Find out how your rent compares and then save on it!

As you may know from reading my articles on home-buying, I’m not a huge fan of buying real estate.  Instead, I prefer (and counsel others) to rent a reasonable home and use excess cash to max out my retirement accounts and other investments.  For most people, housing costs are usually the most expensive item on the monthly set of bills.  It really pays to scrutinize big bills because even small percentage savings equal high dollar values.

Find out what people in your neighborhood are paying for rent

When looking at rental rates when shopping for a new place to live or contemplating your current lease, use Rent-o-Meter to find out what a reasonable rent is in your area.  I just used this tool for the condo I’m renting and got a lot of nearby comparisons.  (My rent’s reasonable, but not dirt cheap 😦 )

Slash your rental costs

Smart Money published a very good article with 5 ways to cut your rental expenses (read it!)  The most important thing you can do is be very picky when shopping for a new rental.  Look closely at many units and pay attention to prices at each one.  The best way to get a good deal is knowing how much your alternatives cost.  Set yourself a rough budget to stay inside of.

I recommend trying to keep your rental costs to a maximum of 10 – 20% of your gross salary.  Keep to the low side of the percentage if you’re on the high end of the income spectrum; use the higher side if your income is low.  So, if you make $30,000 a year, you might have to spend up to 20%, or $500/month.  If you make a heftier salary like $80,000, you should shoot for a max around 10%, which would about $1,300.  Obviously these amounts will differ depending on how expensive the city is that you live in.  Rural renters and those in the Midwest should spend much less than those in Manhattan or other major coastal cities.

Don’t forget to add or subtract amounts for utilities like water/sewer/gas that might be included in some rentals (typically apartments or condos) and not others (like houses.)  Also factor in any other savings like splitting cable costs with other tenants.

Get a roommate

If you’re living by yourself and having trouble staying within the guidelines I set above (or just want to have more money to spend/save), get a roommate.  Having a roommate is one of the easiest ways to live in a far nicer place than you could if you were by yourself.  I find that singles and studios are way more expensive than splitting the cost of a two-bedroom.  You’ll save a lot on utilities too by splitting internet, cable and heating costs.  Plus, it can be less lonely and more fun to have a friend just across the living room.  (Although ladies and metrosexual males might want to spring for a place with two bathrooms if possible.)

The savings from adding a roommate seem to decrease after you have 2 people, but adding a third might save a bit more per person as well.  (Even if you know your roommate well, asking your landlord to put you each on separate leases will make you less responsible if your roommate has to move out unexpectedly or gets behind on the rent.)

Ask your landlord for a discount

After doing your homework to see what rentals cost in your area, ask your landlord to reduce your rent.  Stress that ‘times are tough’ and the economy is down.  Emphasize how you’ve been a great tenant (assuming you have been) and how the rent’s been on time, the place is in fine shape, and the neighbors have never complained.  The worst your landlord can say is ‘no’, so it’s definitely worth a shot!  Even reducing your rent 5 – 10% can save you hundreds of dollars over the course of a year.

Summary

Rent is a big expense.  All big expenses (especially on-going ones) need careful evaluation.  Research rents in your area and search for a good deal.  Use a rough guide of 10 – 20% of your income as an absolute maximum for spending on rent.  Get a roommate to live larger on a smaller budget.  Negotiate an existing lease with your landlord to reduce your monthly rent payments.

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Why I rent (even though I could buy) – Price-to-rent ratios

One rule of thumb in determining whether it’s better to buy or rent a home is the ratio of the price of the home to the cost of renting the home (actual or estimated.)  15 times annual rent  is one starting point.  (I’ve also read 150 – 200 times monthly rent, which equates to 12.5 – 16.7 times annual rent.)  For example, if a house was selling at $300,000 and it (or a very similar place) could be rented for $15,000 per year ($1250 per month), that house’s ratio would be 20, meaning it would be better to rent it than buy it.

I read an article on CNN Money that looked at 10 cities to either buy or rent in depending on the ’15 times annual rent’ rule for average home prices.  Seattle, my hometown, came in at 25 times rent, meaning it’s generally better to rent rather than buy (from a financial perspective.)  As the article shows, the general trend is that desirable coastal cities (Manhattan, San Francisco, Portland [Oregon]) tend to be overpriced using this metric, meaning it may be better to rent than buy in these cities.  Midwestern and Southern cities (Minneapolis, San Antonio) tend to be undervalued, meaning it may be better to buy than rent.  (There are other reasons why you might do one thing or the other, but I won’t get into them here.)

While useful, one problem with this simple ratio is that it doesn’t account for growth rates in real estate in these various markets.*  Presumably, home prices in markets with higher price-to-rent ratios like the coastal cities are likely to grow faster than sleepier midwestern cities.  Thus, some adjustment for growth should be made for a better evaluation.

Lastly, while knowing this average ratio for a whole city is a good starting point, one should always do the calculation for each property.  Even in a city where property is cheap relative to rents, it’s possible to overpay on an individual property.  Similarly, in a city where real estate is expensive compared to rents, you can still end up paying too much rent given the worth of the property.

Remember to account for homeowner’s dues if the property you’re considering is a condo or townhouse where such fees apply.  (As an arbitrary way to compare apples to apples, take the monthly dues and multiply by 60 and add that result to the purchase price of the condo.  Use that adjusted value as the ‘true’ cost of buying for the purposes of the above calculation.)

The graph below shows some housing data for various cities (circa April 2010.)  The skinnier bar at the bottom for each city corresponds to the price-to-annual rent scale at the bottom of the graph.  The fatter bar at the top for each city corresponds to the foreclosure rate scale at the top of the graph.

* For investing geeks, the Price-to-Rent ratio for homes is similar to Price-to-Earnings ratio for stocks.  The PE ratio also doesn’t account for the future growth of companies.  Hence, fairly valued high-growth technology stocks tend to have higher PE ratios than fairly valued, mature consumer goods companies.  Even so, the PE ratio is a useful starting place since the market often overvalues high-growth stocks under the false assumption that the steller growth rates will continue indefinitely, which they never can.  (Think of the tech boom when we saw PE ratios at astronomical levels of 100 – 200, suggesting that investors expected such companies to maintain absurd growth rates well into the future.)

The PE ratio can be adjusted to account for growth by dividing by historical/expected growth rates to get the PEG ratio.  Like all ratios, the PEG is fraught with its own problems as well.

Reverse Mortgages: Tap your home as a last resort for retirement

Ideally, a person would finance their retirement through a combination of fixed income (social security or pensions), individual retirement accounts (401k, IRA) and, if necessary, supplementary income from working, or even family support.  However, as many retirees saw in the recent stock market downturn of 2008 & 2009, things don’t always work out this way.  Fortunately, other options exist that provide retirees with ways to close the income gap (other than ‘starving’, an unpopular method.)

Home, sweet home

Most Americans have at least 50% of their wealth in their primary residences.  Wouldn’t it be nice if, after working hard to pay down that mortgage, there was a way to use the value of your home as income? The simplest way is to ‘down-size’ by selling your home and moving to a less-expensive one, investing the difference to pad your retirement funds.  While this may be great for a purely financial point of view, the obvious downside is the hassle and the emotional or practical undesirability of moving.

Home equity lines of credit (HELOC) are a way to use your home equity without selling your home.  A private bank will loan you the money as an interest-bearing loan taken from your home’s equity (the difference between the house’s worth and the mortgage principal you owe.)  You can then use that money for pretty much whatever you want, paying back the loan according to its terms.  One drawback is that you can unwittingly take out too much, then have to either pay it back at an inconvenient time, go without income, or lose your home if you default on the HELOC.  Additionally, your lender could freeze or reduce your line of credit if your home value declines.  For the financially savvy (you!) there’s another way to get at that home equity in a less-risky fashion.

Enter the reverse mortgage

If you’re at least 62 years old, reverse mortgages, called Home Equity Conversion Mortgages (HECM) when sponsored by the Federal Housing Authority (FHA), allow you take either a lump sum, a line of credit, or fixed payments for a specified term or for as long as you live in your house.  This last payment option, called ‘tenure’, seems the safest and most attractive from a retirement income perspective since your payments come monthly, keeping you from spending the lump sum too fast.  However, all the HECM options keep you from losing your house as long as you stay in it.  The loan is also ‘non-recourse’ which means the bank can only collect what is received from the sale of the home, and not any other parts of your estate, even if the loan is more than the value of your house when it’s sold.

From the FHA HECM site:

A borrower cannot be forced to sell the home to pay off the mortgage, even if the mortgage balance grows to exceed the value of the property. A HECM loan need not be repaid until the borrower moves, sells, or dies. When the loan must be paid, if it exceeds the value of the property, the borrower (or the heirs) will owe no more than the value of the property, if they sell the property to repay the loan.”

Wait as long as you can, and take note of high fees

The positive from the fixed payment reverse mortgage option is that you receive constant income for life that can supplement social security and your (cracked?) retirement nest egg.  The more equity you have built up in your home, and the older you are, the higher this reverse mortgage income will be.  This is one reason why you should wait as long as possible before taking out such a reverse mortgage.  Another is that you want to be sure you actually need to take out the loan.  Reverse mortgages come with very expensive upfront fees, about 6-12% of the value of the loan.

Also, the amount you’ll receive will be much less than the total equity you’ve built up.  This amount is usually a little more than half of your home equity.  (The limit for FHA reverse mortgage loans is $625,000, even if your home is appraised much higher.)  Using this calculator, a 75-year-old Seattle couple who owns their $400,000 house free and clear (no mortgage debt), could take out a lump sum of $202,424, or receive a fixed payment of $1,467 per month.  They would also pay over $16,000 in fees (not to mention the interest that’s factored into the loan amount.)  Remember: a reverse mortgage should only be used after other retirement options fail.

Note that the above numbers are based on current interest rates, and will vary over time.  But, when a person actually initiates the fixed payment option in a reverse mortgage, that monthly dollar amount IS fixed over time, just like the payments you make on a regular fixed mortgage.  Keep in mind, though, that the payments are NOT adjusted for inflation, hence the real value of your received payments will likely decline by about 3% per year on average due to rising costs of living.

The FHA HECM site on fees:

Two mortgage insurance premiums are collected to pay for HECM: an upfront premium (2 percent of the home’s value), and a monthly premium (which equals 0.5 percent per year of the mortgage balance).

A lender can charge an origination fee up to $2,500 if the home’s appraised value is less than $125,000. If the home is valued at more than $125,000, lenders can charge 2% of the first $200,000 of the home’s value plus 1% of the amount over $200,000. HECM origination fees are capped at $6,000.”

Another negative is that your heirs will receive less due to the decrease in your home equity.  If your kids are already set up independently by the time of your death, this may not be a big concern.

A reverse mortgage can keep your retirement moving forwards

The bottom line is that if you end up struggling in retirement, a reverse mortgage might be the best unconventional alternative to meeting your income needs.  Fixed ‘tenure’ payments (or any combination of the other payment options) can be made to you for life without risking foreclosure on your home.  Wait until you really need the costly loan before taking it.  That allows you to build up equity (pay off your mortgage before reversing it for best results) and get older, both of which increase your monthly payments.

Of course, the best retirement solution is to avoid taking out expensive loans for your retirement.  Instead, invest as much as you can for retirement before you get to it, defer retirement a few years if needed, find other (or increase) income sources, and live beneath your means.

____________________

In addition to the FHA site linked above, here’s another handy reverse mortgage FAQ if you want to learn more.

Buying a home for the first time (guest post)

Guest post from Greg Uratsu, a dashing 26-year-old man-about-town who recently bought a townhouse in Seattle, his first home purchase:

I recently closed on a townhouse, and Ward asked me to write a guest post about my experiences on his blog.  This is the first blog I have ever made so Ward, you have my blog virginity [Editor’s note: Uh, thanks?].  I am blogging about the process of buying and closing on a townhouse.  Remember: this is a townhouse.  I don’t know if the process is different for a condo or house.  Thank you for taking the time to read about my experiences.

When this all started I knew close to nothing about buying real estate.  My parents didn’t really help me because they wanted me to learn the process on my own.  This has benefited me greatly because I know a lot more now.  First, I went to a bank to find a loan.  The person giving out the loan is called a lender.  When talking to my lender I needed to figure out how much I could afford so I didn’t waste time looking at townhouses that were out of my price range.  When talking to lenders, they all basically ask you the same questions:

  1. What kind of loan do you want?
    1. 15 year fixed
    2. 30 year fixed
    3. Interest only
    4. There are others but I can’t remember [Editor: like Adjustable Rate Mortgages (ARMs) where your interest rate fluctuates.  I recommend getting the plain vanilla ’30 year fixed’ like Greg did.]

2.  How much do you want to put down?

If you put down less than 20% you have to pay monthly mortgage insurance.  The cost of this insurance varies depending on your loan amount.  A $300,000 loan will have you paying about $100-$125 per month in mortgage insurance on top of your mortgage payment.

There are a few ways to get out of mortgage insurance even if you put down less than 20%. Number 1 is to pay off 20% of the principle over time.  So if you put 10% down, you just need to pay 10% more of the principle over time and BOOM, no more mortgage insurance.  The other way to do this is as follows: say you have a $100,000 loan and you put down 10%, which is $10,000.  Over time the property value goes up to $110,000.  Since you have $10,000 in and $10,000 profit on the place, you add up the two values and have 20% into the $100,000 loan, and therefore the mortgage insurance goes away.

3.  Information from you (be sure to have answers to all these questions)

a.  How much do you make per year?

b.  What are your assets: car, debt, every single bank account, 401 K, IRA, Roth IRA?

c.  How long have you been working at your job and address?

d.  Social security number so the lender can run a credit check.

e.  Eventually the lender will need W2’s from the last 2 years, your past 2 pay stubs, and your residence history (to answer this, it helps a lot if you rented.)

4.  Interest Rates

a.  I didn’t realize what a big difference 1% can be on a mortgage payment.  I put down 20% on a $339,000 dollar place, and 1% can change my mortgage payment $168 dollars per month! The first time I talked to my lender the interest rate was 4.875%, after 1 month the rates went up to 5.875%, a difference of 1% in 1 month, damn…  I didn’t think it was that big of a deal until I did the math: $168 dollars for 360 months (30 year loan) is a lot of money, over $60,000! After gambling and letting the market change, I was able to get a final interest rate for a 30 year fixed rate of 5%.  Whew… I got lucky that the interest rates went back down.  Just for some comparison of interest rates, 5% is pretty damn low, I know people in 2006 that locked in at 8-8.5% which is a lot higher.  My parents in the 80’s locked in at like 12%, or something silly like that.

[Editor: Greg illustrates the importance of getting a low interest rate.  The higher your credit score, the lower your interest rate.  Read this to check your credit score and learn more about the importance of good credit.]

b.  It is important to know what you can and cannot do with each lender because they have different rules.  Once I found a place and had an address to give a lender I was able to lock in an interest rate for free on that day.  This is how it works everywhere.  However, this is where things change.  Some places charge up to $1500 or even more to unlock an interest rate and re-lock yourself.  Luckily, the lender I went with (Bank of America) let me unlock my interest rate after X number of days (I forget how many but at least 1 month) for free.  The catch is I can only do this once and I HAVE to use it within 30 days or else I get charged a large fee in the thousands.  The lender can waive this if your closing date is late and it’s not your fault, but it’s best to close on time.

c.  It’s wise to shop around at multiple lenders to get the best interest rate.  I also had 2 lenders try and beat out the other lender.  If you tell one lender that another lender is giving you say 5%, the lender talking to you may crunch some numbers and give you 4.875%.  It’s just like negotiating for a car, let people bid against each other.  In the world of interest and real estate, this can equate to thousands in savings over time.

After the lender collects information from you they take about 1-2 business days to process your information.  Once they process your information they pre-approve you for some amount.  In my case, I knew I wanted to find a place in the $300,000 dollar range at 20% down, so I applied for a $240,000 dollar loan and I got it.  Now I could go shopping!

One last tidbit before I talk about shopping.  How does money change hands from buyer to seller?  Well there is a middle man called escrow.  Escrow takes care of all the money changing hands.  So at closing, my lender will wire the money to escrow and then escrow will give them money to the seller.  I didn’t know this and this is important information for later on in this blog.

I had no idea where to look for real estate, I also needed an agent.  I will talk about finding an agent later.  First, let’s look at the places online to shop for a home.

1.  Craigslist.com

2. http://www.residentialseattle.com/

3. http://www.realestate.com

4. Ziprealty.com

My favorite choice was craigslist.com.  I looked up the places for sale and found one I liked.  But what to do?  There was an agent’s number but I didn’t know what to do.  Do I need an agent to talk to this agent?  Do I tell him/her I want to look at the place but I have no agent.  Well I learned that you do not need an agent at the time, and when you call the agent listed for a piece of property you tell them you’re interested in looking at the property and they schedule a time for you.  I looked at about 20-25 places before finding the one.  I found my agent that I wanted after the 3rd place I looked at.  She seemed really nice and very flexible on meeting times so I decided to use her as my contact.  When I found a piece of property I was interested in seeing I would call her up and tell her I wanted to see that.  You do not have to use the agent listed with the property to see the place because all property agents have access to keys.

When looking at the different places I learned that it’s nice to go with someone.  Luckily I have a girlfriend who didn’t mind going with me and she was a big help.  It not only helps to get the eye of a women, but also to keep you focused.  All my focus was on was the living room and how I could setup an L shaped couch and my TV to watch sports.  There were many places I saw that had a great setup but the bedrooms weren’t as nice, the kitchen was not nice; she really helped in reminding me to look at the other things.  She also brought in a different view point by asking questions like:

1.  What schools are close to here (when you sell you want to be able to appeal to all kinds of people and that includes families with kids)

2.  What is the neighborhood like?

3.  Is there a lot of easy parking for friends

4.  Is there easy access for the freeways?

5.  Is there a lot of crime?

These questions are important and it was sometimes hard for me to focus because I was only concerned with the living room, the kitchen (because I like to eat), and the backyard (I didn’t want a big one or one I would have to work on).  She also looked at the bathrooms, bedrooms, storage space, closet space, layout of the dials, bells and whistles on the walls, ability to easily to move in furniture; a lot of stuff that helped with my decision.

During the many hours and trips spent in looking at a place I realized that the $300,000 price range was not going to cut it.  I had to contact my lender and ask them if I could qualify for $340,000 home with a 20% down payment for a loan of $271,200.  After processing, I was qualified and I had more wiggle room to find a place.  My goal was to live in Seattle but in an area that I felt would be stable and wouldn’t become run down with crime.  The places I said no to were Beacon Hill, Central Area, International District, and West Seattle.  (The latter is nice but it’s a hassle to get to the freeway for work).  I wanted either Greenlake, Fremont, Wallingford, Belltown, or Greenwood.  After looking at the price range of what I wanted I found out the Greenlake/Greenwood area was the best without sacrificing space and amenities.

My goal was to find a place that was about 3-4 years old so that I would have some history on the townhouse to see if it had any leaks or problems.  A 3-4 year old place is new enough that it won’t be run-down, I wouldn’t have to do maintenance to it (because I am NOT A HANDYMAN), and it would up to date.  The problem is 3-4 year old houses were built during peak real estate prices in Seattle.  Typically your first 5-7 years of mortgage payments go towards interest only so the homeowner’s paying the mortgage for 3-4 years are not paying off any principle.  Therefore they still owe a large amount on their mortgage and if they are selling the place they are selling it for prices that are either at or ABOVE a brand new upgraded townhouse in today’s market.  I was surprised with the number of 3-4 year old places that lack today’s standards.  A prime example is a kitchen without granite tabletops and stainless steel appliances.  If I go out and meet a girl I want to be able to tell them I have stainless steel appliances and granite table tops at my place.  That’s how I got my girlfriend.  [Editor: Coincidentally, that’s also why my wife married me.]

A brand new upgraded townhome SHOULD include:

1.  Granite tabletops

2.  Stainless steel appliances

3.  Hardwood floors

4.  A thermostat in every single room

5.  Motion detector for the garage

6.  Gas Fireplace

The luxuries are:

1.  Security System

2.  Radiant heat (I had no idea what this was: it’s a web of pipes that go through the floor or wall of every single room.  Since each room has a temperature control you can set the heat to whatever you want.  Therefore not only does heat come out of a vent, but if there are pipes through your floor, the water heater shoots out warm water and therefore heats your floor as well.)

3.  Marble tops for the bathrooms

4.  Anything else I am forgetting.  Maybe a balcony?

Luckily, I had all the upgrades and luxuries except for marble tops in my bathroom, I even have a balcony.  [Editor: Boss baller!] This was all for a price much less than for a 3-4 year old townhome of similar square footage and location with non-upgraded amenities.  I realized that I should buy a brand new place and I did.  The only risk I have is I don’t know how the place is going to hold up.  Another reason why I picked my place are personal attractions as well.  The sun hits the back side of my place and is blocked by the other buildings so my place stays cool, I don’t want to live in an oven.  I live near a turn-around so there’s no traffic and it’s quiet.  I live away from the main street so there’s little dust and noise.  It has little to no yard to maintain.  It has a balcony.  It has a lot of storage space.  All of these upgrades and luxuries for today’s homes make me realize what a time capsule my parents live in since they have upgraded nothing since 1979.  Radiant heat in the Uratsu household?  More like fire in a pit for warmth.  Ok maybe not that primitive, but it’s still outdated.

So after finding a place and telling your agent you need to make an offer,  ohmygosh there’s a lot of paperwork and legal mumbo jumbo you have to go through.  Luckily my girlfriend also came with me for this. It’s nice to have a second set of eyes for this.  Off the top of my head, this is the timeline after making an offer:

1.  Builder or Seller either agrees or disagrees on the closing date and price (of course there’s other stuff but the closing date and price are the most important things most people look at).  If the builder or seller do not agree then they send you something back.  A quick tip on the closing date:  You want to close as close to the end of the month as you can.  Once you close you have to pay property tax for that month and it’s nice to buy a place at the back end of a month so you don’t owe that much in property tax for that month at closing.  My big obstacle was the closing date, we agreed on a price fairly quickly, but it took 3 offers to agree on price and closing date.  One thing to do is also add into the contract things that can be added to the house.  I asked for a stainless steel fridge and washer dryer.  It was agreed upon that they buy me that and install it.  I also asked for blinds but I didn’t get it.

2.  Once there is a mutual agreement then a lot happens.  Here is the order of things. First you need to make a check called “earnest money” to the seller.  Since the person is taking the house off the market for you they don’t want the chance of you walking away.  Remember, each day the owner is paying property tax and utilities so it’s not free for them to have the house sit there unsold.  If you were to walk away under certain rules, then the seller gets to keep the earnest money.  Typically the earnest money is 1-2% of the total price of the place.  If you decide to buy the property then the earnest money goes towards the down payment.

3.  You need a house inspection.  It costs about $300-$500.   The inspector has an eye that the normal person does not have and recommends places within the property that need to be fixed, touched up, and makes sure all the appliances work and there are no leaks

4.   You must check with the city to see if there are any additions to the area that the community will be responsible for.  For example, you might buy a place and then 2 months later they re-pave the streets in your area.  The community might have to pay for those streets and you will be responsible for the bill.  You are making sure you aren’t surprised by any extra bills you may have.  If there is something you don’t want being done in the near future with respect to extra bills, you can walk away from the purchase and get back your earnest money.

5.  You need to schedule an appraisal from the lender.  The lender sends a property expert to look at your place.  They also survey surrounding properties and how much they sold for.  This is done because the lender wants to make sure they are letting you borrow money for a place that is indeed worth at least how much you’re buying it for.  This costs about $500.  If the appraisal comes out lower than the agreed price, you can walk away and get your earnest money back.  If it appraises for more then more power to you, good job.

6.  You must find someone to insure your home.  Usually there is a Home Owners Association (HOA) for townhouses and condos which charges you about $100-$200 a month.  The HOA protects the outside of your home from falling trees, fire, and other stuff.  Usually you need to buy extra insurance to insure anything INSIDE your place incase of theft.  The HOA also maintains the building you’re in.  Luckily, I do not have HOA dues, so I needed to get approved for not only the outside of my home but the inside as well.  I needed the insurance to be approved for the purposes of getting the mortgage loan as well.

7.  There is a title you must agree to.  The title states the land that you own (if what you are buying includes land), and states addendums that are in place for that area.  For example, maybe 40 years ago it was agreed that oil could be drilled under your land.  You will know about these agreements as far back as a title company can go to see if there were any agreements that were agreed upon in your area.  If you do not agree with the title because you are scared someone has the legal right to do certain things to your area you can walk away from the deal and get your earnest money back.

8.  You must have your mortgage loan officially approved by your lender by some arbitrary date that you and the seller agreed to on the contract.  Otherwise, the seller has a right to walk away.  They also have the right to take your earnest money since you wasted their time.

9.  For a brand new place , you have a walk-thru with the builder to make the last minute touch-ups to the place.  This is where the inspection comes into play because you list off anything the inspector said should be fixed or touched up.  I asked for the entire place to be dusted, cleaned, and vacuumed before I move in.  I also asked for touch-ups to the paint and anything I deemed not reasonably perfect for a brand new place.  If you notice something after you close,  it would be your responsibility.  You do not want to have to do something the builder forgot or didn’t do.  I also made sure to receive my keys and garage remote at closing.

10.  The last thing is the closing.  At this point, the money from my lender that was put in escrow was officially wired to the seller.  Once that was initiated the place was officially mine (under the 30 year slavery contract I have with my lender.)  Remember also that there are closing costs which typically amount to $6,000-$10,000 when you consider all of them.  You need that much more over the top of what you’re paying for the place.  Poop.  I got my keys, my garage door opener, and the responsibility of up keeping up my new home.  The last thing I did was transfer all utilities from the seller’s name to my own and that isn’t hard.  I was finally done!  Housewarming party!

– Greg Uratsu

More thoughts on why now might NOT be a good time to buy a home (5-28-09 UPDATE)

Check out Patrick Killelea’s site on housing.

From the above link, here’s something to think about regarding low interest rates (and why Patrick claims they make for a BAD time to buy):

It’s a terrible time to buy when interest rates are low, like now. Realtors just lie without shame about this fundamental fact. Prices fall as interest rates rise, because a given monthly payment covers a smaller mortgage at a higher interest rate. Since interest rates have nowhere to go but up, prices have nowhere to go but down. The way to win the game is to have cash on hand to buy outright at a low price when others cannot borrow very much because of high interest rates. To buy at a time of very low interest rates is a mistake.It is definitely far better to pay a low price with a high interest rate than a high price with a low interest rate, even if the mortgage payment is the same either way.

  • First of all, your property taxes will be lower with a low purchase price.
  • Second, a low price gives you the ability to pay it all off instead of being a debt-slave forever.
  • Third, prices will definitely fall as interest rates rise — so paying a high price may trap you “under water”. Then you will not be able to refinance, and won’t be able to sell without a loss. Even if you get a long-term fixed rate mortgage, when rates inevitably go up the value of your property will go down. A low price minimizes this possibility.”

It’s an interesting counterpoint that I hadn’t heard before.  Thanks to me new favorite financial blogger, Ramit Sethi.  You can read some other things on homebuying from Ramit HERE.  Ramit has a very entertaining, information and candid take on personal finance.  I highly recommend his blog (and I’ve been reading it voraciously for the past couple weeks since I discovered it.)

Hopefully it will inspire me to post some more to mine, as I’ve been neglecting the ol’ blog for a while…

UPDATE: Another good link on things to think about (financially) when considering buying a house.

Also, here’s a counterpoint article that initially disputes Patrick’s claim that when interest rates rise, housing prices must fall, but then gives some rationale for why Patrick’s belief may be correct.

What’s so great about buying a home?

An article I read recently on Yahoo!Finance debunked several “Money Myths.” Among these myths were several related to owning a home.  (I recommend reading the whole list, though, as there was much good advice contained therein.)  Also, another really excellent article by Jack Hough at SmartMoney.com gives further detail about why owning a home, at least from a financial perspective, is not such a great thing.

I think home ownership is an important issue to discuss with respect to how it relates to personal finance and growing one’s wealth.  There’s a lot of glib talk about how “renting is like throwing away money” or that buying a home is good for your financial well-being because “you can deduct your mortgage interest” or “your home is an investment.”  However, I believe that more often than not (especially for singles and couples without kids or other dependants living with them), renting is preferable to owning.

Let’s start by addressing the three home-ownership/renting myths discussed in the first article (all italics mine):

Myth #1 – “Renting is like throwing away money.

Do you consider the money you spend on food to be thrown away? What about the money you spend on gas? Both of these expenses are for items you purchase regularly that get used up and appear to have no lasting value, but which are necessary to carry about daily activities. Rent money falls into the same category.

Even if you own a home, you still have to “throw away” money on expenses like property taxes and mortgage interest (and likely more than you were throwing away in rent). In fact, for the first five years, you are basically paying all interest on your mortgage. For example, on a 30-year, $250,000 mortgage at 7% interest, your first 60 payments would total about $100,000. Of that you “throw away” about $85,000 on interest payments.”

This latter point about the “throw away” costs of owning a home is very important in doing a fair comparison between renting and owning.  Such costs are often overlooked by people who mistakenly assume that every dollar they put into their home will be reflected in the house’s dollar value.  I would add to this list homeowner’s insurance (or at least the amount that exceeds any renter’s insurance you might have), home improvements that don’t permanently increase the value of your home (painting the outside, fixing the roof, replacing major appliances, cleaning the carpets, etc), and also the opportunity cost of the free time you are forced to spend (or the money you would pay someone) to make repairs that a landlord would make if you were renting.

Myth #2 – “Home ownership is a surefire investment strategy.

Just like all other investments, home ownership involves the risk that your investment may decrease in value. While commonly cited statistics say that housing appreciates at somewhere between the rate of inflation [~3%] and 5% per year, if not more, not all housing will appreciate at this rate.

[…] And if your house appreciates wildly, that’s great, but if you don’t want to move to a completely different real estate market (another city), the profit won’t do you much good unless you downsize because you’ll have to spend it all to get into another house. Owning a home is a major responsibility and there are easier ways to invest your money, so don’t buy a home unless you are attracted to its other benefits.”

This myth is particularly dangerous.  I think many people have been misled (perhaps willfully) into purchasing a larger, more expensive house than they otherwise would under the faulty justification that “it’s an investment.”  While this is sort of true in that a house generally appreciates with at least inflation over the long term, this doesn’t mean a house is a good investment.  In fact, over the long term, a house is a terrible investment, with average real returns (adjusted downward by 3% for inflation) of 0-2% per year versus 6-7% for stocks.  That means that if you invested $50,000 as a down payment for a home (assuming 0-2% in real returns), that investment would be worth somewhere between $50K and $75K in 20 years.  If you put that same amount in stocks (6-7% assumed), you would have $160K to $195K, a difference of over $100,000.

Another feature that makes a home a poor investment is liquidity, or, the ability to turn your asset into cash.  With stocks, bond funds, and savings accounts, you can liquidate your assets immediately and receive the cash in a matter of days.  With a house, it takes time and effort to sell it, a process which could take months.  As Jack Hough notes: “[h]ome buyers pay around 1% in closing costs when they buy and 6% in broker commissions when they sell.  Share buyers pay $10 trading commissions, which are negligible for buy-and-hold investors.”

Also, the sentence that I italicized in the Myth #2 quote points out that you only realize the gain on a house when you sell it AND move into something cheaper.  My experience is that people are rarely willing to do this, and, if anything, often purchase larger, more expensive residencies as they age (although some retirees may sell their more expensive homes and move into cheaper ones.)

Myth #3 – “One of the major advantages of home ownership is being able to deduct your mortgage interest.

It doesn’t really make sense to call this an advantage of home ownership because there is nothing advantageous about paying thousands of dollars in interest every year. The home mortgage interest tax deduction should only be looked at as a minor way to ease the sting of paying all that interest. You are not saving as much money as you think, and even the money you do save is just a reduction in the costs that you pay. Interest tax deductions should always be considered when filing your taxes and calculating whether you can afford the mortgage payments, but they should not be considered a reason to buy a home.”

Amen.  Now let’s transition to the SmartMoney article.  In it, Mr. Hough makes the case that the driving force behind the increase above inflation (of about 2% annually) in housing prices since WWII has been favorable legislation:

“…while stock returns have come from increased earnings, house returns have come from ballooning valuations, not increased rents… In 1940 the median single-family house price was $2,938, … while the median rent was $27 a month, including utilities. That means the ratio of prices to annual rents was 9. By 2000 the ratio had swelled to 17. In 2005 it hit 20.  […]

Two main events have caused house valuations to inflate since World War II… [T]he government subsidized housing by relaxing borrowing standards. Prior to…1934 house buyers who borrowed typically put up 40% of the purchase price in cash for a five- to 15-year loan. By insuring mortgages, the [government] permitted terms of up to 20 years and down payments of just 20%. It later expanded the repayment periods to 30 years and reduced down payments to 5%. Today down payments for FHA loans are as low as 3%.  …The ratio of house values to incomes has risen 260% in just under four decades.  […]

For house returns over the next 20 years to match those over the past 20, the government and private lenders would have to “up the ante” by relaxing borrowing standards further. Given the recent attention paid to swelling foreclosures, that seems unlikely.  I suspect real returns will turn negative over most of the next two decades … According to calculations made by The Economist in the summer of 2005, house prices would have to stay flat for 12 years with annual inflation at 2.5% for the ratio of prices to rents to fall from its 2005 perch to merely its 1975 to 2000 average.

So to sum up why I rent: Shares…over long time periods return 7% a year after inflation. Houses…over long time periods return zero after inflation. And they look likely to return less than that for a while.”

Hough gives strong evidence for the reasons behind housing’s historic gains since WWII, and why he thinks such gains will not continue.  From a financial perspective, I therefore must agree with Hough that the proper place for the majority of a person’s long-term assets is in stocks (like low-fee index funds.)  This means that it is generally better to rent an affordable home while stashing your savings in tax-advantaged retirement accounts or elsewhere in equities.

All this doesn’t mean that there aren’t any good, non-financial reasons for buying a home instead of renting one.  Perhaps you want to be assured that no landlord can kick you and your family out, or keep you from painting your bedroom wall like a Jackson Pollack.  Maybe that darned American Dream of marriage, kids and property ownership is just too hard to shake off.  After considering everything above and combining your newfound knowledge with that of your personal situation, maybe you’ll still decide that home ownership is preferable to renting.  Just make sure that you don’t try to justify the purchase of a home on faulty financial logic.

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Here’s another great article on J.D. Roth’s ‘Get Rich Slowly’ blog from guest contributor Tim Ellis.

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