Ahh, homeownership. It’s what marks your arrival as an American adult, right? Perhaps.
Wait, but aren’t younger generations rejecting tradition, choosing the freedom of renting over the baggage of homeownership? Not really.
In 2015, the median age of first-time homebuyers--31--was only a measly five months older than in the early 1970s. And any increase in the age is likely less about preference and more about prices today that seem out of reach for many.
Your decision to buy a home, however, is about you--your preferences and preparation--not statistics or someone else’s values and goals.
You shouldn’t be buying a house simply because you or anyone else thinks you should. But if you have an earnest desire to put down roots and invest in your community and your future, homeownership might be the perfect fit.
So, how does one venture into this benchmark life event prepared? How do you know if homeownership is right for you?
Homeownership might be right for you if…
You plan to stay in the home for at least five years. Because of the tangible, physical nature of a house, we tend to feel like they’re “safe investments.” But the housing crisis of the mid-2000s reinforced what has actually been true across the generations--house prices fluctuate just like other assets. Therefore, you never want to be forced to sell a house quickly. Furthermore, the fact that most of us use debt to buy a house means that we can actually lose even more than we invest. A five-year time horizon isn’t guaranteed to shield us from losses, but it does offer a stabilizing buffer.
You have meaningful cash to apply to a down payment. I’ve used a vague word here--meaningful--only because house prices vary so much depending on your geography. Some personal finance gurus insist on a 20% minimum down payment, but what if you’re the software engineer employed at Apple’s Silicon Valley headquarters looking to squeeze into a $1 million studio apartment? Must you rent until you’ve saved $200,000--a sum that would allow you to buy a four-bedroom house in many parts of the country? The point is that your down payment--whether it’s 20%, 15%, 10% or even 5%--should represent a meaningful chunk of change. And if you can’t afford at least 5%, wherever you are, you probably can’t afford the house.
You have sufficient cash remaining for unexpected emergencies and predictable expenses. After price concessions, fees, taxes, closing costs, modifications, repairs, and furnishings, I promise you that buying a house is going to be more expensive than you think. And then it’s likely to cost more than you expect for upkeep and the inevitable surprise repairs. Furthermore, there are many other costs of homeownership that are predictable--like replacing an aging roof, hot water heater, worn out plumbing or a heating and cooling system. That’s why most experts recommend maintaining emergency reserves equal to at least three months of living expenses. While I certainly leave room for justifiable variability in this figure as well--based on the age and size of the house, in addition to the stability and consistency of household cash flow--three months is a helpful rule of thumb.
You don’t see it as an investment. “My house is the best investment I’ve ever had!” bragged a majority of homeowners in 2005. Unfortunately, this perception led to many poor housing choices: buying too much house, risky mortgages and excess withdrawals from home equity, to name just a few. (And with the benefit of hindsight we all know what happened next--one of the worst financial crises the U.S. has ever seen.) While a tiny, educated, and experienced minority of investors will rent out or flip homes, most of us will simply live in them, only benefiting from their investment value if and when we downsize later in life. In short, we make better housing decisions when we see them as homes, not investments.
You set the price, not your bank. Even after banks tightened lending restrictions following the housing crisis, most are still willing to lend more money than families can comfortably afford (assuming they have reasonably good credit). It’s not uncommon for banks to authorize mortgages that consume up to 35% of gross (before taxes) monthly income. However, while geographic sensitivity again creeps back into the picture here, I’d recommend having a mortgage payment that represents no more than 25% of net (after tax) income. At least, that is, if you don’t want to feel “house poor.”
Does this list intimidate you, or make you second-guess buying a house? If so, that may be a good thing for you if it ensures your next home purchase is a blessing, not a curse.
But I’m in no way anti-homeownership. In fact, I bought my first house (with two highly trusted partners) when I was only 22, and I’ve bought, renovated and sold several houses since. I’ve made money on most, but the losses on one house--one that was likely an overreach financially, in the midst of the housing collapse--erased all of the previous gains.
I knew the risks, but even so I learned my lesson. Now I choose to buy less house than the bank says I can handle rather than risk committing to more than I can comfortably afford. The place where you lay down your head shouldn’t cause you to lose sleep, right?
I also recognize that most of the benefits of homeownership don’t show up on a balance sheet. Instead, they’re the intangible benefits that come with connecting our household to a community.
But what about selling a house?
“I’ve made a fortune on this house!” is one of the more common--and unverified--financial self-assessments made (most often at neighborhood parties, perhaps a couple adult beverages into the afternoon, amongst a crowd that would prefer to agree). It also leads to some of the more supreme disappointments in personal finance when reality delivers its own assessment.
So, before you sell your house…
Make sure you’re doing it for the right reasons. If you think it’s because you’ll net a handsome profit, you’ll see in a moment why you might be disappointed. If you’ve decided your current home is “below you” and it’s time to move up, remember that the house you envision as your equal may also require a cash outlay that is above your means. Better reasons to move usually develop over time and come as well-thought-out goals for your family that often don’t involve price or perception.
Extensively research what you believe to be a reasonable selling price. Tools like Zillow and Trulia have made this much easier, but a realistic real estate agent (who is a true professional, not a part-time dabbler) willing to disappoint you can often further hone this number, taking similar comps and the speed of the local market into account.
Account for selling costs, which are typically around 10%. Any Realtor is still inherently biased to inspire you to sell because of the prospective commission. And that commission is likely one of the biggest costs unaccounted for when we start daydreaming about selling. It’s the seller who pays both the buying and selling agents (a number that typically starts at 6% of the home value and rarely dips below 5%, often consuming most of any short-term gains in the home’s value). Additionally, closing costs, price concessions and staging repairs often cost another 5% of the home’s value. What’s more, that doesn’t include the stuff you don’t know about that may be illuminated in the home inspection. In all, home sellers can expect to expend 10% of the home’s value simply as the cost of doing real estate business.
Beware capital gains tax. As long as you’ve owned your house--and used it as your primary residence--for at least two out of the past five years, homeowners receive a break from the IRS in the form of an exemption from paying tax on any gains. An individual can shield $250,000 of gains while a married couple can avoid paying tax on up to $500,000 in gains. But if you buy a house in an upward market and then sell in 23 months, you’ll not have reached that two-year minimum and may be required to pay capital gains tax (typically 15%) on your earnings. (However, as most of the selling costs we accounted for previously add to the “cost basis” of your home, this often eliminates shorter-term capital gains.)*
Recognize reality. After undertaking all this effort, it’s time to put your house on the market, and in so doing find out what it’s really worth! Because we can’t see a ticker with our home’s price running across the bottom of the television (the way we can with stocks, bonds and mutual funds), we may mistakenly believe that our home’s value is unknowable. But once you put your house on the market, the market will show you what it’s worth. If you’re getting tons of showings and multiple offers, you’ve likely priced it correctly. If you’re getting a few showings but no offers, you likely need to drop the price a little. If you’re not getting showings or offers, you may need to meaningfully drop the price of the house.
The biggest challenge in selling a house is that it’s intensely personal. Our home becomes an extension of us, so we tend to take it very personally when the outside world (likely) disagrees with our assessment of its value.
The first time we had a Realtor examine our home with a fine-toothed comb and tell us what he thought it was worth and what we needed to do to get it ready for market, my wife burst out crying as soon as he left. And if your house has been on the market for longer than one of the four seasons, it’s likely that the market knows it’s worth less than you’d prefer to believe. (Hint: The market’s always right.)
Whether buying or selling, the intense emotions that inevitably dominate these decisions can’t be ignored, but they can be acknowledged. In so acknowledging them, and in inviting trusted third parties to clarify reality, we can make better decisions that will help make our homes a place of refuge, not regret.
*This should not be seen as individual tax advice. Consult a tax professional--preferably a CPA--before making any tax-dependent decisions.