Advice for Buyers
Why Buying a Home is a Good Idea
The Best Investment
As a fairly general rule, homes appreciate about four or five percent a year. Some years will be more, some less. The figure will vary from neighborhood to neighborhood, and region to region.
Five percent may not seem like that much at first. Stocks (at times) appreciate much more, and you could easily earn over the same return with a very safe investment in treasury bills or bonds.
But take a second look . . .
Presumably, if you bought a $200,000 house, you did not pay cash for the home. You got a mortgage, too. Suppose you put as much as twenty percent down – that would be an investment of $40,000.
At an appreciation rate of 5% annually, a $200,000 home would increase in value $10,000 during the first year. That means you earned $10,000 with an investment of $40,000. Your annual “return on investment” would be a whopping twenty-five percent.
Of course, you are making mortgage payments and paying property taxes, along with a couple of other costs. However, since the interest on your mortgage and your property taxes are both tax deductible, the government is essentially subsidizing your home purchase.
Your rate of return when buying a home is higher than most any other investment you could make.
Income Tax Savings
Because of income tax deductions, the government is subsidizing your purchase of a home. All of the interest and property taxes you pay in a given year can be deducted from your gross income to reduce your taxable income.
For example, assume your initial loan balance is $150,000 with an interest rate of eight percent. During the first year you would pay $9969.27 in interest. If your first payment is January 1 st, your taxable income would be almost $10,000 less – due to the IRS interest rate deduction.
Property taxes are deductible, too. Whatever property taxes you pay in a given year may also be deducted from your gross income, lowering your tax obligation.
Stable Monthly Housing Costs
When you rent a place to live, you can certainly expect your rent to increase each year – or even more often. If you gat a fixed rate mortgage when you buy a home, you have the same monthly payment amount for thirty years. Even if you get an adjustable rate mortgage, your payment will stay within a certain range for the entire life of the mortgage – and interest rates aren’t as volatile now as they were in the late seventies and early eighties.
Imagine how much rent might be ten, fifteen, or even thirty years from now? Which makes more sense?
Some people are just lousy at saving money, and a house is an automatic savings account. You accumulate savings in two ways. Every month, a portion of your payment goes toward the principal. Admittedly, in the early years of the mortgage, this is not much. Over time, however, it accelerates.
Second, your home appreciates. Average appreciation on a home is approximately five percent, though it will vary from year to year, and in some years may even depreciate. Over time, history has shown that owning a home is one of the very best financial investments.
Freedom and Individualism
When you rent, you are normally limited on what you can do to improve your home. You have to get permission to make certain types of improvements. Nor does it make sense to spend thousands of dollars painting, putting in carpet, tile or window coverings when the main person who benefits is the landlord and not you.
Since your landlord wants to keep his expenses to a minimum, he or she will probably not be spending much to improve the place either.
When you own a home, however, you can do pretty much whatever you want. You get the benefits of any improvements you make, plus you get to live in an environment you have created, not some faceless landlord.
The Business Cycle and Buying a Home
Recession and Expansion
There are times when the economy is brisk and everyone feels confident about his or her prospects for the future. As a result, they spend money. People eat out more, buy new cars, and . . .
. . . They buy houses.
Then, for one reason or another, the economy slows down. Companies lay off employees and consumers are more careful about where they spend money, perhaps saving more than usual. As a result, the economy decelerates even further. If it slows enough, we have a recession.
During such a time, fewer people are buying homes. Even so, some homeowners find themselves in a situation where they must sell. Families grow beyond the capacity of the home, employees get relocated, and some may even find themselves unable to make their mortgage payment – perhaps because of a layoff in the family.
In the business cycle of real estate, there are buyers’ markets and sellers’ markets . . . and some markets in between. It is all based on supply and/or demand.
Supply and Demand – Inventory
During sellers’ markets, homes sell quickly and sellers have a lot of pricing power. As a result, prices rise more rapidly than at other times. During buyers’ markets, homes may sit on the market for a while before selling, so sellers become more flexible and may even drop their prices.
The market is determined by supply and demand.
In real estate, the relationship between supply and demand is calculated as “available inventory.” At the current sales pace, how long would it take to sell the total number of houses available on the market? That is how the real estate industry measures inventory.
Inventory is measured in weeks and months. Longer inventory times are associated with buyers’ markets. Shorter inventory periods are associated with sellers’ markets. Some buyers and sellers hope to time their purchase to take advantage of market cycles.
Timing Your Purchase to the Market Cycle
One problem with attempting to time your purchase to the business cycle is that even experts have problems accurately predicting the future economy. Even when they can, the real estate market does not necessarily move in tandem with the stock market or the economy as a whole.
Part of the reason is interest rates.
When the economy is doing well, interest rates are generally higher. The result is that fewer people can afford houses. When the economy slows down, interest rates fall, the “affordability index” moves up and more people can afford houses.
As you can see, this cycle does not move “in sync” with the rest of the economy. It is also influenced by how many people have jobs, whether they are well-paying jobs, and consumer outlook for the future. All these factors make it difficult to know, in advance, whether the housing market is going to boom or bust.
What makes more sense is the “buy and hold” strategy. Buy a home you expect to remain in for at least seven years or more.
Why You Should Not Wait to Purchase a Home
Even if you could “time the market,” that strategy would most benefit first-time buyers.
You see, people who already have a home usually need to sell it in order to come up with the down payment for their next home. Even if they don’t, they would have to carry the debt and obligations on two homes at the same time. This can create financial hardship, even when you rent out the previous home. There are maintenance costs, renters don’t always make their payments on time, the rent may not cover the mortgage and other costs, and sometimes the property may be vacant.
So if you are a move-up buyer and want to purchase your next home during a depressed market, you generally have to sell your current home during that same depressed market. If you want to sell during a boom, then you also have to purchase during the same boom.
It tends to equal out.
Finally, suppose you are a first-time buyer and wait, thinking the end of a boom is near? If you guess wrong, are you going to wait . . . and wait . . . and wait . . . till the next depressed market? If so, you could miss out on loads of depreciation . . .
. . . and that is assuming you guess right about your market timing. In 1996, when the home market was struggling, who would have predicted what the next seven years would bring.