Is Now The Time For A Young Person To Buy A Home?
Journalist Andy Johns shares his insight and perspective as a potential new home buyer.
I’m also relatively young (29) and just bought a home. I can share with you my thought process when it came to weighing the cost/benefit of buying a place vs renting.
Emotion
Prior to buying my own place I remember thinking “when I buy a home it has to be purely logical.” I felt that way because of the outcome of the recent housing crisis. What I witnessed was a bunch of people buying homes based largely on emotion and not on logic. They paid way too much money for the place because they were caught up in the emotion of being able to live in a big, beautiful place that they never would have anticipated being able to afford. However, affording the place was an illusion. It was a very believable illusion because of how financing was structured, making it seem possible and reasonable for a family to have 97% leverage on a home of their dreams.
So I would urge you to remove as much emotion from the purchase as possible. Anytime you’re thinking about leveraging yourself into hundreds of thousands of dollars of debt, I would err on the side of being logical and not emotional.
But I will say that part of the buying process MUST be emotional. After looking at several places I couldn’t find myself feeling good about paying $250,000 for a place that frankly wasn’t much better than my apartment. Eventually I settled on a place that was $100,000 above my initial budget because it felt much more like a home and that I wasn’t essentially buying an apartment. There is some middle ground between what is logically and emotionally ideal and you should very carefully think about what that line is. In the end, if you plan on buying a place and living in it for several years you don’t want to buy something that doesn’t feel like home. Be happy with the place both in terms of price tag and comfort/appeal.
Personal Finances
Planning – Before you even start thinking about buying a place you should get out Excel and lay out your expenses in a detailed fashion. Know exactly how much you spend per month and which of those expenses are persistent expenses you’ll have monthly no matter what. Do the same for how much income you bring in. From that you should have a clear understanding of what your free cashflow is after all income and expenses.
Cost of Living – My personal stance is that your total costs of living should not exceed half of your net take home income. So if you bring home $10,000 a month, you should not spend more than $5,000/month on all costs (mortgage + insurance + car payment + cell phone + utilities + school loans + etc). This ensures a couple of things:
- You’re not letting emotions dominate your decision and you end up buying a place that is far too expensive
- You give yourself enough buffer so that you can continue to save a healthy amount of income each month
- You reduce the risk of not being able to pay your mortgage if conditions in your professional life change and instead of making $10,000/month you now make $7,000/month. Despite a 30% loss in wages you still have 20% gross margin at the end of the month (not including costs for food and miscellaneous bills)
Savings – Make sure that you have plenty of room in a “rainy day fund” after paying for the down payment and furnishing the place. Ideally you’ll have 6-12 months of living expenses in a savings account just in case you lose your source of income.
Furnishing – Also keep in mind the cost of furnishing the place. Usually a good estimate for furnishing is $5,000 – $10,000 per 1,000 square feet of home depending on if you want to go Ikea style or buy stuff that you don’t have to build yourself.
Lending
Down Payment – I would also aim to pay at least 20% on the down payment. Most lenders will give you the A+ offers if you have at least a 20% down payment. The larger the down payment the lower the risk that the lender is taking, hence the better the financing options you’ll be given.
Avoid ARM’s– Personally I would also suggest avoiding any ARMs on your loan. If you need an arm to get your monthly payment low enough so that you’re not broke each month after paying the mortgage, then that means you can’t afford the place to begin with.
30 Year Fixed – As a first time buyer I would also recommend a 30 year fixed mortgage. It gives you the lowest monthly payment and the interest rate will never change. That gives you a consistent cost you can plan for and won’t be thrown for any loops (such as with ARMs) due to sudden changes in the market. You can always restructure the loan later to make it 15-year or 20-year if you want to pay it off faster and not pay as much longterm by cutting down the principle faster.
No Prepayment Penalties – Most lenders should offer this but double check. If you happen across $100,000 someday and want to pay your mortgage down quickly you should be able to without any prepayment penalties.
Location
Also pick a place that you imagine remaining in good shape (ie low crime, local amenities, etc) for at least the next 10 years. Try to get your hands on local development and zoning plans if their are emtpy lots near the place to anticipate what sort of development will happen in you area. The place I bought for example is a 2 minute walk from the major train commuter station, is 1/4 mile off of major freeway access, a high-end grocery store is being built across the street in 2013, and several new local investments have been made into the neighborhood for gentrification purposes to essentially revitalize parts of downtown. It’s becoming much more neighborhood’y and I can imagine being happy there for quite a while.
Timing
Interest Rates Are Good – I got a 30-year fixed mortgage at 4.125%. Currently lenders are offering rates at record lows.
Buyer’s Market – prices continue to drop (or have stabilized at depressed rates) in many areas. There are also plenty of distressed sellers who are trying to get out of their property. This makes for a good buyer’s market where you can find nice places at reasonable costs with a seller that is willing to negotiate. Take advantage of that and don’t buy too quickly.
You Aren’t Ms. Cleo – No one has a crystal ball. If you’re getting into a home because you think you can speculate and sell the place for a 20% profit in 3 years I would suggest you think otherwise. Just ask everyone that lost everything over the last 3 years.
Data and Research – But there are loads of new tools available that make home buying less risky as long as you’re willing to do your research. Sites likehttp://www.trulia.com have loads of historical data in terms of purchase/sell prices of homes in your area, local amenities, etc. You can use that data to understand your local market more and to have a more informed decision of how home values are trending
Think Long Term – Some people are very successful speculators and flip properties for a living. But most of us are not. I subscribe to the Warren Buffett approach to real estate: “never over-leverage, buy in all cash if possible, and plan on owning it for the next 30 years whether you plan on living in it or using as a rental property”. Of course, most people can’t buy in all cash, but you can save for a 20% down payment, covering the cost of furnishing in cash (don’t use credit!), and still having 6-12 months rainy day fund.
Employment – is your job changing anytime soon? Is your company about to go under? Are you currently being paid a market rate that you anticipate being able to hold for several years or the market rate should go up? Are you working in a high-growth industry that should have high job demand for years? Understand the state of your employment as well. You’ll want to try and time your purchase with the timing of your job prosperity or security.
