Buying a home is major investment decision. But, what did we learn from the housing crisis? When does homeownership make sense?
Deciding to buy a home is the biggest investment decision you will ever make. Some people still believe homeownership is the pathway to prosperity, but have fears after our recent housing market crisis that forced millions of homeowners out or left them struggling to save their most valuable asset. For others, homeownership is not the logical next step in life, because a growing number of people no longer choose traditional lifestyles. However, if you’re at the pivotal stage in your life that beckons the call of achieving “The American Dream” and are on the fence, we help you weigh the odds.
Read: 7 States With the No to Low Taxes In Retirement
Housing Market Snapshot
Mortgage rates are historically low. Currently, the average rate for a 30-year mortgage is 4.2%, but after the housing market tanked, banks tightened lending restrictions – making it near impossible for would be homebuyers to qualify for loans. This resulted in a stagnant housing market that has forced banks to relax their standards and lend to buyers with lower credit scores and smaller down payments. According to the Mortgage Banker’s Association, “Mortgage credit loosened somewhat in June as a result of a slight net loosening in lender criteria regarding Federal Housing Administration (FHA) and Department of Veterans Affairs (VA) loans with respect to minimum credit scores and maximum loan-to-value (LTV) ratios.”
According to US Census data, this year’s second quarter vacancy rate was 7.5%, down 0.7% since 2013’s data. Vacancy rates have been steadily declining since the housing crisis began in 2008 ushering in 4.4 million new renters due to the wave of foreclosures. The national average rent increase is 3.9% – creating a landlord’s market. Rents have outpaced inflation, which indicate a June increase of 0.3% and 2.1% in the past twelve months.
Buy vs. Rent & Invest
Key things to consider: the average cost of rents in your area and whether demand is driving up costs. By taking a look at two very different rental markets we demonstrate how where you live should impact your decision to buy or rent:
In (A) Brooklyn the average rent for a one-bedroom apartment is $2,721, according to real estate brokerage firm MNS. The cost of a one bedroom in (B) Houston is approximately $1,200. Now, taking today’s average 30-year mortgage rate of 4.2% and the standard down payment of 10%, we look at Brooklyn residents pre-qualified for a $500,000 mortgage loan and Houston residents pre-approved for a $250,000 mortgage.
Using a mortgage calculator, we find the Brooklyn mortgage with primary mortgage insurance (PMI) is $2,741 and $1,361 for the Houston home. These figures are about the same as area rents, but factor in roughly 3% of the home’s value for property taxes and you get a slightly different picture. Your monthly expense goes up to (A) $3,971 and (B) $1,986. In addition, condos, co-ops and sub-divisions also have monthly maintenance fees and possible assessments or Homeowners Association fees (HOA). And please don’t forget about property insurance! The takeaway: it’s cheaper to rent, so it’s really a question of affordability.
Can you afford it? Assuming you can, what would happen if you decided to rent for another 10-years and made it a priority to invest, such as investing in well-diversified low-cost ETFs. Taking the initial investments of (A) $50k and (B) $25k that would otherwise be used for a down payment, put into an investment portfolio that yields an annual 10% return, with monthly contributions of (A) $1,250 or (B) $786 (mortgage less the average cost of rent), your investment would grow to (A) $392,654.63 and (B) $230,197.53, you would be debt free and in a much stronger financial position to buy – assuming you choose to.
Where will you be in 10-years on your mortgage? You would have roughly $350k left on your mortgage in Brooklyn and $175k in Houston, but the upside is you would have built some equity in your home, and in 30-years your property would likely have increased in value. Let’s say it’ll be worth 2/3 more than what you paid for it, or (A) $833k and (B) $417k. That’s a drastically different return on your investment than if you were to invest in a well-diversified portfolio. Your 30-year investment portfolio would grow to (A) $3,586,621.49 or (B) $2,142,893.44.
So, should you buy vs. rent and invest? I believe investing in financial markets is clearly the better choice if deciding to buy is based solely on returns. Home values across the nation have continued to decline since 2008, though there are a few markets where values have risen, and renting has become less affordable. If you have to buy, the geography of the property and what’s happening in that area’s housing market should be the deciding factors. It has to make sense for you and depends on your job stability and how long you anticipate remaining in that location, but it’s hard to predict the next 20 or 30-years. Weigh your options carefully before deciding which path you choose.