As a real estate professional, I’m regularly asked the following questions: is the market going to continue to go up or is the real estate market headed for a crash? Should I wait it out to buy until we’re at the bottom of the market?
The issue with these questions is that without a DeLorean time machine from Back to the Future… or a “Hot Tub Time Machine” if you’re into the more recent movie version… there is no way to know if we’re already at the top or if we are going to continue to climb? The opinions from economic experts are all over the board, ranging from doom-and-gloom to continuing prosperity! WHAT WE DO KNOW is that the real estate market has continued to cycle up and down since the beginning of time. It goes up, it goes down, then back up, then back down, and then it goes back up again!
My husband and I bought our first house in 2007 at the peak of the last housing bubble and we never blinked an eye as the value of our property and surrounding properties dropped to almost ½ of what we had paid in just a few years. We knew we were at or near the top of the market when we bought, but we still decided that buying was the right thing for us to do. Based on my experience, here are a few questions and pointers for ON-THE-FENCE buyers who are worried about timing the market. Hopefully, these pointers help you to consider what’s right for you?
1. RENT VS. BUY MONTHLY CALCULATION: In my local market (Marin/Sonoma/Napa areas), we are seeing rents rise to $3000/month for an “average” 3bed/2bath home. You get absolutely no tax deductions from paying rent. As you pay rent, you are helping to pay your landlord’s mortgage down instead of your own, and what’s worse, no matter what happens to the value of the home, you will never gain equity. Because I’m a total math geek, I’m going to walk you through some theoretical numbers. Let’s say that you have a budget of $600,000 to spend on a home. In Santa Rosa TODAY, you have 76 active listings to choose from at this price range. In Petaluma, your choices drop to 10 active listings under $600,000, but with an aggressive and knowledgeable buyer’s agent, you will still be able to buy one of these 10 homes even in a competitive market. A $600,000 home would cost you somewhere in the neighborhood of $3400/month for a standard 30-year loan with a down payment of 5% ($30,000). This includes Principal, Interest, Tax and Insurance (aka PITI). If you’ve tried an online mortgage calculator and the number came out much lower, you’ll want to make sure it includes all 4 of the PITI factors so that you are getting the bigger picture. Rate and monthly payments depend on credit, debt-to-income ratio, current mortgage rates and sometimes add private mortgage insurance (PMI), but this example is just to give you a general idea. At a $600,000 price point, of that $3400 monthly mortgage payment, approximately $625/mo is your monthly property tax payment. Your monthly interest would make up approximately $1,750/mo for the first few years and would gradually reduce over the years as you pay down the principal of your loan. Both of these are tax deductible, giving you a total of $2,375/mo in deductions (or approximately $28,500 per year initially). In addition, there are other costs which are also tax deductible based upon the purchase of your home (such as any points you may have paid when you bought the home). What’s more? – you are paying off the principal on YOUR OWN mortgage instead of your landlord’s. If you keep the home and loan for the entire 30 years, your interest and principal will be down to zero at the end, leaving you with merely tax and insurance payments for your “retirement”. On the flip side, if you continue to rent, you will be subject to your landlord’s climbing rents (wherever those might be in 5, 10… 30 years) and you won’t reap the benefits of the tax deductions. Talk to your tax professional and he can walk you through a more specific scenario based on your income and home purchase price.
2. WAITING FOR THE BOTTOM: “Waiting for the bottom” of the market is still a gamble. How do you know for sure when the economy hits bottom? Should we start to see a decline eventually, you could still have to wait 5-10 years of waiting if your goal is to buy at the bottom. This means that you continue to pay your non-deductible rent while helping to pay your landlord’s mortgage. Let’s go back to that $600,000 home. If you wait 5 years to buy it, you’re gambling on the market going up or down (which it may not even go down in that time). If you’re lucky enough that your landlord keeps your rent at $3,000 a month while you wait for the next 5 years, you are still paying $36,000 rent per year to someone else. That adds up to $180,000 over 5 years. It’s amazing to put the “total rent” number into perspective. On the other hand, after 5 years, your monthly mortgage payment would be very close to the amount of your rent payment, and you would have paid your mortgage balance down to approximately $515,000 with standard loan amortization. After 10 years, your balance will drop to approximately $440,000, and it will continue to drop faster and faster as a larger chunk of your payment is applied to principal later in the life of the loan. If you add the home ownership tax deductions up over the same 5 years, you could have in the neighborhood of $142,500 to offset your income. Over a 10-year period, that number could reach between $250,000-$300,000 in deductions, plus the whole time you could be gaining equity and you’re paying down your mortgage. If you plan to sell in the future, there are additional perks for living in the house for at least 2 of the last 5 years that you owned it (such as tax free gains when selling your first home), but we’ll cover those in a different blog.
3. THE DOWN PAYMENT: A common misconception is the down payment. Many buyers still believe that they need a 20% down payment to get into their first home. While a sizeable down payment (such as 20% down) will typically get you the most optimal interest rates and reduce the need for PMI (Private Mortgage Insurance), there are in fact many programs that offer reasonably low down payments. According to the National Association for Realtors, the average down payment for first time home buyers is 6%. Most applicants can get into a home for 3.5% down on an FHA program and if you’re eligible for a VA loan, you can actually buy with no down payment. There are also conventional programs such as HomeReady, Home Possible Advantage, and Conventional 97 which allow down payments as low as 3%. Many of these programs allow down payment funds to be “gifted” (for example: from your parents, family, etc.). I have several outstanding contacts in the mortgage industry that can help to find a program that suits almost anyone!
4. YOUR PERSONAL SITUATION: Do you want to live where you currently live… forever? Do you love what you do and are you planning to stay with your current career until you retire? When you go back to #1 above and run the numbers, the cost of renting will add up, but if your personal situation is stable and you plan to live where you are for the long-haul (or even just an extended length of time), then it’s worth looking at the perks of buying.
5. GO FOR PAR: Buy what you can afford in a neighborhood that will be attractive to a future buyer. There’s always a temptation for instant gratification to buy your “fancy forever home” which checks all the boxes and is in the same city as the location of your job, but if you’ve got the stomach to move more than once in your life, I would recommend starting with something reasonably priced that won’t stretch your budget too far as you learn the ins and outs of homeownership. It may not be your forever home, but buy something that you will like and make sure that it is something that will be able to attract future buyers to as well (for example, you might stay away from buying on the busiest street since that will take longer to sell should you decide you are ready to upgrade homes in the future). Your first home might mean that you are compensating by commuting a little more, having a little less square footage than you like, or having to put a little bit of “sweat equity” into your first home by buying and doing some of the upgrades as you go. In the end, if you buy at a comfortable price range that you can afford regardless of the ebbs and flows of the economy, then you will be able to ride out the down-cycles and upgrade in the future should your equity build.
6. PRIDE OF OWNERSHIP: We’ve all heard the term “pride of ownership”, but it doesn’t really hit home until you receive the keys to your new house. If renting has been keeping you from having pets, picking your own paint colors in your room, choosing a gas stove over electric, throwing a party, or anything else, then its really easy to appreciate the new freedoms that you gain once get the keys. I would love to help you take this next step!
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