According to combined data from the National Association of REALTORS® and the U.S. Census Bureau, more than 6 million homes will be sold in 2015 — the most in nearly a decade. And, of those 6 million homes, nearly one-third will be sold to first-time buyers. It’s not hard to understand why. Nationwide, rents have been rising at a rate of more than four percent per year, and a survey from Rent.com of property managers nationwide suggests that rents could rise 8% or more in 2016. Meanwhile, as rental rates rise, mortgage rates fall. For nearly all of 2015, 30-year mortgage rates have averaged less than four percent, which helps to keep the costs of homeownership low. And, unlike rents, which can increase every 12 months, the payment on a fixed-rate mortgage never changes. Renters know this. They also know that mortgage lenders are making it easier to get mortgage-approved, with more access to low- and no-down payment mortgages than during any period this decade. Lenders are approving and closing more than 70% of all purchase applications, according to Ellie Mae, whose mortgage-processing software handles more than 3.7 million loan applications annually. That’s a huge number. If you’re a renter looking to buy your first home, today’s housing market is working in your favor.
Nationwide, renters become first-time homeowners every day, more than a million times per year. It’s not a rare occurrence and you can do it, too. Generally, for renters, the decision to buy a home focuses on three big questions, each of which is financial in nature. Should I rent or should I buy? How do I know which mortgage to choose? How big of a down payment should I make? While the answers to these 3 financial questions remain important, there are other considerations a renter should make before deciding to purchase a home.
Every homeowner will tell you, there are certain “lessons” you learn in the game of homeownership. You can learn them on your own, the hard way. Or, you can take the advice of somebody who’s been there before. Among the most important lessons first-time homeowners learn is that homeownership costs only begin with monthly payment on your mortgage. There is plenty more which costs money.
For example, when you own your own home and something breaks, repairs and fixes are your responsibility to fix.
Sometimes, repairs will be large and will necessitate an insurance claim, such as with a damaged roof or windows. Most other times, though, repairs will be small and paid via cash. It’s good to budget 1.5% of your home’s value for its annual maintenance costs.
First-time homeowners will also tell you that — no matter what — the mortgage has to get paid.
Unlike renting, when you get some leeway from a landlord, lenders require on-time payments month-after-month until the mortgage is paid-in-full. Missed payments not only put you at risk of eviction via foreclosure, but can damage your credit score and limit your ability to refinance to lower mortgage rates in the future. Then, there’s the matter of real estate taxes.
Real estate taxes are taxes paid to local governments, linked to the value of your property. As your property value rises, then, so does your annual tax bill. Taxes can also be increased via levies, which are often included (and approved) on Election Day ballots. All of this means that, even with a fixed-rate mortgage, your cost of homeownership can increase over time.
The good news, though, is that homeownership provides stability and security for families, and can be a terrific means to build wealth — two other lessons first-time homeowners will share. By living in a community, you establish “roots” which has been shown to elevate psychological well-being among adults and children; and you also put yourself in position to rapidly expand your net worth. Remember: You own your home and it’s your asset, regardless of whether or not the home is mortgaged. As the asset’s value increases, so does your balance sheet.
Home values are up nearly 6% from 12 months ago. If you bought a home for $200,000 last year, then, your net worth has increased $12,000. As a renter, you can’t leverage a $200,000 home to build wealth. You can only do that as a homeowner. But, are you absolutely ready to become a homeowner? There are a few ways you can know for sure.
There are lot of reasons why renters choose to remain renters. For some, it’s the flexibility that comes with having a landlord and being free to move “with 30 day’s notice”. For others, renting may provide less expensive access to homes in a desirable school district, or for renters living in cities such as New York, San Francisco, or Chicago, access to apartments buildings and condos, which offer unique amenities. However, as a renter looking at homeownership, it’s important that you’re not deterred by the unpredictable nature of life.
For example, for a newly-married couple beginning a family, it can be tempting to wait to purchase until a child is “old enough for school”; or, for a longtime renter, to delay a home purchase because a job promotion may be on the horizon. Life happens. It always will. And, no matter how much you plan, plans change. Therefore, before buying a home, think past “life events”, especially the unexpected ones, and be secure in your choices and finances.
Here are three signals that you’re ready to buy a home.
As the owner of a home, you will incur unexpected costs. The heating and cooling unit will break before its time; a tree will fall in the yard; a pipe will develop a leak — the list of potential problems is endless.
Additionally, you may lose your job; or, become ill; or, add children or parents to your home. Each of these events adds costs to your budget, but when you have a reserve fund equal to at least six months of living expenses, you can manage the unexpectedly nature of life. Note that your 6 months of reserves should include all elements of your spending, not just the PITI of your loan. A good way to determine how much you’ll need is to average your last 18 months of credit card statements, insurance payments, and doctors’ bills, along with your mortgage costs. Multiply that average by 6 and consider it your minimum savings in reserves.
Buying a home is cheap. Selling one, however, is not. This is because it’s U.S. custom for the home seller to pay the real estate commissions due upon the sale of a home, the amount of which is split among the agents. Real estate commissions range near five percent, but can be higher or lower depending on your home and market. This also happens to be about the same percentage that home values have climbed in the past 12 months. Therefore, if you purchased a home last year and sold it today, the gains on your home, $5,000 per $100,000 in price, will be paid to the real estate agents who handled your transaction. This is not a bad thing, necessarily. It can be argued that real estate agents will help you sell your home for more money than you could have sold it yourself, but it’s still something about which to be aware.
Selling your home in fewer than two years can negate your real estate profits. There can be tax implications of selling too quickly, too.
The IRS allows up to $500,000 in profit from the sale of a home to be exempted from capital gains on a jointly filed tax return, or $250,000 on a single-person filing. However, in order to claim the capital gains exemption from the sale of real estate, you must show that you lived in the home as your primary residence for at least 2 of the prior five years. If you sell your home in fewer than two years, you subject yourself to additional federal income taxes. However, be sure to consult with a tax professional before making tax-related decisions.
Before purchasing a home, you should have a reasonable idea of what your household income will look like for the next few years.
This doesn’t mean that you should know to the dollar how much you’ll earn, but you should have a fair idea of the range into which your income will fall. It’s part of the financial planning required for homeownership. For example, if you know that you’re likely to take a pay cut in the coming years because you plan to switch from full-time employment to self-employment; or, if you know that your family may shift to a one-income household with the birth of a child, you’ll want to account for that in your planning. Remember: Mortgage payments are due monthly and real estate tax bills are prone to increase. Understanding your income can help plan for that. Now, there’s always the chance that you get lucky and current mortgage rates move lower in the future, giving you the ability to refinance your home to lower payments; or, to cash-out your home equity for personal reasons. You can’t plan for that, however. A good refinance can offset the effects of a reduction in household income and a mounting of consumer debt. But getting to refinance is a bonus. You do it when you can, and feel grateful for it later.
There are a lot of considerations for renters wanting to shift into homeownership, and it goes beyond just “How much home can I afford?”
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