We plan to send out more blog posts going forward and these will range from personal finance topics to big picture investing and economic topics. Today we are writing about a personal finance topic that comes up regularly in various forms. Here are some example questions we hear:
· Should we continue to rent or should we buy?
· When will the housing market come down? It’s so expensive!
· Should we downsize and invest the extra cash or stay in our current home?
You get the idea. Rather than answer specific questions we’d like to cover some concepts so that a broad range of questions get addressed.
First, over the long-term buying is generally the right choice if you can afford it and don’t expect to move in the near term. Those are two big caveats, though, and we’ll drill into each of them. The cost of buying and selling a home is significant, so buying a primary residence is not something we would recommend if you don’t plan on staying in the home for several years. Ideally you would plan to live there for 10 years or more. This allows for the costs of buying and selling to be offset by multiple years of appreciation of your home’s value.
The other caveat above is affordability. This comes in two varieties: the cash for the down payment and the ongoing expenses. The first is just a question of whether you have saved enough to get a mortgage. Typically, this is 20% of the purchase price, but there are ways around this. The simplest is to apply for an FHA loan where the down payment can be as little as 3.5% of the purchase price. There are restrictions to these loans and you can read about those here. Next is the question of covering the ongoing expenses. Along with the monthly mortgage payment, you will have to pay property tax, homeowner’s insurance and maintenance costs that renters don’t have to pay. Conventional mortgages, as well as FHA loans, have income requirements that should keep most people safe from overextending themselves, but it’s always good to work through the numbers on your own or with a financial professional.
Another common concern, especially in places like the San Francisco Bay area, is that prices are so high that they must come down in the future and waiting for that to happen seems prudent. While this can be considered a compelling argument, it’s not foolproof. What if it takes five years for the housing market to hit another bottom? In the meantime it could go up enough that the drop just comes back to today’s prices. You’ve been paying rent for five years rather than building equity in a home (by paying down your mortgage) only to buy a house at the same price you could have paid five years earlier. There’s no certainty we won’t see a downturn sooner and have the drop be deeper, but buying a home if you can afford it and plan to stay in the area for a long time is generally the right decision. Of course, some people want the flexibility and simplicity of renting rather than owning a home and preferences like that need to be weighed along side the financial considerations.
For anyone who wants to be able to calculate the cost of renting vs. buying, we’ve built a simple calculator to compare the cost with various inputs that you can change. You will want to enter your own information in the highlighted fields. If you don’t know what to enter for some of the fields the default values are reasonable estimates for California homeowners. The most important ones to update are the monthly rent, purchase price, down payment and years of analysis, which is the time horizon over which costs are estimated. To view the calculator more easily you can open it in a separate tab: Rent vs Buy Calculator
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