You're a first time home buyer. You're not sure if owning a home is right for you. You have questions - we've got answers. Over the next few weeks, we'll be walking through the basics of buying your first home. This will be timely, easy to digest information that will leave you better prepared to take that important first step.
Starting at the beginning, let's consider the question of Why: Why should you consider becoming a homeowner?
We will get to the quantifiable benefits in a moment - the numbers - but let's examine some of broader truths first. The greatest single financial asset most Americans have is their home. The largest portion of Net Worth is usually housed in the equity people create and build in their homes.
Building equity becomes the springboard to moving up to bigger and better housing. Today it may seem difficult to find the $5,000 or $6,000 you may need to buy your first home. But in five years, when you are ready to trade up, it won't be. You'll have $25,000 or $35,000 in equity in your current home and that's where your down-payment will come from.
Most people trade up a time or two and then temporarily 'settle,' staying in a home for an extended period of time, focused on paying down the mortgage - which creates even more equity. Now equity in the home becomes financial power. It can be borrowed against to finance everything from home improvements, purchase of rental property, college tuition or even retirement.
To contrast, as a tenant, you have nothing more than the certainty that your rent is going to go up. You'll pay it, but you'll be building nothing. In fact you'll be helping your landlord build wealth instead.
As long as you are going to have to pay for housing (few of us have found an acceptable way to live for free), you might as well pay for housing that grows in value, creates wealth and purchasing power for you.
Sense of Place
We've been talking about financial aspects but there are other reasons to buy, softer reasons. Because they are living at the will and whim of a landlord, tenants tend to move around more often than homeowners. There is a near transient lifestyle that goes with renting that rarely exists with home ownership. As a homeowner, your children can grow up knowing they grew up there, in that house, played in that tree, slept in that room and so on. You decide when and what color to paint the living room and how you'll remodel the basement. This sense of home - being a place in which you have set down roots - is a great emotional reason to be a homeowner.
Currently, mortgage interest on your principal residence is fully deductible on your Income Taxes as are the real estate property taxes you pay. The best way to illustrate this is with an example.
Let's assume you are renting a nice 3 bedroom apartment, paying $800 a month. You are thinking of buying $140,000 home using an FHA Mortgage with minimum down-payment. Homeowner's Insurance on the new home will be about $500 a year and property taxes will run about $1,400. Here is how the numbers break down:
Downpayment: $4,900 plus any closing costs. Most will likely be paid by the Seller, but you should still be prepared with a couple of thousand dollars to set up impound accounts for taxes and insurance and any other expenses not covered by the Seller. Estimated cash needed to close: $7,000
- Mortgage Amount: $135,100 + FHA Funding Fee (UFMIP) $2,364 = $137,464
- Mortgage Payment (30 year fixed rate at 4.5%): $696 principal and interest
- Taxes: $1,400 / 12 = $117/ month
- Insurance: $500 / 12 = $42/ month
- Mortgage Insurance: $152/ month
- Total Payment: $906
It would appear that owning that home will cost $106 a month more than staying in the apartment . . . but appearances can be deceiving. Let's look at this example after tax savings.
You'll be paying $8,352 in mortgage payments the first year to live in the new home ($696 p&i payment X 12). But, believe it or not, $6,140 of that will be mortgage interest, all of which is tax deductible! Also, your property taxes of $1,400 are deductible for a total of $7,540 in tax deductions. Assuming your income is sufficient to make this purchase possible, you are likely in a 15% tax bracket. So the $7,540 in deductions translates to about $1,131 less in income taxes you will pay, all because you bought a house! $1,131 / 12 = $94.25 a month.
Now take that $94.25 in tax savings and apply it to your total housing payment of $906 a month and your net housing expense is $811.75. So for $11.75 a month more than your rent payment, you can leave that apartment and have a nice $140,000 home.
But that's just the beginning. When you buy a home, you're investing in real estate. I feel comfortable saying that because historically, real estate has gained value over time. Contrast that with, say, your car, which depreciates about 15% the moment you drive it off the dealer's lot! Appreciation rates can vary greatly year to year, but over time have been fairly predictable. Typical appreciation for houses has been in the 2.5% - 3.5% per year range.
It is true that home prices slipped in the past five years and at this point are fairly stagnant. It is important to understand this is an unusual situation, an adjustment for an overheated market. All indications are that we area returning to a normal market where homes appreciate gradually over time.
So let's assume you buy that $140,000 home today and keep it five years before selling it to move up. What will it be worth? Bear in mind, nobody knows what appreciation will be, so the best we can do is guess, conservatively. But let's guess home values increase an average of 2.5% per year over that period.
Your $140,000 home will be worth about $178,000. A $38,000 increase in value.
During the same period you will have paid your mortgage balance down to $125,082, so your Equity (the amount of wealth you will have built) will be almost $53,000.
You got into the house with $7,000 and five years later have $53,000. That's a 757% increase in your housing fund! How can that be?! It's simple: you are benefiting from an increase in the house's value, which includes the $137,464 you originally borrowed to buy it. You're not only getting the increase based on what you put in, your getting in on what you borrowed as well! Now that's how to effectively use Other People's Money!
You're a first time home buyer. You're ready to get serious about your financial life, to begin building something for yourself and your family rather than for your landlord, give us a call. We'll help you discover what you can afford and show you how we can get you started on your own real estate journey NOW.