For most of us renters, paying our landlord each month feels like a complete waste of money.
As we enter our mid-to-late 20s and 30s, many of our friends have already taken the plunge of home-ownership. We start getting the imposing question, “So, when are you looking to buy?”
In our culture, home-ownership has become a rite of passage.
Owning a house with a white-picket fence epitomizes the “American dream.” For those of us who haven’t purchased our first home, we may feel like we’re being left behind as our peers buy that 3 bed/2 bath house.
The connotation of being a renter may make us feel like we haven’t succeeded financially. For some unknown reason, signing that 30-year mortgage represents a monumental moment of adulthood.
However, this is obviously not true.
Sure, owning your home provides plenty of positives and should be a part of your long-term wealth plan.
Buying a home provides stability for your family. Owning property means you aren’t at the mercy of your landlord and continuously moving from rental to rental. Your monthly housing payment is fixed (assuming a fixed-rate mortgage). Plus, over the long-term, you build equity in an appreciating asset (in theory).
All of these positives seem too good to pass up. So, why even rent in the first place? How long should you plan to rent until you should buy?
Before you take the plunge and buy your first home, consider these 5 key questions:
- Why do you even want to buy?
- Is your financial situation more conducive to buying or renting?
- Will you be able to afford buying the residence where you want to live?
- Are you able to commit to living 5+ years in the home?
- Will buying this home help you achieve your long-term wealth-building goals?
1. Why do you want to buy?
The first question you need to ask before making any big financial and personal commitment is “why?”
Your “why” represents the purpose and the deeper meaning in the decisions you make.
Determining and completely understanding your “why” for buying a home will be key to the entire process. Considering your purpose will guide your decision-making process as you decide to rent or buy.
If you keep your purpose forefront in your mind throughout the entire process, you can mitigate any distractions that detract from your long-term goals.
Unfortunately, many prospective buyers treat the process as if it’s just a routine, given choice to make.
Instead, be intentional when considering your purpose for buying a home.
Maybe, you’ll see that you aren’t quite ready to buy. Instead, you may be better off extending your lease or renting in the area you think you want to buy. Alternatively, being intentional and laying out your purpose may support and guide your search for the best home for you and/or your family.
Let’s consider some common “whys” for wanting to buy.
You don’t want to “waste money” on rent
Perhaps, the most commonly cited answer for buying a home is that we are sick of “wasting money on rent.”
We all work hard for our money. When we don’t own our primary residence, we often feel like our housing is a huge expense rather than an “investment.” With most of us spending nearly 1/3 of our monthly income on housing, a huge portion of our work day is spent just to keep a roof over our family’s head.
In part, this is true. Renting is absolutely a 100% expense. It’s money we will never get back.
The logical thought is if we owned our home, at least a portion of our monthly payment would be going to pay down principle and build equity. Isn’t this an investment?
However, as we will discuss later on, there are many unforeseen costs of home ownership that make renting LESS of a “waste of money.” Often, the total out-of-pocket expense of renting is much lower than owning your home.
Renting could be better on your monthly cash flow and budget.
As a home-owner, you will bare the brunt of additional expenses that you will not face as a renter.
As a renter, your monthly operating costs are MUCH lower. If the A/C unit quits working, you can simply call your landlord who will be responsible for the $3,000-$6,000 cost to replace. Need a new roof? Obviously, you won’t need to spend a dime of your own money for this capital improvement.
If you live in certain apartment complexes, you may not even be responsible for changing the light bulbs! Plus, you’ll probably have the amenities of a pool and gym without the necessary upkeep.
As a renter, you’ll certainly never spend any time or money at Home Depot picking out shrubs and flowers.
However, when you buy a home, you’ll be responsible for all of these maintenance costs (and time commitments) that end up making renting less of a “waste of money” than you originally thought.
Of course, don’t you know that home-ownership is the next logical step of adulthood?
If your initial “why” is just because society is telling you that home-ownership is the next logical step, then you should really take pause and consider if buying a home is right for you.
Personally, I’ve certainly experienced the pressure from friends and family that make it seem like it’s time to buy.
I’m in my mid-to-late 20s, engaged to be married soon, and have a stable career. My fiancee and I have managed to accumulate a sizable net worth for our ages, so we will probably be financially ready to buy a house in the next year (if we want).
At this point, many of our closest friends have been home-owners for a year or two. Obviously, this has a tendency to induce “house fever.”
However, we have other financial goals we want to accomplish before buying a home – even though we’re certainly in a better financial situation than 90% of people our age (including our friends that own homes).
Before we buy our first home, I’d like to be 100% debt-free. We both want to put down 20% to avoid private mortgage insurance. Ideally, we would like to save another $5,000-$10,000 to furnish the home or make cosmetic upgrades.
While many of our friends jumped into the home-buying process too soon, we’ve learned what NOT to do from their decisions just because we have not fallen prey to society’s pressure to rush us into home-ownership.
I strongly encourage you to ensure you have a bigger “why” than just because it’s the next thing to do on your financial journey.
You want to stabilize your housing for your family
Another commonly cited purpose for buying a home is stabilizing your housing situation for your family.
When you’re young or single, flexibility and choice is probably top of mind. You may enjoy living in the “vibrant” areas of town in your youth.
As you begin your career, renting may offer a cost-effective way to begin saving and building wealth. By renting, you the ability to uproot and move across the country to pursue a new job opportunity, go back to graduate school, or try out living in a new areas of your city. Maybe, you can take more risk in your career because you don’t have the threat of defaulting on your mortgage if things go sideways!
However, once you have a family and children, your priorities and decision-making processes certainly shift. Your choices evolve from being more self-centered to focusing on providing for their needs.
You probably want to live in a nice, safe, and quiet neighborhood. You and your spouse in all likelihood want to ensure they are in a good school district. Perhaps, you want to be closer to other friends and family for social gatherings and community.
If your purpose in owning a home is to provide a certain lifestyle to your family, then your “why” becomes much more noble.
As long as you ensure you buy a home within the parameters of what you can reasonably afford, buying a home to stabilize your family and build long-term wealth provides a great reason to become a home-buyer.
2. Does your current financial situation support buying or renting?
In any given year, owning your primary residence has the potential to be MORE expensive than renting.
For this reason, you should ask yourself if your current financial situation will give you the ability to bare the unexpected costs that come with home-ownership.
To compensate for unexpected repairs and prepare for future maintenance requirements, potential home-buyers must ensure they have the financial bandwidth to bare the additional expenses.
Before buying a home, ensure you have the monthly margin in your budget and enough savings required to pay for these costs and accomplish your other savings goals.
Home-ownership is often more expensive than renting
As mentioned above, home-owners will inevitably be forced to endure major repairs and expenses.
While your monthly mortgage payment may be cheaper than your monthly rent, owning a home comes with very expensive maintenance requirements. Depending upon the age of the home, Forbes estimates home-owners spend anywhere from 1%-4% of the home’s value in maintenance and repair.
For example, the average shingle roof will need to be replaced every 15 years or so. This alone will be a $15,000-$20,000 expense. The cost of the average new roof amortized over 15 years adds another $80-$115 per month of additional expenses that may not have been included in the affordability factor when the home was purchased.
Major appliances certainly don’t last forever.
If you’re a renter, WHEN appliances need repair or replacement, you simply make a phone call to your landlord. However, when you own your residence, you’ll be on the hook for these repairs and replacements.
If you don’t have the margin in your budget to bare these costs, you could end up “house poor.” By contrast, renters will never need to worry about replacing a roof, refrigerator, or sewer line. Their monthly housing cost will remain fixed (until it’s time to renew the lease).
However, in the long-run, home-ownership is more than a financial investment. Buying a home when you are financially ready can be a prudent decision for your long-term wealth and emotional well-being.
Pay down debt
If you have any lingering debt balances, paying off consumer debt is the first place to start before buying a home.
Why is paying down consumer debt vital before buying a house?
Before you take on a mortgage, paying off any consumer loans frees-up monthly cash flow. This extra margin in your budget can be used to save for the additional expenses you will face as a home-owner. Plus, this additional financial bandwidth will help you accomplish other spending goals.
There are a couple of approaches you can take to eliminate student loans, credit card debt, car loans, or other consumer debt.
Debt Snowball
If you are a Dave Ramsey fan, you’re probably familiar with the Debt Snowball method as popularized by Dave’s “7 Baby Steps.”
With the Debt Snowball, list your debts smallest to largest regardless of interest rate. Attack the smallest debt first and pay minimums on all of the rest. Once the smallest balance has been repaid, use the extra cash flow towards the next smallest until all of your debt has been repaid.
The Debt Snowball relies on the power of momentum and the psychology of seeing progress to keep motivation through their debt repayment journey.
Debt Avalanche
Another popular method is the Debt Avalanche method.
With the Debt Avalanche method, list your debts by interest rate regardless of the balance. Attack the debt with the largest interest rate while paying minimums on the remaining debts.
Both of these methods offer viable solutions that will aid you in eliminating those pesky loan payments.
Ensure you have a sufficient emergency fund BEFORE buying a home
After you’ve eliminated most of your debt (especially, high-interest credit card loans), improve your financial situation by building up a large cash cushion in addition to your down payment.
This provides distance between your finances and Murphy’s Law. After all (if you have luck like mine), as soon as you move into your new home, something will inevitably go wrong. A water heater will break. A plumbing issue will be discovered. Maybe, you experience car trouble or a job layoff.
If you’ve spent all of your liquid cash on the down payment and closing costs, you leave yourself vulnerable to when “life happens.”
Instead, provide stability and safety to your family’s finances by saving up ~3-6 months of your new monthly expenses in addition to your down payment.
After you’ve padded your emergency fund to compensate for the additional financial risks of owning your home, you should still have enough to save from your old debt payments for other expenses such as kid’s college, new vehicles, and vacations.
The ability to manage your monthly cash flow keeps you from being house poor. Instead, your house will be a financial blessing and keep you from regretting your decision.
Save up a strong down payment
If you’re considering whether you’re in a financial position to buy a home, ensure you are out of high-interest consumer debt, have an emergency fund in place, and have the ability to put down a solid down payment.
After all, the more you put down on your home, the lower your monthly mortgage expense. This allows for additional money that can be saved and invested elsewhere each month.
The average first-time home-buyer put down just 7%. Federal programs such as the FHA loan program allows first-time home buyers to put down as little as 3.5%. However, this doesn’t mean putting down a small down payment is optimal in the long-term. Instead, aim to put down as much as possible (preferably, 20% to avoid private mortgage insurance).
In the long run, the goal is to pay off your mortgage as soon as possible – especially, by the time you retire. Once you’ve eliminated your largest monthly expense, you’ll have tens of thousands of dollars to invest each year. The result will be incredible wealth and financial flexibility.
The larger the down payment you make, the closer you will be to accomplishing this feat.
3. Can you afford to buy where you WANT to live?
For every homebuyer, location tends to be the primary driving factor when shopping for a home.
Young home-buyers
For younger singles and couples without children, we generally want to be in the middle of the action. We enjoy areas that are young and vibrant surrounded by our favorite happy hour spots and trendy dining options. We want to be near parks or in walkable neighborhoods close to work.
This means younger home-buyers generally want to live near downtown or in city center areas near shopping and entertainment hubs. Because of our stage of life, we may not necessarily want (or need) a traditional 3 bed/2 bath home with a large backyard. Instead, owning or renting a condo or townhome may be preferable. As life evolves, our dreams shift and our housing needs and desires will inevitably change as well.
For now, those in this stage of life may be content with the low maintenance lifestyle of renting an apartment or condo.
However, young individuals and couples who haven’t started a family yet should be conscious of buying in appreciating areas. This can help you build equity faster in your “starter home.” This equity appreciation can be rolled into your next home that may be out of reach otherwise.
Buying the family home
By contrast, families with school-age children are often primarily concerned buying property in better school districts or near family.
For many who live in urban areas where real estate is more expensive, this may mean moving to the suburbs. While the commute to downtown for many will be longer, the family-oriented lifestyle will probably be more conducive to their needs. Plus, the school districts in suburbs may be better than inner-city environments. As an added benefit, the property values are generally substantially more affordable.
These lower property values may leave room in the budget for one spouse to work reduced hours or stay at home with the children.
Older home-buyers
For the older generation, they may be looking to downsize to reduce the amount of hassle on the upkeep of the old family house. Now that the kids are grown and gone, they may not need a 5 bedroom house anymore. Maybe, they want to retire to a community that takes care of maintenance, yardwork, and offers amenities near family and friends.
Perhaps, a substantial portion of their net worth is tied-up in their primary residence and it’s just time to cash out.
Whatever the reason, your stage of life often dictates the type of home you buy, where you buy, and what you can afford.
Decide where YOU want to live the next 5 years
While the above may just be a generalization, you must decide for yourself what kind of lifestyle you want to live.
Do you want to live in a more urban environment closer to work/downtown? Alternatively, would you be happier living away from the epicenter of commerce in your city?
Once you’ve made your decision on where you want to live, you should carefully analyze IF you can afford to live in your desired location.
The price of home is dictated by the size of your down payment, monthly take home pay, credit score, and other debt obligations.
While everyone’s situation is different, aim to keep your housing expenses below 25% of your income. This allows for ample room in your budget to save for other expenses while investing for the long-term.
4. Buying a home is commitment
As if this really needs to be said… Buying a home is a huge financial commitment.
Purchasing a home stabilizes your housing situation.
For a family of four, this could be a wonderful aspect. However, for a recent college graduate who is just entering the workforce who is open to the idea of a new venture elsewhere, owning the same exact home could be an anchor around their neck. The cost and hassle of selling the home could keep them for pursuing their dreams. However, for the family of four, the home could be an integral part of their dream.
Before you purchase your primary residence, you should ensure you’re buying the house that will meet at minimum your medium-term housing needs (i.e. 5 years+).
After all, selling and moving expenses can cost you thousands of dollars. Plus, uprooting your family every couple of years can take a psychological toll.
Depending on your long-term dreams and plans, renting in your current stage of life could provide flexibility until you’re ready to put down more permanent roots.
How long are you willing to commit to living in the home?
If you’re newly married in your early-to-mid 20s, you and your spouse may not be considering children anytime soon. For now, you may be content living in the middle of the action.
However, before you are ready to buy, you and/or your spouse should make sure the house you’re looking to buy aligns with your 5-year plan.
In 5 years, will you still enjoy living where you are? Or will you wish you had rented a couple of years where all the buzz happens and bought elsewhere for your first home?
While you may think you’re willing to commit to the area for the long-term, you may quickly find that your location/area is fun to visit but not fun to live. In order to avoid being underwater or losing money on the house, you may be forced to remain in the house.
More than likely, you didn’t incur any commission to buy the house. However, if you sell the house before receiving any appreciation in the property, the standard 6% realtor commission could leave you underwater (or at a loss) as you look to buy your next property.
On average, you’ll probably need to remain in the property for ~5 years to make the home purchase the best choice. For this reason, it’s best to only buy a home you’re willing to live in a minimum of 5 years. This will substantially reduce the chance of losing money in the real estate market.
5. Will buying this house help you achieve your long-term wealth-building goals?
Owning your primary residence alone will not make you wealthy. Instead, view your house as an expense. Treat any appreciation you may receive as icing on the cake.
If you view your house as an expense (rather than investment), you’re much more likely to buy a house that you can truly afford. Plus, it keeps your housing cost in the proper perspective. Instead of “investing” more money into your monthly payment for that bigger home you don’t need, you’ll have more capital to invest in wealth-building assets (such as your 401(k) or IRA).
Why you should view your primary residence as an expense
Generally, the average home appreciates in value 3%-5% annually. In other words, most homes only appreciate at or just above inflation.
By contrast, investments such as stocks (or many rental real estate properties) generally have total returns that significantly outpace inflation. For instance, stocks have historically appreciated 10% annually (including dividends). These returns allow for real wealth creation.
While you may keep up with inflation on the appreciation in your home, there are other costs that essentially wipe out the equity appreciation. For instance, maintenance expenses average around 2%-4% of the homes value. On top of the additional costs, you’ll generally have higher utility expenses with home-ownership. Plus, you’ll pay thousands in property taxes, insurance and interest on the mortgage.
If home’s aren’t a great investment, then why buy in the first place?
Just because your primary residence isn’t a great financial investment, doesn’t mean ownership doesn’t have some financial benefits and other intrinsic qualities that can’t be easily valued.
As previously mentioned, home-ownership stabilizes your housing payment. With a fixed-rate mortgage, you’ve locked in your housing payment. As you receive annual raises, you’ll have more disposable income to spend or invest. At the end of your 15, 20, or 30-year term, you’ll own an asset that has appreciated with inflation completely free and clear. At the end of your mortgage term, you no longer have any housing payment at all as you enter retirement.
Clearly, this substantially reduces the amount of money you need each month.
If you are a renter, your housing payment will generally rise every year. Often, your rent will increase faster than any cost of living adjustment, leaving you worse off in the long run.
Further, home-ownership provides stability for your family. This investment is more intrinsic in nature rather than financially measurable. You will create memories with your spouse and children in the home. You’ll have space to host family and friends for holidays and avoid the headache of moving every 2 or 3 years to a more affordable residence.
How does buying this home fit into your long-term wealth-building goals?
Before purchasing the home, you should carefully consider how purchasing this particular property fits into your overall goals and financial plan.
Perhaps, you’re goal is buy a home that you can flip or sell in a few years. With this gain you want to buy your “forever home.” Does the house you’re looking at now have the qualities necessary to significantly outpace inflation? Can you rehab the property and earn a significant return on your investment?
Alternatively, maybe your goal is to own a rental empire. In a few years, your goal may be to rent out what was once your primary residence. Does the estimated rent value make sense in relation to the property value?
Perhaps, you’re looking to downsize. Will a smaller, older home with a larger lot result in more or less work than your current residence?
Before buying any property, you must carefully consider how each property fits into your longer-term wealth-building strategy. When you view your choices through this lens, you can avoid overpaying for those straight out of HGTV-spec homes.
Remember these 5 Key Considerations BEFORE you buy your first home
Buying a home can be stressful for anyone.
Whether you’re buying your first home or you’re looking to downsize, these 5 considerations and questions should be answered when asking how long you should rent or if it is time buy a new home.