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At the beginning of 2014, Jordan and I packed up our bags and moved to London. This wasn’t our first move – far from it, in fact. After college, we never spent more than a few years in a city. We were in San Francisco, Honolulu, Durham, NC, Los Angeles, and Bangladesh.
Moving was part of our story and other than San Francisco, none of those cities felt like home.
A few months after we got settled in London, Jordan came home to find me crunching numbers in a spreadsheet. I had an idea – it was time for us to buy a home. Not in London but back in the Bay Area.
Before moving abroad we had casually looked for a home for two years. We went to open houses every month or two, scanned the property listings weekly, and even submitted a couple of offers. But nothing was ever right.
Deciding that it was the right time to buy a house when we lived 5,000 miles away from the Bay Area seemed crazy. Why would we decide to buy a house when we couldn’t easily see it in person?
After looking through all of my spreadsheets Jordan agreed that yes, buying a home while living abroad was the right financial decision for us. We rounded up all of our credit card miles, flew home for two weeks, saw a nauseating number of homes, and found what we deemed to be the perfect home for us. It’s sweet, charming, and fit within our budget.
While we are (mostly) happy that we purchased our home, looking back I can’t say we made a purely financial decision. Yes, we’ve been lucky that the real estate in the Bay Area has continued to climb, but our decision was based more on the fact that we wanted a home-base and less on the fact that it was a sound financial decision.
So should you rent or buy? And how do you even start to make that decision?
Just like all other articles on this site, the goal of this article isn’t to tell you that one way is right or wrong. Rather it’s to lay out some different things you should consider to help you make the best decision for you.
Why do we even have this discussion?
Home buying advice is full of generalizations. Well-meaning friends and family give us their opinion (without knowing our financial situation and goals). Articles designed to catch your attention will publish that home buying is either the best thing to happen to you or the worst, always in absolute terms.
And you’ve probably heard or thought at least one of these familiar sentiments:
“I’m tired of throwing away money on rent”
“Buying a home is the best investment you can make”
“You should buy a house for the tax breaks”
“Buying a house will lead to financial ruin – remember the financial crisis?”
But all of these generalizations leave out the intricacies of the real situation (because it’s so much easier to make a general statement and move on, right?).
“I’m tired of throwing money away on rent.” We’ll talk through this below but for the first part of your mortgage, you will be “throwing away money” on interest. And taxes. And insurance. And repairs. So the idea that you’re throwing away money on rent isn’t the best characterization. You’re spending money on housing – either through rent or through a mortgage.
“Buying a home is the best investment you can make.” Most experts agree that buying your primary residence – the place you’re actually going to live – is an expense, not an investment. That’s a general statement and you may actually make money on a home that you purchase, but on average (nationally), home prices over the past 100 years have kept pace with inflation. Meaning, it could be an investment but you’re probably better off thinking of the house that you live in as an expense.
“Do it for the tax break.” Nope, don’t do it for the tax break. It’s not that great.
“We’re going to have another real estate bubble burst. You’re better off putting your money in the stock market.” Maybe. Maybe not. Historically, the stock market has appreciated more than the nationwide housing market, but that’s not to say that it always will.
The truth? Your primary residence likely isn’t an investment. It’s an expense. That doesn’t make it a bad thing, but that should affect your thought process.
Bottom line: these are all generalizations and your decision on this big purchase shouldn’t be based on one sentence generalizations from someone who doesn’t know your financial situation or your life goals.
Understanding the costs of home ownership
The price of the home is one (very big) component of the cost of homeownership. But there are a lot of other costs that should factor into your decision. These additional costs don’t mean you shouldn’t buy, but thinking about them early can help you avoid being in the situation of buying something that you maybe can’t – or don’t want to – afford.
PITI: Principal, Interest, Taxes, and Insurance
You put down some money, borrow the rest, and you just pay off what you owe monthly now, right?
Mmm, not quite. While you’ll pay the principal on the loan (the principal = the amount you borrowed), don’t forget about the other 3 items that make up your total monthly payment: the interest, your property taxes, and insurance.
If you want to estimate the total monthly payment, this calculator can help you get started.
I can see myself as an eighty-year-old woman still talking about that one winter where everything went wrong with our property. Ok, I’m being dramatic – it wasn’t that bad. But in the span of a month we had plumbing problems in both the bathroom and the kitchen, our furnace stopped working (in the winter), and we needed our kitchen re-wired.
Be ready to pay for maintenance. It might not be every single month, but when it rains, it pours.
Not sure how much to estimate setting aside on maintenance? A rule of thumb that gets shared often is 1-3% of your home’s purchase price each year. So if you buy a $300,000 home, set aside $3k – $9k per year for maintenance.
That’s a huge range so use your own judgment: did you buy an older home that hasn’t had updates done in years? That was us. 3% is probably on the low side of what we need to plan for each year.
Oh, the salt in the wound of any home purchase: the closing costs. Maybe no one else feels like closing costs were that bad, but here’s why I didn’t like them: I was paying thousands in fees just to press “complete” on an already huge-to-me purchase. Closing costs are typically 2-5% of the purchase price of the house. Ouch.
This is a not-so-obvious cost of home ownership. You’ve saved for a down payment – let’s say you saved $60,000 for a down payment on a $300,000 home. Could you have done something more productive with that money? Could you have made a better investment by putting that money in the stock market, investing in your education, or starting a business?
That’s the opportunity cost: losing those alternatives when you’ve chosen one other.
Bottom line: there are a lot of other costs that go into buying a home. If you decide that buying a home is right for you, being aware of these costs can help you make sure you don’t buy a house that’s too (surprisingly) expensive.
Assess your financial situation
So that was a lot. But what does it really mean? Is it better to rent or buy? Can’t I just give you a straight answer?
No, I can’t. And here’s why: it’s personal depending on where you live, what type of property you’re buying, how much it will cost, and how long you’re going to stay.
Here are some questions you should ask yourself:
How long will you own the property?
Since there are a lot of fees that come with buying a place, if you only own it for a short period of time, those fees eat into any equity or return that you’re making on the home. If you plan to own for a longer period of time, buying becomes a better deal.
How much will maintenance cost?
If you purchase a 90-year-old property, like we did, maintenance is going to be on the higher side. Even if you purchase a new home, things break. You may have a few stress free years, but eventually, your furnace will need to be replaced too.
Remember, the rule of thumb is 1-3% of the purchase price per year in maintenance costs, but that estimate will be affected by the condition of the property that you buy. Think about your annual maintenance costs when you’re making your decision to rent or buy.
Can you afford to buy?
We’ve talked about how much it costs to own a home, so now’s the time to really look at those numbers.
Can you afford the down payment?
20% is standard though there are some programs that make it possible to put down less. As a side note though, if you do put down less than 20% you may have to pay PMI (private mortgage insurance) until you have 20% equity in your home. Whatever you decide is the right down payment % for you, can you afford that down payment?
Do you have a good debt to income (DTI) ratio?
You’ll hear this ratio talked about a lot when you start shopping around for a mortgage. The DTI is your monthly debt payments divided by your gross income (income before taxes). So if you have a student loan payment of $1,000 a month and no other debt, while your gross monthly income is $4,000, your DTI is 25% ($1,000/$4,000). When banks are looking to see if you can manage a mortgage payment, they’ll look for a DTI of less than 43% (ideally 36% or less) once they’ve factored in your proposed mortgage payment. So in that same scenario, if you’re applying for a mortgage that would leave you with debt payments of an additional $1,000 per month, your estimated DTI would be 50% ($1,000+$1,000/$4,000). That’s not the strongest DTI and you’ll likely have trouble being approved for a qualified mortgage.
Do you have cash left over for the closing costs?
Remember, that’s likely to be 2-5% of the purchase price.
Will you still have an emergency fund?
Because, as we all know, things happen (have I mentioned our horrible winter where everything broke?).
Can you handle the monthly payments (the PITI?)
Don’t just think about how much you’ll have to pay to the bank for your mortgage (the “PI”), can you also handle the “TI” (taxes and insurance)?
Can you avoid selling in a down period?
As we all probably remember, not too long ago home prices came crashing down. The people who were in the worst position were those who had to sell their home (or walk away from it) when prices crashed. If home prices plunge again, can you avoid selling it in a down period?
This usually comes down to whether you have a good emergency fund and whether you’ve over-extended yourself with the monthly payment. If the housing crisis taught us anything, it’s don’t buy a more expensive house than you can afford.
I’ve left you with so many questions, but don’t worry, I also have something that can help you answer them. One of the best calculators I’ve found out there to help crunch the home buying numbers is the NY Times “Rent or Buy” calculator. Give it a whirl and see how the numbers work out for you.
Bottom line: deciding whether or not you should buy a home should come with more number crunching than “will the mortgage payment be more or less than my rent?”
We don’t make all of our decisions in life because of money, because that would be sad. While I may have had spreadsheets and scenarios laid out for Jordan and I before we bought our home, what it really came down to was this: we wanted a home base.
We had just moved abroad. I’d left the Bay Area years before and always had it in my head I’d return. We were watching home prices go up and we were worried that if we didn’t buy a house, we’d always have a reason to not move home.
So yes, our decision was partly based on the factors I’ve shared above, but it was also partly based on emotional factors. And let me tell you, those emotional factors are really strong.
What are the emotional factors that are motivating you?
You want to put down roots.
This was us. We wanted a place to call home and even if the math didn’t quite work out in our favor, we probably would’ve gone for the purchase anyway. We wouldn’t have purchased something we couldn’t afford, but we were heavily influenced by the emotional factor of putting down roots.
You want to make a place your own.
Maybe you’re an HGTV junkie who wants nothing more than to finally break out that sledgehammer and create a home for yourself. If cruising the aisles of Home Depot at 7 am on a Saturday is your idea of a good time and you can afford a home, go chase those dreams.
You want mobility.
If having to commit to living somewhere for longer than the 1 year lease period makes your skin crawl, home ownership probably isn’t the right move for you emotionally right now. That’s ok! Recognize that before you sign yourself up for a long-term commitment.
You want cash available to invest in yourself or a business.
If what you really want in life is to have capital available to invest in something else, don’t feel the need to strap yourself down to a mortgage. Even if the math works out to buy a house right now, there’s nothing wrong with chasing your dreams and waiting to buy a home when the time is right for you (if the time is ever right).
Everyone else is buying a house and you want to keep up with the Joneses.
I slipped this one in here to remind you that this is not a good emotional reason to buy a house. If you pinpoint that this is your emotional rationale for purchasing a home, back away from the MLS listings and run from open houses as quickly as you can.
Bottom line: it’s not all about the money. It’s ok to let the emotional factors play a part in your decision-making process as long as they’re not the only thing you consider.
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