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The STAARBlogTM
March 1, 2013                Follow STAAR Financial onFacebookandTwitter

Buy or Rent?  8 Questions to Ask Before Buying a Home

By J. Andre Weisbrod

Buying a home is a huge decision.  A bad decision can have an enormous cost in money, emotional distress and time.   But a good decision can create greater wealth, security and happiness. 

I have been practicing and teaching financial planning since the 1980’s and one of my refrains is, “the two biggest mistakes many people make are buying too much car and too much house.”  We saw the worst case scenario in 2008.  With misguided government influence and unethical sales forces, people were encouraged to buy ever more expensive houses with more debt than they could reasonably afford.  Housing prices rose precipitously under a deceptive and destructive psychology of greed and fear that pushed prices higher.  It was a classic economic “bubble.”

In the later 1970’s and early 80’s, inflation rose to as high as 13% and mortgages rates hit the high teens.  But values of homes were relatively stable as they kept pace with inflation, and those who got in early at lower mortgage rates found their homes had become an appreciating financial asset while they had locked in their basic monthly purchase cost.  Rents rose but their principle and interest (P&I) payments remained the same - unless they foolishly used Adjustable Rate Mortgages (ARMs).

Today residential housing is booming again in many parts of the country.   April reports from the US Dept. of Commerce stated that existing home sales were up over 10% from the prior year.  Median sales prices were up over 11% from a year ago.   New home construction has been robust and is at levels not seen since before the 2008-09 crash.   Sales of new single-family homes were 18.5% higher than a year ago while the median sales price was up 3% from last year.  Obviously many people are thinking owning homes are the way to go.  Are they right?

Is it better to buy or rent?  Of course it depends.  A number of factors will guide your decision:

1.    How long do you plan to live there?  The longer you stay the more beneficial ownership is likely to be.  Generally you should plan to be in a house at least 5 years and preferably see yourself living there for 10 years or more.  The longer the time frame the more the math is in your favor.  If there is a reasonable scenario under which you think you might move sooner than five years you probably should rent.  Remember, selling a home is costly in fees and real estate agent commissions.  The home has to appreciate at least 6-10% to break even.  Yes, you will have added some equity through your principal payments on the mortgage, but those are low in the early years.

2.    How much can you afford to put down as a down payment?  One of the craziest aspects of the 2008 bubble buster was that lenders were allowing people to borrow 100% and sometimes more of homes’ market values.   Before the mania, the traditional rule of thumb had been to ideally put down 20% with a minimum of 10%.  The maximum a lender would risk lending was 90% of the home value and some would go no higher than 80%.  That still makes sense and is a good place to start.  Putting down 20% means the property value could go down that far before you would be “under water.”  If you can’t put down 20% perhaps you are buying “too much house.” You should rent and save more money until you can afford to own.  A good goal is to own your home outright in 15 years or less.  A 15 year mortgage has lower interest rate but higher payments.  If you are not sure about committing to the higher payment, you can use a 30 year mortgage and pay it off early by adding additional payments to principal every month.  Or if you are confident your investments can make more after taxes than your mortgage cost, then invest the difference with the idea of paying off the mortgage within 15 years out of the investment funds.  A debt-free home is among the most conservative, safe financial results a person can create.

3.    What is a reasonable monthly budget commitment for your situation?  The more conservative the better.  I suggest making a “worst case budget” imagining what could happen that would threaten your ownership.  The biggest risks to home affordability are poor budgeting, job loss, disability, death of the breadwinner and use of ARMs that keep the monthly payments rising.   If you are married and have two incomes, make your housing budget an amount that you could handle if one person loses his or her job.  If you rely on one income, do you have enough in savings and investments to float your boat for six months to a year?  Do you have disability insurance to replace enough income if you are disabled and can’t work for more than six months?  If the breadwinner dies, is there enough life insurance to cover the mortgage or will the spouse be able to find work to make up the difference.   Considering these risks is important whether you buy or rent, but it can be a bit easier as a renter in that after the lease period is up you can “downsize” with less pain.

4.    What is the interest rate on your mortgage?  If it is low, that is in favor of buying.  If inflation comes back and mortgage rates rise back to 6% or 7% or more, then locking in today’s 3%-3.75% rates will pay off.  Rents will increase, but your mortgage payment will remain the same.  My advice regarding ARMs?  Avoid them like the plague.   One thing to note: low interest rates are part of what is fueling rising home prices right now.  Rising mortgage rates could stall price increases for a season if they discourage buyers.  

5.    What are future interest rates likely to be?  Mortgage rates are still near historical lows.  If you think that rates are likely to go up, then you might want to join those who are buying now.   Note that interest rates are often tied to inflation.  So are rents.  If home and apartment values rise, rents are sure to rise.  This is where long-term home ownership can offer a good inflation hedge, keeping increases in your monthly housing budget lower.

6.    Are the homes in which I am interested over priced?  This was another problem during the period building up to the 2008 crash.   Prices were bid up far beyond reasonable values. 

7.    Is the “home for you” available?  Don’t just buy because you feel pressured by rising prices or other factors.  Consider all that you need and want.  Unlike a rental, you can’t easily change after the year’s lease is up.

8.    Will the home and its location be likely to support excellent appreciation over the years?  I don’t recommend viewing a home as an investment.  View it as a long-term cost of living.  The main idea is to make the value vs. cost as efficient as possible.  But a home does have some investment qualities and that includes appreciation.  It is not always easy to evaluate this aspect, but it is an important consideration.  Over long periods you can expect homes to appreciate around the rate of inflation.  But if you can own one that des better than inflation, then you have gained some investment qualities.

OK, should you rent or buy? If you can answer most or all of these questions positively, then you are an excellent candidate for home ownership.  If your answer to number 1 is less than five years, you probably want to rent unless you are willing to turn it into a rental property when you move.  If your answer to two or more of the other questions is unfavorable, you are probably safer renting.

Copyright 2013, STAAR Financial Advisors, Inc, 604 McKnight Park Dr, Pittsburgh, PA 15237.  All rights reserved.  No publication or dissemination of the contents, either electronically, via internet or physical printing is permitted without written consent of STAAR Financial Advisors.  Subscribers and clients may copy or print for their own use.  Quotes and links may be used according to accepted convention as long as proper attribution and credits are made.

 

 

J. André Weisbrod is founder of STAAR Financial Advisors Inc. and the STAAR Investment Trust headquartered in Pittsburgh, PA. He has been named a 5-star Wealth Manager in Pittsburgh Magazine and is among the longest tenured fund managers with over 20 years managing the same funds. He is also co-founder of the Strategic Assets Fund 1, LP, a private equity fund for accredited investors. He is an author and speaker and has been interviewed, quoted or had articles published in a variety of media including Investors Business Daily, TheStreet.com, The Wall Street Journal, Business News Network, the Pittsburgh Post-Gazette, USA Today, KDKA TV and Reuters TV.

Actively involved in church and community affairs, Mr. Weisbrod is committed to the well being of individuals, families and businesses. Avocations include competitive masters swimming, scuba diving, painting and photography, acting and music.

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