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:
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
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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