The question around if and when someone should purchase a home could be split into two parts; the objective and subjective. Objectively, we can look at interest rates, current costs of houses, what inventory of homes is currently available, personal income/expenses, and a host of other data points to give us a good look at the numbers. The subjective side would lead us to consider your long term goals, your feelings on home ownership, your feelings on debt, and other questions that would make me sound more like a therapist than a financial advisor.
Buying a home is typically the largest purchase you will ever make and therefore can be a large driver for your financial health. It makes sense to measure twice and cut once when it comes to this big of a decision. Let's go through these topics one by one to give some detail around why they each are important.
The Current Housing Market
When it comes to making a purchase, it can be a good idea to think of it as an investment. . In other words, how far is your money going with this purchase? Are you getting a lot of "bang for your buck?" Are the prices of homes currently inflated over what we would expect them to be? Take a look at this chart showing home prices through time:
We can see that it rare for home prices to actually go down. The other thing to glean would be that home prices typically increase at a moderate but consistent clip. Lastly, we can see how quickly home prices increased the last few years and then actually went gone down this past year. My takeaway is that home prices have increased at a fairly consistent basis the last few decades.
What does your local market look like?
Our next point is what your local market looks like. Here in the Lansing, MI area, home prices are up 50% since 2018 but only 1.7% in the past year (source). Grand Ledge is up 43.6% since 2018 and 3.1% in the last year (source). We all know that home prices went bonkers right around 2020 but they have slowed down recently.
What does this mean? Honestly, it is hard to say. Similar to any investment, no one really knows what the future holds. What I would suggest is to use the data we have to make a best guess as to what is more likely to happen. For instance, is it more likely that homes will continue to climb at a moderate pace for the foreseeable future or that they drop sharply/spike quickly? I have heard multiple people comment that they are waiting for home prices to go down to buy a home. Unfortunately, it is possible, if not likely, that home prices will continue on their historical trend.
Comparing rental prices
The next topic to consider is the trade off between buying and renting in your area. Sticking with the data from Zillow above, the average home price in Grand Ledge is currently $275,880. If we put 20% down to avoid PMI and have an interest rate of 6.5%, we come up with a mortgage payment of $1,395 per month. You will then need to add in property tax, home insurance, and any of the upkeep costs to get a total monthly rate. For simplicity's sake, let's say we und up around $1,800 per month. By taking the Zillow rent estimate, a comparable house would rent for around $2,000 in Grand Ledge.
For Lansing. the average home price is $142,831. Using the same assumptions above for a 20% down payment along with doing rough estimates for other costs we come up with around $1,200 per month. Comparable homes might rent for around $1,600 per month based on Zillow estimates.
Keep in mind, these are just rough estimates used for our examples and will likely change based on individual needs and circumstances.
Factoring in additional costs of owning a house
I mentioned this in the rent vs buy example but it bears repeating. You need to include ALL costs of home ownership. HOA fees, property taxes, home insurance, utilities, heat/cooling, and general upkeep (anyone who owns a house will tell you stuff breaks). Don't forget the down payment and closing costs when you purchase a home which can number into the thousands of dollars. It adds up quick.
A common question is around how much of your income should be allocated for your home ore rent. A general rule of thumb says that you shouldn't spend more than 28% of your net income on your mortgage. I would encourage you to spend less.
Is it your forever home?
A key consideration should also be around how long you expect to live in the home you are considering buying. Expecting to spend more than a decade would tend to tilt the scale towards buying the house whereas if you only plan on being in it for a few years it may be better to rent. This is due to fixed costs of buying a home such as the closings costs as well as the fact that mortgages take the most in interest at the beginning of the term due to the principle being the higest it will be.
Do you have a down payment saved up?
This can be difficult to do and people may decide the draw of a house is too much and purchase it with less than a 20% down payment and pay PMI (private mortgage insurance). How much is PMI you ask? It depends on our next topic; credit score. Typical ranges are from 0.58% to 1.86% according to nerdwallet (source). On a $300,000 house, this can add an extra $131 per month at the lowest rate. Easy to see why it is best to avoid this.
What is your credit score?
Your credit score is basically your report card for home good you are at paying bills on time. It is a big deal. A good score not only will help you be approved for a mortgage but will allow for better interest rates. On top of that, it can keep PMI at lower levels if you decide to go that route. If your credit score is low, I would encourage you to work on building it up before making big purchases, like a house. It will save you a lot of money and teach you good money habits in the process.
What is your income situation?
Taking on a mortgage creates a large bill that is required to be paid every month. Take into account how reliable your income is and what other needs you have that can be costly.
On the income side, having a spouse with a separate income can take pressure of you in the case of job loss to still be able to pay the mortgage. On that note, are layoffs common in your profession or is it a stable job?
On the expenses side, do you have other needs that take a large amount of your income such as kids or supporting elderly parents? Creating additional pressure with a house payment can put undo stress and pressure on your finances.
Owning a home is part of the American Dream. It can be a great purchase in a lot of cases but not all.. If you are waiting around for home prices or interest rates to go down, you may be waiting awhile or forever. Go through the necessary steps to ensure you understand the implications and make the best decision for you and your family. It never hurts to include a finance professional in your discussions as this is what they deal with every day.