Housing Has Dropped And Rates Are Low – Should I Buy A House?

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Home prices have dropped 10-20%. Interest rates are at historic lows. So does it make financial sense to buy a house right now? I’ve been asking myself this question for the past few months but can’t seem to find a compelling reason to do so. The numbers just don’t quite stack up.

Since I have a child and a business, my parents are also pushing me to buy a house. Even my accountant is advising me to purchase a home in order to provide a tax shelter. Do I listen to my parents and my accountant? Is it worth sitting down and running the numbers?

In general, I don’t take anyone’s advice blindly unless I have a chance to do my own math. Here’s why I’m holding off on buying a house and a breakdown of my analysis.

Calculating The Monthly Mortgage Payment

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Photo By Fotographix

The easiest way for me to perform a buy vs rent analysis is to run the calculations on the home that I’m currently renting. Right now, my rent is $2200. According to other comparables in my area, the house I’m renting is worth roughly $625K.

If I were to put 20% down, take a 500K loan at 5% (30 year fixed), my monthly payments would be roughly $2684 dollars. As you can see already from a cash flow perspective, buying a house would increase my monthly payments by roughly $484 right off the bat.

Taking Into Account Tax Benefits and Equity

But just taking the mortgage payment at face value isn’t really a complete and fair calculation since there are tax benefits involved with owning a home. In addition, since a small portion of my payment goes directly towards the equity in the house, I need to factor that amount in the final calculations as well.

My handy mortgage calculator tells me that the amount of equity I would be gaining per payment (for the first year) is roughly $600 and the remaining $2084 is what I would be paying as mortgage interest.

If I assume that I’m in the 33% tax bracket, that’s roughly a savings of about $695 dollars a month. If I factor these two numbers into my calculations, my true monthly costs of buying a house come to about $2684 – $695 – $600 = $1389.

Keep in mind that $600 of this money is in equity that I can’t easily extract unless I get a home equity loan. All of a sudden though, it appears quite favorable to buy.

Property Taxes and Other Expenses

What else am I missing here? Here’s something that most people forget to include in the cost of owning a home, the dreaded property tax. In California, property tax is roughly 1.25% a year. For a $625k house, this amounts to $7812 a year or about $651 monthly.

This amount is technically tax deductible but because of AMT, I’m never able to deduct my property tax. Therefore, property tax becomes a pure cost to owning the home for my particular situation.

Another expense that most people forget to include is fire insurance. It really depends on your coverage but the quote that I received from my insurance provider was roughly $100 a month for a comparable home. If you also factor in another $100 (being really conservative) a month for upkeep (gardening,repairs, renovations), that puts us at about $2684 – $695 – $600 +$651 + $100 + $100 = $2240.

Opportunity Costs

Still seems about even in terms of buying vs renting right? The other item missing from our calculations is the time value of money. By sinking $125k of my hard earned cash into the home, I could’ve been using this money to earn even more money. Even if we assume a very conservative 3% yearly rate of return, this amounts to $3750 a year or about $312 a month.

With everything taken into account, it all of a sudden costs

$2684 – $695 – $600 +$651 + $100 + $100 + $312= $2552

to buy the same home that I’m renting. If I look at things from a pure cashflow standpoint, I’m effectively spending $3152 (removing the equity portion of the calculation) to buy vs $2200 a month to rent the exact same house.

The Intangibles

Most people will argue that the pride of owning your own home outweighs the additional costs involved. They’ll also tell you that real estate never goes down in the long run.

It’s tough to take into account the intangibles when buying your own home, but during these hard economic times, one thing is absolutely clear. You need to be conserving cash. You need to be controlling your cash flow to prepare yourself for potentially harder times ahead.

The real estate market is still in the doldrums. Instead of shelling out extra cash for the pride of ownership or as an investment, you need to run the numbers and all of the scenarios involved.

In my case, I believe that real estate prices are going to remain flat for at least the next few years. Why risk my cashflow when there’s very little financially to gain in the near term?

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20 thoughts on “Housing Has Dropped And Rates Are Low – Should I Buy A House?”

  1. Extremely well thought out. An excellent example for those who make impulsive decisions that will be with them for a long time. I think the biggest unknown here is what the housing market will do.

    1. @Jonathan
      My sentiments exactly. In my gut, I feel like there’s still a few years remaining in this recovery so it’s probably best to wait a little bit
      @Nathalie
      My parents made most of their wealth through real estate so they are somewhat biased. Back in their days, a house was only 1.5-2x their yearly income. These days, it’s more like 8x
      @Sue
      Thanks for pointing that out. I tried to make up a modest number to account for repairs ($100 a month) but that probably wouldn’t be enough to cover everything.

  2. I really enjoyed reading your analysis. I’m not planning on buying a home in the near future, mainly because I want to be more mobile. But this is a great analysis for me to show to my parents, who are still interested in the whole “owning a home” paradigm. 😉

  3. Very well written, Steve. But one other thing not mentioned are the hidden costs of home ownership, in that you will now be doing/paying for maintenance on your home, rather than your landlord. If something, say the water heater, breaks, it will now be your responsibility. Need a new roof? Guess who pays.

    While I know those costs can’t be put in as a number, it certainly does add into the equation.

  4. Great analysis!! And – I would completely agree! And the other thing you didn’t mention is that when you own a home suddenly you will feel the need to paint and do a bunch of extra things that you don’t necessarily do as a renter. That is more money and time you will spend. (And in many cases even if you are renting your landlord will pay for those things anyway if you’re a good tenant and she wants to keep you!).

    Buying a home to live in is not the same as buying a rental property … you’re buying a lifestyle more than an investment. There are investment benefits to home ownership, but it’s not quite the same decision. Many people make the mistake of rushing into home ownership – they think that a home is a great investment. But, in many cases, their money would do much better invested in other things while they stayed renting.

    It’s all about personal investment and lifestyle objectives – and I think you’re clear on yours and are making a wise decision for you, your family, and your business!! Great article!!

    1. @Julie
      Good to hear from you! Since you are in the real estate business, I’m kind of surprised that you agree with me:) Though I guess renting a property and living in it are completely different scenarios. I would like to give being a landlord a try sometime and when I do, I’ll be sure to comb each and every one of your articles.
      @ Peter
      When I owned my townhouse, there was a bunch of miscellaneous expenses during my 8 year stay there. Fixing things was quite a pain and I’m somewhat relieved to be renting again.
      @Evan
      Agree with you 100%. I’m going to write a followup article that address this. Thanks for pointing this out.
      @Stephen
      Deep down, I really want a house, but I also don’t want to feel obligated to work for my mortgage. I hope what I’m doing is the right thing, at least in the near term. Thanks for the comment!
      @Asithi
      Yep, I agree with you and Julie. It definitely is a lifestyle. I owned a home for 8 years before selling it last year. It was fun to have full control over the look and feel of my place but I don’t miss the maintenance.

  5. Excellent analysis! Most people forget to take into account all the extra costs of home ownership like insurance, association costs (if there are any) upkeep, maintenance, utilities, etc.

    Home ownership is a lot more expensive than people think. Best to get yourself in as good a position as possible, and save up a nice big down payment first. No need to rush into things, and there’s no shame in renting.

    I also think the tax benefits of having a mortgage can be overstated.

  6. The tricky factor is whether rents and repayments will rise in real (inflation adjusted) terms. It may be that over the thirty years the rents will rise and the repayments fall.

  7. Great article! I loved your detailed analysis. My personal opinion is that you are making the right decision. I think home ownership is overrated and risky. Having said that I have owned a home since I was 21 (the bank has owned it most of the time).

  8. My husband and I just brought our first home a month ago. We did the math and our numbers were an extra $200 a month for the mortgage. But when you add in taxes, insurance, HOA, lawn service, etc, it ended up costing about $900 extra. Since that was the amount of money we were putting aside each month for a down payment on a house, it just makes more sense in our situation to get the house now than to wait a couple more years.

    Julie Board mention that owning a house is more about a lifestyle. I completely agree. I find myself more interested in getting to know my neighbors and involve in community events. Before I would come home and just close the door. And I also find that I love being a home owner. We finally get to paint the walls and I am planning my garden for next spring. It is a nice feeling to go home to my own castle.

  9. Nice analysis. The pride of ownership factor is a big one. I’m sure at some point (if you guys decide to buy a home), while owning a home, you guys are going to decide that you need to upgrade the kitchen for example. Even on a smaller scale, landscaping can get pretty expensive.

    Great post!
    -Dustin

  10. Steve,

    Perceptive evaluation on your part. A lot of people struggle with processing the numbers and easily get caught up in the glamor of wanting their dream home. And when this happens, they’ll pay the price in more ways than one for a chunk of their lives. It’s sad, I remember learning about all of this in college and realizing how ignorant the masses are- I couldn’t recall ever learning this in high school. I was disappointed.

    If I had the cash flow, I’d aim to invest it into a product or situation which will possibly create more breathing room and cash to pursue other opportunities. Thanks for sharing.

    -Mig

  11. Parag says:

    Well written.

    Just a few points I think you missed.

    1. I think it makes sense to compare the rent vs buy numbers over several years instead of just one year. You should ideally use the time you plan to stay in your current home.

    2. My rent has been increasing by $50 to $100 every year. This increment needs to be taken into account.

    3. Lastly, your calculation is making the assumption that the price of your house will stay the same. If I decide to keep the house for say 5 years and then the value of the house increases between 5-10% than house buying may not be all that bad.

  12. a. says:

    What did you do in the meantime? Did you buy a house?

    In my opinion, $625K, for instance, is a lot of money to pay for a house.

    I tend to be very careful and cool-headed as far as buying houses is concerned. (I once did a mistake that took time and hard work to repair).

    People usually tend to be so emotional over houses and don’t always do the math.

    I now prefer having mobility in life and, especially, not having a mortgage. Times can change quickly nowadays. You never now what life reserves. I prefer to have flexibility, mobility, and accumulate wealth in the meantime. When I retire, I will have a house without a mortgage, but not necessarily in an expensive city (to which we are usually tied by work or the kids’ schools). To me, a house is just a place to live. I don’t necessarily want to own one NOW.

    Parents love it when children settle down, preferably close to them (especially when there are grandchildren). :-) Elderly people love to know that they will have family close by. Maybe we are all like this at a certain point in life. However, buying a house requires serious analysis and peer pressure shouldn’t count.

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