Casey, a subscriber and commenter here at Clever Dude, had some great comments on our article Examine Your Motives: Buying A Home, so I asked her to make her comment into a full article. Casey and her husband are in their early 30s and currently live in Houston, TX. Her background is accounting and IT, and his is business and sales. They both have broad interests in personal finance, home improvement, and “way too much interest in TV and movies.” They’re also expecting their first baby in two months.
By “Devoted Reader Casey”
I enjoyed Clever Dude’s post the other day concerning how renting vs buying a home is an emotional decision. I fully agree, that it is emotional, personal AND highly circumstantial.
My husband and I were in a position to ponder that exact point a few years back, and when emotion got the better of us we completely “geeked out”. Basically we did a year over year comparison of rent vs buy costs, and once we were done we had some hard numbers on which to base our decision. Having considered the factors, and knowing how each item fit into our situation we were able to have much more confidence in our home buying decision.
I will start by giving some background on what our situation was at that point in time. We had just sold our first home and moved to a new city with a new job. The move was fast and instead of rushing into a home purchase we got a 6 month lease. Renting gave us the time to shop. This rent vs buy analysis gave us a time frame of how long we had to shop. Additionally it gave us an idea of how long we needed to stay in our home purchase for it to be worthwhile for us. (And if we were going to rent what price we should look for – as the place we were in was strictly temporary.)
So here is the list of cost considerations, as well as the sample spreadsheet. Orange cells indicate “fill in your own data”:
- Mortgage: It all revolves around this right? It helps considerably to have a lender’s Good Faith Estimate at the very start of the process – like before you even take a peek at a house.
- Down Payment: How much you are putting down effects both the type of loan you might get and whether you will pay PMI (see below).
- Length of Loan: Many schools on this (specifically the 15 vs 30 yr fixed). It effects your monthly payment – but it also effects how much principal you pay in the current month, how much interest you pay in the future, and the interest rate. You can ask for estimates at different loan lengths.
- Interest Rate: Again totally personal, but a big part of the equation – make sure you get that good faith estimate and KNOW THY TERMS.
- PMI: Private Mortgage Insurance is typically due if your down payment is less than 20% the value of your home. It should be 1% of your loan and is usually rolled in with your loan payment.
- Property Tax: Know your homeowners exemption for your area. Also, know what you will pay for property tax in year one AND year two. In a new home, the tax assessment may not be in effect yet so basing your estimates on purchase year tax (which is basically taxing an empty lot) will cause a nasty surprise in year two (taxing the lot and the house). If you are having problems getting this information from your realtor/seller keep asking, you should know this waaaay before closing.
- Home Insurance: This could make or break home costs depending on where you live – shop different agents if necessary. Know costs for home owners and flood insurance (and/or other specific natural disaster insurance you may need). Even if you live in a 100 year flood zone, particularly if your house has resided (and thus settled) in that 100 year flood zone for 25-50 years, the flood insurance cost may be worth it.
- Maintenance/Repairs: I plug in 1-2% value of the home, but it is discretionary and should include funds for regular maintenance and emergency items: the plumber, the electrician, termite control, pest control, lawn care, pool care, garbage pickup, etc…These are costs you will not recover, but need to address. Otherwise your home appreciation, and perhaps relationship with the neighbors, will both go down the tubes.
- Home Owner’s Association Dues: Again, know what you will pay in year one, and what increase you can expect in subsequent years. What is included in HOA dues – for example if trash pickup is included that is one less maintenance item you pay for. For what will the HOA assess fines and what are the fines? If you will get fined for a brown lawn (it happens) and you don’t have time for lawn care add lawn care to maintenance costs above AND, if possible, know how solvent your HOA is, this is particularly advisable for Condo Associations – is there a big project coming up that you will be assessed for soon after closing? This last may be hard to find out, but if you have the inside scoop it could be well worth it in the long run.
- Home Improvement: This is entirely dependant on the home you are going to purchase (old/new, pre-rehab/post-rehab), what kind of improvements need to be made, and on what time frame (before move in, or within the next 2 years, or would-be-nice-but indefinitely-on-hold). This is anything you will do to the home which will add value in the long term. I count home improvements back into the value of the home at 80% which is in my world wildly optimistic. The improvement loses value over time and what I call ‘value added’ may be the next owner’s next intended home improvement project. Even kitchen and bath remodels (which should have the highest recovery) are a matter of taste.
- Closing Costs: For analysis purposes you can get this from the Good Faith Estimate from the lender. In my opinion, it is absolutely a cost of the home.
- Real Estate Agent Fee: We sold our first home completely FSBO and it worked out in our favor and was a great experience, I look at this similar to winning the lottery – it just isn’t gonna happen every time. Just anticipate hiring an agent for the sale; if you FSBO, or get an agent with a reduced fee – consider it a windfall. (If you are an agent, or experienced in FSBO, feel free to ignore.)
- Home Appreciation: In my world, in an average market, a home should appreciate at 2-3% and that is what I used for an estimate. If your world is not as conservative and is bullish on housing, feel free to appreciate away! Alternately, if you are bearish in housing adjust downward as needed. In all cases be realistic and know your market. Make sure your estimated home improvement recovery is included in appreciation. So for me: (Original Home Sales Price + Cumulative Appreciation + (Home Improvements * 80%)*2.5%)
- Mortgage Interest / Property Tax Deduction: Remember you will only get this if you itemize your tax deductions — will mortgage interest + property tax + your other itemized deductions be more than the standard deduction? (Not always.)
- Rent: Aside from finding a place and negotiating rent, this is pretty easy, just remember to include estimated increases and any additional pet rent you might pay.
- Renter Insurance: You wouldn’t have it if you weren’t renting, right?
- Storage: Another one of those discretionary items, if you are between home purchases this may be necessary.
- Parking: Again depends on where you live – but may be totally necessary.
- Deposits: I write them off as a loss initially, and count as 50% recoverable in the end.
- Tax (Previous Property Profit): If you made a profit on your last home sale this could make or break your home buying timing, you have two years from the previous sale before it counts as taxable income unless rolled over into another primary residence purchase. So, tick-tock.
- Interest Earned: This is optional, in our case we were able to save a lot renting because we rented a very small apartment and put most of our stuff in storage. If you live in an area where housing prices dramatically outpace rent costs for a comparable place, I would certainly keep this opportunity cost of your funds in for consideration.
- Maintenance: Maybe the rental has some maintenance obligations in the lease – include your maintenance costs for which you anticipate a cash outlay (for example, lawn care or pool care if applicable).
For us, in the end, we needed to buy within two years, and need to stay in the purchased house 3-5 years to experience recovery on our investment (recovery = original sales price + closing costs + home improvement @ 80% + realtor fees on sale; no appreciation, just recovery).
Now this is just the way I laid it out, totally personal, totally circumstantial. But each of these items helped in the home shopping (and partially mortgage shopping) phase. Because when the emotions kick in (and they will – this is where you will live after all) you will at least have some hard numbers to consider. And in the end, renting that place on the beach with no hassles may be exactly what you need for 6-12 months, or buying that pre-rehab house with the huge backyard and pool MAY BE worth it to you. But doesn’t it feel good to know what ‘worth it’ means ahead of time?
Remember, this is not a rent vs buy theorem. There is no proof because the question is not absolute. It is about what is right for your personal circumstances, and emotionally how much risk you are willing to handle. In reviewing each of these items and in particular laying them out in your own terms, YOU can better support this huge financial decision.
*Disclaimer on the spreadsheet: This is just meant to be a baseline for any personal analysis, it does not take into consideration any of the million differentiating circumstances that could be in play, just one example being an 80/20 loan (for which two amortization schedules would be needed). Feel free to customize as needed.