The housing bubble collapse and the recession shattered the long-held belief that you can’t go wrong investing in a home. Ten years later, foreclosures and housing values have generally returned to more traditional levels. However, what hasn’t returned is the unquestioned desire to own a home.
An important takeaway from the recession is that homeownership is not something to go into without some serious thought and preparation. It’s not for everyone and there may be good reasons not to join the rolls of homeownership. Before you take the plunge, consider:
The length of time you plan to stay in the house. Buying a home can be a good investment, but there is risk in taking on a mortgage. And, as the recession proved out for lots of people, investing in property is not a sure thing. There is a general rule that those in the real estate industry use as a guideline—if you don’t plan to stay in the home for at least five years, it may not be a wise financial decision. The five-year rule makes sense because:
- When you take out a 15- or 30-year mortgage, the vast majority of your monthly mortgage payment for the first few years of the loan goes toward interest charges. That means you won’t make much progress in building equity during those early years. And building equity is the primary reason for buying a house in the first place.
- The closing costs associated with a home purchase include fees for mortgage origination, title insurance, inspections, appraisals, legal costs, etc. They usually run about 3% to 6% of the price of the home. So it’s costly to frequently trade up to a new home.
Mortgage debt is considered “good” debt, but there is still a certain amount of risk (and commitment) involved. A lease gives you more freedom to move and the flexibility to adjust your housing expenses based on your financial situation.
Beyond the mortgage
Go into homeownership with your eyes wide open. Owning your own place has costs beyond the mortgage. Make sure to budget for these additional expenses.
- Property taxes. Property taxes support schools, pay for trash removal, and generally support the community you live in. They are necessary. They will be different depending on where you live and are assessed annually. The amount of your taxes may also vary each year depending on the assessed value of your home, the mil rate used by your municipality, and other projects that your community may be undertaking. If you want to get a general idea of what your annual taxes will be, divide that number by 12 and set that amount aside each month in a special “taxes” savings account to ensure you have the money available when the tax bill comes. Or, put it in escrow as part of your total monthly loan payment.
- Maintenance (inside and out). Whether it’s new paint or flooring, remodeling a bathroom to your liking, or must-do’s like a new furnace, roof, or hot water heater, maintaining a home can be costly. Because it’s such a significant investment, you need to keep your property up for resale purposes. Maintenance may also require some basic tools such as a lawn mower, ladder, or dehumidifier, which you wouldn’t necessarily need as a renter.
- Utilities. Be prepared to pay water, electric, and heating costs. Ask to see the current homeowner’s costs for the last year to get an idea of what you may need to budget for. Don’t forget to factor in cable or internet service.
- Insurance. Your home may be the biggest investment you ever make. Protect yourself from financial loss in the event your home is damaged or destroyed with proper insurance. The cost of home insurance is dependent on many factors, including how much coverage you purchase, your deductible, distance to a fire station, etc. Don’t skimp on coverage to save money. You’ll want to have enough coverage to rebuild your home in the event of a total loss. Be prepared to purchase private mortgage insurance as well if you have less than 20% of the purchase price for a down payment. This insurance may be required and will apply until you have built up 20% equity in your home.
- Time. The biggest cost of being a homeowner is time. Cleaning, yard work, shoveling snow, DIY projects—there is always something needing to be done. Lots of people actually enjoy maintaining their home. They get a sense of satisfaction from it and it can be something of a badge of honor. But it might not be how you want to spend your time. Consider the time commitment of owning a home before you buy.
- Your goals. Looking at your personal and financial goals will also help you decide whether owning a home is right for you right now. Taking a big step like buying a home without accounting for it in your plan could throw you off course.
Continue with infographic, “10 things to watch for when buying a house.”