Staying in your own dwelling is always a nice thing to do once you are settled from a personal milestone perspective. You need to do a thorough financial evaluation on whether you can make this dream a reality. From a personal preference perspective, key considerations like size (number of rooms, basement), type (condo, townhome, single family home), location (city/ suburb, school district) and timing of purchase (buyers’ or sellers’ market) would determine the cost of your dwelling. Next step is to determine your budget based on your affordability. In most cases, budget will dictate your key considerations and you would have to let go a few options. Once you have shortlisted a dwelling you will need to determine the upfront payment and monthly recurring payments. This determination with you expected monthly income and expected monthly expenses will determine if it’s right for you.
Factors Impacting Rent v/s Purchase
As a thumb rule, purchasing your home (on mortgage) is better than staying in a rental home. Like everything else, there are exceptions that you need to be aware of and make our own determination:
Continuity of Income
- How stable is your job?
- Do you expect continuity in the current job for the next 3-5 years?
- How soon can you find a new job if you lose this one?
- Is there any other source of income that you can rely on or enhance if you lose your job?
- Are there more than one member generating income in the family?
Continuity of Location
- Do you have the visibility to continue staying in the same city or state?
- Would visa-related issues make you move back to your home country?
- Do you expect to be at the selected location for 3-5 years before you would have to move?
Known Financial Expense/ Commitments in near term/ medium term
- Are there any major expenses planned in the next 3-5 years?
- Is there enough savings to cover monthly payments if your current money gets diverted towards major expense?
Building Asset
When you own a home, you are building an asset which can be monetized in the future. This will be a long term highly illiquid investment. On the other hand, rent paid for a property will not help build the asset. The very fact that you aren’t buying your home is due to the constraints that we discussed above. In which case, these factors take priority over the need to build an asset. You should revisit a decision of rent v/s buy every 12-18 months and see if any parameters have changed that would allow you to change the decision. This by the way is true even if you own a home and adverse circumstances will force you to sell it and move to a rental property. There is no right or wrong here as it all depends on your circumstances.
Increased Expenses
Comparing relative Benefits of Rental v/s Own Home
When you buy a home, it usually comes with increased expenses. The big one-time expenses would be additional furniture, relocation expenses, additional electronics and white goods. The day-to day expenses will increase as well. Like your electricity and gas bills, your property taxes (usually these are part of your mortgage escrow account but they still need to be incurred), your home insurance, HOA dues. You need to consider ballpark expenses when making the determination for the budget.
Rental Termination Fees
You have made the decision to move from a rental property to your own home. At this time, it is important that you consider the increased cost of rental home. Usually you wouldn’t be able to time the move to coincide with your rental termination date. If you terminate your contract early, then you would have to pay the landlord a termination fee and if your move date is a couple of months beyond the termination date then you would need to go to a month to month rental which will again be higher than the regular rent.
Home Maintenance Expenses
When you rent a home, the maintenance expenses would usually be borne by the landlord. You are on your own when you own a home. If there is a faulty washer/ dryer or HVAC or if the roof needs replacement, these costs have to be incurred by you. These parameters should be part of your purchase criteria. Ask questions to the seller when was the date of purchase or service of the equipment. You need to set aside some money for such unexpected contingency.
Key Financial Considerations
Visibility for Next 5 Years
As a thumb rule, buying a home with a 3-5 year horizon may not be a good idea. The reason is simple, when you buy the home you do not have to pay brokerage ad your seller/ builder (in case of a new home) would pay the brokerage. When you sell it, the brokerage amounts are usually between 4%-6% of your sale value. This may wash away all the gains that you may be expecting from your home during the short time period you were residing there.
Rental Expense v/s EMI for new home
Get on the excel sheet and determine the monthly outgo towards rent and the expected mortgage payments. As a thumb rule, your mortgage should be at the most 30% more than the rental outgo assuming other parameters like income and expenses remain the same.
Key Life Events that will impact income or expenses
If you are planning major expenses like children’s education, marriage, car purchase, holiday you need to either set aside money for that from your other savings sources or look at the impact these expenses would have you your home purchasing capacity. You would have to fine tune your home prices if the math doesn’t make sense or defer/ reduce the known life event expenses.
Credit Score and History
Your credit score plays an important role in determining the interest that you would pay on your mortgage. If you are a first time home buyer and haven’t spent a lot of time after you got a SSN allocation your credit score would be low to start with. This will increase your interest rates and thereby your monthly mortgage payments. It’s a good practice to constantly monitor your credit scores once you have taken a mortgage and tap the mortgage market once your score improves and/ or the interest rates reduce significantly and refinance your home so your monthly mortgage payments would reduce.
Sources for making Down Payment and their impact on investment strategy
When it comes to making a down payment for your investments, you would need to start liquidating the sources that give you the least returns and then move to assets that yield higher returns. While you are doing this, you need to keep the short term and emergency funds intact as these can come anytime. Lower down payment (usually less than 20% of the appraised value of your home) would attract an additional monthly charge called the PMI (or mortgage insurance); which needs to be avoided at all costs. It may not be a good idea to make a very high down payment either by liquidating your higher yield investments. Usually your home mortgage will be in the range of 2%-4% and your higher yield investments would give you an average of 6%-8%. So if you pay higher down payment, you will lose 2%-6%. This is not sound financial habit.
