Liz Pulliam Weston
Fear stampeded a lot of people into buying a home during the recent real estate boom. Now we're seeing the even more fearsome fallout.
People who were terrified about being priced out of the real estate market are now horrified by their ever-rising mortgage payments. People who were afraid of missing out on the "easy money" of home-price appreciation are now anxiously realizing that what goes up can also come down.
Foreclosures are spiking. Sales and prices are stalling. Lenders are finally tightening up ridiculously loose lending standards, just at the point where many people are realizing they can't afford the mortgage they have and desperately need a new one.
Despite all of this, I still hear from people who are pressuring themselves into buying a house even when it's not something they necessarily want or need.
It's a fact that homeownership is a great way for most people to build wealth over time. But that doesn't mean everyone should be a homeowner. It's a bigger commitment and more expensive than most first-time buyers ever realize. You should have a clear idea of what you're getting into before you commit to 30 years of payments -- and you shouldn't let any of the following popular legends guide your decision.
'It's a good investment'
Sometimes yes, sometimes no.
Nationally, home prices rose 50% between 2000 and 2005, and in more than 30 cities -- including San Diego, Los Angeles, Miami and Washington, D.C. -- prices doubled.
But that's not the norm. In the 30 prior years, from 1969 to 1999, the average appreciation for homes exceeded the inflation rate by a little more than 1 percentage point. Compare that to stocks, which bested inflation by 7 percentage points in the same period.
And appreciation isn't a given, as homeowners in Detroit, Santa Barbara, Calif., and Kokomo, Ind., are learning.
So far, the price declines have been pretty mild. Let's hope we don't see a repeat of the real estate recessions that gripped Boston, Dallas, Houston, Anchorage and Southern California in the 1980s and 1990s.
After dropping more than 20% in the 1990s, for example, Los Angeles home prices took almost 10 years to regain their peak, says real estate expert John Karevoll, an analyst with DataQuick Information Systems. Anyone who lived here during that time knows people who were upside down -- owing a bigger mortgage than the home could be sold for. Thousands of people simply walked away from houses they couldn't sell, trashing their credit ratings in the process. Lenders slashed the prices on foreclosed homes to get rid of their burgeoning inventories, which further drove down property values. It was an ugly cycle that, once started, was hard to stop.
Even when prices are perking along normally, though, your home may benefit your bottom line less than you think. Home-price appreciation figures don't take into account the considerable amounts homeowners shell out along the way. The Wall Street Journal once estimated a typical homeowner over 30 years would pay nearly four times the house's purchase price in maintenance, repairs and improvements.
A home is primarily a place to live. Its value as an investment is secondary and certainly is no replacement for a well-diversified portfolio of stocks and bonds.
'I'm tired of throwing away money on rent'
Normally, renting is cheaper than owning. But in some cities, soaring real estate prices have made renting so much cheaper that it's getting really tough to make the case for becoming a homeowner.
For many people, the choice is between renting an affordable place in a good neighborhood and straining to buy either a less desirable place or one that requires a tortuous commute.
And as we're seeing, many people stretched themselves way too far to buy houses. They opted for adjustable mortgages or loans with exotic terms; what initially seemed like reasonable payments suddenly spiked, throwing financial lives into chaos and contributing to the current high delinquency rate.
You're not really throwing money away when you send a check to your landlord, anyway. You're exchanging it for a place to live. You're also getting flexibility and freedom -- things you sacrifice when you buy a home.
When you're a renter, it's the landlord, not you, who is generally responsible for maintenance, repairs and the toilet that blows up in the middle of the night. If the neighborhood should start to slide, or you get or lose a job, you can up and move, often with just a few weeks' notice.
It's true that you may have to deal with rising rents and recalcitrant landlords. Homeowners, however, are often stuck with rising taxes and maintenance costs, as well as recalcitrant neighbors.
Moving is never fun, but moving when you own a home is an expensive, time-consuming process. Finding a buyer can take months in all but the hottest markets, and you should figure selling costs will eat up about 10% of your home's value, once you add agent commissions and moving expenses. On a $250,000 home sale, that's like piling up $25,000 in cash and setting fire to it -- that much of your equity is gone for good.
In other words, homeownership is more like marriage; renting is more like living together. Make sure you're ready to be wedded to a house before you propose to leave behind life as a renter.
'I need the tax deduction'
Buying a house just for the mortgage break would be like giving somebody a buck just to get 35 cents or less in return.
That's because your write-off is limited to your tax bracket. If you're in the top federal tax bracket, every dollar you pay in mortgage interest only saves you 35 cents in taxes. Most people get even less, since they're in the 25% or lower tax brackets.
Don't misunderstand -- the tax break is nice, and you need somewhere to live. But you should make sure you can really afford to own a home before you take the plunge.
Remember that many of the real costs of owning a home aren't deductible. Uncle Sam won't give you a break for insurance, repairs or maintenance, for example -- and those costs can really add up.
Most homeowners should plan to spend at least 1% of their home's purchase price each year on maintenance and repairs, says finance expert Eric Tyson -- and more if they plan to hire someone else to do all the work. Tyson, a co-author of "Home Buying for Dummies," recommends setting aside some money each month in an emergency fund. You may not spend the whole amount every year, but sooner or later a big expense will come along -- a new furnace or roof, for instance -- that will consume several years' worth of savings.
If you fail to maintain your home properly, you'll pay even more when it comes time to sell. Many buyers won't even bid on a property that shows significant neglect. Even in hot markets, buyers are likely to ask for expensive concessions to pay for the repairs you should have been doing all along.
The key tests
The best advice on the issue of whether to buy remains the time-tested version: Do it when it's right for you. That means being able to agree to all the following statements:
I plan to stay put for at least three years. If the real estate market in your area is weak, you may need even longer for price appreciation to offset the costs of selling and moving.
I can swing all the costs involved. That requires, most importantly, having enough cash for a decent down payment (which in today's lending environment may mean at least 5% of the purchase price). I'm also a fan of using good, old-fashioned fixed-rate mortgages -- either the 30-year variety or hybrid loans that are fixed for as long as you plan to remain in the house.
If you can't swing the payments with one of those loans, you probably can't afford the place. (If you are contemplating a less traditional loan, make sure you find out how high the payments can go and determine whether you could afford to pay them.) Then make sure you can afford all the incidental costs, including taxes, insurance, homeownership association dues and assessments, repairs and maintenance. It's not a bad idea to limit your total housing outlay to 25% or 30% of your gross income, especially if you want to have money left over to save for retirement, fund your children's college educations and take the occasional vacation.
I want to be a homeowner. Houses are expensive and complicated to buy, finance and maintain. Appreciation is far from a given. If you don't have a strong desire to own your own walls, and do what it takes to keep them in good shape, you're probably better off remaining a renter -- at least for now.
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Fear stampeded a lot of people into buying a home during the recent real estate boom. Now we're seeing the even more fearsome fallout.
People who were terrified about being priced out of the real estate market are now horrified by their ever-rising mortgage payments. People who were afraid of missing out on the "easy money" of home-price appreciation are now anxiously realizing that what goes up can also come down.
Foreclosures are spiking. Sales and prices are stalling. Lenders are finally tightening up ridiculously loose lending standards, just at the point where many people are realizing they can't afford the mortgage they have and desperately need a new one.
Despite all of this, I still hear from people who are pressuring themselves into buying a house even when it's not something they necessarily want or need.
It's a fact that homeownership is a great way for most people to build wealth over time. But that doesn't mean everyone should be a homeowner. It's a bigger commitment and more expensive than most first-time buyers ever realize. You should have a clear idea of what you're getting into before you commit to 30 years of payments -- and you shouldn't let any of the following popular legends guide your decision.
'It's a good investment'
Sometimes yes, sometimes no.
Nationally, home prices rose 50% between 2000 and 2005, and in more than 30 cities -- including San Diego, Los Angeles, Miami and Washington, D.C. -- prices doubled.
But that's not the norm. In the 30 prior years, from 1969 to 1999, the average appreciation for homes exceeded the inflation rate by a little more than 1 percentage point. Compare that to stocks, which bested inflation by 7 percentage points in the same period.
And appreciation isn't a given, as homeowners in Detroit, Santa Barbara, Calif., and Kokomo, Ind., are learning.
So far, the price declines have been pretty mild. Let's hope we don't see a repeat of the real estate recessions that gripped Boston, Dallas, Houston, Anchorage and Southern California in the 1980s and 1990s.
After dropping more than 20% in the 1990s, for example, Los Angeles home prices took almost 10 years to regain their peak, says real estate expert John Karevoll, an analyst with DataQuick Information Systems. Anyone who lived here during that time knows people who were upside down -- owing a bigger mortgage than the home could be sold for. Thousands of people simply walked away from houses they couldn't sell, trashing their credit ratings in the process. Lenders slashed the prices on foreclosed homes to get rid of their burgeoning inventories, which further drove down property values. It was an ugly cycle that, once started, was hard to stop.
Even when prices are perking along normally, though, your home may benefit your bottom line less than you think. Home-price appreciation figures don't take into account the considerable amounts homeowners shell out along the way. The Wall Street Journal once estimated a typical homeowner over 30 years would pay nearly four times the house's purchase price in maintenance, repairs and improvements.
A home is primarily a place to live. Its value as an investment is secondary and certainly is no replacement for a well-diversified portfolio of stocks and bonds.
'I'm tired of throwing away money on rent'
Normally, renting is cheaper than owning. But in some cities, soaring real estate prices have made renting so much cheaper that it's getting really tough to make the case for becoming a homeowner.
For many people, the choice is between renting an affordable place in a good neighborhood and straining to buy either a less desirable place or one that requires a tortuous commute.
And as we're seeing, many people stretched themselves way too far to buy houses. They opted for adjustable mortgages or loans with exotic terms; what initially seemed like reasonable payments suddenly spiked, throwing financial lives into chaos and contributing to the current high delinquency rate.
You're not really throwing money away when you send a check to your landlord, anyway. You're exchanging it for a place to live. You're also getting flexibility and freedom -- things you sacrifice when you buy a home.
When you're a renter, it's the landlord, not you, who is generally responsible for maintenance, repairs and the toilet that blows up in the middle of the night. If the neighborhood should start to slide, or you get or lose a job, you can up and move, often with just a few weeks' notice.
It's true that you may have to deal with rising rents and recalcitrant landlords. Homeowners, however, are often stuck with rising taxes and maintenance costs, as well as recalcitrant neighbors.
Moving is never fun, but moving when you own a home is an expensive, time-consuming process. Finding a buyer can take months in all but the hottest markets, and you should figure selling costs will eat up about 10% of your home's value, once you add agent commissions and moving expenses. On a $250,000 home sale, that's like piling up $25,000 in cash and setting fire to it -- that much of your equity is gone for good.
In other words, homeownership is more like marriage; renting is more like living together. Make sure you're ready to be wedded to a house before you propose to leave behind life as a renter.
'I need the tax deduction'
Buying a house just for the mortgage break would be like giving somebody a buck just to get 35 cents or less in return.
That's because your write-off is limited to your tax bracket. If you're in the top federal tax bracket, every dollar you pay in mortgage interest only saves you 35 cents in taxes. Most people get even less, since they're in the 25% or lower tax brackets.
Don't misunderstand -- the tax break is nice, and you need somewhere to live. But you should make sure you can really afford to own a home before you take the plunge.
Remember that many of the real costs of owning a home aren't deductible. Uncle Sam won't give you a break for insurance, repairs or maintenance, for example -- and those costs can really add up.
Most homeowners should plan to spend at least 1% of their home's purchase price each year on maintenance and repairs, says finance expert Eric Tyson -- and more if they plan to hire someone else to do all the work. Tyson, a co-author of "Home Buying for Dummies," recommends setting aside some money each month in an emergency fund. You may not spend the whole amount every year, but sooner or later a big expense will come along -- a new furnace or roof, for instance -- that will consume several years' worth of savings.
If you fail to maintain your home properly, you'll pay even more when it comes time to sell. Many buyers won't even bid on a property that shows significant neglect. Even in hot markets, buyers are likely to ask for expensive concessions to pay for the repairs you should have been doing all along.
The key tests
The best advice on the issue of whether to buy remains the time-tested version: Do it when it's right for you. That means being able to agree to all the following statements:
I plan to stay put for at least three years. If the real estate market in your area is weak, you may need even longer for price appreciation to offset the costs of selling and moving.
I can swing all the costs involved. That requires, most importantly, having enough cash for a decent down payment (which in today's lending environment may mean at least 5% of the purchase price). I'm also a fan of using good, old-fashioned fixed-rate mortgages -- either the 30-year variety or hybrid loans that are fixed for as long as you plan to remain in the house.
If you can't swing the payments with one of those loans, you probably can't afford the place. (If you are contemplating a less traditional loan, make sure you find out how high the payments can go and determine whether you could afford to pay them.) Then make sure you can afford all the incidental costs, including taxes, insurance, homeownership association dues and assessments, repairs and maintenance. It's not a bad idea to limit your total housing outlay to 25% or 30% of your gross income, especially if you want to have money left over to save for retirement, fund your children's college educations and take the occasional vacation.
I want to be a homeowner. Houses are expensive and complicated to buy, finance and maintain. Appreciation is far from a given. If you don't have a strong desire to own your own walls, and do what it takes to keep them in good shape, you're probably better off remaining a renter -- at least for now.
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