Step 7 – Make an Intelligent Rent vs Buy Real Estate Decision
The 7th step to financial security is to make an intelligent rent vs buy real estate decision. This decision is more complicated than simply comparing your monthly rent versus the amount of a mortgage payment. Things you will have to consider include tax breaks, expenses associated with buying a home, how long you think you will you live there, and other factors. It is further complicated by the frequency of military permanent change-of-station (PCS) moves.
The Benefits of Home Ownership
There are many benefits of home ownership. Most importantly, you have to live somewhere and owning your home offers what we call “imputed rent.” By living in your house, you are essentially paying rent to yourself instead of to someone else.
Mortgage interest and property tax payments are tax deductible. Significant capital gains on home value, up to $250,000 if you’re single or $500,000 for couples, are tax exempt when you sell.
Home ownership forces you to save by making mortgage payments and building equity in your home, which is money you’ll get back when you sell. If you are not financially disciplined, making a mortgage payment will ensure that every month you are squirreling away at least a little bit of money.
Real estate also offers protection against the rising prices of inflation. Burton Malkiel, the author of A Random Walk down Wall Street: The Time-tested Strategy for Successful Investing, says, “A good house on good land keeps its value no matter what happens to money.”
The Downsides of Home Ownership
Owning a home can cost a pretty penny. According to the White Coat Investor, you should plan on spending 5% of the home’s value to buy it, 10% to sell it, and 1-2% a year to maintain it.
If you purchase a home and are then forced to move, it can be difficult to sell. You may be forced to take a loss, pay the mortgage while you wait to sell it, or become a landlord.
The break-even period when comparing renting vs buying a home is approximately 3-7 years, depending on the real estate market. If you are not going to be in the home for at least 3-7 years, you should probably look at renting. The Trulia rent vs buy calculator can help you run some scenarios and take an educated guess at what you should do.
What You Need to Purchase a Home
If you decide to purchase a home, you will likely need a few things. First, you need an adequate credit score (which you can see for free at Credit Karma). Second, you need an adequate income. Finally, unless you are using a no-down payment mortgage like a Veterans Administration (VA) loan, you will need a 10-20% down payment.
Any money saved up for a future real estate purchase should be invested in a safe place, like a money market account/fund or a high-yield savings account. If you have a number of years left until the purchase, you could consider using a short-term bond fund as your savings vehicle. Unless you have more than five years until you expect to need the money, it should not be in the stock market.
One way to do it is to invest in a certificate of deposit (CD) whose maturity matches the anticipated date of the real estate transaction. CDs are safer than money market mutual funds because they are FDIC insured, offer higher yields that money market funds/accounts and savings accounts, and are excellent ways to store cash you’ll need at a defined point in the future.
The downsides are that they are not easily converted into cash when unanticipated needs arise due to early withdrawal penalties. In addition, the interest is subject to state and local taxes (unlike Treasury bills).
Where to Get a Mortgage
There are a few places you can look for a mortgage. First, you can check out websites like HSH.com, Zillow.com, Bankrate.com, and others. In addition to an on-line search, you should also check out some local banks and credit unions because they often have lower rates than on-line sources. Military specific lenders include USAA and Navy Federal Credit Union.
How Much Home?
Every time you are considering a loan, you should ask yourself if what you are about to purchase is worth it. Will that extra-large house truly bring you happiness? Or does it just bring a ton of overhead, increased expenses, and four extra rooms you’ll need to buy furniture for. Because of all the expenses associated with owning a house, including heating, cooling, insurance, maintenance, buying, and selling, owning a home can easily make you house poor.
The book The Millionaire Next Door: The Surprising Secrets of America’s Wealthy was a longitudinal study of millionaires. This study showed that most millionaires don’t live in large houses in expensive neighborhoods. They live in modest, reasonably sized houses in middle-class neighborhoods.
Do yourself a favor and buy a smaller house. One rule to keep you out of trouble is that your housing costs should be less than 30% of your monthly income. Another more conservative rule is to never spend more than 20% of your gross income on housing, including your mortgage payment, utilities, property taxes, insurance, and maintenance.
If you really feel the need to buy an extra-large house, you can probably rent an equivalent home for much less than it would cost to buy it.
What’s the Bottom Line?
In most situations, you should own a home if you can possibly afford it and you expect to live in it for at least 3-7 years. Use the Trulia rent vs buy calculator to make an informed decision specific to your situation.
Now on to the 8th step to financial security…