Seven Things to Consider Before Buying A Home

Buying a home is an investment, but it is a particularly tricky form of investment. See 7 tips to make buying a home pay off financially.
By Richard Barrington

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Usually people get to wade gradually into investing. Buying a house is more like a plunge into the deep end.

With other investments, you can start small and then make bigger commitments as you gain a little experience. So, you put a few hundred dollars into a stock, or have money going into a 401(k) retirement savings plan. Then you ramp up to bigger investment decisions over time. When you buy your first house though, you may be committing hundreds of thousands of dollars to a type of decision you have never made before.

To help overcome that lack of experience, think through the process of buying a home from an investment standpoint.

Why buying a home is a tricky investment

Buying a home is a form of investment, but it is not like most other investments you will make. For one thing, your home does not generate interest or dividend income – just the opposite in fact. In addition to your mortgage payments, your home will regularly cost you insurance premiums and real estate taxes.

The other difference between a house and ordinary investments is that real estate is not a very liquid market. The process of buying and selling a house can cost you money. Those heavy transaction costs increase the odds you have to overcome to make the investment a success.

7 tips to make your home purchase pay off financially

How do you overcome financial obstacles and make your home purchase pay off as an investment?

Here are seven suggestions:

1. Think long term

Buying and selling a home can be costly, but real estate tends to appreciate in value over the long term. That is why you need to buy with a long time horizon in mind. Think about how the future of your family and career will impact what you need from a home. Don’t be too enamored with the idea of a “starter home” because a short-term home purchase is more likely to be a financial loser than a long-term one.

2. Evaluate your location

Think about where you are living, and whether you see yourself staying there for many years to come. This will not only help you avoid the cost of a relatively short-term purchase and sale. It will also help you to factor housing costs into your decision about whether to stay where you are currently.

The most expensive metropolitan housing market in the U.S. is 10 times more expensive than the cheapest. So, if you live in a pricey area, you have to make sure your career prospects justify the additional expense.

3. Consider renting

As valuable as building home equity can be, in some expensive markets, it may not offset the interest, insurance and tax costs involved in buying a home. When you net out all those costs, you might find you can save money by renting at a faster rate than you would build in equity by buying a home.

4. Maintain a good credit score

Any dings in your history can cost you in the form of higher down payment requirements and higher mortgage rates. View keeping your credit healthy as an investment, because it will pay off over a long period of time if you do.

5. Avoid real estate generalizations

Every real estate agent you talk to will have a favorite rule of thumb about what percentage of your income should go into a house payment, but there is more to it than that. Home affordability involves a very individual set of circumstances that includes your other financial obligations plus the stability and growth potential of your income.

6. Go big on the down payment

A larger down payment can help you qualify for a lower mortgage rate, and the time it takes you to save up that larger down payment will give you more time to get to know the local housing market so you will be better prepared to spot a true deal when the time comes.

7. Shop around for the best rates and price

Mortgage rates, insurance and even legal and appraisal fees can all vary, so don’t sign on to anything before you’ve done a little comparison shopping.

Of course, your home should represent more to you than just an investment. It may be a commitment you and your spouse make to your future together. As you go through life and perhaps raise a family, it can become the setting for decades of memories. That future and those memories also have value. Making the right investment decision about buying a house can help protect those other forms of value as well.

Frequently Asked Questions

Q: I am looking to buy a house for the first time and I want to know what to plan for, and I know lenders are tight these days. How big a down payment should I expect to have to make?

A: Low down payments are not as common as they were in the early 2000s, but they are hardly an endangered species. What you need as a down payment on a mortgage depends somewhat on your circumstances, and also on what you want to accomplish.

While mortgage lenders are not as welcoming as they were during the last decade’s housing boom, current mortgage rates remain very low, and low down payments are common enough to make this a decent market for qualified first-time buyers.

The National Association of Realtors reports that as of 2020, the average first-time home buyers were making down payments of 12%. There are some FHA loans available that require as little as 3% down.

The catch is that this partly depends on your credit history. Lenders have gotten much more cautious after being burned by the sub-prime crisis, so if there are some bad marks on your credit, you may well be facing a down payment in the 20% range — if you can get approved for a mortgage at all.

While some buyers are forced by their credit histories to make larger down payments, others actually choose to put more money into the house up front. Why? For one thing, low-down-payment loans for first-time buyers usually come via programs like FHA mortgages that require the borrower to pay mortgage insurance, and the higher the loan-to-value ratio, the bigger the mortgage insurance premium (MIP). A bigger down payment lowers the ratio of the loan to the value of the property, and thus by making a bigger down payment with good credit, you can save money on the MIP.

With current mortgage rates being so low, there is one argument to be made against a larger down payment, however. If it will take you a long time to save for a bigger down payment, you might miss out on those low mortgage rates. So, if you have the money handy, a larger down payment may make sense. If you are starting saving from scratch though, you might want to opt for a smaller one that will allow you to get a loan sooner.

Q: I am 65 and divorced. I am thinking of buying a townhouse as a first-time buyer. Should I go for a 15-year or a 30-year mortgage? I am going to buy something around $200,000 and put 50% down.

A: You are in an enviable financial position of having some flexibility in how you approach this purchase. The best way to use that flexibility depends on today’s market conditions and your particular situation.

As for the market conditions, two features of today’s factors stand out as relevant to your situation:

  1. The gap between current mortgage rates and deposit rates is unusually wide. This means you face paying much more interest on your mortgage than you could earn on your money in savings accounts, money market accounts, or CDs. If this gap were smaller, it would argue for a slower repayment schedule (i.e., a longer mortgage and a smaller down payment) because the effective cost of borrowing would be low, especially when the tax deductibility of mortgage interest is considered. However, with the gap between mortgage and deposit rates relatively wide, it argues for a shorter repayment period.
  2. The gap between 15-year and 30-year mortgage rates is unusually wide. At current mortgage rates, there is nearly a full percentage point difference between the two. This means that 15-year rates represent an unusually large discount relative to 30-year rates.

In short, both of these conditions argue for a shorter mortgage, if your situation can support that.

Speaking of your situation, the key factors here are cash flow and savings, because your plan would put demands on both if you opted for the 15-year mortgage.

Before you make the 50% down payment you are contemplating, make sure you are not cleaning out your savings account by doing this. You will need to keep some cash in reserve — owning a home generally means encountering a series of unexpected expenses, plus you are approaching retirement age.

As for cash flow, before you take on the larger monthly payments that would come with a 15-year mortgage, be sure you have the regular income or other resources to readily meet these payments. Do not stretch your budget so thinly that you would be at risk of missing a payment.

Fifteen-year mortgage rates offer lower interest rates than 30-year mortgages, but the monthly payments are significantly larger because the repayment period is half as long. For most home buyers, this eliminates a 15-year mortgage from consideration, but in your case, your large down payment should mitigate the impact of a shorter repayment period, sharply reducing the principal of the loan.

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Richard Barrington