Oct282014

A fixed cost of housing is the best reason to buy a house

Homeowners generally feel more confident in their ability to make ends meet, largely because they fixed their ownership costs long ago.

The need for shelter is basic, often closely followed by the desire for community. In the United States, this often translates into a desire to take on a very large mortgage to buy real estate. These basic human emotions drive much of the activity in real estate markets. Most people buy because it is the right time for them. Their career, age, family circumstances all come together to push people toward ownership at different times.

The most damaging aspect of our current system is the price volatility because it randomly rewards some and destroys others. Some lucky people buy at the bottom of the real estate cycle while some unlucky people buy at the peak. The personal fortunes of tens of millions of American homeowners should not be determined by the caprice of the market.

The goal of government policy should be price stability; however, lately it seems their goal is price maximization. The end result of their policies is an endless series of market stimuli and manipulations which creates even more volatility.

Reasons to buy a house

Many people choose to rent to avoid the negatives associated with home ownership, and many more rent because they can’t meet the down payment or credit requirements to qualify for home ownership. However, most people who hold down productive jobs have a choice: anyone who chooses not to buy is making a choice to rent by default. There are many different reasons people chose to buy homes to live in, some of them are good reasons, and some of them are not.

Have a place to raise a family

The primary reasons to buy a home are emotional, not financial. At the top of the list is the desire to provide a safe and comfortable home to raise a family. It’s a primal urge. Although it shouldn’t make a difference, there is an emotional quality to home ownership that is not replicated by renting. Satisfying one’s emotional needs is an instinctive drive, and this compels many people to buy houses.

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Be a part of a neighborhood and community

As people grow and develop during their life cycle, they first learn to take care of themselves, then their families, then their neighborhood and community, and finally the whole world. Being part of a broader community one can work to build and improve is a basic human need, and most people see this as a natural extension of buying a house. They dream of watching the children play with the others in the neighborhood, enjoying block parties, and participating in organized events. All things being equal with the house, people will chose to locate in neighborhoods with others of their same demographic with whom they can make friends and socialize.

Following parent’s advice

Many people buy homes simply because their parents did. People grow up, get married, buy a house, have children, and become part of a community because that’s what their parents did, and often this behavior is strongly encouraged by the parents who will even help with down payment money to get started. There’s nothing wrong with this: parents generally have good advice due to their broader life experience. Unfortunately, parents can sometimes be mistaken, as many were that pushed their children into home ownership at the peak of the housing bubble.

Financial Reasons to buy

There are several financial reasons to buy a house. People who pay cash or pay off the mortgage actually own the house, and this asset can be passed on to their heirs. Rich people are by definition those who’ve acquired financial assets in excess of their debts. Owning a primary residence can be, and often is, a solid component of a family wealth-building plan.

As all regular readers of this blog know, I am a big proponent of using rental parity to evaluate whether a property is costly or a bargain relative to rent. Saving money each month is a powerful motivation to either buy or rent, depending on which is a better deal. However, this is a point-in-time analysis that ignores some of the long-term benefits of owning versus renting. The longer a person plans to live in a particular property, the more the math favors owning over renting.

Build equity and hedge inflation

whats_your_excuseHouses tend to go up in resale value over time as workers in a community earn higher wages. The inflation of wages translates into more buying power that allows potential buyers to bid up the price of residential real estate. There is a strong connection between local wages and local house prices. The rising value of real estate serves as a hedge against the ravages of inflation preserving the value of an owner’s investment.

Also tied to the growth of wages in a community is the cost of rent. People who chose to rent rather than own face the likelihood of rising rents over time as they compete against other renters for available properties. There is no way for a renter to fix their cost of housing. Sometimes they may find a landlord content to leave their rent alone for years at a time despite the rising rents around them, but once the renter wants to move, they bear the full brunt of increases in local market rents.

Wise homebuyers use fixed-rate amortizing mortgages, and the primary feature of these mortgages is a payment that never changes. This permanently locks in a consistent and affordable cost of housing that doesn’t rise with inflation (except for some increases in property taxes). While renters face a cost of ownership that typically rises with wage inflation, a homeowner does not. This makes home ownership secured by a fixed-rate amortizing mortgage the best reason to own a house.

As an additional benefit, loan amortization serves as a forced savings account. Fixed-rate amortizing mortgages are the best tools for retirement savings available to most Americans — assuming they don’t foolishly raid this savings account with HELOCs and cash-out refinancing. The gradual increase in value and the gradual retirement of mortgage debt combine to create equity for homeowners, another great benefit of long-term home ownership.

Here’s why renters in America feel trapped

By Mandi Woodruff, October 20, 2014 8:08 AM

Things aren’t looking great for aspiring homeowners in the U.S.

In a recent report by the FINRA Investor Education Foundation, researchers offer a sobering peek into the homes of renters. Nearly one-quarter of renters  in a survey of 25,509 renters and homeowners combined say meeting their monthly financial commitments is “very difficult,” and more than half say they wouldn’t be able to come up with $2,000 to cover an emergency expense.

Homeowners, by comparison, feel much more stable. Half as many homeowners as renters say they find meeting their monthly bills “very difficult” and nearly half say they have no trouble meeting their monthly expenses, according to the report.

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Homeowners do not find it as difficult as renters to make their payments, mostly because they fixed those payments long ago. When people first buy a house, they have no more or less difficulty making ends meet than their renting neighbors, but five, ten, twenty years later, it’s far easier for the owner than the renter to make ends meet because the owner is likely paying far less for housing than the renter.

Because the cost of renting and buying varies so widely across the U.S., you have to take reports like these with a healthy dose of salt. In some metro areas, like San Antonio and Phoenix, it’s actually much cheaper to buy a home than rent.

But the reality is that the cost of renting across the country is on the rise, straining the budgets of many renters. In the largest 25 metro areas in the U.S., rents increased by 5.5% in 2013, eating up more than 40% of the average renter’s household income, according to Trulia. Most financial experts recommend spending less than one-third of income on housing.

“Once [rent] is over 30%, that’s when you start getting into the danger zone financially,” says Helen Stephens, a certified financial planner in Dallas. “And the problem when you’re renting is that you may be in a lease for a year, and at the end of that year your landlord has the right to raise the rent on you.”

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In addition to rising rents, coming up with the cash for day-to-day expenses, let alone a down payment, can be tough for renters. Renters are more likely to be saddled with debt of all kinds than homeowners, according to FINRA. More the half of renters carry credit card debt vs. 47% of homeowners. And renters are nearly twice as likely to have medical debt than homeowners, owing to the fact that fewer renters have health insurance.

Not all renters are 20-somethings eating Cup Noodles and struggling to pay off student debt, either. The average age of renters today is 41, per FINRA, and nearly half of renters say they have dependents at home.

I recently wrote about how restricted for-sale housing inventory saps demand. The post details how renters spend too much on monthly housing costs, and it prevents them from saving for a down payment, thus reducing purchase demand. In truth, many renters spend too much on everything, they carry excessive debt loads, and they can barely make-ends meet. Under those circumstances, saving for a down payment on a house is a distant dream that seems way out of reach.

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In my opinion, the rent versus buy decision boils down to one main variable: how long does a family believe they will live in one place. If there is any uncertainty about permanence, or if a family knows they will move within 5 years, they should rent. However, if a family is in a position to stay in one house for more than five years, and if they are quite certain about the stability of their jobs and their current financial situation, then owning is generally the better choice, largely because the fixed cost of ownership begins to pay dividends the longer a family stays in one place.

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