I want to show you something amazing. Below is a comparison of a $900 apartment with a $270,000 house. (Note for older adults: These numbers reflect Southern California rates, as the market rebounds these numbers will be much higher) I want you to see how rent prices per month go up each year, while the mortgage payment is fixed over the course of the loan.
We will now take a look at the same comparison by year. Notice the total amount that you will have paid at the end of 30 years. You will have paid more than the loan amount of $270,000 because you have to pay interest. It is a lot of money. The interest does add up, so that is why you need to be reasonably sure that you can afford the payments and want to stay in this house for a long time.
If you have to sell before the value of the house appreciates significantly, you will have to literally pay money to sell the house because of the interest payments that you will pay to get out of the house. I made an assumption that you will get a fixed-rate loan, because this type of loan will help keep you from a similar fate that is facing many stressed homeowners. This is something you need to learn out of the housing crash that we have witnessed.
A variable-rate home loan allows you to get into a house at a much lower cost, but it carries more risk that could get you in trouble. The idea of a variable rate loan is that the bank charges you a low interest initially and raises it later. Before the housing crash, the pitch they were making was that the house was rising in value so fast that it didn’t matter; you could just get further loans based upon the value of the house. People were buying houses they could not afford and were banking on unrealistic rises in housing prices.
When your home is worth more than you owe on the loan it is called equity. Equity is nice, but in reality, it is worthless until you sell the house. Since you need to live somewhere, the house you purchase next will eat up much of this equity. If you downsize to something smaller, or move to a less expensive area, you can walk away with a lot of cash in your pocket. In retirement, it typically does not matter where you live, because your kids are grown up and you do not need to be tied to a location for a job.
A variable-rate home loan allows you to get into a house at a much lower cost, but it carries more risk that could get you in trouble. The idea of a variable rate loan is that the bank charges you a low interest initially and raises it later. Before the housing crash, the pitch they were making was that the house was rising in value so fast that it didn’t matter; you could just get further loans based upon the value of the house. People were buying houses they could not afford and were banking on unrealistic rises in housing prices.
When your home is worth more than you owe on the loan it is called equity. Equity is nice, but in reality, it is worthless until you sell the house. Since you need to live somewhere, the house you purchase next will eat up much of this equity. If you downsize to something smaller, or move to a less expensive area, you can walk away with a lot of cash in your pocket. In retirement, it typically does not matter where you live, because your kids are grown up and you do not need to be tied to a location for a job.
Do you see it? You will pay almost twice as much over thirty years for an apartment. I’ll bet you thought that apartments cost less, because that is where the poor people live. You are right, poor people do live in apartments, but they cost more. The reason why poor people do not buy houses and save a lot of money is that it takes a significant amount of money up front to get into a house and the mortgage payment will usually be initially higher than the average apartment rental. You will need to save 20% of the house price (in this case $54,000) to get approved for the loan. This is why poor people can’t get into a house. The up front commitment is too big. If you save aggressively you can get there.
Saving money for a down payment is a big stumbling block for those who are planning to buy a house. In most cases, an FHA loan is the best option. Its minimal down payment of 3.5% of the purchase price is much less than the 20% down payment required for conventional mortgages. However, there has always been a limit on the size of FHA loan you can avail for where the property is located.
ReplyDeleteHi Chris, thanks for the advertisement. It's a little off-topic but close enough for me to comment on without deleting it. An FHA Loan is limited to people with low income and the 3.5% does not apply to all people, some will have to put down 6%. Also lenders are going to want to see a reasonable credit score. The VA home loan was available to my wife and I because I was in the military. It allowed us to get a house with a much lower down payment. For our young adults the point of the article was not to go into loan specifics, but to get you to see the long-term benefits of buying a house in terms of saved rent-money. As you get to the point where you want to settle down and buy a house you will need money. You won't have the money unless you have been saving; therefore, you must start saving now and make it a habit.
ReplyDeleteThe thought of buying a house is intimidating, especially for the young adults, but as you’ve explained, it could serve as a way to improve on one’s financial management. Having a house for a goal is pretty challenging, however, it is certainly better to start investing in your younger years to extensively enjoy the fruits of your labor.
ReplyDeleteRandy Robinson
Getting a down payment is daunting, but the hardest thing is paying a mortgage that is higher than the prevailing rent prices. It takes faith in certainty of inflation to understand that eventually that payment (on a fixed rate loan) will become a smaller proportion of your income because of pay raises over time. Since rent adjusts with inflation it is just a matter of time before a mortgage payment becomes far less than rent. The key is staying put and not hopping around.
DeleteWell, it’s just a matter of preference: whether or not they would purchase a house or an apartment. And material like this would even help a future homeowner; determine what his/her possible choices are. Along with these financial matters that need to be addressed, and be given a proper decision, a professional’s advice could be of good service. It would help enlighten the homeowner with a couple of documents that are, or would be, needed in buying a house (i.e. title fees and taxes).
ReplyDeleteKathleen Salazar
Three days ago Forbes put out that buying a home is 45% cheaper than renting. http://www.forbes.com/sites/trulia/2012/09/13/buying-a-home-is-45-cheaper-than-renting/
DeleteA huge part of this is time. If a person is not in it for the long haul and will be moving soon, then renting trumps buying. Variable rate mortgages often fool people into buying a house that is too expensive,so when rates adjust upwards they can find themselves in trouble. Keep it simple: buy a house you can afford and stay put. Thinking of the house as an investment is very risky as real estate has shown itself to be a volatile market and being forced to sell when the market tanks because of a lack of liquidity is painful.