The high price of housing is a common topic of conversation, and clickable articles may lead sensible clients to believe that now is not the time (for them) to buy a new or another home. But as long as the purchase doesn’t jeopardize their financial security, there are several reasons why even the most prudent people can (and maybe should) buy a new home sooner rather than later.
Sure, housing prices can decline—and likely will at some point. But any drop in prices directly affects the clients only if they are forced to sell during or after a decline. And, of course, prices can rise, as well.
Barring a dramatic near-term change, shortages in labor, materials and available space mean that prices of preexisting homes are unlikely to drop soon or dramatically—especially if interest rates stay in the 3% range for a 30-year mortgage. Even if there is a broad-based slump in prices, that same condition will also reduce what clients may get when selling their current home, thereby offsetting any discount the clients would be getting on a new, slightly cheaper place.
Better to Borrow
It’s great if clients can simply write a check for the home purchase, but most won’t have that kind of cash on hand. And very few will want to raise the money by selling appreciated assets (and paying the capital gains tax) or making large withdrawals from tax-sheltered IRAs or Roth IRAs.
A 30-year fixed-rate mortgage for 80% of the home’s appraised value gives the clients the flexibility of making monthly payments that usually work out to less than the cost of renting a similar property. The borrowers should ensure that if the desire, need or ability arises to pay the loan off early, they can do so with no penalty.
True, the longer the clients leave the mortgage balance outstanding, the more the overall interest cost will be. But that annual interest cost will decline relatively quickly, especially with interest rates so low.
For instance, if clients are considering buying a $500,000 condo and putting 20% down with a 3% 30-year fixed-rate mortgage, their interest costs in the first year would be about $11,880.
But in the 10th year of ownership, the annual interest cost shrinks by about 32%, to less than $9,000. And by the 15th year, it’s a little over $7,000, and only about 35% of that year’s total mortgage payments (the other 65% is principal, the payment of which is like putting money in a savings account).
Better to Buy Than Rent
Unless the clients plan on staying for only a couple of years, they will likely be better off buying a place than renting one.
Say clients are going to take out a $400,000 30-year fixed-rate loan to buy a $500,000 condo that would otherwise cost $2,500 per month to rent. Their mortgage payment would be about $1,700 per month, and even with property taxes and HOA fees, the total monthly cost is unlikely to greatly exceed the monthly renting option. If the landlord raised the rent each year by a not-unheard-of factor of, say, 3%, within five years the clients would be paying almost $2,900 per month in rent.
It’s still up for debate whether recent accelerated inflation figures will prevail over the long term, but residential real estate can serve as an effective hedge against inflation.
For clients who finance their home purchase with a fixed-rate long-term mortgage, their monthly fixed-dollar loan payment will slowly become less expensive in “real” dollars, while the value of their place rises in inflated nominal dollars (in theory).
And if interest rates increase in response to the inflation, the clients can use the money that would have otherwise been tied up in a paid-for house to instead invest in fixed-income investments that pay an interest rate that’s higher than the mortgage rate.
Rent It Out
Would-be homebuyers might be worried about the cost versus benefits of buying a second house they may not use year-round, as they live elsewhere or travel extensively.
That otherwise-empty place can still generate cash via short- or long-term rentals. Airbnb and VRBO are the primary listing spots for daily or weekly vacation or destination rentals. If the clients want to rent the property out for an extended time period (say, for the winter or a full year), a local property management company will take care of most, if not all, of the hassles of landlording in exchange for either a flat fee or a relatively small percentage of the rental income.
Note, homebuyers who are considering renting out their prospective place should first make sure that the condo association or local zoning laws allow the activity.
They Can Always Sell
If for some reason the clients don’t want to live in the house, can’t afford the mortgage payments, and can’t or don’t want to rent it out, they can always sell it.
Although profits shouldn’t be the primary goal of purchasing a primary (or secondary, or tertiary) residence, the clients may of course sell it for the same amount or more than their purchase price. But even if they have to sell it, and then sell it for a loss, that wouldn’t necessarily and retroactively make it a bad decision to buy.
First, if they had chosen to rent instead, all of those monthly payments would be gone, and the longer they rented, the more money they would have “lost” by not buying. In a worst-case scenario, even a decent-sized loss on a home is not likely to have a large overall effect on the clients’ assets. A 20% loss on a $500,000 home is $100,000—a ton of money if it were lying on the floor, but hopefully an amount that represents a minor percentage of the clients’ overall net worth.
And if that type of loss would devastate the clients’ financial security or psyche, perhaps they shouldn’t be buying a new home in the first place.
Kevin McKinley is principal/owner of McKinley Money LLC, an independent registered investment advisor. He is also the author of Make Your Kid a Millionaire (Simon & Schuster).