Financials of Owning a Home
Owning a home is exciting. It’s a staple of the American dream and a rite of passage into the adult world. It seems more difficult than ever for people to take that next step to home ownership. How are you supposed to afford a home at such a large price? How are you supposed to understand all of those terms of a mortgage? Why does owning a home make sense anyway? Let’s dive in to start clearing some of these questions up.
Buying vs Renting
Have you sat down recently to consider the costs of renting a home compared to buying? I’m not just talking about the dollars to rent compared to a mortgage, which will normally surprise you how much you can afford to buy for the rent you are paying, but I’m talking about the opportunity cost in missed equity growth. How much are you paying in rent each month for an asset you will never see a return from? A house can become an asset you can take advantage of later in life. It could be an asset that helps fund your retirement. A lot of people will decide to downsize in their retirement phase because they no longer need the space. You now can use the equity you have earned in the home as an asset to help you travel or supplement an income. Renting is like that tux you get for a wedding. It doesn’t quite fit, it’s not yours to tailor, and you hope you don’t spill too much wine on it because it will cost you a lot when you give it back.
What is Equity?
Everyone always talks about the equity you can earn in a home, but what is it really? It is the fair market value of your home above what you still owe on the property. So roughly speaking, if you own a home worth $200,000 on the market now and you still owe $130,000, you would have $70,000 of equity in your home. What can you use that for? A lot of things. Most will use it for improvements to their home, like a new kitchen or bathroom, maybe even a pool. That may not be the best use of that equity as you normally won’t see that return in value for what you put into the upgrades. One possibility could be paying off other debt. Do you still have credit card debt lingering out there? What about multiple car loans? That speed boat you bought last summer? Compare the interest rates on those loans to the interest you would pay on a home equity line of credit. It could make sense to use your equity to consolidate your debt and create one payment a month at a lower interest rate. Another way to get access to your equity could be through a refinancing of your mortgage. Let’s use that same example as above. You could use a cash-out refinancing for say $150,000 that would replace your original loan with a new one, hopefully at a lower rate, and allow you to access $20,000 of the cash value of your equity in the home. Talk with an advisor to see which option would be best for you.
Saving for a Home
The idea of needing 20% of the home value as a down payment is a thing of the past. There are a lot of options for purchasing a home with less up front. Now, with that said, the more you are able to put down at the beginning, the better it will be for you in the long run. Paying more down now leads to quicker growth in equity, but more importantly, less in interest payments over the life of your mortgage. How do you start to save for that down payment? Start with the basics. Put away an extra twenty dollars each week. When you get used to living without that, gradually increase that amount. Where are you saving that money? Savings accounts are still paying relatively low interest rates so what do you do with your cash to help it grow? I would suggest considering a taxable brokerage account that would allow you to invest those funds. You don’t necessarily have to get aggressive with your investments, but even earning two percent could put you ahead of what you would earn in your bank’s savings account.
Understand your Mortgage
Much like anything else that has to do with finance, mortgages come with a lot of technical jargon that can sometimes be hard to understand. Ask for more details when you are looking at your mortgage options to find the right fit for you. Do you need a thirty-year mortgage or could you afford a fifteen-year instead? Are they offering a fixed rate or a variable rate that could fluctuate year to year? Watch for balloon payments. How much can you even afford in a monthly payment? Most advisors would recommend you don’t exceed 28% of your income before taxes. That house you really love could really squeeze your monthly budget if you aren’t careful. Know what you can afford and don’t forget to consider taxes and insurance costs as well.
Owning a home can be a great adventure and a useful tool for your financial growth. Like many other avenues, it isn’t necessarily right for everyone. Before you take the leap to own or decide you can’t afford it, talk with an advisor to help you sort through where you are.