Why houses aren't always a good investment
Home ownership might be one of the key parts of the American dream, but if the financial crisis taught us anything, it's that buying a home isn't right for everyone. Consider these factors before saddling yourself with a mortgage.
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1. Do a rent/buy comparison
Depending on where you live, renting might actually save you money. This is usually true in large cities or areas with above average real estate costs. To do a comparison, "just divide the sales price of a home in your area by the annual rent of a comparable home in the same area. If you get a high rent ratio, generally above 20 percent, buying isn't the best option," says Sandra Taylor, a financial consultant at Charles Schwab.
2. Don't forget about additional costs
A rent/buy comparison is helpful, but it doesn't take into account the full picture. Maintenance costs are another factor to consider when thinking about buying a house. "The biggest mistake future homebuyers make is comparing a month's rent to a month's mortgage payment," says Dr. Ron Throupe, associate professor in the Franklin R. Burns School of Real Estate and Construction Management at the University of Denver. "There are many additional fees you need to include to make a fair comparison: the principal interest, property taxes, property insurance, homeowner's association fees and maintenance costs." Most homeowners underestimate the maintenance costs, which include everything from new furniture, lawn care and household repairs. Just because you had the house inspected doesn't mean that the hot water heater won't die one month after you've settled in.
3. Decide if you love your city
Depending on how old you are and how stable your job is, you might be thinking about relocating to a new city in the next few years. If that's the case, renting is a safer bet. "Buying a home is a long-term investment," says Charlotte Jungen, CPA, CFP and client service manager for Goodman Financial Corporation in Houston, Texas. "If you become restless and like a change of scenery every once in a while, renting is the safer choice as it is much less binding."
4. Know your neighborhood
Just because you love your neighborhood, doesn't mean it's a good investment. "Ask what is happening with economic development in the surrounding area that could affect the value of your home," suggests Rick Gersten, CEO and President of Urban Igloo. You should know if the homes in the neighborhood are appreciating or depreciating and how many other houses are on the market in the area. "Be cautious if you are purchasing the home solely for an expected increase in price. There are other investments that are safer and offer more liquidity," Gersten says.
5. Consider where you are in life
Buying a new home if you're close to retirement isn't necessarily a good idea. "Many retirees are now discovering the joy of renting instead of owning a home," says Lynn Ballou, CFP and managing partner of Ballou Plum Wealth Advisors in Lafayette, California. "By renting they aren't locked into one area; they have the ability to move closer to their children and grandchildren. Plus, renting is often less expensive per month, which provides a richer retirement by increasing cash flow."
6. Look at your overall debt
If you are already responsible for car payments, student loans or tuition payments you might not be in a position to take on more debt. "As a general guideline, total housing costs shouldn't exceed 28 percent of your pre-tax monthly income and all of your debt combined (including credit cards, car payments, etc.) should not go over 36 percent," says Taylor. "If the home you want pushes you over that debt level, you're not ready to buy yet." If you discover this is the case for your finances, talk to a financial planner to see how you can lower your debt and work toward affording the home of your dreams.
7. Weigh your other financial priorities
If you're planning on going back to school or focused on saving for retirement, you'll have to weigh that against your desire to purchase a house. "Taking out a loan to purchase a home will likely put you a few hundred thousand dollars in debt, which can hinder future financial goals," Jungen says.
8. Know your credit score
Having a good credit score is crucial to buying a house. "If your score is low, take the appropriate actions to increase it before you apply for a mortgage," says Anna Benham, an Ameriprise financial advisor. "Keep in mind that a low credit score can lead to higher borrowing costs. The decisions you make now will be with you for a very long time. Refinancing later may be an option, but it can require additional funding."
Are you currently considering buying a new home?