To buy or to rent? That is the crucial housing question.
Not long ago, many people would have favored buying. But since the bursting of the real-estate bubble, an event that saw millions of homes plunge in price, folks have grown more cautious.
Indeed, if the real-estate market collapse has a lesson to teach us, it is this: Buying a home should be considered a long-term investment—and if you don’t have a long time horizon, you should probably rent.
Scanning the horizon
If you’re a first-time buyer looking to finance a home purchase mostly with borrowed money, you may find that the prospective mortgage payments aren’t that different from what you currently pay in rent. That can make buying seem attractive.
That means that, before buying, you want to be reasonably confident you have sufficient time to build up some equity, either through price appreciation or by paying down any mortgage. With any luck, you will accumulate enough home equity to offset any softness in real-estate prices and also the cost of buying and later selling the house. Those costs include hiring a home inspector, title insurance, mortgage-application costs, legal fees and, maybe most important, the 5% or 6% commission you might pay when selling your home.
Those monthly mortgage payments, however, shouldn’t be your only worry. You also need to consider your chances of amassing some home equity during the time you own the house. Therein lies the problem: Not only is there a risk that property prices could decline, but also buying and especially selling real estate can be hugely expensive.
The hope, of course, is that a hot property market will banish such concerns. But on that score, you shouldn’t be too optimistic. While home prices posted impressive annual gains during the housing bubble, the longer-term historical averages are quite modest—barely ahead of inflation, in fact. With that in mind, before you buy, you probably want to be reasonably confident you will keep a house for at least five years and preferably seven years or more.
Don’t just think about time horizon, however. Also give some thought to your job security and the stability of your income. If there’s a risk you could be laid off, buying a home probably isn’t a smart move unless you have significant savings to fall back on. Even if you’re unlikely to lose your job, you may be asked to relocate to another city. If you have to sell a year or two after buying, there’s a significant risk you will lose money after all costs are figured in.
“There’s another reason you might rent: Perhaps you can’t currently afford the home you would be happy owning for the long haul.”
Biding your time
In fact, for many people, there are strong arguments for renting. While you don’t build up home equity, you typically also don’t have to deal with the cost and hassle of home maintenance and yard care.
In addition, you don’t have to pay property taxes or insurance, except renter’s insurance for your personal possessions. On top of all this, renting doesn’t tie up money that you would otherwise use for a down payment.
As a renter, when you move, you don’t have to worry about big transactions costs. Yes, you might pay moving costs and your new landlord may want the first and last month’s rent upfront, plus a security deposit. But these expenses will almost always be less than the cost of buying and selling.
Indeed, the ease of moving is one of the key benefits of renting—and it may appeal to more than just those early in their career. Retirees might rent so they can give a new community a one-year trial before committing to buy a house. There are also many rental communities geared to seniors that provide recreation and perhaps on-site dining facilities.
To be sure, as a tenant, you face the risk of rent increases. But if you owned your home, your bills for property taxes, homeowner’s insurance and utilities would likely increase periodically as well, and you also face the risk of shelling out large sums for major home repairs.
There’s another reason you might rent: Perhaps you can’t currently afford the home you would be happy owning for the long haul. If you buy a home and quickly sell because you’re dissatisfied, it could be a costly blunder.
By continuing to rent, you will have time to amass more money for a house down payment. That may allow you to buy a larger home and possibly put down 20%, bypassing the need to take out private mortgage insurance. While you’re waiting to buy, you may also see your income rise. That, too, should allow you to purchase a more expensive home.
It is important to understand nothing is free in this world. Do you honestly think a bank will give you a six figure loan for free? That sh*t don’t even sound right. Cars are not free, iHop is not free, Burger King is not free, so why would a mortgage be free. Pay attention, this is where it gets tricky. Banks who lend there own money do not have to disclose how much a rate is paying them. Let me explain.
There is a fee described as Yield Spread Premium. Yield Spread Premium is a fee (described as a percentage) that is determined based on the rate you are given. But a bank doesn’t have to disclose this (regulations change all the time, so maybe by the time you read this article, hopefully they will have to disclose it). Also, understand that points and fees are not the same thing. Points are what the loan officer is charging you to do the loan. Fees are what the bank is charging you to do the loan. So, here is the trick. If you demand that you don’t want to pay points, well, they will just beef up the fees to cover the difference.
Adjustable rate mortgages have taken a bad rap and were partly the blame for the sub-prime mortgage crisis back in 2007 and 2008. Truth is, adjustable rate mortgages are a great mortgage tool, if used correctly. It allows for a lower rate versus a fixed rate which results in a lower mortgage payment. Its how you use it that will determine if it benefits you or hurts you.
When to use an ARM
ARM’s (adjustable rate mortgages) typically come in 3, 5, 7, and 10 year time periods. This means your rate will be fixed for the for first 3, 5, 7, or 10 years. After this period ends, then your rate will adjust based on the LIBOR or SIBOR. Typically the rate will increase which increases your payment.
You would typically use an ARM for the following reasons:
Time: If you know that you are not going to live in a house more than three years, then it may be advantageous to be risky and get a 3 or 5 year ARM. This will allow you to get a lower payment and keep more money in your pocket.
Lower payment: If you can not afford the payment of fixed mortgage, you can elect to get a 3 or 5 ARM to keep the payment low enough so you can afford it. However, during this time period, it is important that you work on your credit and finances so that you can refinance when your ARM is set to adjust or when fixed rates are looking sexy.
When not to use an ARM
Its very important that you understand the mortgage product you are selecting when purchasing a house or refinancing. If you want to be in your home for the long term (over 10 years), then an ARM is not the right product for you. Don’t allow yourself to be put in any mortgage product for the sake of qualifying for a house. If the only way you can qualify for a house is through a ARM mortgage, then you really can’t afford the house. Sounds simple enough, right?
What happened during the mortgage crisis?
A lot of people in the urban community were given ARM mortgages in order to get a lower payment. However, these same people had very low credit scores and a poor credit history. Why does that matter? It matters because when their ARM expired, they didn’t have a high enough credit score to refinance. Real estate markets change all the time. Guidelines change all the time. What was acceptable 2 years ago may not be acceptable today. So the only option was to sale of foreclose on the property. This where an ARM mortgage product can hurt you. Bottom line, they should have never been put in an ARM mortgage anyway.
Pay attention. You are about to become 37% more awesome.
1. This is the only rate you qualify for
If you are going for a FHA or conventional loan, there are a series of rates you qualify for. For FHA, as long as your credit score is above a 620, then the rates will not change based on your credit score. To keep it simple, a 620 and a 720 is the same in a FHA loan. So in a FHA loan, the lowest rate you qualify for may be a 4.0% while the highest may be a 6.0%. However, in a conventional loan, your credit score will dictate what series of rates you qualify for. The lower your credit score, the higher the rate. The higher the credit score, the lower the rate. Just like FHA, conventional may qualify you for a series of rates between 3.0% and 5.0%. So what dictates which rate you get? Read #2.