One of the biggest financial decisions you’ll ever make is whether to buy or rent your home. This decision can feel more important than mere numbers and ratios. After all, most realtors will quickly whisper in your ear “it’s not a house, it’s a home!”
Once you’re settled in a career and have some money in the bank, the idea of renting quickly becomes less appealing. Moving every few years is a pain, landlords raise rent, and you’ve always wanted a backyard for your concrete alligator collection! And don’t forget, if you owned you could paint the dining room that perfect shade of fuchsia…
As for the financials, even the President of the United States says it’s a good thing to own a home:
Today I’ve come to Phoenix to talk about the second component, which is the most tangible cornerstone that lies at the heart of the American Dream, at the heart of middle-class life — and that’s the chance to own your own home. (Applause). The chance to own your own home.
So what’s not to love about owning a condo or house?
- The fees paid when buying or selling a house are substantial. So- called “transactions costs” can really add up!
- Expect that selling a house will cost about 8% of the sales price. The practical result of this is that in order to break even on your house, you need to sell it for at least 8% more than you paid.
- A house or condo is a very illiquid asset. Think of how easy it is to sell stocks or cash in a certificate of deposit. Selling a house can take months and unless you have significant equity, you won’t necessarily be able to get a Home Equity Loan.
- If you need to move suddenly you may have to sell at a lower price. Owning your own place ties you down in a way that renting doesn’t.
- A downpayment can tie up a huge amount of your cash. If you put 20% down in order to get a non-FHA conventional mortgage, that’s serious cash in hot real estate markets!
- Maintaining a house can be a huge hidden burden. If you’re handy, this isn’t a problem, but if you need to call a plumber every time a sink drips or an electrician to fix a light switch, then you’ll be hemorrhaging money. There’s no landlord to call when the basement floods on New Year’s Day (which happened to the Frugalwoods home last year).
- Student loan debt can make qualifying for a mortgage in the first place a real challenge. Mortgage lenders want to see a certain Debt to Income (DTI) ratio and student loan payments can put you in a bind. They also make saving for a substantial downpayment that much harder.
So wow, never buying a house right? Terrible idea! Only suckers would buy a home!
Not quite. For the right person and the right situation, buying a house can be a great financial decision.
Here are a few reasons why buying can work out in your favor:
- Not having to worry about rent increases means that a major component of your cost of living is permanently fixed. Maintenance costs and taxes will increase over time, but that mortgage payment never will.
- Paying off principal is effectively paying yourself back. This cuts the “real” monthly cost of ownership substantially. Of course you can’t easily access this wealth that you own, but it’s yours nonetheless.
- The United States government dramatically subsidizes home ownership. If you’re in a high tax bracket, the mortgage interest deduction can be a substantial help on taxes. Plus, there are homeowner programs for energy efficiency and property tax abatements that don’t apply to renters.
- If you buy a place that needs work, you can build significant value by fixing it up while you’re living there. When you sell, that sweat equity is tax free thanks to the capital gains tax exclusion ($250,000 for singles, $500,000 for married couples).
- Owning a home is a massive leveraged hedge against inflation. If inflation increases, your housing costs aren’t indexed to inflation whereas rentals are. The value of your home would likely increase with inflation though, which is amplified by the fact that you borrowed most of the money. Win!
So now you’re probably nice and confused. Home buying is simultaneously the most responsible and irresponsible thing you can do for your financial future! Let’s see if we can break it down.
You should think about buying a house if:
- You are debt free or your debt is under control.
- You’re certain you’ll stay in the geographic area for at least 7 years. Anything less than that is gambling with appreciation and you’re just as likely to lose money on the transaction than make money.
- You won’t outgrow your prospective place in 7 years. That 2 bedroom, 1 bathroom bungalow looks great now, but will it look just as good with 2 kids, 2 dogs, and 1 miniature donkey? Don’t overbuy for your needs, but don’t buy something you’ll immediately outgrow.
- You aren’t intimidated by maintenance. Even if you end up hiring it out, being generally handy is essential for avoiding being ripped off. Tradesmen can smell a home improvement rube from a mile away and will happily bleed you dry. Being able to confidently say “yes, do this but leave that alone, it doesn’t actually need replacing” will save you tens of thousands of dollars.
- You believe housing prices are sustainable in your area. This is subjective and deserving of its own post. But if housing prices are increasing by double-digits every year in your neighborhood… maybe it’s not sustainable. Remember that not too many years ago real estate was considered an extremely safe investment. We see how that worked out.
Mrs. Frugalwoods and I did end up buying a house. We meet all of the above bullets and so far, it seems like a good decision. I wrote up our specific situation here, but suffice it to say we carefully considered our particular circumstances before pulling the trigger.
We at Frugalwoods aren’t the first bloggers to ponder house buying. Here are some other awesome write-ups on the topic:
Why buying a house is a terrible investment by JCollinsNH. A classic in the FIRE world and a must read.
NY Times Buy vs. Rent calculator. Great for running through scenarios.