Saturday, April 6, 2013

Rent? Own? or Own to Rent? (Part I)

I have been thinking about mortgages and single family homes, perhaps in part because I am in the process of buying my retirement home in another state. Thankfully, this time I will not need a mortgage. The real estate bubble of 2006 proved conclusively that buying a single family home is not always a good idea. Real Estate does not go up forever, even with assistance from Congress and the Federal Reserve.

Still, families seem to do best in single family homes. Owning a home of our own is a deeply ingrained part of the American dream. Actually, I think it is more than that. Even our distant ancestors wanted a cave they could call their own.

If you are single ask yourself, “Do I really need a house?” The answer is no, but buying a house may be a wise investment, even given your marital status.

Always start with the down payment. For young couples that is likely to make or break the deal. Back in 1987 when I bought my first and only home, pretty much all down payments were 10%. That has changed over the years. During the boom 0% down was pretty common. Now banks are looking for 20% down. I think new buyers should target 20% as well. This allows them to avoid the considerable cost of mortgage insurance. It also gives them an equity cushion in case they are forced to sell into a declining market.

Remember what happened in 2006.

I want to recommend a 15 year mortgage, but I’m not going to do it. A 15 year mortgage will save a buyer a lot compared to the cost of the traditional 30 year mortgage. However, for many young couples the lower payments of a 30 year mortgage might make the difference between continuing to rent or fulfilling their American dream. A 30 year mortgage was all I could handle back when we bought our first home, but over the years my salary continued to increase. I put all the spare money I could find into extra payments to principal, allowing us to pay off a 30 year mortgage in less than 10 years. I might have done better beginning a serious push to retirement before I paid off that mortgage, or not. I did miss the dotcom bust of 2000 that destroyed some of my coworkers’ retirement accounts. My mortgage had a 9% interest rate. That is radically different than the 3.5% interest rates commonly available today. Investments are a lot more likely to beat 3.5% than 9%.

The next consideration is cash flow. Calculate affordability on the basis of one income even if you are a two income family. People do lose their jobs. Many couples were hammered in the 2006-2009 meltdown. If husband or wife lost their job, the money to support a two income mortgage wasn’t there anymore. If they didn’t have enough cash to cover the difference between the selling price and the amount still owed on the mortgage, they were in deep trouble.

There is another reason to live in a one income house. Young couples frequently want to start a family. Moms want to spend time with their babies. This is good for the baby and good for the mom. There just isn’t any better daycare available at any price. Give your wife the option of becoming a stay at home mom. Your babies don’t need to live in an expensive home. They need their mommy’s love. When they start school mom can rejoin the workforce. That might be a good time to consider a bigger, two income house in a better neighborhood with better schools.

Buy or Rent Rule of Thumb:

It seems there is always a rule of thumb. Always remember, a rule of thumb is a rule that only works thumb of the time. Take the annual cost of renting a property then multiply the result by 15. If the sale price of the property is greater, rent. If the sale price is less, buy.


A young woman I know lives in a city where the rent for a decent apartment was running around $700 a month. She was eligible for first time buyer assistance from her state government, giving her money for a down payment and a mortgage below the prevailing rate. She could buy a very nice little house for around $93,000.

Renting in a certain city costs somewhere around $700 a month.
Hence $700 a month X 12 months in a year X 15years = $126,000
Therefore, if this home sells for less than $126,000, buy it.
If the home sells for more than $126,000 rent.

Buying this house was a no-brainer. I don’t think she will live to regret her decision.

The year I bought my home, my rent jumped over 10% in one year! At the time the mortgage payments on a $100,000 home were less than the rent on our two bedroom apartment. I don’t remember the exact number for our rent but it was just over $1,000 a month. I had just enough money to walk in the door of my new house with an additional $3,000 loan from my father in law. Today, I don’t think I would advice a young couple to make such an aggressive move, but I decided, “If I’m going to ride this train, I have to jump on board,” and I did.

Here is my calculation:

Renting costs somewhere over $1,000 a month.
Hence $1,000 a month X 12 months in a year X 15years = $180,000
Therefore, if this home sells for less than $180,000, buy it.
If the home sells for more than $180,000 rent.

Our new house cost $98,000. We needed $17,000 in cash to cover the 10% down payment, points, fees, taxes, stamps, and mystery charges.

Let’s revisit a couple of traditional rules of thumb for determining how much house you can afford.

You can afford a house that costs 3 times your gross annual salary.
Your monthly mortgage payment should never exceed 35% of your monthly take home pay.

Hey! Let’s be CAREFUL out there today.

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