pretend it isnt there, your creditors WILL notice it.

You may be able to defer dealing with the debt but youd be better off making a plan, today, for getting rid of the debt and adjusting your borrowing plans accordingly. Suppose, for instance, you planned on paying off the debt over several different time periods.

At ten years, the monthly payment, combined with current auto debt, would take about 18 percent of gross income. Thats a lot more than lenders want to see so it would reduce the amount you could borrow to buy a house to about 18 percent of your income instead of 28 percent of income. That, in turn, translates into about $1400 a month for mortgage, insurance, and real estate taxes.

At five years, the amount you could borrow to finance a house would be reduced to about 11 percent of gross income or about $900 a month for mortgage, insurance, and real estate taxes.

My choice would be to go for the lower priced house, knowing that rising earnings would allow paying the debt off faster and moving to a larger house in a few years.