How do I know if a home
is right for me?
- Understand the risks and benefits.
- Compare renting versus buying.
- Balance a home against other goals.
A home is likely one of the largest single purchases you'll make. It makes sense that you'd want to know exactly what you're signing up for.
What are the all-in costs of home ownership?
Conventional wisdom may lead you to believe that the only costs of home ownership are the down payment and the monthly mortgage payment. However, if you budget with only these two factors in mind, you'll likely be caught off guard when the bills come rolling in.
Some additional costs to keep in mind:
This cost breakdown is not meant to discourage you from exploring homeownership. Rather, this information should help you better anticipate the costs you can expect when you become a homeowner. See the benefits of home ownership
What if there's a market downturn?
Unfortunately, if the real estate market declines, so will the value of your home. On the other hand, if the real estate market rises, homeowners will benefit from the appreciation of their home value. Just like financial markets in general, the only sure thing in the real estate market is that it will go up and it will go down.
The impact of volatility in the real estate market is unavoidable, even if you’re not a homeowner. If you rent and the real estate market is on the rise, you can surely expect your rent to increase. But rent prices do not always increase one-to-one with home prices.
In the event of a downturn, if you have a fixed-rate mortgage your monthly mortgage payments should not be affected by any market volatility. However, you may be at risk if there’s a significant drop in real estate prices and you have a sudden need to sell your home, say for a job opportunity in a new location. In this case, you may be forced to sell your home at a loss. If the value of your home has decreased significantly, you may not have enough to repay the remaining balance on the mortgage. In general, the larger your down payment, the lower the risk that you face this particular issue.
It’s wise to understand what can potentially go wrong. But in the face of certain uncertainty, our home-buying philosophy is the same as our philosophy about investing: The risk of a downturn is a part of life. Having a long-term time horizon, staying the course, and not using too much leverage is your best path forward. Consider the benefits of owning a home.
While a home is a considerable investment, there are many compelling reasons to make this huge purchase.
What are the benefits of owning your home?
Even if you don’t buy a home, you still need to pay something for lodging. For most people, this is in the form of monthly rent. When you buy a home and pay a mortgage, you’re actually saving into a permanent asset. Plus, you get automatic protection against rising rent costs. See how to value a home as an asset
Owning your home comes with a few potentially significant tax breaks. While you don’t get a tax deduction for paying rent, as a homeowner you can deduct the interest you pay on up to $750,000 of your mortgage balance and up to $40,000 in property taxes. When it comes time to sell your home, you can exclude capital gains up to $250,000 (or up to $500,000 if you file a joint tax return with your spouse).
The most significant benefits to owning your home are likely not financial. You want to buy a home because you want a place to call your own, a place that gives you freedom to live the life you want. Your reasons are often justifiably emotional, which is why the case for buying a home can’t simply be rationalized by a financial model.
When weighing the costs and benefits of homeownership, it's natural to compare buying with other housing alternatives.
How do I compare buying versus renting?
When it comes to home ownership, it's tempting to compare your monthly rent with your potential monthly mortgage. While this is a logical way to evaluate costs on a monthly basis, it actually ignores a number of significant considerations.
To make an accurate comparison between renting and owning, you should understand the full costs of homeownership. In addition to monthly mortgage payments, there are a number of additional monthly home expenses to consider, such as property taxes, insurance, and HOA fees. These other expenses can add significantly to your total monthly costs. Review the all-in costs of homeownership.
In order to be approved for a mortgage, you will need to make a down payment. Putting at least 20% down lets you avoid mortgage insurance, but there are loan options with as little as 3% down. The average first-time homebuyer puts about 9% down. In addition, the amount of down payment you make affects the terms of your mortgage. See what you should know about the down payment.
While buying requires more upfront costs, you also own the house outright, albeit with debt from the mortgage. Over time, the monthly mortgage payments you make will start increasing your home equity. The money you pay on rent, on the other hand, is money you'll never get back. See how to value a home as an asset.
Lastly, while progressing towards home ownership is an important priority, it may not be the only financial goal in your life.
How does a home fit in with my other goals?
The right home is one that still allows you to meet your other financial priorities with confidence. This means understanding how much home you can afford, and also having a clear sense of your other goals — both short and long term.
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Before you start saving for a home, consider putting money towards paying down high interest loans. There are differing opinions about what constitutes a “high interest loan,” but as a rule of thumb, you might want to consider paying down loans with interest rates greater than 8%, such as credit card debt.
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Next, consider contributing to your company-sponsored 401(k) if your employer offers a matching contribution. An employer match is basically free money, making it much more attractive to participate.
After you pay down debt and put money towards your 401(k), it's time to understand what your financial priorities are. Do you want to cover your children's college education costs in full? What about having a comfortable lifestyle in retirement? Do you need to buy a home sooner than later? Once you've decided the relative importance and timing of these priorities, you can then determine how much of your savings to allot to each goal.
The reality is you only have so much money to work with, so prioritizing one goal will have an impact on the others. To illustrate how to consider tradeoffs, let’s walk through a very simplified example. Let’s say you’re deciding between buying a larger home that costs $800,000 or a more modest home that costs $500,000.
What's next?
A home purchase is both a major financial and life decision. Once you carefully weigh the costs and benefits of a home purchase, you can start to make decisions on the details — finding the perfect neighborhood, determining what size home you need, and figuring out your timeframe.
Wealthfront is here to support you on your home buying journey. Want to learn more? Join our waitlist