Rent vs Buy- Ending the Debate Once and For All
Weighing the Pros and Cons of Each through Cost-Based Analysis
Silicon Valley home prices are on the rise and rent expenses have followed suit. A robust economy has kept interest rates low and added stability to the market. Many former renters are eager to enter the buying arena to begin building equity. The decision to buy a home is a big one, and potential buyers must consider a multitude of short and long term financial factors. This handbook will serve as a guide to any renter considering purchasing a home and weighs equity, tax incentives, and property values to guide decisionmaking.
How much house can I afford?
This is a common question among many potential homebuyers. Oftentimes people would like the biggest home in the nicest neighborhood and unfortunately many overload themselves with debt. Financial experts advise that no more than 30% of gross income should be spent on housing expenses and no more than 40% should account for any debts- your mortgage included. Also, be wary of online calculators for mortgage payments and home values. Typically these utilities misrepresent costs and fees to encourage you to contact a sponsoring originator. After you’ve calculated how much you can spend on a mortgage or other debts, it’s time to look at initial and monthly expenditures.
Initial and Monthly Expenses
Let’s start with initial expenses. There are several things to consider in the short-term before deciding if buying a house is right for you. The first is the down payment. First time homebuyers can expect to pay anywhere from 5% to 20% of the home’s purchase price depending on their credit, value of the mortgage, and current economic conditions. Secondly, closing costs such as origination fees, title and appraisal costs, and more can add up to another 5%. Typically these initial costs exceed renting expenses such as first and last, security deposit, and renter’s insurance. However for many the opportunity to build equity outweighs these initial costs. Let’s examine some long-run factors.
Renting does come with a certain convenience. If anything breaks or goes wrong, you can simply contact your landlord and they will (hopefully) resolve any issues you may have. But for many increasing rent, troublesome landlords or loud neighbors, HoA fees, and other factors have people wishing they were in a home of their own. Though renting may have more predictable expenses- i.e. only having to worry about rent and insurance payments, homeowners are responsible for the care and maintenance of their own property. Landscaping, appliances, and upkeep must all be accounted for as costs associated with homeownership.
“There’s more to equity than would-be rent payments going towards an asset...There are many factors at play.”
David Harris, Certified Residential Expert
For years, renters were advised to buy homes for three primary reasons: building equity, tax deductions, and the investment value of the property itself. However, Certified Residential Expert David Harris warns that each of these advantages comes with a downside- “There’s more to equity than would-be rent payments going towards an asset,” Harris says. “Typically the first few years of mortgage payments primarily go to interest expenses. There are many factors at play.” Even if a property appreciates in value quickly in the first few years, low equity amount coupled with selling expenses may wind up eating away potential profits. However, buyers that build equity over time are able to use the equity as collateral on a loan or convert it into cash. Equity and appreciating value combined create an opportunity for buyers in hot markets to pocket some serious capital gains.
Another major consideration in homebuying is the opportunity to write off mortgage interest and property tax. Additionally, if you sell your home for profit the majority of the gain will go untaxed and many home-equity loans have tax-deductible interest. However, there is a caveat when weighing write-offs before and after purchase. Commercial Investment Advisor and Founder of Harris Management Services Vicki Harris explains this important distinction:
“The tax incentive for buying a home is only applied when the itemized deduction amount exceeds the standard deduction.”
Vicki Harris, Property Investment Advisor
“Imagine you and your spouse have a standard deduction of $9,700 but an itemized deduction of only $8,500. In this case there is no tax break for mortgage interest or property tax” Vicki explains. “Plus, you are allowed to deduct only a portion of interest paid proportional to your tax bracket. For example, the 33% tax bracket can deduct $0.33 for every dollar paid in mortgage interest.” These calculations are very important when considering the break-even point in your home’s value versus your outstanding mortgage. Many times, spending a dollar to save 33 cents is wise when the market is appreciating quickly. Hot markets like the Silicon Valley, Houston and Seattle Areas, and New York City all enjoy quick rebounds during market corrections and overall upward value trends.
Oftentimes, your primary residence represents the largest asset in your portfolio. In the long-run, price appreciation will add up resulting in a large one-time capital gain. Yet it is important to note that value increases are in no way guaranteed. Consider factors such as historic mortgage rate changes, available cash for a down payment, and your current and future financial prospects before investing. Try to avoid ‘making a quick buck’ as equity takes time to accumulate. Also, taxes are typically only reduced for first time home buyers and primary residences, so anticipate higher expenses for second homes and investment properties.
As with any venture, planning, details, and choosing the right people are all essential to guaranteeing success. Be sure to work with only the highest quality professionals for every step- from mortgage advisors to Realtors and beyond. Buying a home can be the best decision you’ve ever made, cementing stability and creating an estate for years to come. However, if poorly executed, you can get buried under taxes, fees, and an upside-down mortgage.
Speak to a qualified person before undertaking a decision of such magnitude. You can reach David and Vicki Harris by phone at (408) 754-1572 or connect via Twitter @HarrisTeamAPR and Facebook at Facebook.com/HarrisTeamAPR.
Written by Gregory Lyons in Association with Harris Team Real Estate