Five Questions You Need to Ask Yourself Before Buying a Home
Posted on Jun 3, 2014 in Mortgage Market Updates and NewsThe Upshot
The New York Times
One of the pleasures of being an economics writer is that friends and acquaintances routinely ask me: “Should I buy a house?”
And my answer is always the same: “I have no idea.”
It is not for lack of familiarity with price-to-rent ratios or the benefits of the mortgage interest deduction. Anyone who wants to do a financial analysis on whether to rent or buy a home should go to our new calculator, an excellent tool for doing just that.
But the result, no matter how carefully and clearheadedly you approach the exercise, is more a starting point than a conclusion about your optimal living situation. It will give you a good look at the financial dimensions of your decision. But housing is about quite a bit more.
In 2008, I bought a condominium in Washington. I made the purchase after years of thought, and after building a spreadsheet that modeled the costs and benefits — an unnecessarily complex tool to do what our new rent-or-buy calculator simplifies and automates. It was terrifying, plopping down basically the entirety of my savings and taking on a mortgage that was a multiple of my annual salary.
It has worked out fine for me, but for reasons that had nothing to do with any of the stuff I was able to build into that oh-so-complex spreadsheet.
The factors underlying our calculator, where you can adjust assumptions, are important. But you also need to think deeply about these five other things that don’t easily plug into that financial model.
How much is permanence worth to you?
One of the nonfinancial benefits of buying a home is that you know you can live in it indefinitely. You don’t have to worry that the landlord will raise your rent 20 percent, or demolish the building to turn it into something else. You can renovate the kitchen or paint the shutters according to your preference and yours alone. (O.K., maybe a historic preservation board or homeowners association may have some say, but you are pretty much on your own).
So what is that worth to you? This is a question that defies any attempt to analyze using a spreadsheet. It is purely a question of your preferences and priorities in life.
How confident are you that you will want to stay?
One of the biggest factors shaping the desirability of buying versus renting is how long you will stay in a place. Given the huge costs, both financial and psychic, of selling a house, it is generally a far better deal to buy if you will live in a place for a decade than if you will be moving in three years.
But simply putting your best guess of how long you will stay gives you a limited view of things. We all actually have a range of possibilities. What are the odds that a year from now you will get offered a dream job in London, or meet the love of your life who already has a great place, or conversely go through a break-up or divorce?
Our best plans are still only guesses, but some people are more settled and less likely to have a sudden move than others (a person who is absolutely committed to staying in his or her current city, for example, or a happily married couple with all the children they want). Be honest with yourself about how settled, or unsettled, your future living situation really is.
How confident are you about your future income?
One of the advantages of renting is that if your earning power suddenly changes, it is relatively easy to adjust your living situation accordingly. Lose your job and have to take a pay cut to find a new one? That isn’t much fun, but it’s less painful if it results in moving into a smaller apartment rather than having your house foreclosed upon and your credit wrecked.
That’s all a case for being conservative when thinking about your future earnings. If you earn a commission or bonus, how variable is it? Don’t assume that one good year will be repeated forever. Do you work in an industry that is healthy and growing, or one in which layoffs are happening all the time? If you lost your job, how hard would it be to find a new one, and would you probably be paid more or less than you are now?
The more confident you are in your future earnings, the more comfortable you should be taking on that home mortgage.
Can you force yourself to save?
As my colleague Josh Barro has pointed out, one of the real, if underappreciated, benefits of buying a home is that it forces you to save. A typical mortgage pays itself off bit by bit over the 15 or 30 years you are making payments. With modest appreciation in the value of the home, at the inflation rate or a little bit above, people who buy a house in their 30s and stay there can end up with quite a valuable asset, debt free, in their 60s.
But there’s no reason you can’t also save while renting a home. You have the money that would otherwise have been your down payment as a starting point, and then you can easily transfer a few hundred dollars each month into a brokerage account and put the money into stocks, which historically have higher returns than residential real estate.
But will you? One risk for people who elect to rent is that they could lack the discipline to save that way, and so could find themselves at retirement age owning neither a free-and-clear home nor a well-stuffed brokerage account. If you know you’re tempted to spend every last dollar in your paycheck, buying could provide some extra advantage.
Can you accept that the future is unknowable?
A month after I closed on my condo, there was a global financial crisis. Property prices plummeted — if I had needed to sell in 2009, I would have lost a bundle. But the downturn also led to an era of ultralow interest rates that allowed me to refinance a couple of times to reduce my monthly payment. And while the national job market has been miserable, I never lost my job. Meanwhile, Washington, with its influx of federal dollars, rebounded faster than most of the country. My neighborhood in particular continued its long-term upswing and is more expensive than it was in 2008.
I foresaw none of that. Most of the numbers in my complicated spreadsheet were all wrong, but it worked out anyway. I was lucky.
The point is that the world is messy. In deciding whether to buy a home, we can never have perfect visibility into what the years ahead will bring. All would-be home buyers can do is make sure they are buying a place that they can afford — with a sensible price relative to the alternative of renting — and that they can see themselves living in for many years.
Because you can’t know the future, concentrate on the things you can know, about the finances of a potential purchase and your own personality, and leap accordingly.
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