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Before Buying a Your New Home

Many want to rush into buying a home these days because they hear that buying a home is such a great investment and is better than renting.  Some of this information is based on sound advice while other information is misleading.  Owning a home can be a good investment, yet sometimes the advantages of home ownership are over exaggerated.  Thus, before buying your new home, there are a few things that you should think about.

1) How much will the home appreciate by?

We have all heard about how some home prices are increasing by 10% to 20% a year in some cities.  Yet, these increases are not the historical norm but a recent phenomenon.  According to some sources the average home price has increased by approximately 6% annually over the last 20 to 30 years.  Please note this is generally a reasonable indicator of past price increases; however, this increase may be a little over inflated for a few reasons, including:

- 6% is sited as the annual increase in price of new homes going back to 1963.  However, this increase does not factor in that the size of new homes has also increased.  According to the National Association of Home Builders, the mid-sized new home was 1,755 square feet in 1987 and increased to 2,140 square feet in 2004 (a 22% increase).  So some of this 6 percent increase is due to people building bigger homes.

- The Office of Federal Housing Enterprise Oversight which compares the sale of homes that have previously sold also estimates a 6% increase in housing prices from 1975 to 2006.  However, even when comparing the increase in prices of homes previously sold, the analysis still can not factor in that part of the increase is due to home improvements (e.g., adding a new room or pool, finishing the basement or adding granite kitchen counters) and not appreciation.  The increase also only factors in the past 20 years where the large increases in home prices during the last few years are weight heavily into the average (thus over inflate the long-term increase).  Factoring in prices from 1975 to 2000, the average increase is closer to 5.5%.

So, the actual increase is probably closer to 5% than 6%.  This may not sound like a big deal.  Yet, if we assume inflation is 3% to 4% annually, the inflation adjusted increase in home prices are closer to 1% to 2%.  This is also supported by the U.S. Census data of median house prices adjusted for inflation.  From 1940 to 2000, the annual increase in prices adjusted for inflation is 2.2%.  Again, this does not account for home sizes being bigger these days, thus the actual increase is less than 2.2%.

Home prices can not support the annual 10% increase long-term because families need to be able to afford to buy a home.   The increase in average family income adjusted for inflation has been 0.7% annual from 1967 to 2004.  Thus, as we seen with the recent large increase in home prices, younger families are having a harder time to afford a home.  Sooner or later, these families will need to buy smaller houses (reversing the trend towards larger houses) or hone prices need to settle down for families to afford them.  We have not seen this effect yet, because many Baby Boomers can afford and support the large increase in home prices because hey have already owned a home and can cash out their profit to buy their new home.  Plus, many families are pushing their budgets to the limit to afford their home, but this can not continue forever.

2) Cost of home ownership isn't just the mortgage

Originally, many of the buy versus rent calculators focused on if your mortgage will be less than or equal to your rent payment then buying a home was a good investment.  However, as many have realized recently, there is a lot more expenses than just the mortgage payment that goes into the cost of buying a home, including:

One-time costs

a) Real estate agent fees (can average as high as 5% to 7%)

b) Closing costs (can be 1% to 2% of cost of house)

c) Risks not covered by standard insurance (e.g., flooding, mold, earthquake damage, etc.)

d) Moving costs

Annual costs

a) Maintenance (depending on home can be 1 to 3% of cost of house for repairs to things such as roof, carpeting, furnace, etc.)

b) Upkeep (can be 1% of cost of house for things like lawn mowing, mulching flower beds, snow removal, etc.)

c) Property taxes (can be 1% to 2% or more depending on where you live)
So, as you can see, the 2% real gain on the typical home can be quickly eaten away in fees.

3) How long will you remain in the house

Based on the one-time fees with home ownership (commissions and closing costs) the break-even time period on owning a home can range from 2-4 years depending on your specific situations and location.  For a family with firm roots in the community, they may easily live in the house long enough to make a profit.  For others, the 2-4 year break even period may be too short if there is a possible change in jobs or family situation.  This is true for people who are younger whose housing situation can change due to having children, getting married, moving to a new city or getting a major promotion and thus lifestyle changes which changes what home they may want.

There are several versions of buy versus rent calculators that will calculate the break-even time where buying a home is better.  Each will give you a different answer depending on the assumptions that they factor in.  You should run the numbers based on living in the home for various periods (e.g., 1 to 2 years, 3 to 5 years or 20+ years). 

Some of these calculators can be found at:

Please note, these calculators may give different answers and may not take into account some aspects of buy vs. rent decision, including:

Tax break may be less (Tax breaks are calculated assuming a full tax deduction on mortgage interest and property taxes.  The calculators do not factor in alternative minimum tax situations, tax deduction phase-outs and situations where standard tax deduction is used instead of itemizing deductions thus actual tax break.)

Moving expenses

If rent includes water and heating or other utilities

Risk of needing to have a major repair if you buy (including special assessment for condominiums to pay for roof repairs or electrical rewiring)

Decorating and appliance allowance for buying a home (especially for houses that you want to make changes to when you move in)

4) Do you want the headaches of home ownership?

Some people do not want to buy a home because they do not want to spend the time taking care of the home.  It is sometimes easier to call the superintendent when something goes wrong.  Yet, with condominiums and cluster home communities (where the outside maintenance is handle by an association), some of this home owner burden is eased.  Yet, for someone who travels a lot for the job, not having the additional burden of home ownership can make renting very attractive.  And, having extra time to invest in your job or business start-up may be better long term than spending the time in owning a home.

5) Build your budget from top-down

Many budgets are planned from the bottom up.  What I mean by this is that the large items of a budget are usually fixed and set before a budget it considered (e.g., taxes, automobile, housing, etc.).  Sometimes people think that they need a certain car or a certain size house and make this the priority of their budget.  As many people find out, by the time that taxes, automobile, housing and food are accounted for, there is little room for anything else (e.g., things that bring you peace love and joy).

Budgets should be planned from the top down.  This means that you need to look at what really gives you peace, love and joy in your life and make sure your budget has room for these items.  Then see what is left over for our home and automobile.  We typically think that if we have the right home or auto, then we would be happy.  Yet, sometimes it is the little things like an occasional dinner out or an annual vacation that brings more happiness.  If these little pleasures are important to you, make sure you include them in the budget early on even if it means buying a less expensive car or home.  In Don't Give Up Your Latte, I discuss how we should avoid cutting out the things that give you peace, love and joy because if you do, then you may end up feeling deprived and spending even more money than you are trying to save.  So, make sure you allocate your budget first to the items that bring you peace, love and joy.

6) Leave room for unexpected surprises.

Many people buy a home based on their current budget.  Sometimes they even stretch their budget to buy a home (especially on the East and West coasts).  What many people do not think about is the "what if"?  What if they do not get the anticipated pay raise?  What if gas prices rise?  What if the roof needs repair before they plan on it?  What if ....  There are many scenarios that always seem to pop-up.  And, if you have already allocated most or all of your budget, there is no wiggle room for the unexpected expenses (or for the expenses that you forgot to budget for).  And, when surprises occur, it is struggle to find out how to handle them.

A universal law of life is what you focus on will expand.  If you put yourself into a situation where it is a struggle to survive month to month, do not expect it to get easier.  It actually usually gets worse because your energy is focused on the constant struggle is what will manifest in your life (more struggle).  My wife and I decided to buy a home that was well within our means.  This meant that when natural gas and gasoline prices increased, it was no big deal because we had room in our budget to handle it.  Thus, we never stressed out about gas prices, while many other families had sleepless nights wondering what to do next.

Life is funny in that it gives us what we put into it.  If we set up a situation of stress and struggle, we will get more stress and struggle.  When we live on the edge, we will pay the price for it.

7) Figures lie and liars figure

I had a boss that use to say this all the time.  There are a lot of figures out there that suggest owning a home is a no brain decision.  And, it leads to shame for those who have not bought a home.  One of the statistics that I cringe at every time that I hear it is the average net worth of a non-home owner is $4,000 and $184,000 for home owners according to the Federal Reserve.  So, this statistic implies that if you own your home, you will be rich.  However, before you buy this completely, let's consider a few things:

Recent college graduates tend to rent and have sizable student loans (so negative net worth)

Low income workers can only afford a minimal apartment and have low net worth

Older workers tend to be homeowners and have retirement savings that count towards net worth

So, what came first the chicken or the egg?  Do you need a higher net worth to afford to own a home or did the home make you have a high net worth?  Yes, homes are a good investment (as are stocks, bonds, etc.).  Yet, does home ownership make you rich or does saving over a long period of time make you rich?  If you factor in age, income, and % of income saved (either in home or in stock & bonds), the statistics in net worth of home owners and renters would be drastically different.  For me, I saved money before I bought my house.  Thus, my net worth lead me to be able to be a home owner.  And, owning a home has not significantly increased my net worth (due to living in Mid-West where home prices have not increased significantly).

Owning a home can be a great investment.  Yet, like all investment opportunities, you need to do your research of the downside risks versus upside potential.  Owning a home will relieve you of paying rent where the rent includes a profit margin for the owner.  Yet, sometimes the costs of homeownership outweighs the savings that homeownership provides.

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