Home buying is an emotionally loaded decision. The irony of it is, people often spend far more time planning vacations than they do on the decision process for choosing a home. It’s so tempting for this major life decision to be fully based in feelings, not facts.
The reason everyone likes real estate is because it seems so tangible. It’s a piece of property you can look at, touch, and decorate. You can look up property values and compare them to your neighbors. People love “making things their own,” and nesting. There’s a reason why ratings on HGTV are so high.
However, I work with a lot of people who are overcome by a deep seated fear of missing out on the home purchase bandwagon and are nearly willing to throw out good financial sense to “get themselves into a home” at any cost. It concerns me, so I wanted to lay out some of the realities of homeownership as it relates to costs.
How Does Your Decision Fit In With Your Long-Term Goals?
A big problem I see is people getting pre-approved for an exorbitant amount of money. Yes, banks will lend to you if you have a steady, well-paid job, little debt and a good credit score. Problem is, the amount they will lend to you is based on arbitrary guidelines set by regulators, not your own personal goals.
Will the home purchase leave enough left over for you to save for an annual vacation? What about extra time off during the birth of a child? Or starting a business in a few years? No mortgage broker is going to ask you those questions. The realtor won’t either. You have to figure those things out ahead of time for yourself.
True Costs Include Moving, Repairs and Remodeling
Property values tend to increase in the long run (i.e. decades). There’s a demand for property and it’s a market like any thing else. But simply hearing a story about how someone made $200,000 the last time they sold their house isn’t the full picture. You always have to look at what’s left over after your all-in costs. This includes the cost of maintenance, repairs, remodeling, updating, etc. Those won’t be included in the MLS listing. You also must include the cost of selling which includes paying sales tax and real estate commissions. In order to start moving out of feelings and in to facts you should think about the following:
You have lots of one-time expenses when buying a new home:
- Moving costs
- Furniture and decorations
- Initial small home projects (new toilet, paint, appliances and or easy-fix furnishings and finishes such as faucets)
- Larger home projects: replacing or upgrading the heating/cooling system, cabinets, vanity, counters, built-ins, flooring, etc.
- Closing costs. Did you know closing costs of buying (not including down payments closing can be between 1-4% of the purchase price? That’s up to $20k for a $500,000 home. It’s 6% or more when you sell (or $30k on a $500,000 home) most of this is sales taxes and real estate commissions.
- Inspections and earnest money
- Down payment
Then you have ongoing costs of home ownership
A short hand for estimating maintenance costs is 1% the value of the home annually. That’s $5,000 a year or $416/month, for a $500,000 home, give or take depending on size and age of home.
Seem high? Here are some things that go into that annual cost:
Did you know you need to reseal grout in your shower periodically? What about clean vents in your dryer? Refinish wood floors? Have the chimney professionally cleaned? These aren’t the kinds of expenses that will never be recouped in an eventual house sale.
Stuff also breaks. The useful life of most appliances doesn’t exceed 10 or so years. A lot of times you find that you just hate a particular appliance. And you want to get a new <insert your particular appliance like fridge, washer/dryer or dishwasher> the next time you get a raise or bonus because you simply hate dealing with the old one.
These are all costs of homeownership you may be forgetting about.
And then there’s the taxes
Property taxes are owed annually no matter how many extra mortgage payments you make. They typically go up every year and you may or may not have to have a battle with the city about how often and how high the increases are. Many cities have caps on how big the annually increase can be. Rarely are there ever property tax decreases. Typically property tax bills in CA for a $500,000 home are ~$5,500k ($450/mo). They are ~$4,400k/year in the DC area ($360/mo). Property tax estimates are provided with most real estate search tools, but you may be forgetting to factor in annual property tax increases.
You Need to Stay in the Home a Long Time For It To Make Good Financial Sense
Assuming you like this stuff (the maintenance, the nesting and the remodeling) and the costs of the home doesn’t take away from the other things you want to do in life, you have to figure out how long the home is going to make sense for you. Because of all these not-so-hidden costs, for it to make sense financially, you really have to stay in the home for 10 years or more.
However, what I see in practice is that it’s exceedingly rare to stay in a home for very long. Hence, there’s less time for real estate to appreciate enough to cover these all-in costs when you sell. Have you ever looked at an amortization table? Read this explainer. You pay a lot more interest in the front end than the back end. It’s almost as if banks know you won’t stay in the home for the whole 30 years and wanted to get paid regardless.
But I digress. Let’s think about all the things that could necessitate a change your living situation based on real reasons clients have told me they want to find a new place:
- Getting together with a new partner
- Getting a dog or cat
- Neighbor noises
- Breaking up with a partner
- A new job/location
- A change in salary
- Adding members to your family
- Simply growing bored of your place
- Not liking the neighborhood you chose
- High maintenance and/or repairs that break the bank
- Taxes, HOA, or special assessment fee increases that wreck your budget
How many times have you moved in the last 10 years, and why?
Breaking Down the Numbers
It’s more and more rare that you’ll save money buying over renting. This is very regional, but I’m typically working with people in high-cost urban areas.
When I analyze new mortgages for clients what I find is the 2/3 of the mortgage payment is going to insurance, interest, taxes, and maintenance. And 1/3 is going to “equity.” Clients are easily paying 30% more for a mortgage + maintenance than they are for their rent, so it’s a wash. You’re the same financially if you buy or rent, but the big difference is the opportunity cost of the down payment (i.e. what could the down payment money be doing for you in the meantime?)
If you can’t scrape together a 20% down payment, I’ve seen the “costs” of a mortgage go even higher, since banks will charge more, either in the form of a higher interest rate or by requiring private mortgage insurance (PMI).
Despite all this, you might think, putting 33% toward equity each month is better than 0%. I hear you, but it’s the same logic as going to Macy’s to buy the 50% off sale. You would spend $0 if you didn’t go to Macy’s, just like you’d spend less overall if you weren’t a homeowner. If you’re looking for reasons not to buy a home, focus on the fact that homeowners have to spend a significant amount of monthly money that doesn’t go toward building personal net worth.
Despite that homeownership might still be right for you…
…It just depends on your own personal budget and goals. There may be valid reasons you have for wanting to spend more to be a homeowner. Here are some smart financial actions you can take if you’re not a homeowner but want to be:
- Start making a spreadsheet of your own that includes all the potential costs so you can understand what you’re committing to. Most online calculators will include taxes and insurance in the cost of homeownership, but these calculators don’t consider the moving, furnishing, maintenance or repair costs.
- Start writing down your financial goals and consider how these might be helped or hindered by the costs of homeownership.
- Figure out where the down payment will come from. Despite the temptation, borrowing from retirement is dangerous unless you know for certain it won’t jeopardize your ability to achieve financial independence when the time is right.
The bottom line is:
You should make this decision using information about your own personal goals and budget and not about some external pressure to do “what you’re supposed to do.” If you want to make it work in your budget because you love painting and home fix-it projects, then by all means go for it. But if some of this is starting to sound like misery — then I’m giving you the financial permission to breathe a sigh of relief — you’re not missing out like some people might think.
Don’t get overwhelmed by this fear of missing out. You’re not missing out if you are deliberate in your decision making process. I’ll also note that if you save and invest the difference between what you would spend on a mortgage versus rent you’ll have practiced paying a mortgage for a time before buying. You’ll also likely be in a much better financial position with the extra savings.
Have you thought about some of these extra costs of homeownership? Has it impacted your decision to buy or rent?