With the current conditions of the housing market, it is not uncommon for me to get questions about whether or not a client should buy a home or continue renting. Oftentimes, those questions revolve around whether or not interest rates will continuing rising or the housing market will cool off. These are great questions but frankly, I don’t have the answer! Anyone who tells you that they know for certain when the market for buying real estate will improve is overconfident at best. I liken the question of when to by real estate to the idea of trying to time the market. Can you buy at the absolute perfect moment? Yes, you can. Are you likely to time the market with any real certainty or consistency? No, probably not.
When I counsel clients about their investment portfolios, I prefer to focus on the variables that they can control and the data that is concrete. While we do not ignore the market entirely, it has been well documented that a person’s success in investing is tied more closely to their investing habits than it is the performance of the market. That said, when it comes to the question about buying a home versus renting, a good place to start would be to consider the costs associated with home ownership and what you can reasonably afford instead of trying to time the market. Here are three things to consider when thinking about buying a home that are not related to interest rates or the housing market!
1) Unexpected Costs
As a family who is now in their second home since we have been married, my wife and I can attest to the fact that our mortgage payment is far from the only cost of owning a house. Few things strike more fear in my heart (and my wallet) than when my wife calls me to tell me that one of the appliances isn’t working properly! Likewise, I have also needed to replace the furnace and A/C, have cracks in the foundation repaired, and pay for drywall to be fixed as a result of water damage. Don’t even get me started on landscaping! Taken all together these unexpected costs and routine maintenance of your home can easily account for thousands of dollars a year.
While these costs can be daunting, this doesn’t mean that buying a home is always a bad idea. It simply means that when deciding to purchase a home you should take these additional costs into consideration. While it is not possible to know exactly which appliance will break or exactly how much lawncare will cost, it would be a good idea to have developed a healthy emergency fund in order to provide a cushion against larger expenditures.
2) Taxes and Insurance
When renting a home or apartment, one expense that you do not need to worry about is property taxes. Property taxes are generally fairly predictable but can go up or down (usually up) depending on your county or municipality’s assessment of your home’s value. For example, the township that I live in recently did their assessments on our home values which will most assuredly result in an increase in my property taxes. Likewise, while you may have paid for renters insurance, this cost pales in comparison to the cost of home owner’s insurance. Premiums for home owner’s insurance depend on a variety of factors such as the value of your home, location, credit history, age of your home, and other variables like the home’s proximity to water (that lakefront cottage is going to cost you).
For most people, these expenses are paid out of an escrow account. An escrow account is essentially a bank account for which funds are designated to pay taxes and insurance. When you purchase a home, you are given the option (and sometimes required) to pay a portion into your escrow account. A portion of your mortgage payment ongoing will go towards your escrow account as well which means that ideally you won’t ever need to pay a property tax or insurance bill directly. However, if property taxes or insurance premiums increase beyond what your lender estimated then you could see your mortgage payment increase in order to replenish your escrow account. Regardless, these are additional costs to keep in mind when buying a home.
3) Opportunity Cost
Owning your own home is considered by many to be synonymous with the “American Dream”. It can be quite difficult to put off attaining that dream for the delayed gratification of future financial stability. More practically, a growing family can often necessitate a larger living space beyond what is available in an apartment. With that in mind I think that it is still worth considering the opportunity provided by renting that is not necessarily afforded to you in home ownership.
A common refrain that I heard from more enterprising real estate agents is that, “if you can afford to pay rent then you can afford a home!” As we have already seen, this is not always the case. Likewise, I have also heard many people refer to paying rent as, “throwing money down the drain”. The idea of course, is that by paying rent you are not accruing any equity in a home. However, many people forget about the aforementioned costs of home ownership and do not consider how the absence of those costs might affect their financial situation. This is another great example of opportunity cost or, to put it simply, what is the financial opportunity that you are leaving on the table by buying a home?
For example, the median rent in America is currently $1,850 per month. Compare this to the median mortgage payment which stands at $2,700 per month[i]. That’s a difference of $850 a month before we have even considered the unexpected costs and routine maintenance of owning a home! All things remaining equal (although they rarely do), for the sake of example let’s consider what investing $850/month over the course of 5 years would look like. For this example, I am going to assume a return of 8% which is actually lower than the all time average of the S&P 500 by a couple of percentage points. In this example, you would have about $60,000 at the end of 5 years which is a gain of about $7,500. Taking the example further, if you left those funds invested and continued to assume an average return of 8% over the next 20 years your balance would be just shy of $280,000. Not a bad nest egg for only 5 years of investing!
The point of this blog post is not to discourage you outright from ever buying a home to call your own. If that were the case then I would be the biggest hypocrite! The point of this post is to help you identify what a home will actually cost you and if you can feasibly afford it. Additionally, if you can afford it but do not have an immediate need to buy a home (like having kids for example), then you should at least consider the opportunity you have to further invest in your financial future. Thanks for reading this week’s post and feel free to reach out with any comments or questions!