One of the most common questions I hear is, “Should I buy a home now, or wait?”
The question comes up a lot because its complex and without many clear answers.
And the consequences of your decision can long lasting.
Buying property is the easily the biggest financial decision most people will ever make.
It’s totally understandable why the question stirs up fear and anxiety.
One the one hand, there’s the fear of missing out on a giant opportunity. And on the other, the possible regret of jumping into the market at the wrong time.
Every day we hear news reports about soaring home prices, multiple offers, and homes selling within hours of hitting the market. At the same time, rents have been rising right along with home prices. Together, this has put the squeeze on everyone.
Despite the tough market for buyers, an improving economy and bargain basement interest rates make buying a home today more attractive than ever.
So, is buying a home now the right choice for you?
In this article, I’ll lay out the pros and cons of home ownership and walk you through all the financial pieces you should consider when making your decision.
I’ll also show you why the ultimate reason to buy a home may have nothing to do with money at all.
Can You Afford to Continue to Rent?
Conventional wisdom says that home ownership is the cornerstone to financial independence. In large part, that’s as true today as it was for your grandparents. Owning your home can provide a sense of security and peace of mind in a way no other investment can. It’s also one of the proven ways to build future wealth.
- Your housing costs will never go up. With a fixed-rate mortgage, your housing payments will stay the same for the entire life of the loan. Rents will continue to rise over the long term, but homeowners have locked in their housing costs for as long as they choose. This is a no-brainer.
- Interest rates are at a generational low. Mortgage interest rates have been hovering around 4% for a number of years. In the last decade, interest rates have varied between 5% and 6% (the historical norm), almost 50% higher than they are today. This has greatly increased affordability and brought many new buyers to the table. Market forecasters have been calling for a return to normal levels every year. However, unusual circumstances around the globe has, so far, kept interest rates low. The only thing for certain is that this will change.
- Appreciation Real estate rises in value over the long term. Simply put, this means your home is likely to be worth more in the future than it is today. As an owner, you keep all of the profit.
- Take advantage of substantial tax breaks. As a society, we’ve decided that we want to encourage people to own property. There are significant advantages built right into the federal tax codes for homeowners. For instance, owners are allowed, within wide limits, to deduct the interest they pay towards their mortgage from their taxable income. Likewise, owners may also deduct their annual property tax payments from their taxable income. (Individual circumstances may vary. Please consult your tax advisor to find out how income tax rules may impact your situation.)
- Intangible benefits…
One Third of Millennials Buy Houses for their Dogs
According to a survey by Suntrust Mortgage, one-third of homebuyers between the ages of 18 and 36 cite their dogs as a primary reason for buying – not marriage or children. (Full disclosure: Although I’m not a millennial, so did I.) If you don’t have a dog, this may come to a surprise to you. The point is, when it comes to the home buying question, there is much more at stake than simply dollars and cents.
For many people, the most powerful motivation for buying a house is not for the financial advantages, rather, it’s for the intangible benefits. That’s a fancy way of saying quality of life.
Whether its watching your children play on their swing set, your dog chase squirrels across the yard, or spending time with friends on your patio, those moments count. It may be that the only way you get to experience them is owning your own home.
Moreover, owners enjoy much greater control over their home life than renters. As long as it’s legal, owners are free to pursue any lifestyle they choose.
Where we live is also a important part of our self-expression. Drive down any street and it quickly becomes apparent which homes are occupied by their owners. For most people, pride of ownership is naturally reflected in their homes.
Homeowners are able to enjoy a level of control most renters can’t. Like bold colors? Paint your house pink and green. Or, create a vegetable garden, and outdoor kitchen, a sandbox, or a badminton court.
Or, raise a puppy.
Downsides of Home Ownership
That’s not to say it’s all wine and roses for owners. As with everything else, owning a house comes with some drawbacks as well.
- Buying a house takes a lot of upfront cash. Perhaps the biggest hurdle potential buyers face is the down payment. Although lenders minimally require 5% downpayment, the reality of the market is that most sellers want more. Successful buyers today frequently offer down payments of 10%, 20%, or more of the purchase price. In addition, you also have to factor in closing costs, usually around 2% or 3% of the purchase price.
- Owning a home is long-term commitment. While renters have greater flexibility in how long they stay, ownership only makes financial sense after several years. Even in the tightest housing market, selling a home does take time. If you’re unsure where you need to be in the next few years, then buying home may not be your best choice.
- Fixing that drain is now your problem. Finally, as a homeowner, you need to be prepared to take care of all the repairs and maintenance yourself. It’s never a question of if things break down, only when. Know that repairs are a regular part of owning property and be sure to budget the time and money they need.
Breaking Down the Numbers
By now, you’re probably wondering how to make the calculation. I’m about to show you how. Don’t worry. You won’t have to crunch the numbers yourself. Just see how the pieces fit together. At the end, I’ll point you to a good online calculator that will do all the math for you.
The basic idea is to compare the total cost of renting versus the total cost of ownership over a period of time. A good rule of thumb is to choose 5 to 7 years as a starting point.
Here’s how to come up with the estimated costs.
- Add themonthly cost of rent multiplied by the number of months (e.g., 5 years is 60 months)
- Add the cost of renter’s insurance over the same period
- If you paid broker fees to get your rental, add that, too.
- Add up those expenses and you have your rental costs
Pretty simple so far.
1. Add the mortgage payments (principle and interest).
2. Add up the annual property taxes (estimate about 1% of purchase price per year for Los Angeles).
3. Estimate the repairs and maintenance. (A Harvard study found owners spent about $2,370 per year on repairs and improvements.)
4. Add in the cost of utilities such as water, sewer, and trash pickup that’s usually covered in the rent.
5. Approximate the market value of downpayment. This needs a little explanation. Think of it this way. If you didn’t use your savings to buy a house, then it would probably be earning interest somewhere else, maybe a money market fund or a savings account. Add up whatever your savings would have earned.
6. Be sure to account for the transaction costs of buying and selling; 3% of the sales price for the purchase and 5% commissions for selling.)
Now comes the good part. Deduct all the benefits of ownership.
- Calculate the tax benefits (if you’re a U.S. taxpayer). Add up all the interest and property tax payments for the same time period you used above. You’ll need a mortgage calculator to separate out the principle and interest portions of the mortgage costs. Then, multiply that number by your tax bracket percentage. For example, if you’re in the 28% marginal federal tax bracket, then you multiply the total by 0.28. That’s your potential tax savings of home ownership. Again, be sure to consult with your tax professional to see how this deduction affects you.
- Estimate the appreciation over the time period you’re using. Many analysts predict home prices will rise at least 4% to 5% over the next five years.
Deduct those two benefits from the cost and you will have the approximate cost of ownership and a basis to compare to the costs of renting.
To make the whole process much easier, check out this online calculator from the New York Times.
Should You Buy a House Now?
Now that you know the pros and cons of home ownership, the last remaining question is, should you buy now, or wait?
In the last few years, home prices have soared. After the worst real estate downturn since the Great Depression, home prices have made a dramatic recovery.
The last market peak was in 2006. So, how do prices today compare to 10 years ago?
One perspective is the Affordability Index. Just as it sounds, the Affordability Index attempts to predict how many people can afford a median price home today. The formula takes into account not only the median price of homes in a given area, but also average incomes and current interest rates.
Although it is true that home prices have climbed steeply as of late, the economy is stronger today, wages are higher, and mortgage interest rates are significantly lower than in 2006.
In real dollar terms, houses are cheaper today than they were in 2006.
According to the California Association of Realtors (CAR), the Affordability Index for LA County is about 31%. This means that 31% of LA County residents can afford to buy a median price home here. Although that may sound low, in 2006 only 12% of residents could afford to buy a median priced home in LA County.
Compared to the rest of the state, LA County sits in the middle ground of affordability. It’s not the cheapest place to live, but not the most expensive either. That distinction goes to the Bay Area where a mere 13% of residents can afford to buy today.
As anyone who’s ventured into the real estate market can tell you, buyers today face a fiercely competitive market. The very same conditions that make home attractive purchases are also bringing more and more people into the market and driving up prices.
However, renters don’t have it much easier. Supply and demand forces are putting the squeeze on renters as well. The true dollar gap between renting and owning is getting narrower.
The good news is that if you are considering buying a home now, you’re not alone. The benefits are real and they are not going unnoticed. Every year more and more people are moving to the Southland to take advantage of opportunities and the lifestyle.
The future of Los Angeles looks bright.