By BOB CUNNINGHAM
As my wife and I enjoy a brief vacation here in beautiful Big Bear, Calif., about 90 minutes northeast of L.A., the vast view speckled with wonderful homes got me to thinking about my next blog post.
One of the most prominent among the numerous dilemmas that face young adults as they attempt to successfully establish positive financial momentum is when to pull the trigger on the purchase of a house… and thereby cease building someone else’s net worth. Put another way, there are giant advantages to buying a home versus renting for the people who are reasonably in a position to make that leap.
With renting, you are squandering money monthly. Okay, I don’t mean that in the literal sense – your rent gives you a place to live for 30 days or so. But once the month elapses, you have absolutely nothing to show for the rent you paid. Also with renting, you can’t make any improvements without permission from the owner, must trust the owner to make needed repairs in a timely manner, and are restricted by the owner on whom you can have living at the home, whether you can sub-lease… a host of potential restrictions.
Sounds almost like the government, eh?
When you own the home, it is YOURS even though you don’t get sole ownership until after the mortgage is paid off. And who cares about that technicality as long as you don’t have the bank manager claiming dibs on the master bedroom?
Seriously, as long as you continue to pay the bank as promised when you signed the loan documents, you can do pretty much whatever you want with the home, and have anyone live with you as you please, More importantly, every payment you make builds equity (wealth) for you in at least one of two ways – by paying down what you owe, and by possessing a commodity that appreciates in value more often than not.
And believe it or not, it is often better to owe money to the bank on your home than having it paid off free and clear. I will explain in detail why that is in a future post.
Back to the benefits of owning. Did I mention a very huge tax benefit? Interest paid on a mortgage loan is (virtually) always deductible as a write-off. On a new loan, of which much of the payment is interest, that can add up to $10,000 or more in a year. And you can write off the property taxes, too.
Conversely, rent is not tax deductible. And don’t even think about the paltry renter’s credit. There’s no comparison.
But wait! In your adult life up to now, the money talk has likely been about saving more, spending less, and eliminating debt. Doesn’t buying a home go against the grain in that it represents spending and most certainly is NOT eliminating debt but is instead creating it?
Well, as usual, that depends on your specific circumstances.
Of course, I should clarify that I am referring to a young couple or family’s first home, not a vacation castle in the mountains such as those we’re surrounded by up here. With that in mind, let’s skip past the how’s of buying a home – entire books have been written on that subject – and focus here on the more crucial “when?”
Many folks fall into two broad categories when it comes to making this decision, and neither are ideal. The first group is intimidated by the idea of such a massive commitment as buying a home – the process of finding the right place, determining what they can afford, qualifying for financing, having enough for a down payment… it can be overwhelming the first time around. They’re scared to death to make the wrong move.
The second group jumps into the fray before it can really afford to. A pay raise of 50 cents an hour with a promotion to assistant to the assistant manager, and a proclamation is made that it’s time to ditch the studio apartment in the low-income district and go get a two-story with a pool in the suburbs.
Hold on there, Trump! Somewhere in the middle, with a lean toward the overly conservative first group, is where you ideally need to be.
There are essentially four factors that should be in your favor before even considering the decision to buy a home:
1) Gainful, secure employment. If you’re not solidly employed, you won’t qualify for financing anyway… but nevertheless new home-buyers need to have a steady income stream that can be reasonably counted on (note, however, that there’s no such thing as absolute job security or a slam dunk success in business). In short, you should be working at a stable job that you like enough to make a mental commitment to it indefinitely.
2) Little or no other debt. A car payment is OK, or absent that, a SMALL amount of other debt. But if you’re into credit cards and other unsecured commitments more than a few hundred dollars, it is wise to get that taken care of first. And if you have undesirable debt yet have saved what you believe to be enough for a down payment on a house, you should likely use all or most of those funds to pay off the debt instead.
3) Appropriately frugal spending habits. You’re living below your means, putting money away monthly and are comfortable sticking with “staples” like a cellphone which isn’t the absolute latest, greatest model and technology. And you’re cool with eating Tuna Helper or Swanson dinners more often than not even during LobsterFest.
4) You’ve got at least a few months of savings built up already. Stuff happens, so you certainly don’t want to be in a position to get behind on your mortgage if your transmission goes out.
Did you notice that I didn’t specifically make having the money for a down payment a requirement? Let me explain: Many, many folks get caught up in the idea that they can’t or shouldn’t attempt to buy a home unless they’ve saved enough cash for a legitimate down payment – 10%, 20% or even more. It simply isn’t true. First-time buyer programs today are… well, first-rate. Some even require as little as a 1% down payment, and FHA’s basic first-time buyer program requires only 3% down. Closing costs must be accounted for, too, but some programs roll those costs into the loan.
There is a negative to a lower down payment – Private Mortgage Insurance. PMI is charged by the lender whenever a loan is made on more than 80% of the appraised value of the home (in other words, you put down less than 20%). It is expensive – as much as 1% of the outstanding balance on the loan annually) – and undesirable, but not so costly that it should prevent wanna-be homeowners from going forward assuming they otherwise have the means. The numerous benefits of owning your abode outweigh the temporary nuisance of PMI in most cases, and as soon as you have established equity of more than 20%, you can contact the lender (they will not do so automatically) and request the PMI be cancelled.
THE KEY FACTOR HERE ISN’T HAVING A BIG DOWN PAYMENT, IT IS AVOIDING TRYING TO BUY TOO MUCH HOUSE. Banks have their own rules about “how much home” you can afford. My recommendation is to see what they will approve, and reduce that amount by 20-25%. Why? Because it will virtually assure that you won’t buy more home than you can swing.
Simply put, be willing to dictate the terms, or be willing to walk away and try again in a few months. Believe me… the latter is grossly preferable to getting in over your head, assuming the lender guidelines would even permit such a circumstance.
Good common sense (hmmm… is there such a thing as bad common sense?) will usually be accurate in determining when you can and should move forward with the big step of buying a residence. Don’t get eager and foolishly proceed before you’re ready…
But you should also avoid standing pat just for the sake of it.
DISCLAIMER: This post represents the author’s opinion only, sometimes based on and supported by cited numbers and sometimes not. In no way should any part of the content of this post be interpreted as official financial advice, nor does it represent an intention to solicit readers into a specific strategy or investment. Results are NEVER guaranteed. Utilize the information as you see fit, invest at your own risk.