FINANCE A HOME PURCHASE
Now that it has bounced back from the Great Recession of 2008-2010, real estate has once again gained the stability of a solid long-term investment.
For six years in a row, real estate has proven to be the best long-term investment when compared to stocks, gold and savings accounts.
Those involved with real estate investing understand it is the fastest way to grow one’s net worth and wealth. Residential income-producing properties have proven to be a stable investment even during a recession. The reason is that we all need somewhere to live so there will always be a demand for housing.
When measured against stocks, savings and gold, real estate tops the list in terms of long-term gain.
Does Owning A Home Make Sense?
Owning a home has great financial benefits, yet many continue to rent! Let’s look at the financial reasons why owning a home of your own has been a part of the American Dream for as long as America has existed.
Zillow recently reported that:
“In reality, buying or renting a home is an intensely personal decision, with emotional and even financial considerations that go beyond whether to invest in this one (admittedly large) asset. Looking strictly at housing market numbers, there is a concrete point at which buying a home makes more financial sense than renting it.”
Owning vs Renting
The following is a story I recently read of a longtime homeowner that I thought says it better than I can:
We are not wealthy people; we each make about $17/hour. We have made some wise choices in purchases as we have moved from place to place, taking calculated risks regarding were dollars in the city were likely to flow, and we have guessed right.
The result has been that even though we have upgraded housing in each of our moves, by the 20th year we were free and clear of all mortgage, and in a house, we would not have dreamt of when we started.
We aren’t gurus, or wealthy, or anything like that. We just made wise choices, paid extra on the mortgage when we could. We are in a wonderful place, and all we have to do is come up with a couple hundred a month for taxes and insurance.
On the other hand, a ‘rent only’ person reaches age 60 and has to come with $2500/mo to live in a place like ours (more in a high tax area). $30,000 per year is equivalent to about $600k in the bank. If a person thinks they can rent rather than own, and in the intervening time accumulate an extra $600K, go for it. But almost no one does.
1. We recently highlighted the top 5 financial benefits of homeownership:
- Homeownership is a form of forced savings.
- Homeownership provides tax savings.
- Homeownership allows you to lock in your monthly housing cost.
- Buying a home is cheaper than renting.
- No other investment lets you live inside of it.
2. Studies have shown that a homeowner’s net worth is 44x greater than that of a renter.
3. A family that purchased an average-priced home at the beginning of 2017 could build more than $48,000 in family wealth over the next five years taking into account the current rate of home appreciation and market values.
4. Some argue that renting eliminates the cost of taxes and home repairs, but every potential renter must realize that all the expenses the landlord incurs are already baked into the rent payment– along with a profit margin!!
Debt To Income Ratio
Working with a qualified lender will help you get a better understanding of your current finances. They’ll help you identify your current debt to income ratio and offer up suggestions on how to strengthen your hand. This ratio describes the amount of debt you owe, versus the amount of income you make. They will take into account the following:
- Your credit score
- Your current debts (credit cards, student loans, car loans, etc.)
The lender is looking at these areas closely to determine what you can afford to pay for your home. As you might imagine, this is why they look at a person’s credit score. This score rates the consistency and on-time payments over time.
Different loan products allow different debt to income ratios – Conventional, FHA, and VA loans have different ratios for each. It’s okay to have debt as long as they are consistently paying down and thus maintaining a stable record of payment. Having consistency of on-time payments reflects that you are a “low risk” to financial institutions and a much safer bet than someone whose credit history is sporadic. As such, you’ll also be offered more credit and lower interest rates.
If a person has no debt, say you have been a cash buyer for things, the lender has no recorded proof that you, the consumer can pay at all making you a much higher risk in their eyes. It might seem contradictory, but If you aren’t currently paying on a debt or have any recent history of it, they won’t know if you can handle one and will be more reluctant to finance your purchase.
Which Down Payment Strategy Is Right For You?
You’ve most likely heard the rule: Save for a 20-percent down payment before you buy a home. The logic behind saving 20 percent is solid, as it shows that you have the financial discipline and stability to save for a long-term goal. It also helps you get favorable rates from lenders.
But there can actually be financial benefits to putting down a small down payment—as low as three percent—rather than parting with so much cash up front, even if you have the money available.
The downsides of a small down payment are pretty well known. You’ll have to pay Private Mortgage Insurance for years, and the lower your down payment, the more you’ll pay. You’ll also be offered a lesser loan amount than borrowers who have a 20-percent down payment, which will eliminate some homes from your search.
The national average for home appreciation is about five percent. The appreciation is independent of your home payment, so whether you put down 20 percent or three percent, the increase in equity is the same.
If you’re looking at your home as an investment, putting down a smaller amount can lead to a higher return on investment, while also leaving more of your savings free for home repairs, upgrades, or other investment opportunities.
The major positive aspect to home-ownership is owning an asset, which could prove to be valuable in the long run due to the potentiality of market appreciation. In other words, that asset is yours which in turn could be sold to recoup costs and collect on your equity.
A Happy Medium
Of course, your home payment options aren’t binary. Most borrowers can find some common ground between the security of a traditional 20 percent and an investment-focused, small down payment.
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