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The median age of first-time homebuyers is rising — but most people still prefer to buy their home rather than rent it.
So, depending on whether you are older or younger than 32, the median first-time-home-buyer age, you are likely to be considering buying a home soon.
Since you’re probably a millennial (love or hate the label), your high-level considerations include the following: affording the down payment, affording the monthly mortgage payment, likelihood of moving to a new city and when, proximity to work and play, and the convenience-hassle factor regarding repairs and maintenance.
This is probably the determining factor for most young people. The common wisdom is to put 20% “down” on a house to buy it — that is, to pay 20 percent of the house’s purchase price up front.
Perhaps you’re surprised to learn it’s not very difficult to avoid that large down payment, though. Many lenders will loan more than 80% of the purchase price, which could completely eliminate a down payment.
Yep, that means some lenders will agree to buy your house for you without requiring a lump sum to start with. But, yes — to answer your question — it is probably too good to be true.
For example, one major downside may be that you’re required to pay mortgage insurance throughout the term of the loan. This is an extra cost that you’ll continue to pay month after month, year after year. In the end, you may have been better off with a meaningful down payment and no mortgage insurance.
Breaking the traditional 20/80 split in favor of a low- or no-down-payment loan may work fine, however, for individuals on the cusp of high earning power. If that’s you, then maybe you should ask about a 5-percent-down mortgage at Costco next time you pick up a five-gallon bottle of ketchup.
The other affordability component is the monthly payment. In many markets, the monthly mortgage payment won’t drastically exceed your monthly rent payment. And to the extent it does, it’s critical you parse out the principal portion of the monthly payment from the interest portion so you’re not comparing apples to oranges.
There are three primary components of a monthly mortgage payment, which won’t change for any of the 360 payments you’ll make (12 months * 3o years).
Here’s a visual breakdown — for helping purposes:
Principal: this is the portion of the monthly payment that goes toward paying down the $160,000 starting balance. On the top graph, the principal starts out representing only a small part of the monthly payment, but by the last payment, nearly the entire $1,013.86 is principal.
For every dollar of principal, which pays down the balance of the loan, that’s a dollar coming right back to you in “equity” (more on this below). It’s basically like moving the dollar from your bank account into your house. You own both things, it’s just that one is made of sticks or bricks. If you were to sell the house, those dollars would come back to you instead of the bank.
Interest: For most of the life of the loan, the interest portion of the monthly payment will be the largest component. This is part of the true cost of the loan. It’s the 4% that you’re being charged to borrow the money. But the principal portion of the payment isn’t really a cost, so you shouldn’t include that portion in your assessment when comparing to the market rent in the area.
Taxes & Insurance: When you own your home, you’re responsible for property taxes. Well, even when you rent your home, you’re still paying for the property taxes, they’re just in your landlord’s name. Same goes for insurance, which pays to rebuild or repair the house in the event of a fire or other casualty. Mortgage companies will collect money on your behalf to pay the property taxes and insurance, even if taxes are only due two times per year or if it’s an annual insurance policy due once per year.
If you can (stretch to) afford a mortgage, better to put your monthly payments into a house you own rather than into the pocket your landlord owns.
Financially, building equity (the amount by which the value of your home exceeds any mortgage secured against it) is a big reason to buy. Equity is yours. When you move out, you get to take the equity with you.
Example Time — Rent: If you rent an apartment for four years, paying $2,400/month split with your two roommates, then you move out, you don’t get to reclaim any of the $38,400 in rent you paid. And after 15 years of moving from one rental to another, you still have to pay rent.
Example Time — Own: Unlike renting, when you move out of and sell a home you own, you get to keep the equity (sales price minus balance remaining of the loan).
Say your purchase price is $200,000 and you put 20% down — your loan would be for $160,000. With a 4% interest rate and a 30-year amortization period, your monthly mortgage payment (including taxes and insurance) would be $1,013.86. If you live there for four years then sell it for $200,000 (usually, however, there would be some appreciation), you have to pay off the loan, of course, but then get to keep $51,978.31.
That’s the amount of equity you would have built up during the course of those four years. The $40,000 down payment is built into it, but there’s another $12k that you get to take with you.
In addition, our tax laws incentivize homeownership. Just like Congress has created special vehicles for investing so people can pay for their own retirement, education, and healthcare, Congress has created the mortgage-interest deduction, which lets taxpayers who itemize offset the amount of taxable income they recognize by the amount of interest they pay on their mortgage.
Other financial considerations
This is only a convenience consideration. It’s not that you don’t pay for the repairs and maintenance when you live in an apartment — those are built into your rent. But it’s nice to not have to worry about fixing — or paying someone else to fix — the leaky sink or running toilet.
When you own a house and things need replacing, you’ll have to reroof your house and reseal the driveway. And of course, if you have a yard, you’re in charge of mowing and weed control and trimming the hedges.
If those things are more chores than joys for you, there’s a lot to say for renting your home from a responsive landlord. That’s a real value-add for lots of people.
Related to the can-I-afford-it line of questions, you also need to consider location. If you can rent a great space five minutes from your work and play, that’s super valuable and worth tons of time and commute costs compared to only being able to afford the $200,000 townhome 90 minutes outside the city.
And even if you can afford a place, say, 30 minutes away from where you do your living, that 25-minute spread, twice or more per day, costs a lot.
And if living in the city is just a temporary, while-I’m-young kind of thing, and you’ve always planned to move back home or to a suburb, then the ease of moving into and out of an apartment for a 2- or 5-year stint is also valuable.
It usually takes a lot of energy to buy a house and then to sell it. It’s nice to drop off the apartment keys at the leasing office and be on your way on the last day of your lease, around which you can conveniently plan.
So should you continue renting or buy a home?
Homeownership is near the top of many people’s life goals. If you’re not now actively seeking out a home to buy but do intend to “someday,” I can’t recommend enough that you begin a deliberate savings plan.
Create a separate savings or money-market account (or perhaps a CD ladder) to accumulate your down payment. It’s important to check in with yourself periodically to ask whether “now” is the right time.
Based on the financial considerables above, if you can “afford” to buy a home — financially, mentally, and hassle-y — and your timeline lines up, putting (dolla-)dollar bills (ya) into your equity wallet rather than spending money you’ll never get back on rent is a choice you won’t regret.