Buy or RentPersonal Finance
Your actual approach to housing depends on many factors including your financial situation, timeline, the method of purchase, and investment preferences. Buying a home is not appropriate for everyone. The Buy or Rent decision is based on multiple factors, including income, career, family and others. You should approach your decision to purchase a home from multiple angles, not simply your immediate finances and desire to own a home. Split your purchase decision into several factors. Consider all of the following: the financial market, your timeline, the home’s affordability, the upkeep costs, the housing market, and personal investment planning.
You should be living in the home that you purchase. It’s highly unwise to purchase a home you won’t reside in for more than 6 years. The expenses you sink into purchasing your home should be worth the price, and they won’t be if you don’t actually reside in the house long term. If you think that you’ll live in a house for four years or less, you should probably pass on purchasing a home and simply rent. If you also believe you’ll be transferred or are in a highly unstable job situation, you should avoid purchasing a home until your stability increases. In these cases, finding a new rental will be easier than selling the home and buying a new one.
Your ability to actually purchase the home is obviously dependent on your financial situation. A house’s monthly costs should be a maximum of 25% to 27% of your budget. If you cannot find a mortgage with a monthly price within that range, you should not consider purchasing a home. Please note that some mortgages have “adjusting” or “variable” rates. In the worst case scenario, the mortgage should never exceed 30% of your income. Your personal income should be at least 3 times monthly cost of your home. If housing this value, you’ll probably wind up cutting discretionary spending. You might even need to decrease your savings or investment budget just to pay the bills.
Your monthly payment will also need to take into account the long-term interest rate on your mortgage. You may not be able to afford a home at a reasonable mortgage rate. Your credit rating should be taken care of before applying for a mortgage or loan. Pay down debts or eliminate outstanding balances before mortgage hunting to increase your credit score and acquire better interest rates and monthly payments. Be sure to include the potential impact of your long-term interest, especially if you have a variable rate or adjusting payment.
You must be able to handle the down payment. The higher your down payment is, the better off you are. Your down payment should be a minimum of 20% of the house’s negotiated price. Numbers closer to 40% are recommended. If you cannot afford this, continue saving.
Upkeep and Maintenance
The initial home price is only the first part of the financial considerations. The monthly cost of utilities, upkeep, and maintenance the home also hurt your budget. The larger the home and more elaborate the landscaping the more you will pay monthly. Again keeping your housing costs low is important, and while utilities are not explicitly housing costs they are directly connected. Homeowner’s insurance may increase in cost as well.
The price you pay for your home is directly affected by the housing market. By extension, your monthly payments are also affected by the housing market. This market works on supply and demand, just like every other investment asset’s market. You should purchase your home just like anything else when everyone is selling or wants to sell. You should sell when everyone is buying or wants to buy. Purchasing a home when prices are in a recession can save you monthly and long term money, swaying you towards buying a home instead of renting.
The housing market also determines the viability of your home as an investment. If the market for homes strengthens and prices rise or soar, you gain. If prices fall substantially you may sell for less. If prices plateau after your purchase, you’ll still lose. You paid the home’s maintenance, repair, upgrade, and upkeep costs. The costs from sales commission or advertising fees will finish off any potential profit. Your home must gain more value than all of these costs to earn a profitable return on the home.
These aren’t problems when you rent, but you will have to deal with these concerns when you buy. If you need to move, they will affect your sales price and home returns.
Your home’s sale price is affected by other factors as well. Your sales price is limited by neighborhood homes, assuming the equivalent size and build quality. It’s highly unrealistic to expect others to purchase a house that’s used for more than an equivalent used home, or a new house. If the home is on a development plot they can customize their new property to their desires, selling your home at a higher price will not go well for you. Renters are never concerned with this problem.
Housing prices are also affected by other economic factors. The average ability of potential homeowners to afford a home is determined by local unemployment rates, average income, job security and other factors. These factors also determine the crime rate and desirability of the neighborhood. There’s no guarantee that these factors will be favorable when selling. Renters don’t have to sell when they need to move, and thus don’t have to worry about any of these issues decreasing buyers when they’re leaving.
Your price purchasing or selling a home is partially determined by the accessibility of financial loans or credit. Between 2000 and 2008, house prices boomed and continue to soar, only to crash in the 2008 subprime financial crisis. Why? The reason house prices soared was due to credit that was overextended and exceptionally easy to acquire. Literally, anyone could acquire a subprime mortgage if they could not acquire a fixed rate. After the crash, when people realized many who had acquired credit could not afford to pay, there was a sharp decrease in credit confidence. No one could acquire a loan for an extended period of time. During this time very few people could afford a home without credit. Combined with the added supply of homes on the market from foreclosure, housing prices crashed. People who wanted to sell their home could not find buyers or sold their homes for low prices. This was not a concern for renters.
Why would investments dissuade you from buying a house? A home is a place to live, but it is also an investment which can give you a solid return under the right conditions. Like any investment, homes must earn a return to be worthwhile. If your home’s return on investment is less than “risk-free” AAA bonds you haven’t helped your net worth.
If inflation adjusted investment performance vastly exceeds inflation adjusted appreciation, it’s better for your net worth to place your funds in investments. The difference between rent and mortgage can be anywhere from a few hundred to a few thousand dollars. If the difference is small, buying a house is a wise idea. If the difference is large, it may be better long term to invest the difference and let it accumulate over years.
The long-term historical rate of financial markets beats the historical rate of home appreciation. Shares have an average historical rate of eight to nine percent. Homes are roughly 3 to 4 percent. Investing the monthly difference between the mortgage and rent can be better for your net worth long term. This benefit only appears if the difference is large and invested. The investments you pick will need to perform equal or better than long term averages. Your returns must also be allowed to compound and accumulate. No touching!
That plan is also better for your liquidity. When you purchase a home you invest your money into the property. You don’t have to pay someone else for a place to live after your mortgage is paid off, which is a blessing. It comes with a curse: your money is now locked within the property. If any rally occurs in any investment, you can’t move your money into the market without selling your house. You’ll have to watch stock market booms or commodity rushes go by, from the comfort of your home. This isn’t a bad thing, but the illiquidity has an opportunity cost. It also costs you money. You have to pay maintenance and upkeep on your property, as well as property tax. When you sell your home, you will have to pay a commission if you use an agent or marketing costs. Those who invest the money saved between rent and mortgage do not have to deal with this illiquidity problem. They can easily sell out of one investment to move into another they deem as a future performer.
If you’re not a confident or skilled investor, you can very well wind up losing money or having stagnating investment performance. It doesn’t matter if you rent and invest if you’re losing money consistently. In that case, it is absolutely better to simply buy the house.
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