Buying A Home

As with anything, there are pros and cons that change with every complicated variable involved. The concept of buying being better than renting is relative to the context of each side of the equation at any given time. No two situations are the same, but generally speaking, assuming certain conditions are already met, owning a home is MUCH BETTER for long term wealth building than renting.

In an article that I wrote back in 2008 on the SonoranHouse.com blog, I illustrated the financial benefits of renting vs. buying. Here’s what one user had to say, along with my thoughts on the response:

WRONG… Renting is FAR better and Cheaper than buying a house.

Not so fast. There are too many variables involved, and each situation is different, but the principle cannot be disputed. Owning is a long term prospect. Not short term. In order to conclude that owning is better, one must assume that the property will be held for as long as possible.

1. The down payment is $20,000 OUT OF YOUR POCKET on day one. SO by purchasing a house you are immediately $20,000 POORER the day you buy your house. In contrast, you can RENT and only pay a SMALL deposit equal to 1 months rent and keep the rest of your $19,000 to use as a safety net to pay the rent with and live an easy STRESS FREE life knowing you have the rent covered for 19 months if it’s a $1K a month rental.

When you pay a deposit to a landlord, it is a fee that can never be recovered. When you put money down on a house, you are instantly investing your hard-earned cash in an appreciating asset. You are not spending the money. Again, if your investment mindset is short term and you sell your home too quickly, you will certainly cut into your initial down-payment unless your property experiences unheard of appreciation in a short time period. Not likely to happen again. Buying real estate is a long term wealth building investment.

A rule of thumb for an emergency fund is 3 to 6 months worth of living expenses. If your rent is $1000.00/month, you have 19 months of rent paid for, but that doesn’t take into account the rest of your expenses. If a down payment on a house depletes your living expenses, they you are not ready to buy. Your down payment should be above and beyond your 3 to 6 months. So, if your expenses are $2000/month, you should sock away about $12,000. The rest can be used towards your future down payment. This all assumes that you are completely out of debt. If you aren’t, then you shouldn’t be buying a house in the first place. Most renters do not have this much money saved up and they live paycheck to paycheck, so they feel they NEED to have some sort of financial buffer to buy them time.

The problem with this is that they never get OUT of the rat race by behaving this way, and they never put their money to work for them. They will live the rest of their lives working for their money. What would be the difference between having 19 months of STRESS FREE living in a home that is appreciating in value versus apartment living with the same amount of a safety net? The difference is that part of your monthly payment is being added to the home’s equity. Some of that payment will be recovered. NONE of the rent will.

2. The Tax Deduction is nonsense… You spend $1.00 in Mortgage Interest to deduct .10 cents off your tax bill. HARDLY a “savings” at all. Your still LOOSING .90 CENTS in interest!! WAKE UP PEOPLE!!

Tax Deductions are a poor excuse for people who are poor to continue to be poor. The argument here is that it makes sense to pay the bank $1.00 in interest to avoid paying the government ten cents. Obviously that is flawed thinking. Spending 90 cents to save 10 is absolutely ridiculous. That is why the largest mortgage anyone should be financing is a 15-Year fixed. Obviously paying cash is the best way to buy a house.

3. When you own a house you pay PROPERTY TAXES each and every year. These taxes are about 1.5% of the value of your home or around $3000 a year. That’s $3K a year your LOOSING if you own a house.

Hmmm…let’s see. Property taxes at $3000/annually, deductible at your tax bracket rate, or $12,000 wasted on rent. Personally, I’d rather put the remaining $9,000 in growth stock mutual funds to offset the perceived loss, because by the time my $9,000 per year is invested over 30 years, it will pay the property taxes a few thousand times over.

4. When you own a house you pay Property INSURANCE on your house each year. This will be about 1% of the value of the home so figure $2000 a year on a $200K house.

I own a $200K home. Taxes and insurance annually do not exceed $3000.00. In fact, they don’t exceed $2000.00. This has everything to do with location and tax rates. Again, I’d rather cough up $2000/year for insurance than blow $12,000/year on rent. So based on points 3 and 4, which add up to $5000.00, I’m still ahead with $7,000 invested annually in growth stock mutual funds. Come to think of it, my down payment of $19,000 as used in this example will be reimbursed fairly quickly.

5. When you own a house you pay for ALL MAINTENANCE/REPAIRS/REMODELS. This means spending about 1.5% of the value of your home EACH YEAR to keep it in livable condition so figure another $3000 a year on maintenance/upkeep.

Nobody forces remodeling, so we’re going to remove that from the equation. Deferred maintenance is a price that everyone has to pay for, whether you own, or you rent. As the king of your castle, you determine what’s used on your property to improve and maintain it and you have a choice over the cost/savings realized from it. By renting, you have no control over these things, and the cost of rent is at the discretion of the landlord, who can easily raise it high enough to force you out to make room for someone else as a result of increased management costs. Owning your own home offers greater long-term housing security.

6. In order to “get your money back” out of your house you will need to SELL your house. This means FINDING SOMEONE ELSE TO BUY IT. You’ll have to pay Closing Cost, Real Estate fees, etc. and it can take a LONG TIME to find a buyer. THEN even if you sell, you will have to live somewhere so you would have to turn around and buy ANOTHER house or do what most smart people do in the first place… RENT.

False. As a long term investment, the asset appreciates and the value of the loan decreases over time. If you paid cash, you have an instant money making machine creating passive income. If you didn’t, you’ll eventually reach a point at which renting your home to someone else will generate positive income above what you owe on the mortgage payment. The tone of point number six seems to emphasize the dependence upon cash in the bank to provide a safety net. Obviously if you’ve been able to save $19,000, you’re making more than you’re spending, so the time that it takes to sell should be irrelevant unless you’re forced to move via relocation or other circumstance beyond your control. It’s true that if you sell too early, you’ll erase your gains because you didn’t have a long term mentality. There is so much more risk to buying a home when you borrow, but if you are able to pay cash for a home, then I’d say you’re living well financially. One’s intelligence is not a factor determined by the decision to rent or buy. One’s wealth, however, is. If you want to get rich and live free like nobody else, then you’ll invest wisely. Renting is not investing.

Owning a house ONLY makes sense IF you could pay CASH for it. Even then, your still going to “Throw money away” on Taxes, Insurance, Maintenance, and the excess bills that come from owning a house when if you RENTED many of those bills are included in the rent.

Paying cash for a home ISN’T THE ONLY time it makes sense to buy a home. It is the BEST practice for sure, but you’re not throwing money away on taxes because your home is appreciating in value, and in theory, you’re renting that home out, collecting $1000.00/month rather than spending it. Can you imagine how nice it would be to be able to put $12,000.00 less a few expenses every year without having to work for it?

The fact that there are additional bills when you own versus renting is also a false assumption. Do the math over a long period of time. Take the appreciation of real estate and the potential passive income from owning a rental and see where it would be in 30 years if invested wisely, long term. Compare it to the real costs of owning. Remember, we’re talking about ownership versus renting. We’re not talking about owning a high cost property that has no potential to generate future income. That would not be a wise investment. Of course, you could just keep on throwing your hard-earned money away. In fact…

…I’ll look forward to renting one of my properties to you because you sound like the perfect tenant.

For most, buying a home is the largest purchase they’ll ever make, and it will most likely become the largest portion of their monthly budget as well. There are many programs that have been put into place to make it easier for you to buy a home, but the question you must ask yourself is whether or not you’re truly ready to buy.

I love when I have the opportunity to teach a client about real estate while finding them their first home, but many times, I have felt like telling my client that they’re not ready to purchase a home.

Perhaps that is because I’m rather conservative with finances. I am a tried and true believer of old school finances, which you may be familiar with if you’re a fan of the Dave Ramsey show. Dave Ramsey is a financial expert above all financial experts, who applies common sense and real math to financial equations with the premise that you can become wealthy, self-insured, and be able to live the life you’ve always dreamed about if you simply exercise some patience and hard work.

Those of us who “have to have it now” are part of the majority of people who believe the only way they’ll ever have $500,000.00 in the bank is if they win the lottery. It simply isn’t true.

The simple rule that I follow when I advise clients who are looking to buy a home is to keep their total housing expenses, which include their mortgage payment, taxes, and insurance to about 25% of their take-home pay. This allows you to make room in your monthly budget to do those things that most people say they’ll do, but never get around to doing, like investing for their future, and their family’s future.

If you’re not investing, you’re losing, and there’s no reason in today’s day and age to believe that your payments to “social insecurity” will come back to you by the time you retire. You’re on your own, and you better be doing all you can do to make sure you have taken care of yourself and your family through retirement.

So How Much Home Can You Afford?

Based on the 2009 IRS tax tables, an individual making $40,000.00 per year will owe $6200.00 in taxes. With a smart plan, you’ll be saving that money in an interest bearing money market account rather than withholding it from your paycheck. Why let the government earn interest on your earnings? That leaves you with $33,800 in take home pay. This is your budget. Divide that by 12 and you have an idea of what you have to live on every month. In this scenario, it’s $2816.00. If you follow the 25% rule, your house payment, including taxes and insurance, should be no greater than $704.00 per month.

Another point to note is that you want your mortgage to be no longer than 15 years, and when interest rates are low, you want to fix that rate for the entire loan. So how much home can you afford?

Assuming you’ll be going with an FHA loan with only 3.5% down on a 15-year fixed rate mortgage at approximately 5.3%, the sales price of your home should be in the $90,000 – $95,000.00 range, and no higher. (click here for a list of currently available homes in this price range)

By sticking to the basic rule of 25% of your take-home pay going towards your housing, you should be in great shape to help build your future. Compromise your savings, and you’ll be throwing away your future. If you aren’t able to live by a strong, well-planned budget, and you’re attempting to devote too much of your monthly payment towards your home, you will become house-poor, and you won’t have much to show for it. If this is you, perhaps it’s not the right time for you to buy a house.