Is it time to buy that house we always wanted, or should we wait until prices fall further?
As a financial planner, I’m often asked that question and it frustrates me to hear otherwise rational people talking about home ownership the way a speculator might talk about the price of gold. Nobody needs gold, but everyone needs a place to live.
If you’ve found the house you love, you intend to make it your home for the long haul, and the financials add up, why would you wait?
Talk about the collapse of real estate prices destroying the American Dream makes good headlines but it simply isn’t true. Yes, it may feel bad to know that the house you bought in 2006 has lost a big chunk of its market value. But if you can afford the mortgage payments and upkeep, you bought it intending to live there for a decade or more, and you leverage that asset to its best advantage as part of your financial portfolio, the state of the real estate market is irrelevant.
Trying to time the housing bottom is as much folly as trying to time stocks or any other investment vehicle. In fact, it’s greater folly because if housing prices do fall further, it’s likely to be because mortgage rates are rising, which would mean that over the long term that slightly lower price you may have paid could end up costing more in carrying costs than you saved. Furthermore, how much lower could prices go? The economy can’t get much worse than it’s been in the past three years and the difficulty in getting a mortgage couldn’t be much greater.
My answer to those who ask whether now’s the time to buy a house is that the American Dream is and always was alive and well. It has nothing to do with the direction of housing prices but everything to do with your financial situation, income stability, ability to shoulder the costs, and if the home you have your eye on is your version of the American Dream—a home you love that you hope to live in for an extended period.
The financial benefits of home ownership haven’t changed and neither has the math. Here are a few basics to consider:
1. Waiting could be costly. A further decline in real estate prices might occur but may come with a price tag in the form of higher interest costs.
2. Renting may make more sense. Home prices rise on average over long periods of time by about the same rate as inflation—historically about 3% a year. Unless you plan to live in your home for a decade or so, you may be better off renting—it takes about a decade for the value of a home to rise enough to offset the fees, commissions, and other expenses incurred in the purchase and sale of a home.
3. Mortgage math favors 30 years. Opting for a 15-year mortgage to save on interest expense is mathematically unsound. Mortgage debt is good debt so long as the interest payments are tax deductible and you hold the home for at least ten years. My rule of thumb is to try to keep the net cash expense to carry the mortgage below the annual increase in the property’s value, assuming the historical growth rate of about 3%. If the value is rising more than the cost of servicing the mortgage, you’re building wealth.
4. Home equity earns you zero percent. The dollars of principal you pay back to the bank as part of your mortgage payment become locked up in your home and can’t be put to work earning money in another vehicle. Instead, extra dollars that might be spent on a shorter mortgage can be invested in conservative investments that offer compound interest, ideally with tax benefits.
5. Cash is all that counts. Most people describe the increase in their home’s value as if they had paid cash in full. My rule of thumb is that the increase should be based on how much cash you put down—what you actually have at risk. If the home for which you paid $500,000 has risen 3% and is now worth $515,000, but you only put down $100,000 cash and borrowed the rest, your return is 15% before interest and other expenses. Grasping the difference matters because it’s misperceptions like that which often drive our choices.
6. Forget about market tops and bottoms. Whether you buy a home at the top or bottom ultimately shouldn’t matter if you’re buying into the American Dream and plan to see it through. If you bought at the top, it’s foolish to assume your home’s value is destined to go back up there anytime soon. The house that cost twice as much in 2006 as it does now was never worth twice as much to begin with. Regardless of where the home market is headed, the house you love today that you can afford and plan to live in for the long term is the house you should buy. In time, the highs and lows end up smoothing each other out. Meanwhile, you’re putting money in the piggy bank every time you make a mortgage payment that includes principal.
John E. Girouard via Forbes.com