Sometimes we think buying a home is exclusively a financial decision but very often it's far more than that. In this episode we're going to cover some of the areas that lead people to buy a home and talk about the reasoning behind why you should proceed with home ownership.
The title of the episode is Why Buy a Home. It's a very simple question yet one that requires a relatively detailed answer because the answer is not always on the surface. It's not always easy to see. Sometimes we think buying a home is exclusively a financial decision but very often it's far more than that. In this episode, we're going to cover some of the areas that lead people to buy a home and give you the standing, or reasoning, behind why you should proceed with home ownership.
[00:00:37] The format for this episode comes from my book 12 Steps to Home-Ownership. We're covering Chapter 1. Chapter 1 gives us that baseline reasoning and understanding behind why home-ownership is a very important aspect to a family's life and not just their financial life but also their well-being and that's what we'll be discussing in this episode today. There are four subheadings to chapter one in 12 Steps to Home-Ownership under Why Buy House and we'll be covering those for today.
The Big Picture
The first is The Big Picture. The big picture is twofold; it's an emotional versus a financial decision. And then it's a rent versus and buy decision. Those two are separate and distinct because even if you can afford a home it doesn't necessarily mean that you're ready to purchase a home. And when I say emotional, I'm not referring to your emotional state so much as your mindset and a willingness to set down roots. For some folks that's a really hard decision. For others, they're running fast and hard towards home-ownership as rapidly as they can.
[00:01:50] Home-ownership is a personal decision; whether or not you want to become a homeowner- or not. The "why" behind deciding on home-ownership is also a personal decision. Do you really want to grow roots in a community and become part of a community? Or are you ok moving every few years maybe from city to city with no interest whatsoever in settling down?
[00:02:11] Once you've made that decision, emotionally, about if you want to become part of a community and grow some roots, the next part of that equation is what's the financing behind it? What are the financial ramifications of accomplishing home-ownership? And can you accomplish home-ownership given your financial standing?
The barometer that I provide people regarding what they can afford is a range of 2.5 to 4.0 times your annual household income. Now that presumes a standard down payment of 10 percent or 20 percent. Of course, if you have a higher down payment you can increase that into something higher than 2.5 to 4 times your income.
[00:02:59] That's the baseline. If you're home purchase price is 2.5 times your annual income the home that you purchase will be very affordable. If you ratchet that up to four times your annual income then it'll be a struggle in the early years to make those mortgage payments. It will be a struggle for the first few years unless and until your income increases or you're in a position to refinance and lower the payments.
[00:03:27] Once getting past the emotional versus financial decision the next decision point is rent versus buy; another lifestyle choice. It's another decision point where you come to that Y in the road, whereas, it's a strictly an either/or decision. Very seldom do people rent and buy at the same time of course- they do one or the other. And that's a decision point that's in this big picture, past emotional and financial, after rent versus buy. When do you want to cross over the bridge from becoming a renter, or do you? Or, when do you want to cross over the bridge to become a buyer, or do you? That can be a very hard decision.
[00:04:14] Some people are perfectly fine being renters for life. And there's nothing wrong with that if that's the path you've chosen. But if you've decided to become a homeowner the earlier in your lifetime or career that you can accomplish that the better off you are because your cost of living becomes a fixed price when you have fixed rate financing.
[00:04:35] If you're paying $1,500 or $2,000 dollars a month in rent and you move someplace into a home that you purchase where that dollar amount is $1,500 or $2,000 dollars (with a fixed rate mortgage) then that's all it will ever be unless and until you move or something changes. Granted, taxes can increase of course. Insurance can increase. But the loan that's in place, if it's a rate mortgage, that caps your mortgage price point and monthly payment for as long as you remain in that home.
[00:05:10] But what if you are priced out? If you are priced out of the marketplace that often means you have to go further away from employment centers. If you're okay with that then expand your search area. If you're not okay with that, that means you have to devote more time to savings until such time as you can afford to be in the area where you want to be.
A Place to Call Home
[00:05:35] If you're ready to commit to home-ownership the next stanza I refer to is called "a place to call home." If you're not willing to commit a path towards home-ownership that means you are committing to continuing to be a renter. For some people, that's imposed upon them for others, they're fine with it. Decide what camp you're in and proceed accordingly. If you have decided to become a homeowner then the next archway is deciding on that place to call home. This decision comes with fear and excitement because both of those happen at the same time. It's kind of like a roller coaster. If you love roller coasters they're not that fearful- they're exciting. If you don't like roller coasters, they're very fearful and exciting. So there's fear and excitement that comes with making that decision that you are going to become a homeowner.
[00:06:30] Along with that, recognize that once you do become a home-owner then everyone knows where you live. And we do mean everyone from creditors to family including a few people that you don't like. Finding a place to call home means that you are committing to a plot, a place on this earth, where it's a little bit harder to become invisible within our larger society. Everybody does it; 70 percent of the people in the U.S. over the age of 25 are homeowners. It's not that big a deal unless, for you, it is. Some people kind of like being, as my daughter says, "in the cut" away from everyone not really being part of the community, moving from place to place often. But if you're going to be in a community just recognize that people know where you live.
[00:07:22] The next question is do you buy big? Do you extend to the highest price point that you can afford or do you decide on less financial stress and buy something within your means? If you buy that biggest-baddest house the one that you can barely squeeze into (from a mortgage perspective) then recognize you're increasing your financial stress. This goes back to that barometer of 2.5 to 4 times your annual household income. Stretching to that four, or even higher, means financial stress on the front end and it can be for an extended period of time. Versus buying a smaller home, or a less expensive home, which will carry with it less financial stress.
[00:08:10] It's really a balancing act in; deciding on not necessarily one extreme or the other, but what's the balance for you? Where do you want to be in reference to your house payment as a percentage of your household income? Granted, lenders will allow you to ratchet up, all things considered meaning that your credit is in good standing. The lender will allow you to ratchet up. But it's up to you to make the decision as to how far up that ladder you want to take it.
[00:08:43] A placeholder would be for you to say our maximum purchase is three times our annual income. And then if you end up a little higher or lower than that you'll likely still be comfortable from a financial stress perspective. What we're really doing, with home-ownership, we're attempting to create peace of mind. If we are are creating peace of mind concurrently with increasing financial stress those two don't jibe. They don't go together. You have to assure yourself and your family, as a homeowner, that the home that you're purchasing is one that you can keep. It doesn't do you any good to exercise your right to maximize your financial commitments on the mortgage only to lose the home because you can't sustain that financial commitment.
[00:09:38] Think about home-ownership as a peace of mind persona and don't over leverage; meaning don't buy more than you can afford to maintain. This frame of thinking will back down to the norm, to the mediun, of remembering that creating the peace of mind that you get with home-ownership should not concurrently increase your financial stress exponentially. Those two things in tandem will keep you centered; to not buy too much house and at the same time recognize that balancing your financial commitments is a part of becoming a homeowner with creating a place to call home.
[00:10:22] You're really making that life changing decision for you and your family because what comes with home ownership is stability. A place that is consistent and a place to call home. As much as any place where you live can be a home there's a big difference between a house and a home. Your home can be a condominium and it is your home or you can have a very large house on 50 acres that rented and it's just a house.
[00:10:56] Our third heading in Chapter 1, Why buy a Home, is changing your financial life forever. That really is part of home-ownership. Let me give you three reasons why buying a home will change your financial life forever. The first is that government data confirms homeowners have a higher net worth than non-homeowners. And it's not just a small amount. It's not just five or ten thousand dollars. The difference between the net worth of homeowners and those of non homeowners is the difference between 30 and 50 times. In other words homeowners have a net worth. that is 30 to 50 times greater than families that did not own a home. To put that into perspective, for every renter that has a net worth of five thousand dollars a homeowner will have a net worth of between $150,000 to $250,000. So you can see there is major financial incentive to become a homeowner. And of course that doesn't happen overnight, right? Just because you buy home your net worth doesn't explode and go to some high/huge number just because you've purchased a home.
[00:12:12] There are advantages that come with home ownership. One is what we call a forced savings plan. Whether your home is a hundred thousand dollars or $500,000 dollars a percentage of your monthly payment. the mortgage payment, reduces the loan each and every month. It changes over time. It gets larger the longer you have to allow in place. As an example if you're paying one thousand dollars a month towards your mortgage (principal and interest) it be in year one that only $50 or $75 dollars per month is paying down your principal mortgage balance. But by Year five it's likely two hundred dollars per month that's paying down your mortgage principal. So every month you have less debt on the home and every month you have the potential for appreciation. Those two things in tandem is what causes your net worth to rise with respect to home-ownership.
[00:13:13] Our last area to cover in Chapter 1 from 12 steps to Home-ownership, which is why Buy a Home is share with everyone something that you already know and that is that rents keep rising. On average rents rise about 3 percent per year. But if you're in a large city you know that number could be much higher than 3 percent per year. And that's what causes people to move. You're in a nice spot, everything fits it's a good commute for you and your family to job centers and all the things that you like. But then the property owner raises rents 5, 8 or 10 percent and that's quite a quite a shock, quite a jolt to the system, financially, so therefore you end up moving in.
[00:14:03] Where you move to is likely further away from the job center and further away from the places that you know only to find a place that's not quite as nice, not quite as adaptable to the place that you were but yet the rent is cheaper. You're moving to that less expensive place even though it's causing some significant changes in your life in terms of commute times, maybe even where the children are going to school. Rental increases have a major impact on daily lives.
[00:14:37] As a homeowner, with a fixed rate mortgage- I know I keep saying that- there's two types of loans (basically mortgage financing loans); there's those that come with a fixed rate and those that come with a variable rate and the variable rate mortgage can change a lot over time. We've seen it do just that. That's why we suggest to everyone to obtain a fixed rate mortgage each and every time if you can because then you have a fixed rate of payment forever and that forever means for however long you have that loan.
[00:15:11] Back to rents keep rising. The reason to become a homeowner is because when rents do rise if you're a homeowner that really doesn't have anything to do with where you live. Because now that you're a homeowner that rental increase that was a part of your annual life, or at the very least every other year, is no longer part of your lifestyle. As a renter you have no control over the cost of your (future rent) expenditures for housing and they have the potential of increasing every year. Now granted as a homeowner you do need to set aside for repairs and replacement of items. If you're a renter you have to set aside for rental increases. You can pick your poison. As a homeowner, you have not only more stability and control over where it is you reside, you also have control over the financial aspect once you put a fixed rate mortgage in place.
[00:16:09] Home-ownership can provide a fixed cost of housing to you and your family whereas with continuing to rent you really have no or little control over the cost of rent in the future and it's very likely that the price, maybe not every year, but most years will increase over time. People that are paying rent of $1,000 this year may be paying rent of $1,200 in two or three years and $1,500 in five years. As a homeowner, if you have a fixed $1,000 a month mortgage then five years from now, assuming you have the same loan, your fixed cost of housing will be the same. That's the overriding reasoning behind becoming a homeowner. Not only is it an emotional decision versus a financial decision but if you make the decision to become a homeowner you're also making a positive financial decision that will impact so many other parts of your life for years to come.
[00:17:16] And with that I hope you do make the decision to become a homeowner. Please consider purchasing the book 12 Steps to Home-ownership. There's also an online course. That online course is on Udemy.
[00:17:29] Thanks for listening today. This has been John Wilhoit on Real Estate.