Homeownership: Should you take the plunge?

For many Americans, the decision to buy a house is the biggest financial decision of their lives up to that point. It’s also a topic surrounded by misinformation, from TikTok videos advocating real estate over a 401(k) to experts who warn against incurring any debt even in the form of a mortgage.

With home prices and mortgage rates in a constant state of flux in the wake of COVID-19, inflation, and the Federal Reserve’s response to inflation, we wanted to take a moment to review what you should consider when deciding whether to buy.

The unwritten rule on buying

The (sometimes written) rule for when to buy goes something like: If renting is cheaper than buying, rent. Then, invest the extra money you’re not spending on home ownership.

The reasoning here seems sound on the surface: The stock market returns about 7% per year on average over long periods (say, the 30 years specified in most standard mortgages). Any real estate you purchase is likely to appreciate much less.

There are several flaws to the logic, though. First: Very few people have the discipline to invest the difference between a rent payment and a presumptive mortgage payment. Second: Home ownership builds equity. Even if the asset (your home) doesn’t increase in value, your monthly payments still go toward purchasing a tangible asset.

Beyond those basic flaws, the accepted logic that renting is more affordable than buying isn’t necessarily true any longer. According to ATTOM Data Solutions’ 2022 analysis of government and wage data, mortgages are cheaper than rent in roughly 60% of the country.

Of course, home ownership comes with other considerations, such as maintenance, property taxes, and more. And costs can vary significantly based on the terms of your mortgage. Still, this confluence of factors means deciding whether buying is the right financial move for your family is anything but simple.

Two questions to ask when deciding to rent or buy

How affordable is buying where you live? In San Diego, renting remains cheaper than buying, per ATTOM data. But this assumes average wages and average home prices. Whether you can afford to buy is a separate issue. If you’re considering buying a home, you likely have a rough idea of what prices are for the type of property you’re looking for. Of course, these prices can fluctuate (2020-2022 was a great example of this), which can impact affordability.

Beyond that, what affordable means is different for every person. Most budgeting websites tell you to spend roughly 30% of your after-tax income on housing. But that number is largely arbitrary—it was set by the Department of Housing and Urban Development many decades ago as a way to define affordable housing.

Even with these variables, it’s a good idea to start with the math. Think about how much of a down payment you have or want. (If you need time to build a larger down payment, consider that, too.) Look into mortgage prequalifications (which are

different than preapprovals) to get a sense for the type of mortgage you’d qualify for, making sure to note both total amount and interest. Finally, tally any additional costs and savings. Will you be able to eliminate a parking expense? Rent out a room? Skip paying for hotels when family visits from out of town? Use these calculations as the baseline for your decision.

How will buying impact your family? If you’re planning on having (more) kids or think you may need to care for aging parents, decisions around housing take on another layer of complexity. The benefits of having space and the restriction of being tied to a mortgage can be about much more than money.

Have a conversation in which you think through the next 5-10 years of your life. Consider your goals, potential risks, and any other events you think might happen. How would owning a home help or hurt you in any of these various scenarios? What do you anticipate valuing more in the coming years: security or flexibility? There are no wrong answers here.

Stay skeptical

It’s easy to get excited when a mortgage broker or financial institution prequalifies you for an amount greater than what you expected. And while the temptation to increase your budget and upgrade your home search can be tempting, we advise Reason Financial clients to resist that temptation.

All else equal, a more expensive property translates to a bigger payout for the financial institution, so these individuals have incentives beyond helping you afford your dream home. We tend to suggest clients make lateral moves. If you buy a home where the monthly payment is similar to your rent, you’re able to take advantage of the equity and security that come with home ownership, without sacrificing too much flexibility. Ownership still comes with closing costs and other proverbial strings, but this approach helps you avoid becoming “house poor.”

You may also wonder about appreciation. For years, the rhetoric said home values always increase. Many people learned that this isn’t true the hard way during the Great Financial Crisis. But it’s still possible that your home may appreciate in value over time. This appreciation may be less than other assets, and it’s also possible that your home may decrease in value. Try not to get too caught up in the future value of a home when deciding to buy.

Finally, remember that there is rarely one right time to buy a home. The only general guideline we tend to offer here is that you may not want to have a mortgage in retirement. Otherwise, the right time to buy is when it makes sense for your family, and that could be any time between now and when you retire.

Want to discuss how buying a home would fit into your financial plan? Set up a meeting to discuss. Content in this material is for general information only and is not intended to provide specific advice or recommendations for any individual.

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