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The cost of home ownership
Legal Disclosure: Tony Robbins is a board member and Chief of Investor Psychology at Creative Planning, Inc., an SEC Registered Investment Advisor (RIA) with wealth managers serving all 50 states. Mr. Robbins receives compensation for serving in this capacity and based on increased business derived by Creative Planning from his services.
There has been a lot of discussion around the housing industry lately: why millennials aren’t buying homes, what it might cost you if you wait to buy a home, and whether you should buy or rent your home.
The answers provided for these questions can be paralyzing, because invariably the answer is “it depends.” It depends on the city you live in, your personal economics and your financial psychology.
Of course, the biggest determinate is where you live; it turns out that if you live in the 100 largest American metro areas buying is cheaper than renting over a seven-year period. However, if you include HOA fees and if you plan on staying less than 7 years, it is often cheaper to rent. These various factors have such an impact on the outcome that the New York Times put together a handy calculator that can tell you what is better for you based on more intricate details.
This is all very helpful information, but before you determine whether or not to buy a home, what you must know is your own numbers.
Know your numbers
If you are like the majority of the population, you will be looking to utilize financing to purchase your home. The bank or lender you attempt to get a loan from will tell you how much you are prequalified to receive. However, the bank is making an educated guess – it is your responsibility to determine if you can really afford what they are offering.
Just because the bank determines you are worth the risk of $300,000 doesn’t mean that it’s a good idea for you to spend that much on your dream house, especially if, for instance, you know that your spouse plans to take paternity leave in a year, reducing your combined income stream. Take into consideration your life goals, get to know your numbers, and determine what you can afford each month. (Most experts agree your housing costs should not surpass 1/3 of your income.)
Next, what is your FICO score? Your credit rating will determine the rate of loan you are eligible for, meaning the better your credit, the less you’ll have to pay in interest over the lifetime of your loan.
Let’s say you’ve looked at the cost of renting versus buying in your area. You’ve determined you’re ready to stop “wasting your money on rent,” and in preparation you’ve collected your FICO score and your income information. Realistically, are you ready to buy now?
What would it cost you now?
Well, if you’re a first-time homebuyer you may be surprised at the actual upfront costs. You are no longer in the world of first and last month’s rent, plus deposit. To start owning your own home you’ll need: your down payment (most experts recommend at least 20% down), upfront origination fees, closing costs, any mortgages points you might pay + the interest on your loan (currently around 4%). And that’s not including realtor fees, home inspection costs, or any new furniture you might buy for your new home.
Combine this with your monthly mortgage payment, homeowners insurance, ongoing maintenance costs, and potential homeowners association fees and suddenly you have a much clearer picture of what you need to be prepared to spend before you gain that “pride of ownership.”
What would it cost you to wait?
For many people, it is worth the cost to feel that they have a place that is all their own. Perhaps that’s you, but you know that it’s not personally feasible for another five years. You’re in good company; a recent report from the Federal Reserve said that 81 percent of renters would like to like to buy, but cannot afford it. Unfortunately, the longer you wait, the more expensive it may become to buy.
Mortgage rates are subject to the same market shifts as any other investment and the near record-low interest rates that the United States has been experiencing are likely to rise again as the economy improves.
Just how much does that interest rate affect you?
A 1% difference in the mortgage rate translates into at least a 10% difference in the monthly mortgage payment, according to Trulia’s Chief Economist (via Forbes). Consider their example: on a standard 30-year fixed-rate mortgage, the monthly payment on a $200,000 loan would be $955 for a 4% mortgage versus $1074 for a 5% mortgage. That’s a monthly difference of $119.
Knowing the impact that this interest rate will have will motivate some of you into taking massive action in order to be able to afford a home now. But it is also something to take into consideration when you are determining what type of mortgage is best for you; Because although the monthly payments of a 15-year mortgage are higher than those of a 30-year mortgage (but not double!), the interest rate is also lower. Of course, the shorter-term mortgage would also mean that you are paying off your home sooner, and therefore paying less overall in interest costs.
One last essential
Finally, do not think of your home as a financial investment. This may be hard to do, knowing that your home may be the most expensive purchase you ever make. However, over the past 100 years, home prices have grown at a compound annual rate of just 0.3%, adjusted for inflation, according to Yale economist and Nobel prize winner Robert Shiller.
Your home is your haven, but as long as you continue to live in it, it belongs on the liability side of your balance sheet. That is not to say that you cannot make money in real estate – investment properties that bring in an income can be lucrative, but your primary residence will not bring you income until you sell, and even then a profit is not guaranteed.
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