Is This A Good Time?

Over the last several years with the price of real estate dropping like a rock and far too many homeowners ending up underwater (i.e. owing more on their property than it’s worth), the decision whether to buy a home has been a relatively easy one.  Now, however, with the economy beginning to sputter its way forward and with home loan rates still near historical lows this could actually be a good time to consider owning a home.  Still, the decision whether to own or rent is a personal one.  It depends on a variety of things, like how much money you’ve set aside for a down payment, your credit rating, the income you earn, how long you intend to stay in the area, not to mention the local real estate market.  So how do you know whether you should buy or rent?  Here are 8 items to consider:

Weighing Your Decision:

(1) How much of a loan payment can you afford? The first thing to consider if you’re interested in buying is income.  Using a calculator, multiply your gross household income (the amount before taxes) by 28% (or .28).  This percentage represents a figure mortgage lenders suggest is a sustainable long-term maximum housing cost for consumers.  They call it the front-end ratio. Note: This debt to income figure is usually converted to a monthly number and includes any amount you’ll need to pay for homeowner’s insurance, homeowners fee and taxes.  That means you’ll have to do a little research to figure out what those amounts will be in your area.

Front End Example

Now, let’s take an example:  Say you earn $40,000 per year.  Multiply $40,000 x .28 and you get $11,200.  Now, divide the result by 12 (i.e. $11,200 divided by 12) and you get $933 a month. You can now back out taxes, insurance and dues to end up with the amount of monthly interest and principal you should be able to afford on a loan.  If taxes were $100 a month, dues $25 and insurance $80, then the amount of principal and interest you could afford to pay every month (at least according to the bankers) is ($933 – $100 – $25 – $80 =) $728.  To give you some idea what kind of loan a $728 figure would amount to depends on both the number of years in the loan and the interest.  If we assumed a 30 year term with fixed rate interest of 5.5% that would amount to a loan just over $128,000.  If interest rates were a point higher (i.e. 6.5%) the maximum loan would be less at just over $115,000.  You can get a better idea of your money payment by using a mortgage calculator like this one at BankRate.com.

By the way, if you multiply your gross income by 36% (or .36), that’s the maximum amount of all debt you should carry including alimony and child support. This number is also known as the “Back End Ratio”. This would put your maximum monthly debt at ($40,000 x .36 divided by 12 =) $1200.  Thus, if your credit card debt was $500 a month, you’d only have $1200 – $500 = $700 a month for your mortgage interest payment, insurance, taxes and dues.

Okay, so now you’ve got a couple numbers to look at, but how likely are they to hold up over time.  In other words, have you considered whether your job is stable or whether you could find a similar or better paying job if you got laid off?  If your employment situation looks “iffy”, it’s probably not be the best time to commit to buying a home.

(2) Do you have money set aside for a down payment? Yes, you might qualify for a 3% down payment through the FHA, but just because you can, it’s worth asking if that makes sense in your situation.  With so many foreclosures, mortgage brokers insist you buy “mortgage insurance” if you have less than 20% equity in your home (i.e. make less than a 20% down payment).  You’ll have to pay this insurance premium on top of your loan payment until you’re equity comes up to 20%.  This can make your loan cost thousands more over the long run.  It’s certainly worth asking whether owning now is more important than waiting a few more years as you save up a higher down payment. Also worth consideration: The more you can put down up front, the more your loan monthly loan payment goes down and the less chance you’ll be underwater if home values take another dip.

(3) Compare to rents in your area. Once you have a number to work with compare what the cost of most rentals are going for in your area.  You can often do this online or by picking up one of those free booklets that advertise apartments at your local grocery store. However, you’ll want to visit some of the more interesting sites in person to make sure you like both the location and the unit.  Rentals vary considerably.  Also, don’t forget to include the cost of homeowners insurance, property taxes and maintenance when you compare owning a home to a rental.

(4) Decide how long you intend to stay. Staying in a home less than five to seven years increases your risk for taking a financial hit as you won’t have built up enough equity in it (Note: Equity is the difference between the market value of the home and the home loan).  Before signing any contract, take the time to consider your long term plans and do a lot of research into the local area to make sure you’ve got a winner.  You also want to pick an area that has a more stable sales picture as you’ll want to be able to resell when the time comes.

(5) Consider commute time. As you zero in on the location of a potential new home, don’t forget to check on commute times.  Lower cost homes are usually going to be located farther away from a city center.  Check the commute at rush hour, not just when it’s convenient for you.  Then consider whether the commute would be worse in bad weather.  For example, if you end up on a hill and it snows frequently over the winter, will that impact your ability to get to work?

(6) Schools, Churches, Shopping. Are you considering the same area for owning and renting?  If not, do some research.  If you have children be sure to check on the local schools in the area.  Also, consider the distance to your local church, the mall, the post office, your bank and grocery store.  The time you spend going back and forth to these places can add up fast and that can really impact your quality of life.

(7) Make sure you understand the fine print. Buying a home usually involves signing dozens or even hundred of pages and most will contain lots of legalese.  Don’t just sign without taking the time to understand the risks involved.  If you’re uncertain about anything ask.  If you are still uncertain, then consult with an attorney.  Most real estate agents can suggest a good attorney familiar with real estate law.  True, it can cost several hundreds of dollars to use the services of an attorney, but isn’t that better than making a mistake that can cost thousands?  Also, when it comes to your mortgage papers, make sure you ask whether the interest rate you’re getting is fixed or variable.  Variable rate loans may start out low, but often jump up in a year or two, depending on market interest rates.  Make sure you get the type of loan you want.

(8) Tax considerations. Home owners receive a tax break from Uncle Sam as the interest they pay on mortgage debt is deductible against income.  See the IRS regulations for deducting interest for more information.

Finally, you may be interested to learn there are a number of rent versus buy calculators online.  Here’s one at NYTimes.com And here’s another one at Ginnie Mae.  It’s worth entering different numbers and playing with the figures to see the effect.

Lots To Consider

There are a lot of factors worth considering as you decide to own or rent.  For many people, the decision can come down to cost alone, but for others it will involve a host of lifestyle choices.  No matter which way you’re leaning, take the time to research your potential options, thoroughly.  Go in with armed with facts and you’ll end up spending less and getting more for your money.

By Bob Anderson
© 2011 Javabird LLC.  All rights reserved.

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If you liked this article you may also be interested in:

“How To Cut Your Rent In Half“  By Bill West or

“Great Savings Tip #65 – Rent Out A Room In Your Home” By Bill West

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