Friday, July 13, 2012

Buying a House

 As a young adult it may seem that buying a house is a long, far-off dream; but I want you to see why buying a house is key to your economic success.  Once you see the importance of buying a house,  then you are more likely to watch your spending now and begin saving money. 

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. 

            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.