Buy or rent? Compare the costs

Many American renters want to buy houses regardless of the cost of homeownership. For some, it’s a rite of passage and confers unquestionably grown-up status. For others, it’s the security of ownership: the home is theirs for as long as they want it.

Of course, finances inevitably play a part. You’ll probably need to save a down payment and closing costs. You’ll also have to cover thmonthly cost of homeownership.

Find mortgage rates for first-time buyers (Jan 26th, 2019)

Ongoing costs

Once you’ve moved in, you’ll need to be able to comfortably pay all those expenses that renters don’t have to worry about. In other words, the continuing cost of homeownership in all its forms.

So what are those costs? How much, in hard dollars, might you be looking at? This article will help you answer those questions.

Rent vs. buy: a question of time more than timing

Of course, there are periods when buying is obviously cheaper than renting. Those recently occurred when home prices and mortgage rates were both unusually low.

The trouble is, those seem to happen mainly during recessions and depressions — when lenders are willing to offer mortgages only to those with stellar credit scores and huge down payments. So your chances of pulling off a classic buy-low-sell-high investment strategy or a fast flip are limited.

Think long term

It’s generally better to see homeownership as a long-term investment. Of course, market and economic conditions when you buy are considerations.

However, years of owning one home or successive homes is likely to iron out all but the most severe of those. Historically, home prices nationwide follow a long-term, upward trajectory, and recover from falls within a few years.

And remember: if you buy when mortgage rates happen to be high (which often causes prices to stall or drop), you can always apply to refinance your bargain home when they fall. For example, in October 1981, rates peaked at 18.45 percent for a 30-year, fixed-rate mortgage, according to Freddie Mac’s archives.

It’s unlikely many owners were still paying that when rates dipped down into single figures less than four years later.

Should you buy now?

ATTOM Data Solutions, the self-described “curator of the nation’s premier property database,” suggests that 2019 began badly for aspiring homeowners. Only 41 percent of the counties surveyed were more affordable for homeowners than renters.

So does that mean you should delay purchasing a home if you live in one of the 59 percent of counties in which renting is cheaper? Not necessarily.

Of course, it does if your only interest is in your current monthly outgoings. But, if you have other motivations for owning your own home, such as fixing your monthly costs, or creating wealth, you may choose to prioritize those and leave it to time to iron out short-term wrinkles.

Certainly, you may wonder whether home prices might increase sharply if and when the situation switches and the cost of homeownership becomes the more affordable where you live. Mess up your timing and you could end up paying more than you need for the property you eventually buy.

Breaking down the cost of homeownership

When you break down the cost of homeownership into its elements, you’ll find two distinct types:

  1. Those that are ongoing
  2. Those that occur only once, when you sell

Although you’re likely to think of them rarely or never, it’s the second type that often makes or breaks affordability. But let’s begin by exploring the ongoing costs, if only because they’re the ones that will be constantly on your mind.

Mortgage repayment — principal

The “principal” is simply a fancy name for the sum you borrowed. And you won’t be surprised to learn that your mortgage lender would very much like it back.

If you have a 30-year, fixed-rate mortgage (FRM), you’ll make the same payment every month. And while your taxes and insurance costs may rise, you’ll at least have nailed down the majority of your housing cost (unlike renters, who may be subject to increases any time landlords can justify it).

The lower your principal balance (all other things being equal), the lower your housing costs. You can control this by purchasing a cheaper home, or by making a larger down payment.

Mortgage repayment — interest

One big factor in what you pay for your home each month is your mortgage interest rate. Every month, you’ll pay mortgage interest for the previous month. Your lender calculates this amount based on the remaining loan principal balance and your interest rate. Once the interest is taken care of, the remaining amount of your payment goes toward reducing your balance. The lower your interest rate, the lower your payment.

You can control the interest rate by shopping for the best deal — mortgage rates vary among lenders by .25 to .5 percent on any given day. You can choose to pay more fees upfront to purchase a lower interest rate. And you may decide to take a loan product with a lower rate — such as a 15-year mortgage, or a hybrid adjustable loan with a rate fixed for three, five, seven or 10 years.

Mortgage repayment — how amortization works

With a fixed-rate mortgage (FRM), your monthly payment won’t change. What will change is the amount of the payment allocated to interest and what’s allocated to reducing your principal.

So if, for example, you owe $300,000 and pay 4 percent, your monthly payment is $1,432. Of that, $1,000 goes for interest, and the remaining $432 reduces your balance. So the next month, your balance is $299,568, your interest charge is $999, and your principal reduction is $433. After 10 years (120 payments), $788 goes toward interest, and $644 reduces your principal balance.

It’s important to understand that during the first few years of homeownership, you won’t be paying down your balance much if you make the required payment. You can choose to accelerate your mortgage payoff by paying extra.

Mortgage insurance

if your down payment is less than 20 percent, most mortgage lenders require you to purchase mortgage insurance. This can add hundreds to your monthly payment. Your mortgage insurance costs depend on the type of policy, your credit rating, down payment and loan term.

For example, insurance for a 15-year mortgage on a 90 percent loan for a borrower with a 700 credit score is .44 percent. For a borrower with a 30-year, 95 percent loan and a 640 FICO score, it’s 1.19 percent.

Government-backed mortgages also have mortgage insurance costs. In some cases, the premiums are called “funding fees.” You can control this cost by improving your credit score, increasing your down payment, and comparing the cost among different mortgage programs (FHA versus conventional, for instance).

Homeowners’ dues/HOA fees

If the home you buy is in a planned community or condominium complex, you’ll likely have homeowners association dues or fees. These can range from a handful of dollars a year to insure a private road to thousands a month for luxury amenities and items like expensive insurance for beach-frontage in hurricane or tsunami-prone locations.

In 2013, CNBC reported on a Manhattan condo that was then on the market for $95 million and that had maintenance fees of $60,000. Per month. HOA and condo payments can have a big impact on the cost of homeownership. Mortgage lenders count them in your expenses, and you should, too.

Assessments

A good HOA is financially healthy. Mortgage lenders evaluate the HOA’s financial condition before approving a home loan, because poor management can lead to foreclosures on units.

But not all HOAs and condos are well-run. And even with good HOAs, extraordinary costs like earthquake damage or a huge lawsuit loss can arise. And these costs may exceed existing reserves.

If that happens, the HOA imposes an “assessment.” That’s an estimate of the total cost, which will be divided up among the home or condo owners in accordance with a formula contained in the by-laws and rules. So you’ll have to come up with a one-time payment. It may be hundreds or thousands of dollars, and that can hugely add to your cost of homeownership.

Know before you buy

That’s why it’s essential that you or a professional crawl all over the HOA or condo association’s books and by-laws and rules before you buy. You must be sure the organization has sufficient funds to cover all eventualities. If you apply for a mortgage, your lender will do a lot of the legwork in order to protect itself.

And you must be equally certain that you’re comfortable abiding by its rules, aka the CC&Rs (Covenants, Conditions and Restrictions). You may be banned from displaying political lawn signs, erecting a shed or playhouse in your own yard or having certain kinds of pets. Failing to honor these could see you fined, sued and ultimately (and rarely) foreclosed on by your HOA.

Property taxes

According to the non-profit Tax Foundation, the average American pays $1,518 in property taxes each year. But that per-head figure disguises some extreme variations.

To start with, property taxes are typically assessed on the value of the home rather than the number of people living in it. And then there are the wildly varying assessment policies and charge rates between different parts of the country.

Those don’t just change from state to state. They can vary from city to city and county to county. And even within cities and counties.

Property tax rates

When the Tax Foundation analyzed the amount raised from property taxes in each state per head of population, it found evidence of these fluctuations. It published an overview in 2018, but had to use 2015 data. The most expensive places then were the District of Columbia ($3,350), and New Jersey ($3,074). As a rule, these taxes are highest in the Northeast.

And they’re at their lowest in the Southern states, where states prefer to impose higher sales taxes and lower property taxes. So Alabama collected only $540 per person, while Oklahoma took $678.

How to find out how much you’ll pay

Real estate listings generally tell you what the current owner is paying. And that should be fairly close to what you’ll pay. However, in some locations, property taxes alter when the home changes hands, and that change usually involves an increase.

Mortgage lenders count property taxes in your debt-to-income ratios. They usually take the annual amount and divide by 12 to calculate a monthly cost.

Escrows / impounds

Your lender may not give you the option of paying your homeowners insurance and property taxes yourself. Instead, it may require you to establish an impound or escrow account (not to be confused with the escrow process of buying a home). Every month, an amount to cover your annual insurance and property taxes is added to your principal and interest payment.

In that case, your total mortgage payment is often referred to as your PITI, for principal, interest, taxes and insurance. The PITI represents the total payment you’ll make to your lender.

Establishing an impound account can add to your upfront buying / borrowing costs. You’ll usually have to pay several months of these costs at closing to ‘front load” the account, so the lender has a cushion when these payments come due. Do you have to have impounds? if you put less than 20 percent down, you almost always have to. Otherwise, you may be able to waive impounds.

Maintenance and repairs

What you pay for maintenance and repairs will largely depend on the age and condition of the home you buy.

So, if you’re the first owner of a newly-built residence, you may end up paying very little for the first few years. And with new construction, most systems will be covered by warranties.

However, if you purchase a run-down place with underlying issues, you could acquire a money pit. There’s nothing wrong with that it you go in with your eyes open. But you could be opening yourself up to a world of pain if you buy an old place without having a home inspection first.

How much?

When Forbes looked at home maintenance and repair costs in 2018, they suggested that you should set aside 1 percent of the home’s purchase price for each of the first five years after it’s built. If your home cost $200,000, plan on $167 a month to establish your fund. Even if you don’t spend it all each year, you’ll have money for necessary repairs in the years or decades ahead.

Once your home’s five years old, begin to ramp up that amount. And, by the time your place is 25 years old, you should each year be setting aside 4 percent of the purchase price. So we’re looking here at a significant element in your overall cost of homeownership.

Obviously, all these are just averages. If the home you buy was especially well-constructed, you could budget less. Similarly, if you’re able to do much of the repair and maintenance work yourself, you may not need such a large amount.

But, if your home was shoddily built and you have to call in someone to change a light bulb, you maybe should up your budget.

An alternative to setting aside quite so much can be a home warranty. Many sellers even include one for the first year in your purchase price. Home warranties cover system failures like heating and cooling as well as appliances. You pay a policy premium and a co-pay for repairs that come up. That can be a lifesaver if your $2,000 water heater fails.

Costs of buying and selling

So far, we’ve only looked at the continuing expenses that make up the cost of homeownership. But, to make a side-by-side comparison between renting and buying, we need to add the one-time costs of buying and selling.

Moving not included

Those costs don’t necessarily include the expenses involved in physically moving. Renters…