With both home prices and mortgage rates still near historic lows, is now the right to buy a home? That’s a question many would-be first time home buyers are asking themselves, myself included. For most of the first few years of my career, I was working on a full-commission basis and my unstable income and need to maintain a large savings account balance made me reluctant to commit to the upfront costs and monthly mortgage payments associated with home ownership. By the time my income was more stable, I was living in NYC, where buying just didn’t make sense to me, and then I was in law school with barely any income at all. As a result, I missed both the rise and the collapse of the real estate bubble.
Now that my income has stabilized again, I’m tempted to pick up some of the pieces of that burst bubble. Cruising around zillow.com, there are quite a few nice looking one-bedroom condos that I could own for a monthly mortgage payment that would only be slightly more than I’m currently paying in rent for an apartment that I’m sharing with two other people. I could also get a 3 bedroom condo, rent out 2 of the rooms, and pay about the same in housing costs while my tenants help me build equity. Either way, it seems like a great time to buy. But is it? Let’s take a look at some of the factors I and anyone else in my position should consider:
How stable is your income?
First of all, lenders are going to want to see at least two years of job stability, especially if you’re self-employed. In my case, I’ll hit that two year mark in January and my company is expanding and actually looking to hire more people so I’m not too worries about layoffs. If your income is unstable, either because there’s a good chance of being laid off or because a large part of your income comes from self-employment, commissions, or bonuses, you’re also going to want a large emergency fund of at least 9-12 months of necessary expenses to make sure you can keep making your mortgage payments through thick and thin. Even if your income is relatively secure (and by secure, I mean something like being a tenured university professor), you’ll still want to have at least 3-6 months of necessary expenses in an emergency fund. Keep in mind that this savings is in addition to what you’ll need for a down payment and closing costs. Speaking of…
Do you have enough in savings for upfront costs?
Ideally, you’ll want to have enough to put 20% down, which lets you avoid having to pay for private mortgage insurance and qualifies you for lower interest rates. You may also need 3-5% of the loan value to cover closing costs. While you may be able to get most of those costs rolled into the mortgage or even covered by an eager seller, it’s better to have too much in savings and be safe than sorry. After all, you may also want some extra money for renovations or furnishings.
What’s your credit score?
You’ll want to stay above 720 to get the best rates. That may mean paying down debt and waiting until you’ve built up a positive credit history. I like to keep an eye on my credit score with creditkarma.com, which gives you access to your credit score, a tool to see how various actions could affect it, and ongoing credit monitoring all for free.
How long will you keep the home?
This is the toughest question for me. Since my job isn’t tied to a specific location, there’s a good chance that personal circumstances could lead me to move to LA, NYC, or even somewhere in Florida next year (I should add Seattle just to cover all 4 corners of the continental US) and I’m not sure I want to be a remote landlord. The problem is that it usually takes a few years for buying a home to start paying off because of the upfront closing costs and the fact that you’re mostly paying interest rather than building equity in those early years. You can use this nifty rent v. buy calculator to see how long it would take for owning a particular home to make more financial sense than renting. (If the answer is “never,” that home is probably overpriced relative to rents in the area, which is a good sign that the price is likely to come down.)
There are a few caveats to this though. One is that homeowners’ association fees can vary considerably so don’t just use the default maintenance costs if you have a specific condo in mind. Second, calculators like this tend to overestimate the value of the deductions for mortgage interest and property taxes. That’s because you only benefit from these itemized deductions (which also include things like state and local taxes and charitable contributions) to the extent that their combined value exceeds your standard deduction. In my case, I would get the full benefit because California’s high state income tax rate already puts me over the standard deduction. However, many people may find themselves not benefiting from those deductions much if at all. There have also been proposals to limit or even eliminate these deductions to simplify the tax code and help pay off the national debt.
Are you worried about higher inflation in the future?
Speaking of the national debt, this could actually be one of the arguments for buying a home right now. If the national debt continues to grow out of control, we could see much higher rates of inflation in the future. That would mean higher future rents and possibly higher rates of housing appreciation than the calculator assumes. Even without higher home prices, inflation would whittle away at the value of your mortgage debt while making you feel glad you don’t have to pay the higher future rents or interest rates. On the other hand, higher inflation could mean higher property taxes and maintenance costs too but the overall effect is likely to favor homeowners over renters.
Are you emotionally ready to “settle down?”
Money isn’t everything. Just because something makes more sense from a financial perspective doesn’t mean you should always decide to do it. The feeling of being king (or queen) of your own castle or having the freedom and flexibility of being able to move on a whim can easily outweigh the financial costs involved. Still, it’s good to be aware of what those costs are so that your decision is an educated one.
In my case, I’ve enjoyed being a renter because I like the change and new experiences that comes with moving to a new place. That being said, becoming a homeowner would itself be a new change and experience that I’m willing to try if a particular purchase makes sense to me. If you have your own thoughts and experiences to share about renting vs. owning, please leave them in the comments section below.