Photo courtesy Robyn Flett
Many people get tired of making those rent payments and being restricted by all of the rules. Homeownership seems like such a great deal. Often, you can find a home with payments not much more than your rent. The temptation can be to run right out and make that purchase. There are a few things you need to watch out for though.
The Down Payment
Do you have at least a 20% down payment? Sure, you can get a loan without that much, but as with everything, there’s a price to be paid, the most obvious being a higher monthly payment due to a larger loan required. There are other not so obvious costs though.
Did you know you’ll need Private Mortgage Insurance (PMI) if you have less than 20% down? The amount varies due to many factors, but it can add $50 or more to your monthly payment. As long as you don’t default on your loan, the money goes straight into the provider’s pockets. It provides no benefit to you.
Another negative is one that many people have been experiencing in our current economy. The less of a down payment you have, the closer your loan value is to the appraised value. What happens when the housing market tanks? You’re suddenly upside down on your mortgage. Forget moving. You can’t sell your house without coming up with cash to make up the difference. That 20% down payment is kind of like insurance against that happening, although it still is a potential in particularly bad economies.
So maybe you think you’ll just take a loan or distribution from your retirement account? Oooooh. Bad move! While initially it may seem like a good idea since you’re “investing” that money in your home, the reality is that there is a very large cost involved that you probably aren’t even thinking about. That cost is the future value of your money. The single biggest factor in successful investing is time. The longer your money sits building interest, the larger the return. By pulling that money out, even if you pay it back eventually, you are costing yourself HUGE returns. Let’s say you have 30 years to retirement and you pull out $15,000 for a downpayment. Assuming a 10% return on your invested money, that $15,000 would return you almost $262,000 at the end of the 30 years. If you pull that money out and repay it to your retirement account over the next 10 years, it’s only going to yield about $101,000. That $15,000 withdrawal just cost you $161,000! And that’s only if you repay it!
The best alternative is to take your time. Plan ahead, get agressive and save up that 20% downpayment before you decide to buy.
Property Taxes
Okay, so you’ve got the 20% downpayment, and the mortgage payments are only $50 per month more than your rent payments. You’re good to go right? Nope. Did you factor in the property taxes? These can vary greatly from area to area, so this can have anywhere from a small to a HUGE impact on your budget. Make sure you look at the previous years property tax amount and make sure there aren’t any big changes in the works to the tax rate. Take this annual tax amount and divide it by the 12 and add it to your monthly budget. Can you still afford it?
Homeowner’s Association Dues
Is the home you’re looking at in a subdivision? Do they have annual dues? You’ll have to factor this value into your budget as well. Also don’t forget that part of that freedom from rules will be taken away as well if there are bylaws you have to abide by. There could be extra cost involved as well when you make improvements if there are appearance criteria you have to meet for those improvements.
Utilities
Have you given enough thought to the changes you will see in your utilities? Does your current rental agreement include some basics such as electric, water, or trash service that you will now be paying yourself? Don’t forget also that a larger living space means greater heating and cooling costs to pay as well. All of these factors must be considered and researched before you determine if your ready to step into a new home.
Maintenance
There are a lot of freedoms that come with your own home. You get to have pets; you can remodel the interior to your liking; you don’t have to worry about the drummer who lives upstairs. The price for that is not having a landlord to call when something breaks down. My wife and I were so happy when we bought our new home. A couple of weeks after moving in, it was my birthday. I woke up that morning and jumped in the shower to get ready for work… no water. Doh! The well pump had gone out. That was a $500 fix less than a month after moving in. You’ve got to make sure there’s enough room in your budget to save up for routine maintenance. You should also have an emergency fund for those issues that go beyond routine.
Insurance
I hope that if you’re currently renting, you do have renters insurance to protect your personal property in case of damage or theft. You’ll find though that the cost of homeowner’s insurance can be quite a bit higher than what you are currently spending. Get some preliminary quotes for the home you are looking at and divide that cost by 12 to see how it will affect your monthly budget. This is a necessity. Also make sure you evaluate whether it’s in a flood zone or something else that may add to the insurance costs.
15 or 30?
Okay, so everything else checks out and you’re ready to get that mortgage. The payments for a 30 year loan are so much more attractive, right? Once again, there’s a price for that. You sacrifice tomorrow for today’s convenience. On a $100,o00 loan at 6% you will pay a couple of hundred more dollars per month for a 15 year loan. However, your interest payments will drop from $116,000 to $51,000 over the life of the loan. That’s a big difference! The other benefit is that you will be paying down the loan principle faster. This gives you a bigger buffer against housing market crashes as well and keeps you from becoming upside down on your mortgage.
It’s a lot to think about isn’t it? When you’re making a decision this big though, you really need to consider all of the factors so that you don’t end up becoming one of the statistics we keep reading about in this economy.
For those of you who own a home, what other things are there that caught you off guard about home ownership?