To Buy or Not to Buy
Homeownership has long been regarded as one of the key elements of the “American dream.” America has one of the highest proportions of homeownership in the world, with more than six out of every ten families living in owner-occupied housing.
The reasons for America’s love affair with homeownership are many. Some are financial. Our tax code continues to subsidize heavily the ownership of homes, making it more attractive than renting for most people. Homeownership is also America’s favorite forced-savings and investment plan, with an increasing share of the monthly mortgage payment going into the building of equity for future uses-another home, college expenses, retirement, etc. A home is, truly, the only investment you can live in, and over the past 40 years, it has been a generally well-performing investment, relative to alternative uses of money.
But much of the motivation behind homeownership is psychological. This country was founded on principles of individual destiny, personal control over one’s life and surroundings, and freedom of individual expression. A home of one’s own helps fulfill all of those promises, giving the owner freedom from rent hikes and the whim of the landlord, and the freedom to live life as he or she wishes. A home can provide a sense of security and pride. A home gives a feeling of stability and commitment, not to mention autonomy and privacy. It is often the first step in an owner’s putting down roots in a community.
But like most freedoms, the benefits of homeownership also carry heavy responsibilities-financial obligations and duties of maintenance, recordkeeping, and planning.
The Intangibles of Buying a Home
It’s no wonder that psychologists rank buying a home high on the list of stress-producing events. Not only is it the biggest purchase most people make in a lifetime, but it also forces a wholesale examination of goals, commitments and lifestyle. It’s an emotional as well as a financial investment.
People buy homes for lots of different reasons. Before you go into the market for a home, examine your motives, clarify your wants and needs, and focus your investigation.
With so much at stake, don’t rush into the market without thoughtful preparation. If you join the ranks of buyers charging about searching for answers without knowing the right questions, you may, by luck, end up with a house you can live with. Then again, you may spend weeks, even months, looking at houses only to end up feeling thwarted and confused.
Before you take the plunge, address questions like these:
What does being a homeowner mean to you? To your spouse?
What do you really want in a home, and from a home? If you have children or plan to some day, how will your choice of home affect them ? Your home determines where children will go to school and what facilities will be nearby for recreation, shopping and worship. What about proximity and convenience for friends? Its location or design can make it a favorite gathering place for your friends or extended family.
How will becoming a homeowner change you and the way you live? Who hasn’t heard stories about the totally unhandy new buyer who ends up renovating his or her home from top to bottom; the successful business that had its beginning in a spare room or basement; or the irrepressible free spirit who is transformed into a model of financial responsibility by homeownership?
Homeownership Financial Benefits
Treating a home solely as an investment probably is impossible. Financial calculations alone fall short of giving you the perspective you need for such a big decision. Still, a home is a major investment, and the financial aspects of homeowners hip should not be ignored.
Here are some of the key financial benefits of homeownership:
Budgetary Discipline
Accumulating the down payment on a home is often the goal that creates a family’s first real savings program. Later on, paying the mortgage is a strong inducement to creating and sticking with a budget. Depending on your personality and level of discretionary income, this form of enforced savings (and consequent equity buildup) can be an important factor in boosting family net worth. Stripped to its essentials, equity is the difference between what you would get if you sold your home and any debt outstanding. Equity includes the down payment, all payments against the principal balance, and any appreciation in the market value of your home that occurs after you buy it.
The Power of Leverage
Buying a home offers you the opportunity to magnify the purchasing power of your money through what is called leverage-the use of borrowed money to purchase an asset that is likely to appreciate, magnifying your profit.
Normally, you buy property-whether it’s a home or a commercial building-with some of your own funds plus a long-term mortgage. That use of borrowed money enables you to profit from price increases on property you haven’t yet paid for.
The larger your loan as a proportion of the home’s value, the greater your leverage and potential gain. Say you purchase a $100,000 single family house with no loan and sell it three years later for $125,000. The $25,000 gain represents a 25% return on your $100,000 outlay.
Suppose, on the other hand, that you had invested only $20,000 of your own money, while borrowing the other $80,000. When you sell (ignoring for the sake of simplicity the cost of the loan, tax angles, commissions and other costs) you have made $25,000 on your $20,000 investment, a spectacular 125% return on your investment over the three years of ownership.
Using maximum leverage-with a very small down payment and very large mortgage-isn’t prudent or advantageous for everyone, but most first-time buyers will need all they can get just to open the door.
Appreciation
If your home is worth more now than when you bought it, that’s appreciation. When you sell it you can use the profit as a springboard to a better home. Or you can tap the equity/appreciation build-up to pay college tuition, to buy a vacation hideaway, to take a long dreamed-of ocean cruise. For many people, the equity in their homes becomes a major source of retirement funds.
Tax Benefits
Homeowners benefit from the tax deductibility of mortgage interest and property taxes. When you sell, you can defer federal taxes on all the profits if within two years you buy another home of equal or greater value. When you reach 55, you can sell the home and keep up to $125,000 of profit completely free of tax.
The Risks and Hard Work of Homeownership
So far, it may sound like there’s no way to lose. But homeowners hip is not for everyone. There are risks-as well as burdens.
Financial Risks
The value of your home is not guaranteed to go up, and it could go down. The leverage that is so alluring when real estate values are on the rise can act to magnify losses as well as gains. For example, suppose you invested $20,000 in a home valued at $100,000 in a booming economy. Then recession hits your community, you lose your job and you’re forced to sell for $80,000; the $20,000 loss wipes out 100% of your investment, and you’ll probably have to dig into your pocket to cover commissions and other expenses. Real estate is not a liquid asset. You can lose if you have to sell in a hurry, because of a divorce or job loss, for example.
You lose, too, if you invest in a home a sum of money that could have been invested elsewhere for a better return. If alternative investments-such as stocks or bonds-are rising in value faster than homes in your area, you might do better, in the short run, as a renter/investor rather than a homeowner.
Even if you buy a home, you may want to hold back some of your cash to invest in income-producing assets, rather than pour it all into your new home; this is especially relevant for the trade-up home buyer who has substantial cash from the sale of the previous home.
Homes cost money to maintain. You have to be prepared to pay for routine maintenance (usually with time and money) and for the inevitable replacement of big-ticket items, such as the roof or furnace.
Reduced Mobility
Homeowners have less freedom of movement; it’s not as easy to pack up and move for a change of scenery or a new job. And a hefty mortgage payment may make it hard to maintain any other savings and investment programs for retirement, vacations and other things.
Rent vs. Buy
In the short run, renting often makes more financial sense than buying, in terms of how much shelter one can afford for a given price.
Rents tend to be an accurate reflection of the free-market pricing of housing simply as shelter. But the ownership cost of a house or condominium is a combination of both shelter value and investment expectation.
So at any given moment, you can usually rent an apartment or house for less than the monthly carrying costs that a buyer of that property would have to pay to carry it through the early years of ownership.
This explains why many young people can’t afford to own the very condominium that they’ve been renting with no financial strain, or why a young family might be able to rent a much fancier, more spacious house than they would be able to buy.
That’s the short-run picture, but the long-range view is different. Over time, rents tend to rise, but the basic cost of owning your own home - the monthly payment of principal and intereststays the same. Combined with a record of price appreciation, this is what makes homeownership financially attractive in the long run.
Until the “long run” arrives, however, you may have to make some sacrifices to become a homeowner. You may have to put up with less space if you have to pay more to own a small home than to rent a larger one. To find a house you can afford, you might have to move to a location farther from your job and favorite haunts; that means extra traveling cost and possibly two cars for your household, where one used to suffice.
Buying a House with Others
The vast majority of houses are either solely owned by individuals or jointly owned by married couples.
But with a surge of unorthodox living arrangements in the 1970s came a new variety of ownership arrangements among unrelated individuals sharing the same principal residence or vacation home. Single people living as couples or just groups of friends wanted the advantages of homeownership, too.
Many lenders are still cool to such arrangements, but some are not.
There are proper ways to go about buying property jointly with relatives or unrelated friends, the two most common being tenancy in common and partnership. A good real estate attorney can explain them to you.
Owning in a group can create problems. When a tenancy-incommon ownership share changes hands, the lender may declare the loan due. The only recourse, if you don’t want to sell the property, is to refinance.
Setting up a general partnership to own the place can head off many of those problems by anticipating and dealing with them in the partnership agreement. Use your lawyer to draw up the agreement.
Make sure the partnership agreement addresses the following points:
- How ownership will be divided, which in tum determines who pays how much of the down payment, monthly payment, maintenance and repairs. The contract should also describe how any profits or losses from rent or sale of the place will be divided and how tax benefits will be distributed.
- How use of the house’s space is to be divided.
- What constitutes a deciding vote and under what circumstances such a vote is considered necessary.
- Which owner will act as managing partner and thus be responsible for signing checks and paying routine expenses.
- How much advance notice a withdrawing partner must give and how the buyout price will be set.
A partnership may also protect the existing mortgage when a new owner enters the picture if the lender agrees that it is an interest in the partnership-not an interest in the property-that is being transferred.
Ideally, a general partnership should try to find a lender who is willing to limit each partner’s liability on the loan to his or her respective percentage of ownership, even though such agreements are unusual. Otherwise, each partner is responsible for 100% of the loan, so a lender could single out any partner to sue for the money if there’s a default, instead of going through complicated foreclosure proceedings. Regardless of this protection, you’ll want to be confident that each member of the buying group is financially responsible, creditworthy and stable in his or her career.
The legal and financial techniques associated with ownership by unrelated individuals are just the beginning of your consideration of this issue.
Just as important, or even more so, is compatibility of lifestyle and the prospects of a durable friendship among all involved. As for investment value, keep in mind that partnership interests in a commonly owned house are not highly liquid. To get full value for anyone’s share, the group may have to sell the whole house.
There are a lot of obstacles to overcome in such an arrangement, but with careful planning and thoughtfulness among friends, it can work out well both socially and financially.
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