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Friday, 15 Sep 2006

Knowing Your Home Buying Potential
Posted in Articles

Brian Yui

Owning a home, whether it's a "starter" or a dream home is a goal shared by millions. The good news is that today, it's easier to buy a home than ever before. Loan programs have become more readily available, terms are negotiable and numerous creative ways to circumvent a large down payment are often possible. In fact, sometimes it takes less cash to buy a home than it does to rent an apartment!

There are several home buying fundamentals you should take into consideration when evaluate whether the time is right for you to buy.

Reasons to Rent

Most of us rent prior to buying a home. Eventually, most renters want to purchase property, not only as the realization of a dream, but also as a reliable long-term investment and hedge against inflation.

Depending upon your circumstances, there are both pros and cons to renting. As a renter, you need a security deposit but not a down payment or long-term financial commitment. You also have the flexibility to change residences with few costs other than moving expenses.

In higher priced areas, renting may even be less expensive than buying. Rent does not go up proportionally with the price of the home. For example, a $100,000 home may rent for about $800 a month, but a $500,000 home will likely rent for considerably less than $4,000 a month. If you can't afford to buy in the area of your choice, renting there and purchasing a rental unit in an area you can afford will bring you all the benefits of home ownership.

When deciding whether to rent or buy, the first step is to weigh the cost of home ownership against the cost of renting. When you purchase a home, in addition to your monthly mortgage cost, you accept responsibility for the payment of many expenses, which should be incorporated into your budget estimates. These expenses include property taxes and special assessments, home/hazard insurance, utilities, maintenance (landscaping, painting, etc.), and in many communities, a Homeowner’s Association Fee or membership fee covering recreational facilities and services.

Reasons to Buy

Home ownership provides excellent tax and investment benefits. Home mortgage interest and property taxes are usually tax-deductible. Additionally, as housing prices rise, homeowners can reap the benefits of paying a fixed mortgage while rents continue to increase in the same neighborhood. When the value of your home increases to the point at which you can sell it for more than your purchase price, that difference in value is called "appreciation."

When you own your home, you are paying rent to yourself instead of a landlord. Most homeowners pay for property by obtaining a mortgage; as they pay off that mortgage, they gain an increasingly larger share in a valuable asset. The best way to look at it is like a forced savings plan. When your mortgage is paid off, you will obtain more net proceeds when you sell your home.

Another advantage of owning a home is that you are not beholden to a landlord. You aren't subject to rent increases or eviction. You're free to redecorate and remodel and to choose your own contractors without the property owner's permission. Best of all, the value of those improvements becomes yours.

A Few More Facts About Renting vs. Buying

When deciding which option is right for you, use the following calculation: If paying rent saves 35% or more versus the costs of owning (mortgage, insurance, taxes, maintenance, etc.), renting is generally a better option. As you do the math, don’t forget that the interest paid on a mortgage is tax-deductible up to one million dollars, and that you’re calculating the after-tax expenditure of purchasing a home versus the after-tax costs of renting a home.

The length of time you plan to stay in a home should also influence your decision. It's usually a bad idea to buy a house that you will own for less than four years; costs of selling and buying are high, so if the home's value does not appreciate adequately before you sell, the consequence could be a net loss. Obviously, the exception to this is if your area is experiencing rapid growth and appreciation.

Finally, if you have past credit problems that remain on your record, it may be wise to rent until the issues are resolved. Otherwise, mortgage rates might be too high and the amount you can borrow may be limited.

The Bottom Line

Most lenders prefer that homeowners have at least three months of living expenses available after closing on a loan. Keep in mind that closing costs, which generally depend upon the location of the house, type of loan and amount of down payment, will have to be paid. Sometimes a buyer can negotiate closing costs with the seller and lenders and/or finance a portion of the closing costs as part of the loan amount.

The truth is that most people can afford a house valued at roughly 2 1/2 times their gross annual salary. Individual circumstances vary and can alter this estimate in either direction. For instance, if you have more money available for a down payment, a more expensive house may be manageable because your mortgage payment will be smaller. Or, low interest rates may encourage you to buy a higher priced home while high interest rates may limit what you can afford. Generally, lenders will allow you to pay no more than 29% of your gross salary toward your mortgage while keeping monthly debt payments to about 41% or less of your gross income.

Few accomplishments in life are as enduring or enriching as the experience of owning a home. Nevertheless, carefully weigh the pros and cons of both renting and purchasing before making any decisions. Don't be discouraged; there is a home out there that fits both your needs and your budget!