Dec 112011
 

No, really…think again.

I think I got interested in buying my own place pretty soon after I graduated from college, in 2006. It wasn’t something I wanted to rush into; I was definitely going to spend money to satisfy some of the desires I had while I was in college, like buying a new car. But at the same time, it was in my mind, and I would frequently look to see what was available, while also building up money for a down payment. Then the market crashed. Perfect for me, so I started looking for a place in hopes I could get something fairly cheap. I ended up buying a condo in July of 2008 (only to sell it a year and a half later after deciding to go to law school…but that’s another story).

What I have realized now is that in the two years or so of doing research, I can’t remember reading a single thing that said buying a place to live was a bad decision as long as you could afford the mortgage payment. Some point, more recently, I finally read an article that opened my eyes about how silly the “American Dream” of owning a home is, at least financially. I can’t for the life of me remember where the article is, or find it (and trust me, I have tried), but the end conclusion was that it’s probably best to just consider buying a place as prepaying rent. This is completely opposite the normal sentiment, where all the talking heads will talk about how you will build so much equity and how people who buy houses tend to be more successful (this latter point is ridiculous, when you actually think about it). So, like I said above, let’s think again about buying a house, and see why this is.

To do this, we have to look at property taxes, which will vary from place to place. I will pick the tax rates from Austin, TX, simply because that’s where I bought my condo. (Alright fine…their property tax rates are generally pretty high, so it skews the numbers in my favor.)

Assumptions

  • Property Cost: $130,000
  • Amount down: $26,000
  • Mortgage Amount: $104,000
  • Mortgage Interest Rate: 5%
  • Mortgage Length: 30 years
  • Property Tax Rate: 2.3169%
  • Appraisal Value: $130,000
  • Income Tax Bracket: 25%

Property Taxes

Let’s take a look at property taxes first:

$130,000 * .023169 = $3011.97 ≈ $3000
$3000/12 = $250
$250*.75 = $187.50

All I did was take the appraised value of the property, multiplied it by the property tax rate, then divided it by twelve to get the cost per month in property taxes. I then multiplied it by the income tax rate, since you get to deduct it from your federal income tax. Two things to keep in mind: First, the deduction for property taxes may not be available for much longer (and is only available now if you itemize), and second, this is money that you will never get back. So, currently, that puts us at paying out around $190 a month in money that isn’t equity. Let’s continue by looking at the actual mortgage this time.

Mortgage Interest

We’ll start conservatively. Using BankRate’s mortgage calculator, the payment for our $104,000 mortgage at 5% interest for 30 years is $558.29. Let’s figure out what the average amount of interest paid per month over the life of the loan.

$96,986/360 = $269.40 ≈ $270

For this, I just ran the amortization table using BankRate’s calculator, took the total interest paid (last line of the second to last column) and divided it by the number of months in the mortgage. Adding that to the taxes we’re paying, and we’re up to $460 that we won’t be getting back. Here is where you have to be real honest with yourself. Do you actually expect to stay in that particular home for thirty years? Even if you say yes, the odds are pretty good that you won’t be. Doing some quick research, it seems to be difficult to figure out what the average is. This article has a fairly lengthy discussion but seems to come to some fairly weak conclusions (because of the available data, not because of their analysis). Let’s just err on the side of caution and say the average length of time someone lives in their house is fifteen years. For the sake of this hypothetical, it will be useful to illustrate what happens. Doing the same math as above with the new length of time:

$67,092.27/180 = $372.73 ≈ $370

To get this, I found the total amount of interest paid as of Dec. 2026 (fifteen years after the start of the mortgage) and divided it by the appropriate number of months (if you’re surprised by this result, you should go understand how mortgages work). So if you end up staying in the home for fifteen years, you’re paying $560 a month in money that you aren’t getting back. Of course, the shorter the time you’re there, the worse it is.

HOA Fees

A quick addition we can make to this without having to do much math is the monthly cost of homeowner’s association fees. But these will typically have a broad range, such as $0 for some housing subdivisions, to $400+ for some high end condos. My HOA fees were around $110 and I was incredibly happy about that because they were on the low end of the range for condos in that area. If a housing subdivision has an HOA, the fees will generally be pretty low, and for condos in the price range we’re looking at, will probably range from $100-$200 a month. (And will probably increase throughout the time you own the place!)

Let’s pause here for a second. We’ll assume $200 a month is the highest for the sake of our hypothetical. What we’re looking at is a range from $460 to $760 in monthly payments that you will be paying out and not getting back in equity. That could be a lot of money, and at the top end of the range is getting close to how much you might pay in rent for a place with similar specifications.

Closing Costs

I almost forgot something: Closing costs. I used Zillow’s closing cost calculator, and just used my old zip code (78759) and picked the provider for each of the required services that was listed at top, left out a home warranty (you’ll see why later), and added home and pest inspection. Oddly enough, the top listed provider for title insurance and house inspection were the ones that I used (Independence Title Company and TexCode…both of which I was very happy with). I also selected zero points at the beginning. My estimate came out to be $3,835, which is in-line with the general 3.5% rule of thumb. That’s only an extra $10-20 a month depending on how long you’re in the home. This also assumes the seller pays all of the commission, which is a reasonable assumption. But here is the kicker: if you sell the property (again, regardless of whether you plan on living there forever or not, it’s more likely than not you’ll end up selling the property at some point), you’ll have to pay additional closing costs, plus a commission, which is is probably 6%. My estimate using the same calculator came out to be $1150 in closing costs and $7800 in commission, for a total of almost $9000. That’s $25 a month for thirty years, or $50 a month for fifteen years. Added with the closing costs as a buyer, we can say the range is $10-75 a month. That brings us up to $470-835 a month. Now let’s continue on to a more amorphous cost: maintenance.

Maintenance Costs

Maintenance costs on homes and condos are really hard to calculate. For a condo, some of the building maintenance will be figured into your HOA fees, but you still have to be aware of things that might happen but aren’t planned for. As an example, I got hit with a $2000 special assessment when I had my place. They had replaced the roofs in 2005, but they found out, three years later, that the builders did a shoddy job, and they needed to be replaced, AGAIN (this should only be something that occurs every ten or twenty years). This site has a pretty good discussion about home maintenance costs, and does a very good job at showing how difficult it is to calculate them. But that should not deter you, because it’s very important to factor them in. Let’s steal some of the numbers from that site:

  •  1-4% = $1300-5200/year (all costs as estimated by Coldwell Banker and HouseMaster)
  • $324 a year for routine maintenance (from somewhere in this report)
  • $600-1100 a year for the cost of replacing major appliances, roof, etc.

The first one seems to be fairly all-inclusive. We can put the second two together, since they mostly cover different things. That gives us a range of about $900-$5200 a year, or $75-433 a month. You can begin to narrow this range a little bit by looking at various things, including: how old the current appliances are, how long it has been since major repairs were made (such as roof replacement), what the maintenance history is like (has it had foundation problems before?), when the place was built (older places are going to cost more to maintain), and the quality of the builder. For example, if it’s an older house that hasn’t had the roof replaced in ten years and the appliances are an off-white color (i.e., old), your maintenance costs are going to be higher than a condo that’s two years old. I think that, on average, the top end of the range is a bit high, and to have that for a place of this cost would require really, really bad luck. But it’s still useful to add in as a worst-case scenario. As I mentioned above, I left out the home warranty from the closing costs. This was so the maintenance costs could be factored in at full price. Throwing in a home warranty makes this calculation a lot more amorphous, and might not be that helpful in the end, for many reasons.

What about my rising home values!?

I haven’t been paying attention recently, but I really, REALLY hope people have stopped touting this as a benefit of home ownership. Sure, home values will rise, but when they’re adjusted for inflation, the amount is almost negligible. Looking at the first chart on this page, you can see that over forty years, the median house prices only gained about 18%, which works out to be less than a half percent per year (not taking into compounding). And that’s only going back to 1970, and that’s assuming house prices won’t continue to fall. It would be very, very unwise to assume you’ll get lucky and be able to take advantage of a housing bubble, since this is unrealistic in reality. You want to calculate it anyways? Okay.

( $130,000 * 0.135 ) / 360 = $48.75

If we assume an 18% increase over forty years, we can assume a 13.5% increase over thirty years (but it doesn’t matter, since we’re assuming a linear rate). That amounts to $48.75 a month increase in value on top of inflation. That’s based on long-term trends. If you got lucky and were in a bubble, you could make more than that, but if you were unlucky, you could LOSE money. But, again, on average you might make $50 a month. You can factor that into the range if you want, I’m going to leave it out.

Other considerations

What if you want to “update” the property? Or remodel? How much might you spend on that over the time you own the place? You might increase the value of your house more than the amount you put into it, but you could also lower the value of your house (if you have taste that doesn’t appeal to many others, for example). This would be an extra cost to consider.

What about the amount of time you spend working on your own place? People certainly put more time into taking care of a place they own than if they rent (since the owner will take care of much of that). Time is money, so this yet something else you should consider.

What about rent prices? According to the second graph on the above page, they stay fairly close to that of the long-term trend in home prices. Which is to say, they track fairly closely with inflation.

Owning a home can improve your credit, lowering the cost of financing other things. This is something that can be difficult to calculate, but is a consideration that vitiates my point a little.

Conclusions

That puts us at $545-1250 a month in costs that aren’t going to equity. That’s a huge range, but we could probably assume that the upper end of the range probably wouldn’t be more than $1000, except in rare circumstances. If you didn’t see where this was going a long time ago, do you see now? When you add up all the actual costs that don’t go to equity, you don’t actually save much money when compared to rent, if any at all. The best case scenario might be a decent savings over renting, but that’s a best case scenario…i.e., highly unlikely. If you take the median amount from our restricted range, you’d be looking at $750 a month or so, and even this may be unrealistically low. The numbers can vary wildly depending on how you change the assumptions (I should make a Javascript calculator for this, shouldn’t I?).

Owning a house has a bunch of intangible benefits, and many people will buy a home for reasons other than just financial reasons. But the fact is, you have to consider the financial reality when you make such a big decision. You can’t simply listen to people that tell you that owning a home is such a great deal, because the reality is…it’s not. This forms most of the basis for the conclusion that buying a house can, and maybe should, be thought of as simply pre-paying rent (at least from a financial standpoint). One must then consider whether the intangible pros/cons outweigh the financial pros/cons. An intangible benefit to renting is that you’re much more mobile than if you own a place. If something unexpected happens, such as being laid off, or you have to cut your budget significantly, renting can make this much less painful.

In sum, when you are doing the math to figure out if you can afford a house, you should make sure to do the more complicated analysis that I have shown in this post. Take it into consideration before you just assume that buying a house is the right decision just because everyone else says so.

Note:

This obviously only applies to the sole purpose of buying a house to live in. The calculus is a bit different if you are buying it for investment or flipping purposes. If you’re planning on doing that, you should probably have figured out what I presented in this post on your own. If you didn’t, or you didn’t have someone do it for you, you probably shouldn’t be buying a house for either of those purposes.

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